The Economic Cycle: Where it’s Been and Where it’s Going
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Russ: This is PKF Texas – The Entrepreneur’s Playbook. I’m Russ Capper, this week’s guest host, and I’m coming to you from the Gulf Coast Regional Family Forum. I’m here with Scott Clemons, Partner and Chief Investment Strategist of Brown Brothers Harriman. Scott, welcome to The Playbook.
Scott: Good morning, Russ. Thank you for having me.
Russ: You bet. Tell us about your firm.
Scott: Brown Brothers Harriman & Company is a rather old firm. We were founded in 1818 as a private partnership, which, in 1818, every bank on Wall Street was a private partnership. What’s unique about us today is that we’ve never changed that ownership structure. Over the past 200 years, one by one, firms have gone public; they’ve limited their liability in some way. We’ve retained that unlimited liability structure. There are 31 people who own the firm outright – no outside capital, no debt on the balance sheet. And those 31 people, all of whom operate the business, carry joint and several unlimited liability for the activities of the business.
Russ: So, that includes you.
Scott: That includes me. It tends to focus the mind. It makes risk management a core competence. What we really like about it is it really does align the interests of the owner operators with those of our clients. Every firm has that alignment, but for us it’s embedded within the DNA of the ownership structure for the business itself. That’s rather special to us.
Russ: My goodness. So, 1818, so this is like a birthday year.
Scott: We had a big party—we had a series of big parties last year. We had big cakes and celebrated the history of the firm and also the future of the firm. One of our events in New York, we had a guest speaker, George W. Bush, former President Bush. We had him because his grandfather, Prescott Bush, H.W.’s father—Houston connection here, was a partner of the firm back in the 1930s and the early 1940s. So, we celebrate that history, and the challenge, of course, is to be informed and influenced by the history and the legacy without having that legacy dictate what you do. We have to weave into our business a certain amount of entrepreneurship for our third century, which we’ve embarked on in 2019.
Russ: How unique that is. I’m fortunate in just being able to see you speak for about 30 minutes in front of a very smart and interested audience. Does that arrangement – that partner arrangement – does that sort of affect everything that you are, all the advice you give and the predictions that you give?
Scott: It does, because I think if there’s a common thread among all of our clients, it’s that they, for the most part, they are business people. They are families who have built their wealth through the ownership of a business, and it may have been a generation or two ago, and in many cases the business is still the biggest part of the portfolio. For those clients to work with other owner operators, there’s a natural resonance there, for one thing. For a second thing, the owners of Brown Brothers Harriman are also clients. When I sit in front of a client and I talk about the markets or I talk about investment strategies or investment solutions or how we’re investing, I’m actually talking about my own portfolio as well. There’s another alignment of interests there that’s very important to us.
Russ: Two hundred-year-old firm, I mean, do you ever get new money in? New, young, entrepreneurs who have exited very successfully?
Scott: Yeah, it’s amazing how – and I can’t put a number on this because I don’t know it off the top of my head – but an increasing number of our clients are young and sometimes delightfully young people in their 20s or 30s. More often than not out of the technology space, who have worked hard, and they’ve have gotten lucky, and they’ve had insight, and they have maybe monetized an idea, and they’ve taken some money off the table and they’ve turned to us to help preserve and grow that money even while they may look for another business venture. It’s remarkable, and it’s also very healthy for our business to have an increasing number of clients who are at the early stages of wealth creation.
Russ: Very interesting. So, I do want to get to some of your perspective on the economy. It’s real interesting right now, because I think we’re nearing the 10-year anniversary of incredible economic growth. I mean, I’ve heard people say, “We’re in the ninth inning right now,” of this. What’s your perspective?
Scott: The baseball analogy—we may go into extra innings, if I could extend that. There’s no expiration date on an economic cycle. You’re right: by the summer of this year, we will hit the 10-year mark for an economic expansion, which will be a record for the United States of America. What’s interesting, if you look at the long history, and here’s where working for a two hundred-year-old firm, I think, informs my thinking. In an early era of the republic, economic cycles look like agricultural cycles. Economic cycles were measured in months, not quarters or years. Move into the 20th century, they look more like manufacturing cycles, or industrial cycles, where inventory was really important. Companies would over build inventory, the demand wouldn’t be there, that would slow the economy down. Where we are in 2019, we’re not agricultural, we’re not manufacturer – we’re service.
What does inventory mean for Google, or for Amazon, or for Netflix? It’s sort of an antiquated concept. It’s not going away all together, don’t get me wrong, and the business cycle hasn’t gone away all together, either. The technological nature of this economy is one in which we don’t have to have as frequent cycles as we have had in the past. What’s interesting is that if you look at the past three big economic cycles, what happened on Main Street really started on Wall Street. So, in the early 1990s, the banking crisis, which was actually centered here in Texas in the savings and loan association, created an economic recession in the early 1990s.
The late 1990s, it was excesses on Wall Street with the dot-com stocks and the bubble and the bust that then followed. Of course, in 2007 and 2008, it was excesses in the mortgage market. It was really financial excesses that drove the economic cycle. When I step back now and look around the financial world and say, “Where are the excesses now that might pose a threat to Main Street?,” you can identify some. Sub prime auto loans are problematic, but where there are excesses, they’re small enough to not pose the systemic threat that mortgages did 10 years ago. That says to me that this economic cycle has probably got some legs to it.
Russ: Cool. I like that. So, you also talk a lot about economic and personal consumption and sentiment, and the role that those play, that sounds huge.
Scott: It’s pretty straight forward. I think economics is not rocket science; it’s not brain surgery. I start with the simple observation that personal consumption, all the money that you and I and our fellow Americans spend on a daily basis, accounts for two-thirds of economic activity. It’s big, I mean, we’re a consumer led nation. That’s not to be dismissive of the role that government spending plays, or trade, which gets a lot of headlines these days, or business investments, certainly. It’s simply to put them in the context of those drivers adding up to 30%, whereas personal consumption is 70%. That’s why I spend a lot of my analysis focused on the health of the consumer. That’s a real question about income and wealth, but it’s also the psychological question of: to what degree are consumers willing to part with those dollars. That’s the fuel for economic activity.
Russ: Right. I always remember after 9/11, W made his famous speech and said, “Get back out there and go shopping again,” and I thought, “I guess that is important.”
Scott: Politically, that may not have been the wisest thing to say, but economically it’s completely accurate. If you look back to what happened around 9/11, and I was in New York in Brown Brothers Harriman’s offices on that day – we were about three blocks away – so I had a front row seat to a lot of that, about 10 days later people went back shopping. Russ, it was remarkable to see New York City real estate, post 9/11, stopped on a dime for about two weeks and then roared back. It’s a testament to the resilience of the nation; it’s a testament to the importance of personal consumption as well.
Russ: I want to ask you about China, too. We know we all live in a very global economy now, too, and there’s these trade issues, the tariff issues. At the same time, there’s sort of a feeling that China is discontinuing to grow and what impact that might have on us.
Scott: There’s no question if you look at the headline data that Chinese economic activity is slowing down. That’s given rise to a certain amount of anxiety about the impact that China will have on global economic activity. I think what we’re actually seeing in China is a rare example, maybe a unique example of an emerging economy actually emerging, actually making the transition to a first world, globally competitive economy. It’s hard to put that into context, because it’s never happened before. You can’t say, “Oh, this is like the time that x-y-z made the transition,” because there’s no answer to that. Most of the emerging economies remain emerging economies forever and ever, amen.
In China, what’s happening is they have a demographic reason to make that transition. 1.3 billion people in a rapidly aging population without the national safety net that the developed economy like the U.S. has. There are no Chinese words for Social Security, Medicare, Medicaid or the Affordable Care Act. This is a source of civil unrest unless the Chinese government finds a way to get enough wealth to create some of those national safety nets. Now, historically in China, it’s a very family-oriented society, but one of the impacts of the one child policy is that you’ve got individuals with four grandparents and no siblings, and that pyramid is inverted—that support pyramid.
China has got a generation to get rich before it gets old. That’s why they have to make the transition. What that implies is that they’re not going to grow at 10 or 12%. Developed economies don’t grow that fast. They grow at three or four, if they’re lucky. Chinese economic activity now is at about 6%. I think it’s on a glide path down to something like 3 or 4%. We should welcome that. We should welcome China as a competitor on the global economic stage with a leveler economic playing field. Although it’s controversial, I actually think that will be the outcome of these talks on trade with China. The fact of the matter is that China continues to compete under a series of trade deals that were completely appropriate 15 or 20 years ago when China was truly an emerging market.
Times have changed. They’re a thirteen trillion-dollar economy, still growing rather rapidly, the trade deals need to come up to date. That’s all the White House is trying to accomplish in fits and starts. I wish they weren’t using tariffs to do it. That’s the tool that the White House has chosen. I think the outcome of this is rather benign. We arrive at a new set of trade agreements with China that allows them to compete, allows us to compete on a leveler playing field, that will be good for global economic activity, not bad.
Russ: Do you think the Chinese know everything that you just said?
Scott: They do, Russ, because they think in very long term. Very long term. At the risk of stating the obvious, American politicians, for the most part, find it hard to think beyond the next election. The Chinese Communist Party thinks in 5 - 10 year, 5- or 10-decade plans.
Russ: Because they’ll remain in office.
Scott: They will remain in office, right. The Chinese government publishes a five-year economic plan. They’ve done it every five years since the second world war. In the West, we’re accustomed to hearing campaign promises that go unfulfilled. What’s remarkable is when you go back and look at the Chinese five-year economic plans, they’ve done them.
Russ: They do them, interesting.
Scott: They do them. So, I think they’ll carry through on this as well, and they think longer term. And they appreciate that they’ve got some room to give on issues opening up their markets, intellectual property – all the things that the White House is talking about.
Russ: Interesting. Before I let you go, you know, I’ve spent most of my career in the technology world. The technology world has been in this disruption mode for at least a decade, depending on how you look at it, but just in the past couple of years there has been this concern that robotics, artificial intelligence is going to eliminate so many jobs that it’s going to impact the economy all the way to the point where some are even discussing the idea of an allowance for everybody.
Scott: Universal basic income.
Russ: Is that real?
Scott: Yes, it’s real, but it’s not new. And here, too, the history, my experience as a historian comes into play. Arguably, this technological disruption – what economists call the substitution of capital for labor, hire a machine instead of hiring you – started in the Industrial Revolution. This goes back to the English looms, and remember the Luddites who would storm the factories and break the automated looms because they were taking the jobs away from seamstresses. This is the 18th century. The details have changed, the technology has changed, obviously, but the underlying economic fundamental haven’t. The magic, what allows this to happen without destroying human labor, is this idea of creative destruction.
If we allow entire industries to be disrupted by technology, but in a creative way, it creates whole new jobs and even industries that were previously unheard of. I had a conversation on a panel with an Air Force Officer a number of years ago, and I asked him about the economic impacts of the unmanned aerial drone program, which, at the time was very much in the news. I said to him, “So, how many jobs does that cost? There’s not a guy or two guys flying a plane anymore.” And he said, “Oh, no, you’ve got this completely wrong. Yes, there’s now one individual in Tucson, Arizona with a joystick, flying missions in Afghanistan, but the amount of data that drone is pulling, and the amount of analysis that has to take place, employment in that unmanned aerial drone program has gone up by 20%, and the payroll for each of those people is higher because they’re trained Ph.D.’s, training and analyzing big data.”
So, that’s an example, one example, but as long as we let that creative destruction be both destructive and creative, it actually creates whole new jobs. The proof statement for that is so much technological disruption over the past decade or so, unemployment in this country, 4%. And they’re good jobs. It requires training, it requires education, but they’re good jobs.
Russ: Scott, thank you so much. I really appreciate that.
Scott: Any time, Russ. Happy to join you.
Russ: And that wraps up my discussion with Scott Clemons with Brown Brothers Harriman. And this has been another Thought Leader Production, brought to you by PKF Texas – The Entrepreneur’s Playbook.