Some highlights from the Levy Economics Institute

A few nuggets from the July 2007 Levy Economics Institute conference:

Dimitri Papadimitriou foresees an improving current account deficit over the next three years. Private sector debt should level off as a proportion of GDP. The Congressional Budget Office's forecast and targets for 2010 assume continuing home borrowing, but if this doesn't happen, the model suggests that budget deficit needs to increase to 4.6% of GDP. The alternative is a depreciation of the dollar, which is unlikely because (a) this would increase inflation and (b) China does not wish the renminbi to rise significantly against the dollar. A propos the last, Robert Barbera explained that a renminbi appreciation would raise the price of China's farm products and hit the living standard of its large rural population.

Robert Parenteau looked at US private borrowing: "the prospect of a hard landing should be taken seriously".

Wolfgang Muenchau of the Financial Times thinks that despite having stronger fundamentals than America, Europe is likely to be affected by a US downturn, because European stocks, property prices and interest rates tend to follow America's lead, and a strengthening of the Euro against the dollar would hit European exports and economic growth.

Torsten Slok considered longer-term inflationary pressures in the US: demands for pay raises, an increasing proportion of retirees overstraining the budget, and the possibility of an overheating Chinese economy that would up US import prices.

James Paulsen thought that the US could regain some of its consumer market share through "a long-term sustained contraction of its trade deficit to revive domestic manufacturing".

Frederic Mishkin of the Federal Reserve was relatively relaxed about subprime borrowing, saying that such loans represented less than 10% of all mortgages.

Buffett on trade imbalances

Warren Buffett's 28 February 2007 letter to shareholders is available online, and makes educational and entertaining reading. Here's a pithy extract:

As our U.S. trade problems worsen, the probability that the dollar will weaken over time continues to be high. I fervently believe in real trade – the more the better for both us and the world. We had about $1.44 trillion of this honest-to-God trade in 2006. But the U.S. also had $.76 trillion of pseudo-trade last year – imports for which we exchanged no goods or services. (Ponder, for a moment, how commentators would describe the situation if our imports were $.76 trillion – a full 6% of GDP – and we had no exports.) Making these purchases that weren’t reciprocated by sales, the U.S. necessarily transferred ownership of its assets or IOUs to the rest of the world. Like a very wealthy but self-indulgent family, we peeled off a bit of what we owned in order to consume more than we produced.

The U.S. can do a lot of this because we are an extraordinarily rich country that has behaved responsibly in the past. The world is therefore willing to accept our bonds, real estate, stocks and businesses. And we have a vast store of these to hand over.

These transfers will have consequences, however. Already the prediction I made last year about one fall-out from our spending binge has come true: The “investment income” account of our country – positive in every previous year since 1915 – turned negative in 2006. Foreigners now earn more on their U.S. investments than we do on our investments abroad. In effect, we’ve used up our bank account and turned to our credit card. And, like everyone who gets in hock, the U.S. will now experience “reverse compounding” as we pay ever-increasing amounts of interest on interest.

I want to emphasize that even though our course is unwise, Americans will live better ten or twenty years from now than they do today. Per-capita wealth will increase. But our citizens will also be forced every year to ship a significant portion of their current production abroad merely to service the cost of our huge debtor position. It won’t be pleasant to work part of each day to pay for the over-consumption of your ancestors. I believe that at some point in the future U.S. workers and voters will find this annual “tribute” so onerous that there will be a severe political backlash. How that will play out in markets is impossible to predict – but to expect a “soft landing” seems like wishful thinking.

It's reassuring that Buffett thinks per-capita wealth will increase; this is an antidote to the most extreme doomsters. But it begs the question of how equitably that wealth will be distributed. The transfer abroad of industrial jobs leaves most of their former holders in less well-paid employment, while boosting the profits of large multinational companies (such as Wal-Mart, in which Berkshire Hathaway has close to a billion-dollar stake). From James Kynge's China book, it seems that the gap between America's rich and poor is widening, and the middle class is shrinking. Save and invest while you can.

Buffett is also enlightening on the future of newspapers in the electronic age, and the occasional bargains to be had in insurance. His firm has made money out of carefully-considered reinsurance (including for Lloyds of London) and derivatives. Berkshire Hathaway has gradually moved from being a "growth" to a "value" business, delivering returns increasingly from income earned, and insurance business helps. BH has made a profit from "super-cat" insurance in the past year, but Buffett warns that Hurricane Katrina wasn't the last nor the worst possible.

Note also the warning in the extract about the dollar. Recent falls aren't the end of the necessary decline - see to the Levy report referred to in my previous post.

Global imbalances: new report

Please click here for the July report from the Levy Economics Institute: "Global imbalances: prospects for the U.S. and world economies".

A weakening dollar means lower US living standards

Addison Wiggin in yesterday's The Daily Reckoning Australia spells out how the dollar, US debt and declining American living standards are related. Some will contest this proposition fiercely - have a look at the recent globalization thread on Cafe Hayek, for example.

For those who read the bruising commentaries (this seems to be typical of blog-related correspondence), I did look at the articles to which LowCountryJoe referred me, but the first only makes clear what a fiat currency is, and the second theorized that all currencies must originally have had some intrinsic value. Neither of these articles disproves the bears' contention that there is a horrible temptation to inflate fiat currencies for temporary advantage, and that the end result is a flight from those currencies. We shall have to see.

It's an ill wind...

A funny piece by Tim Hanson in The Motley Fool for June 26. He makes the point that travelling to a place may not change the facts, but can change your perspective, and he is bullish on some sectors of China stocks.

As you might expect, given that the outgoing tide of wealth from the West is rising in the East and floating Chinese boats. They will bob up and down, and some may tip over, but that seems to be the trend.

Richard Duncan's worry is that the ever-inflating dollar is causing the markets to operate inefficiently, so that China's rise may be preceded by a crisis that creates a long and deep global slump. I really must post a summary of his book soon.

James Kynge on China in 2014

If you've read James Kynge's very worrying book "China shakes the world" (2006), you may be interested in an article he published before then, in November 2004. It's in "The Alchemist", which is the quarterly journal of the London Bullion Market Association. Some salient points (though I can't say whether Kynge would say exactly the same things now):

1. The housing market has soared in China, creating massive wealth.
2. "The economy does not look terribly overheated or overbuilt."
3. "Consumer spending - especially on services - is quite a bit higher than official statistics show." (Perhaps this will answer Richard Duncan's recommendation to stimulate demand in developing economies.)
4. Property prices are so high (in 2004) that the rate of appreciation must slow down, which in turn will reduce the demand for steel, aluminium and cement; "a GDP slowdown is in prospect."
5. In 2003, China was responsible for nearly all the increased demand for copper, nickel and steel, but its appetite will endure: "When, and if, China overtakes the US as the world's largest economy, its people on a per capita basis will only be one sixth as wealthy as Americans. They will still be hungry, still cost competitive."
6. The middle class will grow more quickly than GDP; high-tech industrial wage rates will increase; low-tech factories are being forced inland, away from the trading seaboard.
7. China will move from manufacturing (at that time 60% of GDP, versus 30% in the US) towards services and a knowledge economy.
8. China will not collapse, but environmental problems will slow its industrial growth. Land is already intensively used, the north is short of water; air pollution is increasing the burden of health care to the point where the cost may exceed the value of extra factory output.
9. Demographics will also slow China - the over-60s are expected to rise from 11% of the population in 2004 to 28% by 2040. "China may grow old before it grows rich."
10. "China already has too much stuff" - the oversupply of manufactured goods has wiped out profit margins and the banking system is full of debt.

Going back to point 5 for a moment, Kynge doesn't see an end to the trading imbalance. China may decelerate, but it's still going to suck wealth out of the West for a long time.

Marc Faber: consumer spending to decrease

Seeking Alpha's Sunday review of fund manager stock suggestions reveals that Marc Faber expects consumer discretionary spending to decrease:

"He calls for a 10% correction by year-end, with emerging markets down 20%."

That may reduce the monthly trade deficit for a while, but won't turn it into a surplus. China's ultra-low wage costs, combined with what seems to be very loose enforcement of intellectual property rights, are still set to hollow out Western industrial production of all kinds, as James Kynge's book makes abundantly and frighteningly clear.

It's all very well finding ways for individual investors to benefit, but if you haven't got spare money to invest, you can't back the winner in this unequal contest. Without some degree of prosperity, what real peace will our countries have? I'd like to see a credible national economic plan from our politicians.

Pay your bills, or lose your assets

You can rely on Richard Daughty to carry on fighting the brave fight - I really think it's pro bono publico, as I don't see any attempt to turn his work into sales leads for him.

Yesterday's essay continues with the theme of global credit expansion to keep up with the seemingly unstoppable increase of dollars. I suppose that wouldn't be so bad, if it weren't for two considerations:

1. Inflation is unevenly spread, and the 10+ % money supply increase is inadequately reflected in your bank savings interest, so your money is rotting away there. You then have the unenviable task of deciding where else to store your wealth to stop it shrinking.

2. While our governments continue to turn the currency into used bus tickets, the trade imbalances deteriorate, and the international wealth transfers and the world's economic instability worsen.

Will America always be able to make the interest payments on its rapidly-swelling debt? Or is she prepared to see the debt turn into foreign ownership of the economy?

There's a century-old Punch cartoon that shows a plumber sitting on the step of a middle-class house. A passing colleague asks him how the job is going, and he replies that he's taken the house in payment for his work.

To sum up... from India

A chartered accountant from India today summarises the general bear case about USA trade deficits and the future of the dollar. Mr Venkatesh apportions some blame to Asian countries, for choosing to keep their currencies weak in order to sustain their trading advantage.

The article is well worth reading in full, in particular the comments on oil and the threat of trading crude in Euros rather than dollars. It is also worrying that...

On March 28, 2006, the Asian Development Bank is reported to have issued a memo, advising members to be ready for a collapse of the US dollar. [see the International Herald Tribune report here.]

Since end March 2006, the US Federal Reserve has stopped publishing the quantum of broad money [...] This is the worst possible signal that the US Federal Reserve could have sent to the world.

[The rise in commodity prices] has led to inflation across the globe. No wonder countries are forced to increase their interest rates to fight inflation. This has triggered an interest rate hike across continents and the US is finding it extremely difficult to sustain its current borrowing programme: it hardly has any elbow room to manoeuvre.

The author says that the US can neither raise interest rates much further, because of the cost of servicing debt, nor lower them, because that may deny it fresh supplies of credit.

Either we are witnessing a global meltdown of the US dollar, or a controlled US dollar devaluation (read, revaluation of other currencies). If it is a global meltdown the global economy is doomed, if is an orderly devaluation, it is damned.

US Commerce Department figures: the good news is bad news

The US Commerce Department reported on Friday a narrowing of the trade deficit in April.

What is remarkable is the positive spin on the story. When you look at the figures, exports increased by $0.25 billion, but imports fell $3.6 billion. So 94% of the improvement is simply down to reduced demand for imports. This could be interpreted as a sign that Americans are tightening their belts, rather than improving their trade.

And how do we factor the dollar's exchange rate into these import and export figures? How do the numbers actually translate into quantities of physical goods?

Also, it's still a deficit, and at $58.5 billion in one month, divided by the USA's estimated (CIA, July 2007) population of 301 million, that's $194 bucks worse off per head. Or, given the average US household size (2.59), it's $6,037 per household per year. AAA statistics show you could run a small sedan on what you're losing to overseas trade.

US dollar needs to fall; intellectual property needs protection

An interesting report from China Daily yesterday. The American Chamber of Commerce there is asking for less pressure to revalue the renminbi and more for structural reforms in China.

The value of the renminbi is not the answer to everything. If the Chinese yuan rises against the dollar, then Chinese imports will cost more, and America might well cut back; but US industrial exports could be slow to grow because of eroded manufacturing capacity. And a weaker dollar would mean foreigners could bid more for US products (including foodstuffs), so creating price inflation in the US while production lags behind demand.

And there is also the question of just how much the dollar would have to drop to make US products globally competitive anyway. What you could see is Chinese light industrial manufacturers suffer a contraction, losing business to countries that have even lower wage costs, such as Vietnam. When the dust has settled, America's balance of trade crisis could simply have widened from US-China to US-Far East.

So it's not so much the renminbi that has to rise, but the dollar to fall.

Also interesting to see intellectual property rights come to the fore. As America sees her economic strength sapped, she must worry about the scruples of her competitors. If "might makes right", patents and copyright may not be the pension she was hoping for. I did discuss this a while ago (May 23), and think it's an issue to follow.

The monstrous scale of the US and UK trade deficits

Have a look at the table in this article from Market Oracle. The figures speak for themselves!

British readers, please consider the fact that we are only two above the US, although our GDP is far smaller.

Globalisation and economic depression - some strategies

China has its problems. Monsters and Critics, quoting UPI, says that 3.5 million jobs could go if the yuan appreciates much more against the dollar. But if it doesn't, the trade imbalance continues and the economy and stockmarket carry on overheating. So China too is between a rock and a hard place.

In the long run and given free global trade, surely low-wage economies will take work from the higher-wage ones, until we reach equilibrium. It's the rate of change that makes it messy. For people like the Chinese, they have to work out how to take over our manufacturing capacity without bankrupting their biggest customers; for the West, how to lose all this work and wealth and remain democracies.

Richard Duncan thinks it can't be done without some original form of intervention - he suggests a steadily rising minimum wage, to give the worker in the developing economies enough money to take over the job of buying things, a job that we in the West thought was ours for life.

But the implication for us seems clear - we must become poorer. The winners among us will be those who are able to extract capital out of their possessions and preserve it. Marc Faber says that there are bubbles everywhere - property, shares, commodities - but I guess that in a deflationary world there must be something that will increase in value relative to most other things.

Cash seems obvious - the deflation of the Thirties was such that in the UK we had the Geddes Axe, actually cutting the wages of public servants to maintain a steady relationship between money and things (UPDATE: I got Geddes wrong - see HERE - sorry). So public servants who had accumulated savings would have done well - if they had saved. For many others, it was unemployment and poverty. To get an idea of the process and consequences, read "Twopence to cross the Mersey" by Helen Forrester, a real-life story about the economic descent of her middle-class family, which had (typically) lived on credit before the Crash.

Some fear that our governments will shudder at the thought of repeating that period and will try to buy their way out of the jam by printing money, in which case we could go from deflation to hyperinflation, and this is where the gold-bugs raise their voices.

On this analysis, I should think the strategy is clear. First, get out of/avoid debt. Then, live simply, and if possible convert unnecessary assets to cash - which you may partly invest in whatever you think will hold its value. And look for the steadiest job you can find?

Small progress in US-China talks

The Strategic Economic Dialogue talks have concluded, to be resumed in another 6 months. Judging from Business Week's report, not much was gained by the US; but then, China is negotiating from a position of considerable strength. She's only doing what we would do in her place. Interesting that there were extra talks afterwards.

But America's indebtedness is also a challenge for China and the rest of the world, in a different way. Richard Duncan's book makes it clear that making too much money in international trade is perhaps as big a problem as losing it. More about this soon.

Wu Yi lays it on the line

Chinese Vice Premier Wu Yi said in her opening statement yesterday, "We should not easily blame the other side for our own domestic problems. [...] Confrontation does no good at all to problem-solving."

Tough, but true, and tough. The press weren't in on the whole two-day session, but this kind of sets the tone, don't you think?

US-China "Strategic Economic Dialogue" resumes

We're waiting to hear much from the Western side on the talks, but see here for a Chinese-angled general background to the series. However, this one from China View is more frank about the differences between the two sides.

Pakistan's Daily Times gives useful detail on the economic issues: US manufacturers are calling for further appreciation of the Yuan against the dollar, but "an international think tank, Oxford Economics, estimated that even a 25 percent revaluation of the yuan against the US dollar would decrease the total deficit by only 20 billion dollars after two years."

For the American side, it must be like an uncomfortable meeting with your bank manager.

China goes shopping for the world's resources

China is taking in $20 billion a month of foreign capital, according to this 9 March article from the International Herald Tribune. It has set up an agency to decide how to invest its (now) $1.2 trillion in foreign currency reserves.

There are many implications, some contradictory. Diversification could mean less demand for US Treasury bonds, and if China lends less to America, interest rates could rise in the USA. On the other hand, increasing its holding of other currencies will make it less disruptive for China to let the dollar drop against the yuan.

A stronger yuan will affect some Chinese businesses that trade with America, as previously noted. In a thread discussing America's trade deficit on China Daily, "tradervic" from Chicago says: "Mexico thought it had the cheapest labor market, welcoming all the American companies they could get. Then China showed up with their workforce, and those same American companies left Mexico, leaving the Mexicans running into America looking for jobs. It will be interesting to see what happens when the American companies start pulling out of more factories out China for Vietnam, Bangledesh, and other countries. It is like I told my cousins-in-law in China what happened to my cousins-in-law in Mexico and my immediate family in Detroit: Do not get too used to the jobs - they will not last forever."

I have previously suggested that China may be willing to accept these consequences, to some extent, as part of a strategic economic plan. Just as the Chinese in light industry should not take their jobs for granted, the US cannot rely forever on its bargaining power as one of China's biggest customers.

A Bloomberg article today explains how China is trying to manage the currency appreciation so as to limit the damage in employment terms. It also has a stockmarket bubble on its hands. Did China ever expect that wealth and success could be such a problem?

Now it can also start buying the world's assets. The IHT article quotes Jing Ulrich of J.P. Morgan: "They're not going to be looking for financial assets, but energy assets and natural resources, minerals — things China desperately needs." So bears who look to buy commodities as a hedge against US inflation, may be doubly motivated when they see a big player enter the same market.

Protectionism dressed up as concern for worker's rights, the environment

The Detroit Free Press reports on new terms of trade set by America which require that Panama and Peru "...maintain and enforce five basic international labor standards: freedom of association for workers, the right to collective bargaining, and eliminating forced labor, child labor and discrimination in employment." They must also "adhere to environmental protection standards in their manufacturing."

Next in line for this treatment is Korea - but will such terms apply to China? Don't expect too much, Motown: remember Vice Premier Wu Yi's warning two days ago - "Attempts to politicize trade issues should be resisted." Wait till China's car industry really gets going.

Meanwhile, let's see what transpires in next week's resumption of the Strategic Economic Dialogue talks between the US and China, for which Wu Yi's Wall Street Journal essay on May 18 is an advance keynote-setter. Since she'll also be representing the Chinese side there, I don't expect much to be decided in America's favour.

Chinese business can suffer, too

An article in WTOP news says that some areas of Chinese industry are surprisingly vulnerable to the currency exchange rate:

A rise of 10 percent in the yuan could lead to the loss of 5.5 million jobs in China, according to a report by the Chinese central bank. It said companies hardest hit would be those that make textiles, furniture, shoes and toys for export.

"If the yuan rises by another 5 percent, our profits will be totally wiped out," said Li Shaoxiong, deputy general manager of the Fujian Ala Shoe Co., which sold half its 2006 output of 6 million pairs of athletic shoes to American retailers.

Beijing is counting on such labor-intensive light manufacturers to create millions of new jobs. Even though its bustling economy is expected to grow by more than 10 percent this year, a big share of that is in heavier manufacturing and other industries that create fewer jobs.

Perhaps China will take the view that it can tolerate a rise in foreign-trade-related unemployment while it continues to amass capital; as the East gets richer, it will eventually generate its own demand for the products of light industry.

America's debt economy

As part of a longer item explaining why China is becoming the world's most important economy, Puru Saxena crisply summarises America's position:

"...the U.S. is the largest debtor nation the world has ever seen, its debt to GDP ratio is over 400%, it has a negative personal savings rate, its currency is overvalued and its society is heavily dependent on consuming cheap, imported goods."

If you, personally, owed 4 times your annual income and were now supplementing your income by further borrowing ("negative savings rate"), you'd look for debt counselling.

Add this to Jim Willie's comments about the export of jobs, and you can see why The Mogambo Guru is raving in his latest letter.