Why Manufacturing Left America
“Situations emerge in the process of creative destruction in which many firms may have to perish that nevertheless would be able to live on vigorously and usefully if they could weather a particular storm.”
Joseph Schumpeter
Nearly a century ago, Austrian Economist Joseph Schumpeter observed that capitalism has two fundamental processes, both construction and destruction – not only are enterprises created, but some are also destroyed. Furthermore, destruction may come from several different directions: a loss of customers, supply issues, or, as we'll see, from a lack of capital.
Today, we'll explore the story of how one of New England's premier businesses, one that employed 12,000 workers, was shut down by its owner, who had found better alternatives for its capital.
This discussion is especially relevant now, as President Donald Trump seeks to revive some of those long-forgotten manufacturing businesses. Today, the story of Berkshire Hathaway, the textile mill that gave its name to one of the most significant conglomerates, and how Warren Buffett decided to close its doors.
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It would be years before I learned that Berkshire Hathaway had been taken over by one of the preeminent investors of all time, Warren Buffett. Buffett had identified Berkshire as an undervalued company that made a worthwhile product. And at that time in his evolution as a portfolio manager, Buffett was renowned for buying what some on Wall Street labeled as "cigar-butt" companies. Companies that weren't particularly attractive or scintillating but produced positive financial results year after year.
It was a type of investing that became increasingly known as "value investing." Putting your money with companies that weren't likely to "grow-to-the-moon," but also weren't likely to lose money either. This conservative approach, focused on little-noticed, backwater investments, was especially popular with investors who had just endured the dismal market of the 1970s.
It is a perspective that is incomprehensible to today's investors, entirely out of sync with the prevailing thinking on Wall Street, where nearly everyone's objective is to maximize profits.
However, these old-time investors had been through the fire, investing at a time when profits were scarce but losses mounted quickly. They had seen a stock market that remained flat for a decade, having first surpassed the magic 1,000 level in 1966, repeated that level in 1972, and remained below that peak until 1982 – a decade without progress. A time when brokerage firms failed and mutual funds went out of business, and many investors forgot what profits were.
Investing in a company like Berkshire Hathaway, with its paid-in-full mills, and loyal customers, like me, made a lot of sense - steady results proven over decades.
However, by the dawning of the 80s, a new wind was beginning to blow across the country. In Washington, this time, was different; it was becoming fashionable to be successful, it was suddenly acceptable to drive at full speed on the Turnpike, to stay comfortably warm in winter, and to strive for wealth. The old thinking was retired, and with it, ways of thinking, concepts like "Stagflation" would not be heard again for a generation.
President Ronald Reagan brought a new perspective, promoting the private sector, reducing taxes and regulations, and revitalizing the economy, particularly on Wall Street. The Reagan Revolution introduced new investment strategies, paving the way for a revolution in how we plan for our later years.
All of those retirement accounts that we take for granted began then: the IRA (Individual Retirement Account), the 401(K), Keogh, and other investment accounts. People who had never considered "investing" were now setting aside funds in their retirement account. Investment managers and advisors observed that retirement assets often matched or even exceeded those in traditional investment accounts.
Times had changed, and in what was likely his most prescient moment, Buffett adapted to the times. For years, Buffett's partner, and the Vice Chairman of Berkshire Hathaway, Charlie Munger, had admonished that it was better to invest in good companies at a cheap price rather than cheap companies (paraphrased).
It was a lesson that Buffett observed daily in the 1980s, as the financial results of the Hathaway mills continued to underperform. Month after month, the textile business saw margins squeezed as offshore makers and aggressive retailers forced price concessions. Tragically, it wasn't anyone's fault; Buffett had hired skilled managers, the mills themselves were in good condition, and the laborers worked diligently. But still profits lagged.
It was then that Buffett realized that his investment model was at fault. The decision to invest in "can't lose" needed to change. Likely to "win" was a more rational approach.
In 1985, Buffett decided to close Berkshire Hathaway, the company's namesake. Addressing his shareholders, Buffett put it this way:
"Likewise, a textile company that
allocates capital brilliantly within its industry is a remarkable
textile company - but not a remarkable business.
My conclusion from my own experiences and from much
observation of other businesses is that a good managerial record
(measured by economic returns) is far more a function of what
business boat you get into than it is of how effectively you row..."
https://www.berkshirehathaway.com/letters/1985.html
No doubt, for Buffett, this acknowledgment was a bitter pill. It was one of the few real losses that he had suffered in his career. It indicated an entirely wrong approach, one that he would not suffer again.
The closure of the old Berkshire Hathaway marked a secular transformation not only for investors, but for the way America does business. There was a time when the textile mills of New England were at the very apex of industry and commerce – the source of wealth and income for the owners and workers of the mills. But that time had come to an end, and Buffett knew it.
Capital is often the first to recognize a transition, and Buffett's move did not go unnoticed on Wall Street, where investors gradually fled the American textile business.
Of course, the Textile Industry isn't the only field that has seen the out-migration of American Capital; nearly all of the country's basic manufacturing enterprises have lost investor support.
It's hard to think of a single manufacturer (with the possible exception of Tesla) that has acquired Wall Street Support. Indeed, entire industries, ranging from consumer electronics to basic household goods and low-priced consumer items, are manufactured overseas.
Why? Although there are many factors contributing to this flight from the US, at least some of the reasons are that foreign capital (offshore investors) do not have the same investment criteria as we in America.
Along with Warren Buffett, we voted with our wallets decades ago, indicating that we wanted returns far above those of any conventional manufacturer. You need look no further than the Stock Market to see where America puts its money. Today, this country has it all riding on the Magnificent 7, the world's most expensive group of high-tech companies. Nearly one in every three dollars invested in the stock market goes to the Mag 7. As a result of this focus, each Mag 7 company is currently valued at more than a trillion dollars, a level first achieved by Apple Computer just seven years ago.
Nvidia, the AI Chip Maker, currently has a market capitalization of over $4 trillion, a level 100 times greater than America's formerly dominant manufacturing company, Ford Motor Company.
It should come as no surprise that, with a surplus of capital, companies like Apple, Microsoft, Alphabet, Facebook, Amazon, Tesla and Nvidia, among others, will continue to expand and develop their products and services.
However, it should be equally apparent that companies starved of capital, such as Ford, General Motors, and others, will likely suffer.
Ultimately, capital has proven to be the decisive factor between success and failure for American enterprises. And to the extent that investors allocate capital away from some, as Buffett did for Berkshire Hathaway, and toward others lies our economic future.
Who can argue with Buffett's investment success?