Reply #50: Confusing the effects of inflation with real improvement

[54anickel]

http://www.321gold.com/editorials/saville/saville011707.html

The combination of massive inflation and factors that help suppress some of the 'bad' effects of inflation* has allowed imbalances to become much greater than would otherwise have been possible. It has also created the illusion that the rules of the game have changed.

The analysis done by research firm GaveKal provides us with a good example of an illusion created by rampant inflation. Over the past two years the GaveKal team has published a book ("Our Brave New World") and many articles in which the argument has been made that it is different this time; and that one of the main reasons it is different is due to a larger percentage of the US economy becoming "knowledge-based". In particular, a bullish structural change often cited by GaveKal is the rise to prominence of "platform companies": companies such as Dell Computer that outsource the low-margin capital-intensive parts of the business -- manufacturing, for instance -- to countries where labour costs are extremely low, and keep the high-value-added/high-margin parts of the business such as marketing and R&D.

According to GaveKal, the long-term shift from a manufacturing-based economy to a "knowledge-based" economy is largely responsible for US corporate profits becoming abnormally high as a percentage of GDP and is why we shouldn't expect the after-tax cash flow generated by corporate America, as a percentage of GDP, to revert to its long-term mean. Dr John Hussman exposes some of the flaws in the GaveKal argument in his commentary, but we think there's a bigger issue not covered in Hussman's rebuttal.

The bigger issue is that GaveKal et al make the mistake of treating money as if it were neutral and attempting to explain economic/financial trends by looking only at business developments. The thing is, what central banks and governments have done and continue to do to their currencies is at the core of today's major trends and deviations from long-term averages.

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