Make Hay with High-Tech

The darling one-product company of today can suddenly find it has a new competitor with a far-superior product line.

We are already six months into the boom year of 1983. And contrary to the consensus of official and establishment forecasters, it is not going to be a weak or moderate recovery.

This recovery was foreseeable as early as a year ago. The US composite index of leading economic indicators rose in eight of the last nine months of 1982. This pointed to a recovery beginning in late 1982 (in fact, the recovery began rather promptly in January 1983). And whenever the Federal Reserve Bank significantly alters the rate at which it pumps money into the US economy and sustains that change for six months or more, certain consequences invariably follow. Broadly speaking, this is the "business cycle."

In February, Mark Tier wrote in World Money Analyst: "The 1982–86 expansionary phase is beginning with record deficits, and record rates of money growth for the early stages of the cycle. Come 1984, inflation will be well into double-digits, and most of next year should see inflation in the range of 12–17 percent, and closer to 20 percent by the end of that year. This means that interest rates will range from 10–15 percent, and be approaching 18 percent by end-1984.

"…This scenario is nothing less than a recipe for hyperinflation. This is the second part of my reason for thinking that 1983 will be the best year (economically) for many years to come."

In October 1979, at a time of rampant inflation and soaring commodity prices, the Fed announced a change in "policy," saying that its open-market operations—buying and selling US Treasury securities—would no longer be guided by interest-rate targets but rather by setting monetary "growth targets." Subsequently, it became apparent that what was really being hinted at was a significant downward change in the rate at which the Fed would be inflating the money supply. M1, the most volatile measure of money supply, had been inflated at an average rate of 8 percent since early 1978. But from October '79 through April '80, it was under 3 percent, which caused the sharp mid-1980 recession and commodity price slump.

Then, from May '80 to April '81, the economy was "fine-tuned" with a 10 percent rate of M1 inflation, fostering the mini-recovery of early 1981.

Then, guess what! You're right—another "policy" reversal. M1 inflation proceeded at a "tight" 5 percent average rate from May '81 through June '82. Guess what again. You've got it—the mid-'81 to end-'82 recession.

By the middle of 1982, with virtually the entire world teetering on the edge of bankruptcy and deflation, the Fed caved in and in the final half of 1982 inflated M1 (hold your breath) at a rate of 17 percent! Hence, the boom of 1983 and the coming global currency collapse.

The decline in interest rates that began in the third quarter of 1981 (when, significantly, short-term rates fell below longterm rates) accelerated dramatically in the second half of 1982 and continued at a more modest pace in 1983's first quarter. Between June '82 and the beginning of '83, the discount rate fell from 12 percent to 8½ percent (nearly twice the 2 percent decline in the preceding 12 months) and the prime rate was off 6 percent. Even consumer loan rates at some banks were off about 5 percent in the same period, and mortgage rates had fallen by nearly 6 percent.

These declines were accompanied by a decline in business loan demand of about 25 percent in the second half of '82. This reflected a healthy combination of reduced inventories, increased productive efficiency, greater reliance on businesses' internally generated cash flows, and stepped-up conversion of short-term debt into long term—reliquifying business for the 1983 boom. With the recovery, business loan demand has picked up since December '82.

After a string of 12 consecutive monthly increases, unemployment dropped at the beginning of 1983. Similarly, after 11 consecutive declines, factory capacity utilization rates increased and industrial output generally was up. Durable goods orders, which tend to lead other indicators of economic activity, jumped 9 percent in December and up another 4.5 percent in January.

Both businessmen and consumers are responding to lower interest rates, healthier balance sheets, and pent-up demand after a long recession. Housing starts, which had been in a rising trend since mid-1982, are soaring. Further, this buoyancy comes at a time when the number of new homes on the market is at its lowest level in 11 years. Automobile output showed a healthy jump as 1983 got under way. Housing and autos—shelter and transportation—are the trend-setters for modern industrial economies. Surges in these basic industries invariably must be followed by increased demand for all the metals, lumbers, appliances, and services that more new houses and autos require.

High-technology industries in 1983 may well take second place to housing and autos in leading the emerging boom, simply because housing and autos were so severely depressed earlier. But high-tech industries will give the boom of the mid-1980s a depth and breadth far beyond the thrust in housing and autos. And the share prices of well-managed high-tech companies will continue to reflect the inherent leverage such companies enjoy.

At the end of 1982, James Powell wrote in World Money Analyst: "The fundamental reason for the strength in the high technology movement is as simple as it's powerful. High technology products boost productivity in every field. To understand the importance of the high technology-productivity connection, it is necessary to understand the role productivity plays in the competitiveness—and therefore the profits—of any business or industry.

"The competitiveness of a business or industry depends primarily upon the final cost of the product or service rendered compared with that of the competition. If you look at the costs that go into determining the final cost of a product or service, you find that there are really only five. These costs are: the cost of money; raw materials; energy; the cost of capital goods; and human cost, which is a combination of the cost of labor and management. Of these five basic costs, the first four are largely equal from industry to industry and between one country and another. Thus the only way a business or industry can increase its competitive edge is to decrease its human cost. That is, it must find ways to increase productivity.…

"Thus, we find the high technology-productivity-profits link to be responsible for the incredible growth in the high technology industry."

The trend-setters in high-tech are the small, flexible, and innovative high-tech entrepreneurs. They have thrived in competition with the hidebound, bureaucratic conglomerates in the recent recessionary environment. New business start-ups have doubled in the past seven years, and the numbers of self-employeds now stand at an all-time high. Many of them fail—one-third of new businesses fail in the first year. But those that succeed generate prosperity for uncounted millions more than do the biggies such as GM and GE.

What we have been witnessing structurally throughout the early 1980s recession and even before is industries adjusting to dramatic changes in both consumer preferences and the technologies available to satisfy these demands. As we move forward in this decade, these trends will intensify.

A recent report in the Wall Street Journal provides a clue to the shape of this recovery: "'Even when we return to 1979 levels of manufacturing, say in 1984,' says Charles Burton, an economist at the Confederation of British Industry, 'the structure will be much different.' He believes that several sectors—autos, steel and textiles, to name three—either will gradually disappear or be transformed by modern technology. Factories will be more automated, employing fewer people.…"

The high-tech companies in electronics, particularly those in the burgeoning computer and communications industries, will be the world growth leaders in the emerging mid-1980s boom. Electronics and electrical-industry demand for silver will probably outpace the growth in the photography-industrial demand for silver within two to three years and become the number-one silver user by 1986. That vast, growing, price-inelastic demand is one major consideration behind my prediction of a silver price of over $100 per ounce (in 1982 dollars) by 1986. Of course, taking my prediction of a hyperinflation by 1986 into account, the nominal dollar price will be in the hundreds of dollars per ounce, if not thousands.

Much of the basic industry in the United States has fallen behind international competitors over the past decade. Many US steel, auto, and rubber plants, along with much infrastructure, are outmoded and inefficient. The reason is clear. Just to keep up with its global competitors for world markets, US industry every year in the past decade would have had to plow 12 percent or more of the gross national product into capital investment for new or improved plant, tools, and automation. In fact, US firms reinvested less than 11 percent of GNP over the past decade. Meanwhile, the Japanese were investing 16 percent and the West Germans 20 percent of their GNP.

As a result, by one estimate, the United States has more than $300 billion of backlogged demand and need for capital projects. If government stepped out of the way of that investment, the United States could experience a capital boom in the next several years that would lift Americans to new peaks of production and prosperity.

Nearly 40 percent of all new businesses are started from the personal savings of the entrepreneurs and their personal backers. Additionally, in 1982, for example, venture-capital firms committed over $6 billion to high-risk, high-tech ventures—a new record. According to the National Association of Small Business Investment, companies financed by venture capital generate 10 times more new jobs that other businesses. Further, according to an MIT study, 66 percent of all new jobs are provided by firms with fewer than 20 employees. If Congress is serious about wanting to cure chronic unemployment, all it needs to do is to repeal the minimum-wage law and give these small firms a tax exemption (the revenues forgone by the government would be far less than its savings on subsidies for the unemployed).

The smaller high-tech firms that have survived the recent recession will do extremely well—far better than any of the industrial giants—in 1983 and beyond as the recovery gets under way in earnest. And they will need new infusions of capital to grow. Many will "go public" or, if already public, will offer new issues of common stock to expand. Simultaneously, the shares of publicly traded high-tech companies, both large and small, that are already well capitalized for growth will rise well ahead of the overall stock market. Many of these companies' stocks have the potential of multiplying in value as the recovery becomes a boom in late 1983 and 1984.

This said, it also needs to be noted that technologies and high-tech companies are extremely dynamic. Thus, the darling company of today, especially the one-product company, can suddenly find it has a new competitor with a far superior and often cheaper product or product line. Managements of such companies, therefore, need to be both alert and flexible.

As 1983 unfolds, a number of carefully selected high-tech stocks should be brought into investment portfolios, with enough diversification to increase the likelihood of including some of those that will multiply in price and to allow for the possibility of one of two selections going sour because of sudden product obsolescence.

Jerome Smith is the author of Silver Profits in the Seventies (1971), The Coming Currency Collapse (1980), and Silver Profits in the Eighties (1982). This article is adapted from his quarterly report for Applied Austrian Advisors, an investment service.