Sushi Roll Economics | The Acquirer's Multiple®

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

Jake: That’s right. So, anyway, take it for what it’s worth, but as a rebuttal to that podcast, which I’m not going to name specifically, is this really great little October 2008 paper from this guy, Professor Robert Murphy. He’s in the Austrian school. He’s a pretty funny writer, and he has like a really good sense of humor. And coincidentally, I’ve hung out with him a few times. He’s pretty good at karaoke.

Bill: Oh, big man!

Tobias: [laughs]

Bill: [crosstalk] –right there. Coincidentally, I’ve hung out with him.

Jake: So, the name of this article that he wrote is called The Importance of Capital Theory. And he in that article was rebutting Paul Krugman basically. But I’m going to try to walk through what Murphy lays out here and for us to maybe think about it, and you’re probably better off just reading the article than what I’m going to do butchering it, but here we go anyway. All right.

Imagine that there’s this hypothetical island economy. There’s 100 people that live on this island. The only consumption good that’s available are sushi rolls. Every day, there’s 25 people who they get into their row boats, and they go out and they catch fish with nets. And 25 people are out there gathering rice. Then, there’s another 25 people who take the fish and the rice and assemble it together. And then, the last 25, they do the–

Tobias: They work for the Feds.

Jake: [crosstalk] –boats. Yeah, that’s right. They’re PhD economists. They keep the boats and the nets up, so that they can keep catching fish. Okay, so in a nice equilibrium, this island economy will produce 500 sushi rolls, which is five sushi rolls for each person. One day, then Paul Krugman washes up on the beach, and he starts advising them about how he can boost aggregate demand for sushi rolls, everyone can have more consumption. He shows them this his outboard motor that he used to get there, so we have a new technological advancement. All right, cool. So now, he’s advised them and they’re following his advice.

Now, there are 30 islanders who are out in the boats catching fish, including one of them with this motorboat. We have 30 now who are gathering rice, and there are 30 making rolls. And that leaves then we have five people divided out to go look for the materials to keep, like oil and gas to keep this engine running. So, we had to reallocate some of the people. We have five left now to maintain the boats and the nets. Okay.

As we’re going along, Krugman looks like a genius because now all of a sudden, we’re producing over 600 rolls. And that’s more than– that’s six each, including feeding Krugman as the new king. And [crosstalk] everything is great because now we have six rolls each instead of five. We’re all wealthier. We’ve boosted aggregate demand, and it’s all good. Now, a lot of people would say like, “Oh, this is probably due to the motor that we’ve introduced, this new technology.” But really, it’s mostly about the reassignment of tasks and getting people working on– we have 30 people who are now going fishing instead of 25.

Eventually, though, as this goes on, there’s a reduction in the boat and net maintenance, and that starts to catch up with you because now there’s holes in the nets, the boats– maybe someone’s got to be bailing half the time because they’re getting holes in them. And they’re getting less fish out of the sea now. So, what ends up happening is now we have an imbalance of rice, we have the same 30 people who are doing rice before. What they do is they start cheating and putting smaller amounts of fish into each sushi roll.

Eventually, the boats break down to where now we’re only running some of the boats, and now we have a lot less sushi. What’s going to end up having to happen is that they’re going to have to have a period of deprivation, where we get more people working on fixing the boats and the nets, so that we can get this thing stood back up and everyone eating again.

What ended up happening there really is, it looked like we were wealthy, we had six sushi rolls each instead of five. But what we were doing was consuming capital. We were consuming our fixed goods of our boats and our nets and not keeping them up. So, that initial prosperity was really illusory. It wasn’t real prosperity.

Now, and obviously like during the transition, as we try to get things back up and running again, there’s going to be a bunch of islanders who don’t have anything to do because we already have enough people making rice, or gathering the rice. We already have enough people producing the sushi. Now, we have guys just standing around. And obviously, that’s how we can end up in a situation where everyone is starving, and we have unemployment. We have a mismatch between the coordination of resources. So, I’m going to read this really nice little passage that Murphy wrote on this, that sums it up.

“In modern economies, workers use capital goods to augment their labor as they transform nature’s gifts into consumption goods. Because of the time structure of production, it is possible to temporarily boost everyone’s consumption, but only at the expense of maintaining the capital goods, the boats and the nets, which are thus consumed. At some point, engineering reality sets in and no stimulus policies can prevent a sharp drop in consumption.”

The conventional wisdom right now is that we are stimulating the economy through all of these different programs, whether it’s the Fed or direct fiscal stimulus from the government. Well, is this actually that we’re creating this consumption that we were all going to enjoy? Or are we really consuming capital that we’re going to have to end up paying for later?

Murphy makes the point, because he’s writing this in October of 2008 when the housing crisis is– we’re in the teeth of it. I remember very specifically that time period when TARP was announced, and it was $700 billion–

Tobias: That felt like a lot of money.

Jake: That was so much money. It was an unconscionable amount of money at the time. You had people who were much more up in arms about that. I don’t know if you remember, but they were like– you had economists, you had businesspeople saying, like, “What are you doing?” And now, that’s such a quaint number. I find it fascinating.

Tobias: We count in trillions now.

Jake: I know.

Tobias: Plural.

Jake: For how much longer are going to use trillions? So, he’s talking about how Americans in 2006, they consumed a massive amount of consumption goods that were imported during that housing boom, because they erroneously thought that the rising home values would more than make up for that. But then, it turns out that that was kind of illusionary and they ended up basically overconsuming and consuming really the capital of their houses without realizing it.

When you think about all this stuff, and you think interest rates exist to coordinate the time of consumption now versus consumption later, do we do invest more to create the production for more of us to have more things later? Or do we want to consume it now? The interest rate is what tells us, that’s the price of time. We have a lot of meddling with interest rates around the world. I guess my big takeaway from all this is that to declare it a victory now is, I think, horribly shortsighted and we have to see all of the effects of this before we can say whether fiscal and monetary stimulus is really a good thing and that we have these new tools that are amazing that plug all the holes and are going to help us. Long, pedantic, but maybe brought a little bit of real-world feeling to it by this island, this sushi economy.

Tobias: Can I just play devil’s advocate?

Jake: No.

Tobias: [chuckles] The arrival of the motorboat or the engine, why does that then require us to allocate more people to fishing?

Jake: It didn’t. It was Krugman advice to get more people consuming now to get more aggregate demand boosted.

Tobias: To get more people consuming. So, you start with the consumption, everybody’s going eat six sushi rolls. Now, we need more. Now, we’ve got a deficit of 100 sushi rolls.

Jake: Well, we need to get more people making more sushi rolls, we need to consume more.

Tobias: And to boost sushi rolls. Okay, so it’s at equilibrium at 500. We allocate more resources to fishing because that’s the bottleneck in the sushi roll production. And now, we’ve got more– now, we can eat more sushi rolls, but we do it at the expense of the equipment. So, what’s the direct analogy– That’s the analogy. What does it mean in the context of this of our economy?

Jake: Well, I can’t help but wonder if we don’t underinvest in some things– and this isn’t the only reason. A lot of it is, I think, the short-termism of a lot of– the way that management tenures are structured, what is the average CEO, under five years? That’s the turnover in the S&P 500? I don’t care about the boats and the nets if I know I’m out the door in four years with a big option package and a golden parachute. I will need to boost those numbers today. I need to have everyone eating lots of sushi rolls today. Don’t worry about the nets. I think it’s pervasive and a lot of it might even be fighting human instincts to consume more now. But I think interest rates being squished down like they are, only encourages more of this behavior. You can borrow more now. You think that you’re going to have a very easy time to be able to borrow in the future as well, so there’s not that liquidity concern, the markets are always going to be open with fresh money for you. So, you can just keep kicking the can down the road.

Tobias: I think about it in terms a little bit like– So, you think about Tobin’s Q. What Tobin’s Q is, is the market value of assets versus the replacement value of assets. The market value of the assets that are in Tesla is massive. So, you get a massive multiple if you can come out with some sort of truck or car that runs on a battery. Trevor Milton says, “Well, that’s what I’m going to do. I’m going to invest essentially nothing, and I’m going to say this thing is going to be doing that thing.” And then, look at the massive multiple that it actually got in the market. So, he really did demonstrate that in real time. We don’t know if that’s a valuable thing that he’s created or not, but I suspect that there are other truck companies out there that are going to be able to do something similar if it turns out that it is. So, we’re misallocating resources by putting it into those things, which the market seems to be valuing extremely highly.

Jake: Yeah. And that buy it versus build it calculus, it’s even easier to just promise to build it.

[chuckles]

Jake: You would never buy it, and you don’t even actually have to build it. You just have to– [crosstalk]

Tobias: I’ve got this killer PDF of what I’m going to do, and that’s worth $30 billion.

Jake: Well, we’ve got that HTML5 supercomputer.

Tobias: Oh, yeah. I forgot that. That’s how I made the deck.

Jake: [laughs] Jesus. All right, enough veggies. Let’s get something more fun here.

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