SAFT ON WEALTH-Crumbs today, jam tomorrow?

Wed Jul 9, 2014 4:30pm EDT

(James Saft is a Reuters columnist. The opinions expressed are his own)

By James Saft

July 9 (Reuters) - Creating needs among consumers is both the basis of our economy and a really risky investment strategy.

That is the message from the demise of cupcake company Crumbs Bake Shop, a (former) seller of cupcakes each of which averaged about one fourth of your daily caloric needs.

Crumbs, which not too long ago had lines out the door, said this week it was ceasing trading and would shutter all its locations.

Shares in the publicly traded bakery, which had 48 stores in 10 states, now change hands at 1 cent, down from its peak of $12.72 in 2011 shortly after it went public via a reverse merger with a publicly traded special-purpose acquisition company.

While it is easy to dismiss Crumbs as an ill-conceived business surfing the confluence of several self-limiting trends (diabetes might arguably have been mentioned as a risk factor in its SEC filings), the company is actually worth considering in a bit more detail as an illustration of how we live, invest and function as an economy now.

A crucial feature of our modern economy is that, as old human needs are filled more easily and cheaply, newly manufactured ones must arise. This is important in that it redeploys otherwise underused capital and labor to new markets. This is why, despite the migration of the cotton mills from Massachusetts to Alabama in the 19th century and on to China more recently, those locations, while suffering unevenly during the process, saw living standards rise.

That's been done through the creation of markets for new needs and services, most of them undreamt of by our ancestors and former selves. Be it iPhone cases, day spas or cupcakes, the country would arguably dissolve into depression and riot if we all weren't buying stuff we until recently didn't know we needed.

Now, many of these new goods and services are hugely useful - think GPS-based location applications - and are simply the result of the clever use of technology to fill old needs better. (Think, for example, of how often you would consult a map in 1980.)

Some, like those services which allow you to turn on the kitchen light from your office, span the gap between useful and obsessive-compulsive.

ONE MAN'S CUPCAKE ...

Still others, like massage or cupcakes, are, though they usually make some appeal to being therapeutic, essentially about pleasure, and pretty much entirely optional. Pleasure, of course, is a good thing, and lots of money has been made from it.

The problem, and here we return to Crumbs, is that what people consider to be pleasurable is so changeable. The tasty, affordable treat of 2008 is 2014's shuttered retail premises.

And yet, as investors, we are almost forced to commit capital to some of these areas. Arguably it is very difficult to be an investor in 21st-century America without being heavily exposed to trends, many of which may prove to be evanescent.

Another way to look at it is to look at household expenditures on non-necessities. According to the Bureau of Labor Statistics, household spending on life's extras has risen from just above 20 percent in 1901 to more than 50 percent at the turn of the millennium. That's a huge share of the economy.

Crumbs is one example, albeit one at the indiscriminate edge of discretionary spending. But, just as people today aren't interested in the cupcakes that seemed so 'fun' three years ago, so might they decide in future that Facebook (or Myspace) isn't where they want to spend time. True Facebook's network is a powerful force, in essence a very effective loyalty card, but these things often develop unexpectedly.

The creation and adoption of new needs is inevitable, but highly unpredictable. It is not at all clear that the publicly offered securities in businesses in these sectors reflect these risks.

Which brings us to the last trend that Crumbs seems to represent - financialization, which as a concept boils down to the increase in a country's financial spend as a percent of the economy. Your typical chain of restaurants 35 years ago would grow more slowly than today, use less debt and have far less of an eye to an exit for founders and early investors via equity markets. Everyone's best exit is via the stock market, and the stock market's offerings, inevitably, reflect that.

Chains today grow very quickly and, it seems, take large risks in order to get a chance at large paydays via public markets.

Investors would do well to remember that when considering the latest hot IPO. (At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. You can email him at jamessaft@jamessaft.com and find more columns at blogs.reuters.com/james-saft) (Editing by James Dalgleish)