Market Watch - January 25, 2004
Between WWII and the Korean War, General Douglas
MacArthur was fond of saying “the economic history of the
world in the next one hundred years will be written in the Pacific
Basin”. When questioned as to why, MacArthur always said,
“an abundant supply of cheap labor”.
Taking a look at economic history, it’s important to remember
two things, (1) investment capital will follow inexpensive labor
and (2) all economic analysis can be reduced to understanding the
flow of funds (heretofore known as gold!).
With that in mind, let’s take a quick look at the development
of great wealth in written history which started in the Middle East
many thousand years ago. As the Middle East increased its wealth,
the cost of living, even with slaves, began to rise. The rise in
the cost of living, meaning higher wages, caused Middle Eastern
economies to invest their gold with newly developing economies in
the Mediterranean Basin. As Mediterranean Basin countries became
“mature economies”, the cost of labor rose necessitating
the development of trade with, and the investment of gold in, Northern
Europe. As the cost of living in Northern Europe increased because
of higher wages, and more expensive resources, Europe began to trade
with, and invest gold in, developing economies in America.
In 1949 the United States owned an unbelievable 80% of the world’s
gold reserves. Most of our gold reserves are now depleted. The winds
have changed and are blowing towards the Pacific Basin. Japan, with
a population of just less than half of the United States, became
a viable competitor to the US only thirty-five years after WWII.
Japan had an educated, hard working source of cheap labor. By 1990,
Japan’s labor rates equaled, or exceeded, US rates causing
Japan to begin developing manufacturing facilities outside of their
own country. Japan and America developed huge operations in Taiwan,
Hong Kong, the Philippines, Singapore and Thailand. Their labor
rates are too high now which has caused the world’s manufacturing
countries to look towards less expensive sources of labor in China
(and India).
Wealth is shifting to the Pacific Basin. Does this mean we are going
to be broke? No – it simply means there will be a continuing
leveling of the playing field. On a percentage basis the United
States will receive less of the world’s future wealth and
Pacific Basin economies will continue to receive more.
Japan, the United States and Europe account for roughly 75% of the
world’s 30 trillion dollar annual GDP. The United States’
GDP is roughly 10 trillion dollars, or 1/3 of the world’s
GDP. Consumer spending in the United States represents about 7.5
trillion dollars of US GDP. American consumers, therefore, spend
about 25% of the world’s GDP on consumer goods, (let the good
times roll!). While this is terrific for us, it is unlikely that
only 4.5% of the world’s population can sustain such enormous
spending habits for the following reasons:
1. | As cash (wealth), through negative trade balances, is transferred to poor countries, the demand for consumer goods in those countries will increase, thereby increasing the cost of those goods to Americans. Increased costs are Ok as long as you have increasing wages to sustain buying habits. With our 500 billion dollar trade deficit, however, money is being transferred to the east more quickly than capital is being created here. | ||
2. | This last year, for example, we have had a real increase in GDP of around 300 billion dollars and an increase in corporate, consumer and government debt equal to 2.4 trillion dollars. Every dollar increase in GDP, therefore, was bought with 8 dollars of debt. Using a simple example, put 8 building blocks on top of each other representing debt and 1 building block next to it representing real GDP growth. As years go on and the building blocks of debt stack up relative to the blocks representing real GDP growth, something will have to give. What’s “giving” is the value of the dollar. If you were Japanese or European and you were invested in US stock markets, since May 2001 you have lost around 37% of your money. That discourages investors from making commitments in America that produce jobs. | ||
3. | Manufacturing and agriculture produce wealth. Our manufacturing and agricultural jobs are being lost, the former because of the movement to lower wage countries, and the later because of productivity gains making the component of labor in producing a bushel of grain a lot less than it used to be. |
The next question is, what will happen to the
United States while this huge shift of funds is occurring? And the
answer is, nobody really knows. It’s likely we will look very
much like Europe in the future: a big, welfare state government,
huge debt, high labor costs, and an inability to compete in world
manufacturing markets. We will be prosperous but not like we have
been. It is simply not feasible to assume a continued loss in manufacturing
jobs, and the increase in debt in our economy will not have a negative
impact upon growth. The deteriorating manufacturing base and loss
of jobs, coupled with the need to service our debts and meet our
future obligations, along with the cost of carrying our government,
simply means we cannot price our products competitively. There must
be huge fundamental changes such as: a much lower dollar, lower
wages in the United States, drastically reduced government spending,
a reduction in the increase in debt, and a reduction in overall
debt. That’s just the basics, and they are overwhelming!
If this is true, is everything going to get really bad and should
we consider suicide? No, of course not. What is, is, and there’s
no reason we cannot continue to live happily within our own economic
system. We will have less disposable income, and countries with
currently inexpensive labor markets will have more disposable income.
China’s growth is currently much greater than anybody else’s,
they have huge unemployment problems and a willing labor force,
and they represent 21% of the world’s population. Their potential
for growth is enormous compared to mature economies with high labor
rates like America, Europe and Japan.
CONCLUSION
We are not correctly positioned to compete in this rapidly changing
world, and we cannot reverse the cost of our expensive social programs
in time to compete with China. Several Standard & Poor 500 companies
have excellent potential to succeed because they have positioned
their manufacturing facilities in China. However, those companies’
stocks are already more fully priced than any time in history.
We are in a bear market, and we’ll continue to be in a long-term
bear market until fundamentals in the US change. Bear
markets exist to correct the excesses of the past. A sell off on the down side could deliver a knock out punch to investors.
The cautious investor will stay liquid.
It’s wise to listen to financial prophets like Warren Buffet
who is not now investing in US markets. He is fond of saying that
“over the short term the market is a voting machine, but over
the long term the market is a weighing machine”. Imagine what
will happen to the US markets if Buffet is right again. How about
what has happened over the last fifteen years to the Japanese markets
happening to the US markets? China’s vast supply of inexpensive
labor has the potential to cause the US economy to be in a stagnant
position for years to come.
Caveat Emptor!
George Rauch
January 25, 2004