A View Of The Future

In order to look ahead, let’s review the past. And let’s bear in mind the prophetic quote of General Douglas MacArthur that “The economic history of the world will be written in the Far East the next 100 years”.

The elements of production include three items: land (resources), labor and capital. After World War II, the U.S. had capital, huge resources and an abundant supply of “reasonably priced” labor. The outlook for our economy was rosy as far as we could see. At that time, South Korea, Taiwan (Formosa), Singapore and Hong Kong were feudal economies. The next 40 years transformed them into economies with a strong economic class system that is now better educated, healthier and living in conditions with modern conveniences much like we enjoy in America. Adjusted for inflation, world production grew from $6.5 trillion in 1960 to $32 trillion in 2000. Far Eastern economies’ growth exceeded the rest of the world during that time.

Why was that? More importantly, does that trend lend itself to prediction of future economic activity? The answer is cheap labor. Currently there exists cheap labor, and an educated work force in Eastern economies that will make competition with them very difficult.

Why Asian economy’s growth will exceed the rest of the world’s growth

There are three things that provide for the creation of wealth in an economy:

1)		Invention: Do you remember grade school history classes discussing the importance of inventions like the Cotton Gin, the Reaper, the Bessemer steam engine, and so forth? These inventions, and others, spawned entire industries.

2)		Engineering: Before an idea can be produced, it has to be engineered so that production is possible. Throughout our history, we have realized the importance of engineering and science. Universities created productive and challenging curriculums that complimented the economies’ needs.

3)		Production: This is the big potential for profit. Profits provide for saving and reinvestment in plant and equipment to sustain growth.

To the producers of products go the largest profits. In free market economies, the producer will be the “low cost economy” which supplies the least expensive labor.

Let’s examine current trends:

1)		Question: The average wage in the United States is $21.00 an hour verses .65 cents an hour in China and India. China and India together comprise 1/3 of the world’s population. How is this huge population, coupled with low wages, going to affect the U.S. economy? Answer: Never before has the world had such a large supply of inexpensive labor become available in such a short period of time. The $20.00 difference in labor that currently exists per hour will easily make up for the cost of transportation to ship more competitively priced products to markets.

2)		Question: The October U.S. trade deficit “un-expectantly ” climbed to an all time high of $55.5 billion, $666 billion annualized. How will this affect our trading partners in the long run? Answer: Trade deficits are actually charges against, or obligations of, the dollar. In the long run, theoretically, the dollar will continue to go down, and competing foreign currencies will increase in value, to the point where equilibrium will exist in the cost of production and the sale of products. Since we have never been exposed to anything quite like this in economic history, who knows if economic theory will play itself out. What we do know is that countries like China will continue to extend us credit as long, and only as long, as it is in their best interests to do so. If the dollar continues to go down, and the euro continues to go up, Europe is going to be a much more attractive trading partner for Far Eastern economies than the U.S.

3)		Question: The U.S. has slipped from first in graduating and training computer engineers to number 3 behind India and China respectively. The number of bachelor degrees in the U.S. is around 60,000 annually and the number of bachelor degrees in Asia is around 270,000 annually. Of that total, degrees in math and computer sciences in the U.S. is only half of the math and computer science degrees earned in Asia. How can this be expected to affect us in the long run? Answer: In the long run, Asia will do to us exactly the same thing that America has done to Europe over the last few hundred years. We educated our masses and educated them well. The fruits of that education became a booming U.S. economy, the development of the U.S. into a world military power and the creation of a lifestyle that is unparalleled in history for luxury and convenience. Educated people will learn that a better standard of living is available if they earn more money, and they will endeavor to succeed economically so that they have what we have. As long as labor overseas is significantly cheaper than labor in the U.S., the U.S. standard of living must remain stable, at best, or go down. Economies that have trade surpluses will reinvest those surpluses in further education, which will improve the standard of living in those countries.

4)		Question: China has accounted for 40% of the growth in oil demand since 2000. Russia recently passed Saudi Arabia as the world’s largest exporter of oil, and Russia’s biggest customer is China. How will this affect our economy? Answer: In addition to China accounting for a large percentage increase in the demand for oil over the last few years, Russia and India have disproportionately increasing demand for oil and gas, too. With the cost of their labor, their geographical position, and huge resources, it’s probable the world will end up with three large trading blocks: Europe, the West, and Asia. If resources are more easily available to them, and if labor remains substantially cheaper for them, there must be a huge shift in wealth to those countries.

5)		Question: The Euro was introduced at 116 cents to the dollar in 2000 before it dropped to 82 cent to the dollar in early 2001. The Euro is currently at 134 cents to the dollar. What do all these changes in value mean? Answer: When the U.S. government was creating large budget surpluses, the dollar was strong relative to the Euro and relative to the rest of the World’s currencies. As deficit spending occurs, and as trade imbalances increase, obligations are attached to the dollar, which cause it to go down relative to the rest of the world’s currencies, and relative to historical currencies like gold. Gold, for example, in only a few years has advanced from $242 per ounce to $450. What we are seeing is the beginning of the currency equalization process. This does not mean that our standard of living and our economy are going down the tubes. This country still produces 30% of the world’s GDP, and this country is still by far the most integral part of the world’s economy.

Conclusion

In addition to all of our problems, there is no doubt that China, India and Russia have problems of a magnitude equal to or greater than ours. They will run into rough spots and struggle more than we will because of their unstable political systems and their massive poverty. Each of those countries has a war, or near war, on their borders, which must effect both their economic growth and their national concentration. Massive illiteracy, massive unemployment and massive monetary problems must be dealt with. Any of these problems can create economic setbacks. We don’t know what will happen. There is no way of telling.

What we do know, however, is that every one of the issues discussed above will have an effect on U.S. stock markets. The playing field so favors foreign producers in terms of profits that over the next several years it is hard to see how U.S. stock markets can climb from current levels. U.S. values are already too high. Increases in consumer debt, un-competitively priced labor, trade imbalances, and continued government deficits will put extreme pressure upon U.S. corporate earnings. Based upon our current economic outlook, it is more likely that the market will go down from these levels rather than stay at this level or increase from these levels.

The operative words are: caution, conservation of capital and be happy with 5% returns in money market instruments. Do nothing that makes it difficult to sleep--do nothing that gives us anxiety. These are tough economic times. During uncertain times it is always more prudent to position oneself so that one does not loose money.

Caveat Emptor!
George Rauch
December 2004

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