China Takes the Ruhr

The Daily Reckoning PRESENTS: You may not be surprised to learn that Germany lost thousands of steel mill jobs to China. But you may be surprised to learn that it also lost the steel mill itself. Once in Dortmund, Germany, the same mill now works on the banks of the Yangtze in China. Chris Mayer explores…

CHINA TAKES THE RUHR

The Ruhr Valley was the heart of Germany’s industrial might. For more than 200 years, the smokestacks in this northwest corner of Germany pounded out the steel and iron that would form the backbone of the nation’s industry. And when the war drums rumbled, these factories supplied imperial Germany with its field guns, armored tanks and shells.

Prosperous communities grew up around these old blast furnaces and mills. People took pride in the stuff they could make with their hands. Tens of thousands found work in the factories of the Ruhr. Generations passed with the knowledge that their sons and daughters could make a life here and carry on the legacy of such a place. For a long time, that was the way it went.

But the winds of change patiently grind away at even the most impressive of advantages. In the early 1990s, the industrious workers of Asia powered the mortar and pestle that would crush the Ruhr’s traditional way of life.

It was a slow process, but the endgame was not hard to see. While the South Koreans became the most efficient producers of steel in the world, German workers were agitating for a 35-hour workweek. While the Chinese worked all day in their mills and new factories sprouted up like spring peepers all through China, Germany increased taxes and expanded its bloated government programs.

By the turn of the millennium, no one could ignore the stark reality any longer. The mills and factories of the Ruhr started to close – forever. In his terrific book China Shakes the World, James Kynge tells the story of ThyssenKrupp’s steel mill in Dortmund, one of the largest in Germany. The Germans called it the Phoenix, inspired by its rise from the ashes of bombing raids in World War II.

Within a month of ThyssenKrupp closing the mill, a Chinese company bought it with the idea of disassembling the entire mill and taking it to China, near the mouth of the Yangtze River. Soon after this Chinese company bought the mill, 1,000 Chinese workers arrived in Germany to begin the process of taking the plant apart and bringing it to China.

The Germans got an up-close lesson in why they could not compete. The Chinese worked seven days a week for 12 hours a day. The Germans started to complain. So the Chinese, in deference to local law, took one day off.

In the end, the Chinese dismantled the mill in less than one year – a full two years ahead of the time ThyssenKrupp initially thought it would take.

When the Chinese departed, they left the makeshift dormitories and kitchens they occupied for a year neat and clean. There was, however, a single pair of black boots left in one of the dormitories. The boots carried the brand name Phoenix, which was the same name of the plant the Chinese just took apart. The boots also carried the label “Made in China.” Kynge writes, “Nobody could tell, however, whether the single pair of forgotten boots was an oversight or an intentional pun.”

Over 5,000 miles away, the Chinese rebuilt the steel mill exactly as it was in Germany. As Kynge writes: “Altogether, 275,000 tons of equipment had been shipped, along with 44 tons of documents that explained the intricacies of the reassembly process.” Doing all of this was still cheaper – by about 60% – than building a new mill. Plus, in China, the demand for steel was such that the mill could start producing steel immediately at full capacity.

As recently as 1975, China’s entire output of steel could not match this one mill in Dortmund. Now, the Dortmund plant itself stands in China. And in Germany, you have a dying industrial city, unemployed steelworkers and the scarred earth where the mill once stood. Germany is thinking of turning the site into parkland and perhaps creating a lake and marina. But as one burly steelworker says in Kynge’s book: “Do we look like yachtsmen to you?”

This remarkable vignette captures, on many levels, how the game has changed. Comfortable workers in the factories and mills of America and Western Europe have no idea what they are up against. Even so, the nature of global competition keeps shifting.

We tend to think of emerging markets, such as China, as occupying a place down on the food chain of the global economy. We tend to think of these places as sources for cheap labor and natural resources. But more and more, these emerging markets are home to world-class companies in all kinds of industries.

This is the thesis of Antoine van Agtmael, author of a new book called The Emerging Markets Century. Agtmael is the man who coined the phrase “emerging markets” to describe growing, but less-developed economies such as China, India, Brazil, Argentina, Mexico, Thailand and other places. Before him, we called these markets “third-world” – which brings to mind many negative associations. To sell the idea, Agtmael came up with “emerging markets.”

I saw Agtmael give a presentation in Washington, D.C., one evening. I’ve also since read the book. Agtmael spent 30 years in these kinds of markets. “I have helped IranAir lease airplanes and hire crews in Ethiopia, was involved in financing Ghana’s cocoa exports,” he writes, “and grew wise to the ways – many of them laughably one-sided – that developed nations interacted with what were in many cases recent European colonies.”

Agtmael selected 25 companies to profile in his book. All of them exemplify best practices and are widely recognized as leaders in their industries. All of them call an emerging market home.

Agtmael writes about spending time in High Tech Computer Corp.’s research lab in Taiwan in 2005 and how “Suddenly, my BlackBerry looked like a Model T.” He writes about how the regional jets we fly are made in Brazil (by Embraer). How computers are now not just made in China, but designed there. How Indian and Slovenian labs produce proprietary new drugs. And on and on it goes.

The world has changed in a profound way, but the typical investor probably doesn’t appreciate this fully. One more nugget from Agtmael: In 1988, when he started his fund, there were only 20 emerging market companies with sales of more than $1 billion. Most of these were banks or commodity companies. (Overwhelmingly, they were located in Taiwan.) Today, there are over 270 companies with over $1 billion in sales, and 38 with more than $10 billion.

Many of them are high-tech companies or provide consumer products and services. This bolsters Agtmael’s point that many of today’s emerging market stars do not rely on cheap labor, abundant natural resources or protective government policies. Instead, they have developed competitive advantages in technology, design, logistics and other areas.

Agtmael also gives his tips for investing in emerging markets. The most important of these may simply be this: “Don’t be afraid to invest in them.”

Regards,

Chris Mayer
for The Daily Reckoning
May 1, 2007

P.S. My advice to you: follow Warren Buffett’s investment strategy – buy stock in solid companies that most investors overlook…and that most money pundits would consider ‘boring.’ Today, Mr. Buffett sits atop a fortune of over $40 billion, almost all of it coming from shrewd investment in boring, overlooked stocks.

Hey, if these techniques worked for the Oracle of Omaha, they can work for you too…and I’ve pinpointed ten companies that are so mundane sounding that they’re almost completely ignored by mainstream money. And that’s a good thing from where you’re sitting – the stealth profits these humdrum securities can quickly rack up for the astute investor who pays attention and has an open mind.

Editor’s Note: Chris Mayer is a veteran of the banking industry, specifically in the area of corporate lending. A financial writer since 1998, Mr. Mayer’s essays have appeared in a wide variety of publications, from the Mises.org Daily Article series to here in The Daily Reckoning. He is the editor of Mayer’s Special Situations and Capital and Crisis – formerly the Fleet Street Letter.

Former Morgan Stanley (NYSE:MS) star Andy Xie says he thinks China is ready to crash.

“I think it’s going to be bust very soon,” Reuters reports Xie saying, laying the blame on the usual suspects: excess liquidity, rising inflation and rich valuations.

“People will be surprised. When the end comes, it’s going to be pretty bad,” Xie said.

Well, we won’t be surprised. What surprises us is that the crash is taking so long to get here.

How DO you say ‘bubble’ in Mandarin?

Last night, we dreamt that the Dow was crashing. We woke up and wondered if it had been a dream…or a prophecy. We’ll have to wait and see, but for now we keep our Crash Alert flag flying here at the Daily Reckoning headquarters, just in case. Dreams foretold Caesar’s death on the Ides of March…maybe they’ll foretell the Dow’s demise.

Meanwhile, more evidence that China is readying as a crash cometh – in a letter from a Chinese reader, sent to colleague Porter Stansberry:

“All the people I know in China now gamble in stock. On one of China’s TV stations yesterday, was the report that out of the 16 million people in Shanghai, close to 11 million now put money into the stock market. Almost everyone – you name it: taxi driver, security guard, mini fruit-shop owner, high school student, retiree. But in the long run, a lot of this will end in tears, no matter how quickly China’s GDP grows. There is simply no decent research to educate Chinese people on how investing is different from speculating out there.”

What do we care what happens in China?

Well, the Chinese central bank has a cash hoard of U.S. dollars mounting up towards $1 trillion. What will happen to all this money when the country goes into an economic crisis? If the Chinese chose to, they could send the U.S. dollar into free-fall, force American interest rates up sharply…and drive the U.S. economy into a slump. More than 80% of the U.S. budget deficit is financed by foreigners…and much of it by the Chinese.

Or maybe China will use its money to buy weapons. That would be interesting, wouldn’t it?

Or, they could try to corner the market on the key strategic supplies of modern economies – such as oil, uranium and granite countertops.

Yes, dear reader, it is free cash flow that makes the world go ’round…and China’s got it – because China makes things that people want to buy.

Meanwhile, back in our beloved homeland, mommas send their children to the very best schools so they can get jobs in finance! Ah…that’s where the money is…not in making THINGS but in making MONEY itself.

Harold Macmillan once described Britain’s post-war service economy as one in which “we take in each other’s wash [laundry].” But in the 21st century U.S. economy, people don’t even get their hands wet. They take in each other’s money; one manages his neighbor’s money…another lends his neighbor money for a house…and another takes his neighbor’s company, ‘restructures’ it, and sells it back to him.

The United States, for example, used to be the world’s largest steel-maker. No more. Where the United States used to make steel, now it gambles. Literally.

Here, another message from Porter Stansberry:

“‘I’m not making this up. Beth Steel’s flagship iron works in Bethlehem PA – where the steel in the Golden Gate Bridge was made – has been purchased by Las Vegas Sands Corporation and will be turned into a casino.

“…I’ve never been more willing to buy gold.”

The AP Story:

“A sprawling 130-year-old steel plant that armored hundreds of U.S. warships and provided the raw material for the Golden Gate Bridge, Madison Square Garden and many other famous landmarks will become a hive of activity over the next few days as workers start preparing some of its buildings for demolition.

“More than a decade after its towering blast furnaces went cold, Bethlehem Steel’s flagship plant is being transformed into a $600 million casino complex run by Las Vegas Sands Corp., owner of the Venetian Resort Hotel Casino in Las Vegas.

“…State gaming regulators awarded Sands a slots license in December. The company plans to open a casino with 3,000 slot machines by the end of 2008, a 300-room hotel and 50,000-square-foot convention center three months after that, and a casino addition with another 2,000 slot machines in summer 2009.

“‘It will be one of the most unique economic development projects in the country, and people will come far and wide to see it,” [Mayor John Callahan] said. “It will be a national model for the redevelopment of an industrial site.'”

The whole U.S. economy has become rather gloriously mad, in the sense that none of it really makes any economic sense. Glorious in the sense that Deng Tsiao-ping must have had in mind when he said: “To get rich is glorious”; for the illusion of wealth has never been easier, faster or closer to hand. Just step on into the casino!

Central banks all over the planet are serving helpings of money like McDonald’s cheeseburgers…over $2 trillion served in the last five years. Maybe they should put that up in lights. All a smart investor has to do is to get in line.

In the late ’90s, the way to make money was to start a dotcom and take it public. Investors would give you millions. Then…take the loot and speculate in property. Better yet, start a property fund. Who didn’t want to be in property in 2000-2006?

And after that, it was a good idea to sell the property fund before lenders started asking questions, and move into private equity. Borrow a lot of money to buy a company. Then, have the company borrow a lot of money so it can pay you big fees, because you are such a genius. Then, sell the company to the ‘mom and pop’ investors in the public market.

But after that, get out of town – because each get-rich-quick era is followed by a posse with revenge on its mind.

After the tech bubble blew they strung up Bernie Ebbers and Henry Blodget. Now that the bubble in subprime has blown up, they’re chasing New Century (OTC:NEWC) and other lenders. It won’t be too long before the bubble in private equity goes up too. And, not too far behind will be a mob clamoring for some kind of rough justice.

Already, we read in today’s paper that French presidential candidate, Nicholas Sarkozy, is threatening ‘predator’ hedge funds with a tax on their speculative investments. It probably won’t be long before his Anglo-Saxon confreres pick up the rope.

More news:

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Addison Wiggin from Baltimore, reporting on the housing market…

“Investors itching to buy housing stocks (God forbid) just got another reason to steer clear. ‘Boston is still in the pits… in Florida, it’s like death takes a holiday… Las Vegas is now terrible… Michigan may be a situation where is doesn’t come back.’ These are the comments of Robert Toll, chief executive at Toll Brothers, one of the nation’s largest home builders.

“Home sales of existing homes fell 8.5% in March – the fastest drop in 18 years. Supply is up to eight months and climbing. Housing prices, as a result, keep falling.”

For the rest of the story read today’s issue of The 5 Min. Forecast

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And more views:

*** Ethanol producers in the Midwest have to use 4 gallons of gasoline in order to convert corn into 5 gallons of ethanol. Not sounding much like a viable solution to our oil dependence…

Kevin Kerr, writing for MarketWatch, reports from the front line of the ethanol boom…at a farm in Knox, Indiana:

“I couldn’t help noticing all the ethanol plants springing up along the road to Knox from Chicago.

“The average ethanol plant uses 100 million gallons of water or so. Now pile on top of that when farmers start having to irrigate this summer (those that can afford it) and you’re talking about a severe water shortage potential.

“Lawrence [farm-owner] showed me his vast irrigation system. Of course most of these systems are run on diesel fuel or natural gas, another major problem as these commodities will skyrocket this summer, in my opinion.”

The ethanol boom has done more than dump extra costs on already stretched farmers – it has sent the price of corn skyrocketing. One helpful reader pointed out that in his local grocery store, you can buy two ears of corn for $1 dollar…when last year you could have bought ten for the same price!

And while this may put a crimp in your backyard BBQ, the high price of corn has almost tripled the price of tortillas – a major food staple in Mexico.

Back in January, hundreds of thousands of Mexicans marched in protest against rising tortilla prices, spurring the government to cap prices of tortillas to control inflation.

Even with the price control, the poor in Mexico are still having trouble affording tortillas. The Washington Post reports, “The typical Mexican family of four consumes about one kilo – 2.2 pounds – of tortillas each day. In some areas of Mexico, the price per kilo has risen from 63 cents a year ago to between $1.36 and $1.81.”

Here in the United States, even the Department of Labor’s own bean counters say food costs, for average Americans, are already nearly double what they pay yearly for energy. Could a coming corn “crunch” force those costs even higher?

What happens if that trend continues…or even stays at a high price plateau?

*** Our old friend, Scott Burns, is reading reports on American retirement financing.

“Here is what I culled from the two reports:

“Most of us are clueless about retirement… Few workers are aware of the impact of receding pensions. Or of the rising age requirement for full Social Security benefits. Worse, only 66 percent of workers have saved money for retirement. Only 43 percent have attempted to calculate how much money they will need as a nest egg.

“We’re also wrong about our sources of retirement income. Those still working expect that personal savings will provide 50 percent of retirement income. They also expect that employment will provide 11 percent and Social Security only 14 percent. But retirees report that Social Security provides 40 percent, while savings provide only 24 percent. Employment is barely worth mentioning at 2 percent.

“In retirement, income falls steadily. The government study figures show that income falls dramatically as people age. The median income for married couples declines from $68,612 at ages 55 to 61 to $28,490 for couples 80 and older. The decline is less severe for singles, going from $24,000 to $13,321.

“Social Security is very important for all but the rich. Even for those in the second-highest income quintile, Social Security was usually the largest single source of income. In 48 percent of those households, it accounted for 50 percent or more of all income.

“Income from assets, on the other hand, plays a small role for most people. In the bottom 80 percent of all households, income from assets accounted for 50 percent or more of income in less than 4 percent of households. Even in the top 20 percent of all households, asset income accounted for 50 percent or more of all income in only 12 percent of households.”

U.S. Comptroller David Walker has been traveling around the country on his ‘Fiscal Wake-Up Tours’ warning Americans about “unfunded liabilities.” These are the future responsibilities, programs, and activities the feds are already committed to spending…and Social Security, Medicare, and the expensive new Prescription Drug Benefit falls right into that category.

In 2004, the trustees of Social Security and Medicare projected that the unfunded costs of their obligations to $74 trillion. Add in the recent boondoggle promise of prescription drug coverage and you add another $1.2 trillion to our growing list of unfunded liabilities.

And our buddies in Washington then conveniently forget to calculate this $75.2 trillion into the current debt numbers.

What else have they been sweeping under the rug?

*** And now, tiiiiiimbeeeeeer! The Financial Times reports that China is using so much wood it is driving up the price. Sawn softwood has risen 30% in the last six months, according to the FT.

“China seems to be consuming mind-boggling amounts of wood,” said a representative of the Scottish Timber Trade Association.

Of course, what isn’t China consuming mind-boggling amounts of?

It’s true, China is getting a bit to big for its britches – but does that mean that the window of opportunity to invest in the Far East has slammed shut?

Find out for yourself at this year’s Agora Financial Investment Symposium. This year’s topic is “Rim of Fire: Crisis & Opportunity in the New Asian Era” – think of it as bootcamp for global investing. Join your favorite DR experts at your first look at investment opportunities, global market concerns, and the best investment bets across the globe, taking place July 24-27 at the Fairmont Hotel in Vancouver, B.C. Secure your place now by calling Agora Travel at 800-926-6575.

More on China, below…

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