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       Investor's Insight - Wednesday, March 1, 2006           
          "A Digest of Investment Opinion From the 
             World's Leading Financial Advisers"


Comment The Post Below...

by Scott Burns

TEMPE, Ariz. -- Edward C. Prescott stands quickly, walks 
to his blackboard and writes an equation for growth. The 
last item in the equation is "plus residual." He underlines 
it with his chalk.

The word "residual" is to economists as dark matter is to 
astrophysicists -- it's something that's there but difficult 
to see. Maybe it is impossible to see. 

But without it, equations don't explain results -- what we 

Prescott, who won a Nobel Prize for economics in 2004 and 
teaches here at Arizona State University, has spent most 
of his career thinking about economic growth, what supp-
orts it and what hinders it.

A poster in his office intimates a basic life stance: 

Loyalty to petrified opinion never yet broke a chain or 
freed a human soul. -- Mark Twain

Unfortunately, I am having some trouble keeping up. It is 
one thing to read his papers. Then, I can move my lips at 
leisure. Here, listening, I get a visceral understanding 
of the phrase "drink from a fire hose."


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But one thing is certain: Residuals are important.

One of those important residuals, explored in a series of 
papers with Minneapolis Federal Reserve economist Ellen R. 
McGrattan, is the intangible stuff not measured by con-
ventional accountings -- investments that are treated as 
expenses, and what most people call "sweat equity."

He describes the '90s -- all the start-ups, the dot-coms, 
the rush into a 24/7 world of long workdays, the MBAs who 
turned down $100,000 jobs to work 80-hour weeks for 
$2,000 a month -- THAT, he says, is sweat equity.

More important, it doesn't appear in any official statis-
tics because, well, how could it?

So while the hours of work were going up and there app-
eared to be little to show for it in national output, 
something was really happening. We just didn't have the 
measuring tools.

Finally, all that work -- all that unmeasured investment 
-- showed up. Where? In IPOs, big capital gains and rich 
public stock prices, as all that sweat equity found a 
way to be monetized. Skeptics should consider that Yahoo, 
a product of the Internet boom, was worth $55.5 billion 
at the end of 2005, while Rupert Murdoch's NewsCorp, 
which has been around for decades, was worth somewhat 
less, $53.9 billion.

And that's not even considering Google, which, at its re-
cently reduced $369 a share and $109 billion market cap-
italization, is still valued at more than eight times 
General Motors and nearly twice as much as the entire 
newspaper industry.

So expensed investment and sweat equity are real, not 
hype. And they explain some of the mysteries of the '90s.

I asked Prescott if he thought the United States could, 
and should, privatize Social Security.

"I'm pushing hard for more savings; otherwise, we'll have 
generational warfare," he answered. "And, by the way, it 
(more private saving) would knock the hell out of poverty, 
raise the median wage, and we would have much higher 

Can we afford the debt? I asked, referring to the unfunded 
liabilities of Social Security.

"If we had more explicit debt out there, it would be man-
ageable. We can honor the promises, and we should. On the 
other hand, Europe shouldn't. I see the U.S. as just re-
forming its retirement system with cash plans. Add problems 
at the Pension Benefit Guaranty Corp., and the system will 
move toward mandatory savings. 

"I think ownership is important. In Mexico they're develop-
ing a mortgage market. It's making big changes as people 
see things differently."

I asked what he thought about our tax system.

"It's a bad system. If you increase tax rates, you won't 
get much more revenue. We're pretty close to the top of 
the Laffer Curve. Today, what we need is some time consist-
ency with the tax code."

Do you think the Fair Tax proposal (for a national sales 
tax) would work to stabilize taxes?

"What scares me is that tax rates would just pop right up. 
They can't keep their fingers out of the jar," he said, 
referring to our legislators. "In fact, our income 
tax is really a consumption tax, because we can put aside 
money to consume later (in qualified accounts)."

I asked what he saw as major dangers to the future.

"One would be the anti-globalization nuts. The people 
protesting may screw up a good thing. If countries become 
islands to themselves, we'll have another depression.

"Will it happen? I don't think so," he said.

What about the price of oil? I asked.

"I don't think the high price of oil is anything. We've 
let the market adjust before."


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Is our current account deficit a major concern?

"The question is how can you spend more than you earn year 
after year and not be overwhelmed. I've been digging into 
these numbers and find these measures don't reflect true 
asset values. We see the earnings of the foreign subsid-
iaries and believe they indicate the value of the subsid-
iaries is greatly understated."

Again, the key is "residuals" -- the expense investment 
that never shows up in conventional accounting.

"Huge investments have to be made to establish a distrib-
ution network like Wal-Mart," he says, pointing to the 
knowledge that is embedded in organizations that never 
shows up on a corporate balance sheet but does show up in 
corporate profitability.

I leave his office as the sun is setting, heartened. If 
one of the best economic minds on the planet believes 
individual initiatives and creativity will power a posi-
tive future, maybe those of us in the whining trades 
should lighten up.

(Questions about personal finance and investments may be 
sent to Scott Burns, The Dallas Morning News, P.O. Box 
655237, Dallas, TX 75265; or by fax: (214) 977-8776; or 
by e-mail: scott@scottburns.com

Check the Web site: www.scottburns.com

Questions of general interest will be answered in future 

(Investor's Insight reflects the opinions of experts. It does 
not recommend any specific investments, and no endorsement is 
implied or should be inferred. For more information, contact 
the individual firms cited).



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