Ghost Town Economics | The Acquirer's Multiple®

During their recent episode of the VALUE: After Hours Podcast, Taylor, Brewster, and Carlisle discussed Ghost Town Economics. Here’s an excerpt from the episode:

Jake: This one is a little town called Bodie, California, B-O-D-I-E. A couple summers ago, I took the family on a little RV trip and we stopped by there. The place is pretty crazy because if you know the eastern side of the Sierras, it’s down this Highway 395. The place is about as close as you can get to Mars in the United States, I think. You’re up on this plateau and so it’s windy as shit. It’s 100-mile an hour wind sometimes there. It’s tied with some other place in Alaska for– it averages 300 days a year where it’s below freezing overnight. That’s because you’re at 8000-feet elevation. So, it’s pretty—[crosstalk]

Tobias: Why is it abandoned? [chuckles]

Jake: Yeah, right.

Bill: Can’t figure out why this went wrong.

Jake: Yeah, exactly. It was found in 1876 and it peaked in 1879. You had a three-year boom here basically. And what’s nice about this is that– why it’s good for economics lessons, is that it’s a very self-contained little universe to study and it also has this rapid boom and bust that happened. And then, the gold that was the reason why people came there will help inform some of the things that we’re going to learn. A couple quick stats on it. It peaked with 7000 people, had like 2000 buildings, and there were 65 saloons on a one-mile stretch in the main area. If you thought you had a drinking problem– [crosstalk]

Tobias: That’s my kind of town. [laughs]

Bill: A bunch of dudes just hammering rock and getting hammered.

Jake: Pretty much, yeah. Now, let’s transport ourselves to that time period. 1879, we’re walking down the street, looking around. How does it get decided what we want to consume now versus what we consume later? There’s no central planner that’s telling you that you need to go have a drink now or do you go build something?

Tobias: Sixty-five saloons, I guess, is a bit of a hint.

Jake: Yeah, that’s true.

Bill: I mean, dude, your life probably sucks. I’d just get drunk all day, and then I’d go hammer some rock and try to get some gold out of the ground. And then I’d hope to God, I could stop that process, it would be bad. And probably most people would be dying super young.

Jake: Yeah, you probably have a shorter time preference than what we might have today. You’d be more in favor of consuming now. Let’s assume that the more that you save for later– basically the more supply of capital that’s available for later, which then lowers the price of capital for later. What do you call these coordinating prices between today and tomorrow? We have a name for them.

Bill: You talking about interest rates?

Jake: That’s correct, Bill.

Bill: Thank you.

Jake: I’m going to send you a prize. Interest rates are the prices that coordinate time preferences between us. What we want to do with our capital now, our consumption now versus later. Let’s assume that there’s more investment today versus consumption. You could actually think about wood as a pretty good little proxy for this world because being that it drops below 30 degrees 300 days a year, you need wood to keep warm overnight most likely, or you can use it to go say, build a saloon or whatever. We have a very real consume now versus build for later dynamic that’s happening with pieces of wood.

Let’s say that there’s a gold rush what’s happens. And now, gold actually flows into the banks that are inside of this little town, and by the way, there was a Wells Fargo there at that point.

Bill: Shoutout when the brand was strong.

Tobias: They had 14,000 accounts.

Bill: Taking advantage of customers for hundreds of years, folks.

Jake: Yeah, it’s a good one. Well, I am going to make this a little more realistic because just like today, as more deposits come in, they counterfeit that money to create more. This is just how fractional reserve banking works. And it’s no different than it was back then. You deposit a piece of gold, they may loan out more pieces of paper against that gold. As long as no one comes back all at the same time to get claimed their gold back, it works out fine. With a gold rush like that, what’s actually doing is it’s lowering the interest rates there because it’s an increase of the supply of money, so to speak.

Well, let’s pretend that an enterprising young businessman goes to the bank and he decides, “I want to build the biggest hotel in all of Bodie, California.” And he borrows the money from Wells Fargo. He builds this big hotel. So did nine other people. They build these giant hotels. They see this boom, they think they’re getting out in front of it. Well, what happens, when it’s 1880, a year later, and they have these hotels, and there are no customers to come stay in the hotels because the boom is over.

Bill: Wells Fargo has more branches.

[laughter]

Bill: That one’s loan loss reserves are going up.

Tobias: They’ve opened another 7000 accounts too.

Bill: Yeah, you’re hoping that that one’s in one LLC, or C-Corp and you can fold it.

Jake: That’s right. So, there’s no way to service that debt. The debt now basically has to be destroyed. That capital is disappeared. We need new ownership most likely of these hotels. That malinvestment took place. This is very analogous to what we see today with the Fed, basically creating a gold rush in a way. They lower the rate of interest for everyone. And by the way, that hotel, that enterprising entrepreneur, if he saw that the interest rate was 10% to borrow the money, it’s most likely that he would say, “Oh, my project doesn’t really pencil out at a 10% rate.” But when it’s 1%, all of a sudden, my project makes sense. The nine other guys looked at that same math and did the math and came up with it was going to work or not based on that low rate versus a high rate.

Well, we get to the future period. And it turns out that that low rate was a bit of a mirage, and that people didn’t actually want that much hotel space. So, we end up with what economists would call a confluence of entrepreneurial errors. Why does everyone make a mistake all at the same time? It’s because the low rates told them– it gave them the green light that this was a good project. That people wanted to consume things more later than they do now, which is what a low interest rate is telling him. But if it’s a head fake of a low-interest rate, now we get everyone building things that we don’t actually end up wanting.

One of the things that’s amusing to me is that, if Greenpeace knew what was really going on in the world, they’d be protesting the Fed. There’d be people out there in front of the Fed protesting at all times. Because the Fed has really is pulling so much from the future, they’re greatly increasing the chances that we use people, energy, capital, material, and tax the environment in a way that ends up being not building the things that we all wanted. We send all these green lights to everybody and they build things that turns out that we didn’t actually want.

It’s so amazing to me to think that you could take all the consumer tastes– all of our things change all the time, what we want to buy, take all the time preferences of do you want to save a little bit more money now versus later. The labor force, the skills as they change as people move. You don’t go tell the Fed, “Hey, I’m planning on moving to Colorado next week, does that work out with your model okay?” And we take all this stuff including resources that we discover or deplete, and we have all of these things happening. And the idea then that we try to enforce stability on this kind of a system that is changing so much, is to me is so asinine. It gets to what Hayek called, The Fatal Conceit, to think that you could understand and try to keep stability when there’s all these factors changing is just the height of being conceited.

That leaves us with where we are today, which is we are doing everything in our power, basically to stop the liquidation of that bad debt that can’t be repaid because we had all this boom time and probably a lot of malinvestment. How much retail space do we have in the United States that we probably don’t need at the moment? I think it’s quite a bit. All of these things have been built that are probably ahead of where any of us ever needed them or wanted them or the world changed. How much office space do we have now that we may not need as much because working from home is all of a sudden, much more palatable? The long story of this– Well, go ahead, you had a–

Tobias: I’ve just got a few questions, but I want to wait until you finished. I’ve just got a few devil’s advocate positions but I’ll wait until you’re done.

Jake: Probably can’t answer them but go ahead.

Tobias: Well, the first one was, in this town, I don’t know if this is the analogy part, this is the case. When you’ve got your gold and you’ve deposited your gold, you weren’t storing your gold in a lockbox. They were giving you some sort of right on your gold. You were depositing it as money?

Jake: You would deposit the gold and they’d give you a piece of paper that said, “We own this piece of gold for you. Now, you can go out in the world and trade it with other people for a drink at the saloon.”

Tobias: You can show that to other people. Right.

Jake: And then anytime, you could go take that down to the bank and say, “I would like my gold back, please.”

Tobias: And then the way that they’re creating money is they’re lending against the gold that’s in there as well. So, you deposit the gold, they give you cash for it, and then they also lend against your gold that’s deposited there?

Jake: Why not be able to just give two pieces of paper for every one piece of gold?

Tobias: So that’s what they’re doing?

Jake: As long as no one comes back. As long as two pieces of paper don’t come back at the same time, we can figure this out.

Tobias: As long as there’s no run, right. And so your gold is fungible in this instance. You put it in, you’re just like “I’m going to get some gold back, not the gold that I’ve put in my lockbox.”

Bill: It’s just fractional reserve banking.

Tobias: Yeah, I just wanted to make sure that that was the– just understanding the analogy properly.

Bill: And then you dial up how many pieces of paper you can give. Right now, we’re not allowing banks to give as much pieces of paper as we used to. The banking system is less levered than it used to be. But I digress.

Tobias: The next question I have, so they built 10 hotels at once. We’ve got two– or we’ve got multiple electric car companies at the moment. Are we building multiple electric car companies because it doesn’t cost that much to build an electric car company. Let’s say, it costs a billion dollars to build an electric car company, but in the market maybe it costs even less than that. You’ve just got to tell people that you’re going to do it, and you get a gigantic valuation. That’s the market telling people that they want more of these things, which is what inspires the overbuilding. Is that more important than interest rates or how do they fit together?

Jake: Well, I think a couple things to think about there. I’d like to go back to our little town or ghost town. If you think about the lowered rates, which ends up happening, all that money now is out there and it’s bidding up the price of labor, supply. All the factors of production now are more expensive. And so, it looks temporarily things are more profitable than they are. You end up with an over-profitability estimation at that point. The other thing to take away from this is that the closer that you are to the consumer with your product or service, the less variability there is in these booms and busts that can occur. And the farther away you are, the longer your timeline from when production actually gets to the consumer, the more variants there is in how big the boom and bust can get. So that’s why commodities tend to have much bigger boom and bust cycles than say like retail, historically.

Bill: Is that true? I mean isn’t part of the commodity thing is just so easy to recreate? And retail is historically a distribution advantage, and you’ve got to set up suppliers and whatnot? I guess the thing that I keep thinking about is, in this analogy, that what you have to allow eventually is for the lenders to go broke because the lenders are the one that are increasing aggregate credit. If this guy’s hotel goes down the dumps, he still transferred money to employees and stuff to buy it or to build it. There was still money that went to the people that supplied the commodities, there was logistics. The only people– it seems to me to be a wealth transfer. Obviously, once you add on like all the fractional reserve banking stuff, then you get a problem, if it’s systemic, but–

Tobias: Wouldn’t you be better off building something that’s going to be useful in the future then?

Bill: Yeah, but I just don’t know that you can say– I agree that there is overbuild. I don’t think overcapacity is a new story. I just don’t know that I necessarily agree that there’s all this waste going on. I don’t disagree that there’s some malinvestment, and I think people are way pushed out on the risk spectrum, because to your point, Toby, you’ve got people that are looking for some return and some of the people that are looking for return or pension funds and they’re underfunded, and they have obligations that they have to go to, so maybe they don’t have the choice to not lend. There are motivating reasons that are causing behavior. But it seems to me if you let the lenders get wiped out in this scenario, a lot of this stuff fixes itself.

Tobias: Well, I’ve got the solution. What that town needs is a central bank and what they do is they go and buy up all of the debt. But because they can’t buy the debt directly, they need some sort of ETF to stand in between. That ETF buys up all the debt, then they buy units in that ETF. Problem solved.

Bill: Yeah, well, look, man, this is part of why I railed against corporate debt. And then, if we rewind to March, I thought corporate debt might actually own everything. I don’t know what I know. But this is why I haven’t liked corporate debt because I think it’s hard to argue that the spreads aren’t artificially compressed.

Tobias: You don’t like the fact that the Fed is buying Berkshire Hathaway debt and Apple debt?

Bill: I doubt they’re buying that. I think there’s enough–

Tobias: Indirectly?

Bill: [crosstalk] –to that. I think they’re probably buying United more than Berkshire.

Jake: [laughs] Yeah, it’s not about return of the money.

Bill: I don’t know that Fed [crosstalk] people are okay holding that. I think they need to step into the places that no one wants.

Tobias: All right, JT.

Jake: But isn’t that signal that it needs to be liquidated and that we need to clean it out so we can start from a fresh base as opposed to–

Bill: This is the same conversation we had three months ago. Look, if they sustainably support zombie companies ad infinitum, I agree with you. Right now, we’re in the middle of a pandemic and cases are spiking again. I don’t think this is the time, dude, to say, all of our policies that have led up to this, now we’re going to get religion and start a deflationary bust in the middle of a pandemic. No, I think that’s a horribly flawed policy. Might be nice in a textbook, it would be terrible for society. You’d have people running out of their house. You’d have people totally freak the fuck out in the middle of a pandemic. “That’s what you actually think we should do? That’s insane.”

Tobias: But it’s fine backwards.

Bill: But I [crosstalk] with the textbook.

Jake: That’s fair. I think the problem was the 10 years before that.

Bill: Yeah, I don’t disagree. That’s like I was saying yesterday about this– Don’t extend the unemployment benefits. The idea that is being floated today, like no, we shouldn’t have had trillion-dollar deficits for the last three years. You’re going to throw people out on the street now? That’s inhumane. The problem is all the shit that we did that led up to this. Sorry, I ranted.

Jake: That’s a good rant.

Tobias: No dispute from me. Did I cut you off, JT? Do you have concluding thoughts?

Jake: Well, just one other thing that, you think about all those hotels that were built in our little ghost town that now sits there as a state park monument– and those counted as GDP by the way and were cheered, but that’s why GDP is such a stupid measurement.

Tobias: Well, I can keep the GDP up. What we do is we go and chop those– we hire guys to chop those hotels down, burn them for firewood. Rebuild them.

Jake: Build them again.

Tobias: [laughs]

Bill: That’s right. With government stimi.

Tobias: And I get my first vote for federal reserve board governor, fed chairman.

Jake: You’re a shoo-in.

Tobias: Yeah. I know how this stuff works. This is easy. Get GDP right up, I can really get GDP red hot.

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