Americans should invest abroad - Wasik

Writing in Bloomberg yesterday, John Wasik considers how Americans should invest, since homes, equities and bonds all seem poor value. He recommends high-yielding foreign (i.e. non-US) equities, something Peter Schiff (Crash Proof) has been tipping for quite a while. This, he thinks, will provide yield but also hedge against further falls in the dollar's exchange rate.

Energy crunch = higher food costs

Continuing the theme of energy demands, the Contrarian Investors' Journal comments that the search for alternatives to oil is causing inflation in food prices.

Energy crunch?

Frederick Sheehan's article Reaping the Whirlwind, originally posted in Whiskey & Gunpowder, is reproduced today in Prudent Bear. The prose is rather poetic, but the issue is how an overheated world economy is straining the world's capacity to grow energy supplies to cope. Worse still, new housing designs in the US and upgraded housing in the developing world, are building-in permanent excessive energy demand.

Safe Haven suggests Dow 9,000 "in the intermediate term"

Chartist Robert McHugh at Safe Haven reads the runes and predicts a significant correction for the Dow - in real terms (i.e. as measured against gold), if not nominal terms.

How far to fall? iTulip on the Dow and house prices

iTulip shows charts that follow the Dow and house prices, comparing them with inflation over a long period. The implication of the way this information is presented, is that stocks are about 100% over trend, or to put it another way, have a 50% fall to get to the trend line, and house prices would have maybe a third to lose.

I would guess that in terms of crystallising loss, this is more significant for equities than for real property, because you have to live somewhere.

News hub for sub-prime mortgage issue

A contributor has kindly alerted me to a blog that explains the issues and collates news items - please click here. Sub-Prime Mess is now also on the link list (see sidebar).

Subprime mortgages: bad news and more to come

Following the collapse of Braddock Financial's $300 million Galena Street, Reuters (6 July) looks ahead to what other hedge funds will have to report.

The Mogambo Guru includes subprime loans in his latest Daily Reckoning rave. I do hope someone posts his Agora Financial conference speech onto YouTube.

Marc Faber bullish on Indian real estate

See here for Moneycontrol.com's interview with Marc Faber, where he expresses enthusiasm for Indian realty:

...I think that is a no-brainer in the long run. It is a problem for people who will have very high borrowings, against their realty because of interest rates. Realty has always been a cyclical industry, where prices move up or down. But by and large if I look at the world, the reason so many families are rich, that came out of realty, is that the money was tied up in realty. They did not do anything more stupid with their money like buying Internet stocks in 2000 and then losing 90% of their money as prices went down.

So, my advice essentially for people, if you are not an expert in financial matters, to own realty - a safer avenue to wealth.

Faber also predicts a near-future stockmarket correction in the US of more than 10%, and in the longer term:

I expect over the next 20 years interest rates in the US will go much higher than it is perceived by the market place as I think inflation in the US will accelerate on the upside partly because of the rise in the prices of commodity, energy and food. This is also partly because of the weakness in the dollar that will eventually lift import prices.

Calls for a fully-funded Social Security pension

Free Market News Network (July 2) interviewed Peter Schiff, who said that the current rob-Peter-to-pay-Paul pension system will unravel in a few years, because of demographics. Newt Gingrich (former Speaker of the House) thinks a funded pension system should be introduced, but control of the funds should be out of the hands of the government.

This is very similar to proposals put forward in the UK by the Pensions Reform Group, chaired by former minister for welfare reform, Frank Field MP. The working name for it is a "Universal Protected Pension". The proposals betray the same worry as Gingrich implies, which is that the government may find a way to steal all or part of the fund.

Houses and mortgages - reality worse than the news?

Rachel Beck of AP has an article in The Arizona Republic (July 3), showing that dodgy housing data may be understating the scale of the problems.

Living off our inheritance: global wealth distribution, GDP and debt

The World Institute for Development Economics Research of the United Nations University (UNU-WIDER) launched a report last December, about household net worth around the world. Here's a nugget or two from their press release:

“The study finds wealth to be more unequally distributed than income across countries. High income countries tend to have a bigger share of world wealth than of world GDP.” (p. 3)

This suggests to me that the wealthy countries are to some extent living on their capital.

‘China … fails to feature strongly among the super-rich because average wealth is modest and wealth is evenly spread by international standards. However, China is already likely to have more wealthy residents than our data reveal for the year 2000, and membership of the super-rich seems set to rise fast in the next decade.’ (p.4)

Surprisingly, household debt is relatively unimportant in poor countries. As the authors of the study point out: ‘While many poor people in poor countries are in debt, their debts are relatively small in total. This is mainly due to the absence of financial institutions that allow households to incur large mortgage and consumer debts, as is increasingly the situation in rich countries….many people in high-income countries have negative net worth and—somewhat paradoxically—are among the poorest people in the world in terms of household wealth.’ (p. 5 - italics are mine.)

Figure 7, “Asset Composition in Selected Countries”, shows the proportion of real property, financial assets and debt in 7 countries, including the US, Canada and Japan. Looking at the ratio of debt to financial assets, China is clearly the least debt-burdened.

When a spendthrift heir meets a poor but hard-working and hard-saving entrepreneur, the result seems predictable. Look at page 16 of Warren Buffett's 28 Feb 2007 letter to shareholders, which I quoted at greater length on July 5:

"The world is ... willing to accept our bonds, real estate, stocks and businesses. And we have a vast store of these to hand over.... [but] 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."

The world is flat - or is it? Is Leamer right about Friedman?

Thomas Friedman's book, "The World Is Flat" is a best-seller - Wikipedia summary here. Friedman's related website is here - I think the photograph of the author is interesting, for those who like to read faces.

Last year, Edward Leamer reviewed Friedman somewhat snippily here. Gosh, I wish people could be more succinct. As Byron wrote of Coleridge, "I wish he would explain his explanation". Still, I guess Leamer has to fly the flag for critical scholarship.

The issue is important: does globalization threaten America's standard of living? Free traders say no. But have a look at Figure 6 on page 33 of Leamer, showing global income distribution in 1980, when US per capita GDP was 4 times the world average. That's quite some inequality, and if they were two very different levels of water in the same canal, opening the lock between them would see wealth gush from A to B.

So as barriers to trade are coming down, why hasn't this happened? Leamer says (p.34), "Much of the difference in GDP per capita among countries comes from the greater amounts of physical and human capital in the West, which advantages aren’t going to go away any time soon."

I'm not so sanguine. As regards human capital, I think the East is very keen indeed to increase its investment in education and training, and isn't hampered by notions of equality of outcome for its students. As to industrial capital, we are watching a vast sucking-in of resources, right down to our iron manhole covers, by China and other emerging economies; but also (particularly in China) we see a rapid and determined acquisition of slowly-accrued Western intellectual capital.

I think the catch-up process would be even faster in China if their industries observed patent and copyright more scrupulously, so they weren't almost wiping out each other's profit margins in their domestic market; and financial capital will accumulate far more rapidly when Chinese manufacturers get to keep more of the foreign buyer's price, instead of losing most of the profit to shippers, distributors, marketers and advertisers. If I were Chinese, I'd be looking at those areas for the training of my bright young people; and I bet they are.

Figure 7 on page 35 compares global income distribution in 1980 and 2000. The rich have done fine, the middle earners have made almost no progress, the poor are gradually rising. But when you think about it, maybe the middle is progressing: Western industrial workers are losing their jobs and looking for work in less well-paid service industries, while new industrial jobs are being created abroad. James Kynge ("China Shakes The World") says he sees heavy industry taking over on the Chinese coast, and labour-intensive light industry being forced inland. The move from low-skilled to higher-skilled labour in China is certainly a progression, matched by downward movement in the West. I wonder what the higher end of the graph will look like in another 20 years, when the Chinese have their own armies of industrial tycoons, company VPs, economics professors, investment analysts and marketing experts? I bet they're quite content to watch their coolie-work go to even poorer countries, as long as it doesn't happen too soon in the game.

Leamer admits (p.46): "The real bottom line: we do not know the breadth and intensity of global contestability of US jobs, and until we do, we will not have a real handle on the impact of global competition on the US workforce."

Why is he relaxed? See page 48:

"Finally, I want to comment on what I think is the big issue. It isn’t globalization or a flat world; it’s technology and the post- industrial labor markets.

The US is in the midst of a radical transformation from industrial to post-industrial society. Some of this transition is associated with the movement of mundane manufacturing jobs to low-wage foreign locations, but much of it comes from the dramatic changes in technology in the intellectual services sectors. The policy response to the globalization force is pretty straightforward: we need to make the educational and infrastructure investments that are needed to keep the high-paying non-contestable creative jobs here at home and let the rest of the world knock themselves silly competing for the footloose mundane contestable jobs."

Well, I don't think the rest of the world is quite as silly as that. I don't think Western education systems are geared to excellence, as once they were; so for that reason, as well as IPR enforcement issues, I don't think we can bank on using our intellectual property to sustain our global income differential. I don't think multinational businesses have, or feel they can afford, nationalistic sentiment. And whenever I read statements that start "we need to do x", I get the feeling that x isn't going to happen. Individuals will still make their stellar way, but I can't envision the West as a whole reclining in comfort in a "post-industrial" society.

But maybe I'm wrong.

Soros increases his mining stocks

Coat-tail Investor reveals Soros' largest holding by far is Companhia Vale Do Rio Doce, the world's second-largest mining corporation. Soros has increased his holding by around 10% as of end March. He's obviously sold on the commodities/natural resources/industrial metals theme.

A useful feature of the Coat-tail site is that you can re-order the information by clicking on each column heading, which makes searches much easier.

Portfolios of leading investment managers

Here's a site that claims to reveal the investment portfolios of top managers such as Warren Buffett and George Soros. I don't suppose it will be able to say when they got into a stock, and at what price, but it should be instructive.

Subprime debt as a form of gambling

Those who are concerned about Bear Stearns and the subprime mortgage fiasco should read Paul Tastain's article in today's Daily Reckoning. He explains in detail how junk lending has gone from risky investment, to default insurance and ultimately to a kind of gambling. Some of the worst of this product has been bought by institutional investors, such as pension funds who have been almost forced to buy it by legislative pressure to increase bond holdings. He guesstimates potential losses in the region of $72 billion, or 20 times what it cost to bail out LTCM

These are certainly large figures, but maybe we should look at them in context. Interpreting the Russell 3000 Index data on this site, total US equities were worth around $15 trillion in 2005, and obviously rather more now. The 2007 estimated Federal Budget outlay is $2.655 trillion. That would make the putative $72 billion junk mortgage loss only about 0.5% of US investments overall, or some 2.6% of US government expenditure.

But the article is a wonderfully clear example of how systemic risk is created and expanded.

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".

Railroads: further details

Chris Mayer writes about railroads in today's Daily Reckoning Australia. After describing Chinese technical feats, he looks at factors that make railways more attractive in today's America:

- Container transportation is booming as America imports more of its non-perishable goods. But fuel costs are rising. The energy-efficiency of rail is an advantage over trucking.

- The US population continues to move to the cities, where land is at a premium. Rail is more space-efficient, and less polluting than cars or planes.

So Buffett is doing his customary thing, of backing dull, dependable, comprehensible business that's going with the flow.

Looking at wider issues, maybe a highly concentrated population implies not only highly-capitalised amenities, but centralised power. How will America change as urbanisation continues? Will the internalised society (life governed by shared expectations of decent behaviour, liberty, egalitariansm) become a society of rule imposed from outside and above?

As it happens, I am reading Bill Bryson's childhood memoir of Des Moines, Iowa and the Fifties ("The life and times of the Thunderbolt Kid"), and he remembers when America had millions of small, family-owned farms and the Midwest was dotted with thriving little towns. When the farm went, what went with it?

And coming back to the resource-efficiency/sustainability arguments, I have an idea that although cities seem to be more efficient (because people are closer to each other), they are highly entropic - it takes a lot of work to stop them falling apart in all sorts of ways. Maybe the more distant future is back out on the prairies, with a return to localised production and self-government.

A note of caution about the Gold Standard, and the Euro

Until I looked it up (isn't the internet wonderful?) I had thought that the "Geddes Axe" (which slashed UK public expenditure) was a response to the Depression. Far from it: some would say it was a major cause. It turns out that after the First World War, our politicians wanted Britain to be great again, and thought that meant getting the pound back up to its former exchange rate against the dollar - just as I dream about getting into my old teen jeans.

They managed to do it for a while, but the result was a deflation that failed to take into account Britain's postwar economic weakness, and the 1925 restoration of the gold standard at this fatally high level prolonged the suffering. Then the zip bust.

More recently, some felt that lacing the pound into the Euro would stiffen our backs. Or perhaps this idea owed more to fuzzy notions of European brotherhood, modernity etc - we in Britain have had ten years of being led by a fuzzy thinker.

But not all agreed that the time was right - see the 2002 Cairncross lecture by Ed Balls. This lecture, by the new Prime Minister's former economic adviser (see Wikipedia bio), sets the historical context for the "five tests" that he formulated with Gordon Brown in a New York taxi in 1997. The tests were designed to determine the timing of the UK's entry into the Euro - for details, see this Scotsman article of 2003, which also reviews progress. Perhaps the timing will never be right.

Some hope that's the case -because it's not just about economics. Can Europe ever be a country? What will happen to our mode of government, civil liberties and economic prosperity in this herd-rush towards an "ever-closer union" commanded by a remote, opaque elite?

Is currency stability generally desirable? Sure; but another return to fixed exchange rates would certainly need extremely careful management, especially in fundamentally unstable conditions. I don't think Western trade deficits are purely due to monetary inflation; China's rapid rise from poverty seems just as challenging to our budgets as the Great War that drove us off the gold standard.