It's past midday in the dead of summer here in the nation's capital and with the NASDAQ hovering right around 1900 and interest rates falling on 10 YR TRES, we can't help extending our mind half way around the globe. After all, way back in the year 1900, there must have been contrarian thinkers out there ready to predict the meteoric rise of the US economy to a position of world dominance. Nobody (but their relatives) had to tell the streams of immigrants coming from Poland, Russia, Italy, Ireland, the Ukraine --you name it-- that factory jobs were opening up in hard to pronounce places called Waterbury, Bridgeport, the Bowery, Trenton, Buffalo, Toledo, Chicago, Seattle etc. Nobody had to tell Tesla or Marconi where to bring their ideas.
In a world dominated by the global colonial powers the equation was quite simple: the poor countries provided foodstuffs and raw materials to the rich countries which turned them into usable items that were then exported at a premium back to the same suppliers. Of course, like everything else in life, it wasn't quite that simple but in taking a look at a fading photo of a meeting of the world's leading physicists, Conseil de Physique Solvay, held in Brussels (see brownish pic) at the Hotel Metropole in 1911 not only is there no attendee from Asia, there isn't one American although names like Plank, Curie, Einstein, Rutherford would later take on international significance.
Most Americans, we'd wager, couldn't give a damn about any of this in July or any other month but even among those who do, it's unlikely many have grasped just how much of the US trade picture is third worldly. To a large degree we export agricultural and capital goods and import manufactured goods. Last year, for instance, the only sector in which the US had a trade surplus, was agricultural products, according to the US Census Bureau. In the single month of May of 2004, in a recent but wholly typical example we exported, to China alone, a little less than $3 billion and imported a little more than $15 billion for a gap of more than $12 billion. The capital goods segment is important because it actually underlines the trend. Capital goods, is the term economist's use for machinery that is used to make manufactured goods. In simple terms, capital goods means machines that American factories might be using to provide manufacturing jobs that are instead being sent to Asia, Mexico and other cheap labor cost areas.
China, like Japan and the US and Europe before it, has become a massive siphon of raw materials like iron ore, copper, petroleum and other agricultural goods and manufacturing know-how that has primarily benefited neighboring countries like Australia, New Zealand and Japan.
Lately, the Chinese government, sensing an impending bubble, has started to cause a slowing mainly by restricting lending activity.
On October 30, 2003 Greg Mankiw, the Bush Administration's Chairman of the Council of Economic Advisers testified to Congress on the subject "China's Trade and US Manufacturing Jobs" The speech is famous because in it Mankiw argues that despite the enormous imbalance, trade with China is a positive with little impact on US manufacturing jobs.
In a concluding paragraph Mankiw states:
"Imports from China are one of many factors that influence manufacturing employment. The five industries that have contributed most significantly to manufacturing job losses since July 2000 are: computer and electronic equipment (16% of all manufacturing job losses), machinery (10.8%) transportation equipment (10.7%), fabricated metal products (10.7%), and semiconductor and electronic components (7.5%). These are export-intensive industries for the United States where imports from China are small. This suggests that US job losses are more closely related to declines in domestic investment and weak exports than to import competition."
What are we supposed to make of these comments?..... Perhaps, that the real losses in jobs to China are okay because we are also losing jobs to other parts of the world, (Europe, airplanes, Singapore, chips) in more vital areas?
So what's going to happen now that it's clear to anybody who knows how to read (and isn't a member of the band) that the much anticipated present US recovery is nearly stillborn despite --or perhaps, because of-- the massive dose of steroids it's been given by the Fed for the last three years? One thing is for sure --and the bond market knows it-- it's going to be very, very hard for the Fed to raise rates any more than the measly 25 basis points it got back last month. Like Japan, after its big bust, the Fed finds itself with absolutely no room down on interest rates. Given, the upcoming election sensitivities, they will probably stand pat.
But after the election, there's going to be noise all over the place no matter who wins. The dollar is already nearly back to its lows against the Euro and Pound and gold has crept back up over $400. Suddenly, we can expect to see a lot of attention given to the Chinese RMB by the Americans. A devaluation against the RMB would slow Chinese imports and raise Chinese buying power vis a vis the dollar, they will exclaim, even as the noise alone drives the dollar further down against the Euro, Pound and Yen. That will, if history is any example, rekindle interest in gold.
But even under intense pressure from its major trading partner, will the Chinese government accede to a revaluation? This is a tricky question. The Chinese do not want to give up their competitive advantage, which is working out just fine for them. They face enormous pressures from the massive populations in their own hinterlands to create their own Waterbury's and Akron's and San Jose's.
One thing we do think: Alan Greeenspan will not stay out the full six years of this present term he just got appointed to. The kitchen is going to get a lot hotter.
The US trade imbalance and what used to be called back in the quaint old days, "the dollar overhang", have been pet subjects here at DW. You might ask why we are so obsessed with a situation that seems, after all, to work pretty well. In short, the American consumer gets to borrow and do what he does best, consume; the Asians make and service, OPEC pumps oil, and the dollars get recycled back in the form of direct investment and government notes.
What's the alternative?, you might ask. All this global economic activity is pretty good, isn't it? and prices for goods and services are holding pretty steady, aren't they? You're not suggesting some sort of protectionism, are you?
The answer, of course, is that we have no belief in building artificial barriers whether it is around the trade of goods and services or the movement of bits and bytes. It's as if we had just discovered that two wrongs don't make a right or some other profound old saw. How about, "if it ain't broke why fix it?" We say, ask Ken Lay! Just because it ain't collapsed don't mean it won't collapse.
Here's the scary thought in our mind: everybody acknowledges that the present economy rests on the shoulders of the American consumer. Great news, you say, why just last month the university that measures such things noted that consumer confidence was up! Having borrowed against her house, maxed out her plastic, this gal was coming back for more. She can even get a new SUV with nothing down and 0% interest. GM is even offering $5,000 back on some of its more macho models. In other words, it's a dream come true, it's almost like, like... you get paid for buying. Who wouldn't have confidence?
And so the Fed prints more dollars even as it bumps up interest rates a quarter of a point. And the world continues to buy our notes.
Here's the way it is supposed to work: with advances in technology the children of farm workers move to the factories and then on to cubicles. The business of America becomes intellectual property, brainpower combined with know-how resting on a base of demand for bigger, faster, more complex systems. In this scenario, information becomes the only real currency. Forget about shiny metal, black liquid and fiat currencies, she who knows how, wins. As they might edit the sign on the bridge across the Delaware River going into Trenton: from Trenton Makes and The World Takes to The World Makes and Trenton Thinks
Sounds good, n'est-ce-pas? So how does that reconcile with a public education system that has lost the confidence of middle class families in the cities and the suburbs? How does it reconcile with a world order in which growing masses of left-behind peoples reject edgy angst-ridden "entertainment" --a major export of the "knowledge" society-- for a return to the relative security of a pre-Galilean world view? Of course, to put it mildly, there is no shortage of contradictions.
Perhaps you can run ever greater trade deficits year after year. Perhaps the world will never tire of taking more newly minted greenbacks. Perhaps Trenton will take and take and take ad infinitum. And so with our dominance we can pretty much get what we want. If you feel that way there is little to worry about.
As for us, we're a little more old fashioned. We actually think there may come a day when investors and government bankers around the world start taking a harder look at all those dollars accumulating in their vaults. So here's a thought, instead of concentrating on imports that fill our need for tchotckes; we might note that only half the current accounts balance is based on imports, the other half registers in a countervailing manner, exports. In other words, if we can get exports up to all those newly minted Chinese and Indian shoppers not to mention all those Europeans we can offset rising imports.
Now let's look at what is certain highly valuable US intellectual property, our brand names. Here's some rhetorical questions we will pose to the current administration: does dropping out of highly charged international conventions like the Kyoto Treaty help or enhance US brands abroad, does rejecting the rule of the World Bank over US behavior, does unilateral US foreign policy, rejection of the role of the UN, insults to old allies, a cavalier attitude that looks like bullying, etc. enhance the world view of US brands? Fade left as we imagine that shining city on the hill topped by giant golden arches.
US foreign corporate earnings have been somewhat masked in the last couple of years by a falling dollar that quite automatically boosts incoming profits denominated in Yen and Euros on US corporate balance sheets. If the real cutting edge of US business is measured in the extension of US brands into the new and old countries whose goods we buy, can we count on government and corporate decision-makers in these countries purchasing proprietary mission-critical systems from companies like Oracle, Cisco and Microsoft whose intellectual property has now become, along with Hollywood's, not only key to our prosperity but also a major concern of Congress?
One of the reasons we have put a major focus on the debates raging around Open Systems and digital rights management (DRM) here at DW has a lot to do with the above. After all, as Microsoft has itself acknowledged in its Trustworthy Computing initiative, it all comes down to Trust, doesn't it? And Trust is in mighty short supply these days.