THE INTANGIBLE ASSET BUBBLE

13 JANUARY 2021

Intangible assets account for 90% of the SP500’s total assets.

 “Wow. The SP500 is made of fairy dust.” – My first instincts.

Is the US in an intangible asset bubble?

SP500 Tangible vs Intangible Assets

Supposedly, digitization and rising tech stocks are what account for the 90% figure. But I still think the ratio is abnormally large.

In accounting, most intangible assets are from goodwill and intellectual property.

Goodwill comes when a company overpays for another company in an acquisition.

Intellectual property includes things like patents, trademarks, copyright, R&D, etc.

This means the SP500 is made up of assets that are hard to value and historically never lead to great returns. There’s a reason book value exists – to cut out any nonsense hidden in intangible assets.

As I thought about it some more, it became clear that the 90% figure was caused by more than just rising tech stocks.

US dollar reserve status and the current monetary system

We didn’t get here by accident.

Yes, increased digitization decreases the amount of tangible assets the world needs relative to the amount of intangibles. But only the United States has seen a continually increasing ratio of intangible assets to tangible assets.

Is it a coincidence that the ratio of intangibles to tangibles accelerated upwards after Nixon took the US off the gold standard?

I think not.

To understand why, we need to understand how the current monetary system works.

Most commodities and energy is priced in USD. So in order to buy commodities from resource producing nations, countries need to use US dollars.

As such, there is always demand for US dollars. This is what people mean by “reserve currency” – countries need to keep US dollars in “reserve” so they can trade with other countries and buy stuff from the US.

Normally, a country will pay for its imports through their exports so there are no long-term trade imbalances. I give you something and you give me something. This is common sense and how healthy trade should look like. It would be awkward and unfair if one country was consuming more than it produced.

Yet, that is exactly what the US is doing by consuming $600 billion more than it produces (the trade deficit).

Here’s why.

Trade Under the US Fiat Monetary Reserve System

What trade looks like under a US fiat dollar standard

The US has to run a trade deficit or forfeit reserve currency status, but not both.

When America buys foreign exports, they send over US dollars. Normally, foreigners would return the dollars to buy US exports, evening out the trade balance. But this won’t happen since other foreign countries price their commodities in US dollars which means foreigners must hold US dollars to trade with each other.

So the US must run a trade deficit to keep the world full of excess dollars.

The consequences of holding reserve status

Because the US imports more goods than they produce, productive assets like machines become less necessary. As a result, the US has exported away most of their manufacturing to other countries (mainly China).

Early in the COVID-19 pandemic, the US struggled to produce enough masks for the country. This is one of the downfalls of being the reserve currency.

Other than that, millions of jobs are lost since they’ve been shipped off to foreign countries. This leads to more unemployment, homelessness, stagnant wages and larger gaps between the rich and poor. As people realize their lives aren’t improving and something is wrong with society, they look for solutions. People turn against the establishment or follow radical or populist leaders leading to class divisions and increased social unrest.

On the other hand, Americans get to consume more than they produce, which is why the “American consumerism crisis” is largely true.

America Consumes more than it produces

This privilege (or issue depending on your POV) of over consuming mainly manifests itself in the way American’s treat money: overspending, large amount of personal debt and low savings. Of course, these problems expand into other areas of life.

Sound familiar? This is where America is today.

Intangible assets compared to China

Over the last 50 years as the US shipped their plant, property and equipment overseas, the value of tangible assets on SP500 company balance sheets has decreased.

On the intangible end, a lot of SP500 businesses do not operate in hard asset industries like energy and industrials. Rather, they provide digital goods and services. Think of companies like Netflix (NFLX), Facebook (FB), Amazon (AMZN) and PayPal (PYPL).

Also, as stock valuations have increased, companies tend to overpay for acquisitions, inflating goodwill. Venture-backed tech companies with no proven business model only add to the problem.

The combination of the above is why intangibles dominate the SP500 balance sheet.

We should see the opposite trend in China if my reasoning is correct:

Tangible vs intangible assets for Shanghai/Shenzhen CSI300 Index

Indeed, tangible assets dominate the CSI300 index. All the PPE needed to produce American goods moved to China.

The increase in 2010 is likely due to the short reduction in the US’s trade deficit caused by the 2008 recession.

US Trade Balance Chart

US trade balance chart

An intangible asset bubble?

For some reason people think only poor countries have to be industrial economies – the US “is passed that stage” and it’s now a service economy.

That’s a load of shite.           

The tangible vs. intangible ratio or trade balance has little to do with being a first-world country. Take a look at Japan and South Korea; both are large trading partners with the US like China and have positive trade balances with the US.

Tangible vs intangible assets for KOSDAQ

Tangible vs intangible assets for Nikkei 225

The truth is the US is consuming more than it produces and they’re paying for their excess consumption with excess dollars.

This won’t last forever. Eventually, the chickens will come home to roost.

Foreign countries will want to get repaid with useful assets. The problem is the US doesn’t have the factories and industrial base it once had so there’s no way it could repay their debts.

The overly inflated intangible assets of the SP500 have to shrink in value for America to rebuild its industrial base. The intangible asset bubble must pop.

Ways to trade this event

  • Invest in countries that bear the burden of producing for the US. China is the most obvious example, although I would be cautious and focus on individual businesses instead of ETFs since the CCP is going rogue. Japan is a safer macro play.
  • Invest in commodities and hard assets to hedge against inflation.
  • Invest in commodities and energy companies that will benefit from the US rebuilding its industrial base and energy security. For example, the US is looking to produce more of its own uranium. US uranium miners like Energy Fuels (UUUU) will be a direct beneficiary.

I also have some stock ideas that will benefit from increased tension between countries, which is inevitable as the world reorders itself.

We’re at an interesting time in history and it’ll be interesting to see how things play out.

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