What Goes Around Comes Around

by | May 9, 2001

Just like old times. Cisco beat by a penny. It was easy, too. All they had to do was lower expectations far below anything you would have dared to imagine in your worst nightmares a year ago. And according to CEO John Chambers, it’ll be a snap to grow revenues at 30% to 50% a […]

Just like old times. Cisco beat by a penny. It was easy, too. All they had to do was lower expectations far below anything you would have dared to imagine in your worst nightmares a year ago.

And according to CEO John Chambers, it’ll be a snap to grow revenues at 30% to 50% a year. But there’s just one little thing, you see… to do that, he says he’ll need a healthy global economy. And unfortunately we’re all out of those just now.

Yesterday all eyes were riveted on Cisco — starting with Morgan Stanley’s surprise upgrade before the opening, and then climaxing with Cisco’s report after the bell. So investors ignored the real story of the day: the Labor Department revealed a shocking drop in non-farm productivity, a fall of 0.1% in the first quarter. That compared with a 2.0% advance in the fourth quarter, and was the first time nonfarm productivity has fallen since the first quarter of 1995.

This is code blue in the boiler room, folks. Because productivity is just about the only place that non-inflationary growth comes from — the growth that Cisco needs to produce the returns its investors demand.

How many times have you heard Fed Chairman Alan Greenspan sing the praises of the striking productivity growth engendered by the high-tech wonders of the New Economy? For example, in a speech last December he said, “Technological innovation, and in particular the spread of information technology, has revolutionized the conduct of business over the past decade and resulted in rising rates of productivity growth. Accelerated productivity has been elevating standards of living, and it has been containing cost and price pressures, even as the economy operates at unusually high levels of labor resource utilization.”

Productivity only has three sources. It can come from the natural economies of scale that occur when an economy expands in scope, for example by an increase in international trade that allows workers of different nations to specialize in what they do best. And it can come from workers becoming more skilled and experienced. But predominantly it comes from investments in capital equipment that allow people to produce more output with the same amount of labor.

Greenspan, to his credit, saw the drop in productivity coming. In the Federal Open Market Committee’s press release announcing their surprise 50 basis point interest rate cut last month, he forecasted that “…measured productivity probably weakened in the first quarter.” And he drew the critical nexus between productivity and capital investment: “…capital investment has continued to soften and the persistent erosion in current and expected profitability, in combination with rising uncertainty about the business outlook, seems poised to dampen capital spending going forward.”

And as Greenspan has so often pointed out, in the New Economy the capital spending that counts is spending in information technology.

So here’s the conundrum. Cisco needs a growing economy to produce the 30% to 50% revenue growth rates its investors expect. And for the economy to grow, productivity has to grow. And for productivity to grow, businesses have to invest in capital equipment made by Cisco.

That didn’t use to be a conundrum. It used to be a virtuous cycle. But then Alan Greenspan — the man who has spoken so often and so passionately about the productivity revolution of the New Economy — broke the cycle. When the Fed raised short-term interest rates too high in 1999 and 2000, they took away the incentive to take risk at the margin. Why invest in another router when the yield on CD’s is so high?

The inverted yield curve that persisted throughout virtually all of the year 2000 signaled that there was no incentive to invest for the long term. Now that Greenspan has lowered rates dramatically this year, the yield curve has steepened again, and is signaling that there will again be rewards for investors who are willing to take long term risks.

But how quickly will investors come out of their bunkers and take those risks? Virtuous cycles are easy to break. Any vandal knows how easy it is to break things. It’s much harder to make things in the first place. It’s not clear to me that the virtuous cycle is going to get started again any time soon.

Don Luskin is Chief Investment Officer for Trend Macrolytics, an economics research and consulting service providing exclusive market-focused, real-time analysis to the institutional investment community. You can visit the weblog of his forthcoming book ‘The Conspiracy to Keep You Poor and Stupid’ at www.poorandstupid.com. He is also a contributing writer to SmartMoney.com.

The views expressed above represent those of the author and do not necessarily represent the views of the editors and publishers of Capitalism Magazine. Capitalism Magazine sometimes publishes articles we disagree with because we think the article provides information, or a contrasting point of view, that may be of value to our readers.

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