Decline of the Old Order

Our favorite British historian puts today’s macro-political and economic puzzle in historical perspective.

Early in the 20th century there was much fashionable concern in Europe about the decline of the West. Many observers thought that the European lead in 19th century manufacturing would prove to have been a temporary advantage, that Europe was suffering from long-term social decadence, and that Asia would become the dominant continent by sheer weight of numbers.

This fear was particularly widespread in Germany, where it not only related to the massive populations of India and China, but also to Russia, the Asian country that already had a European presence. Some at least of the Kaiser’s advisors at the start of the First World War thought that they were fighting a pre-emptive campaign. If they did not destroy Russia while they could, Russia would simply become too strong for them.

Most Europeans also took a racist view of the Asian populations and, as with all racism, there was fear mixed in with the feeling of racial superiority. In 1914, everybody feared populations to the east of them. The Russians feared the "Mongol Hordes" and the Japanese, who had defeated Russia in the War of 1905, the first war in which an Asian power proved to have technological superiority over a European country. It has to be admitted that the Russian navy in 1905 was astonishingly incompetent, shooting up some British trawlers in the Dogger Bank incident before traveling around the world to be sunk by the Japanese at Port Arthur.

The Germans and the Austro-Hungarian Empire feared the Slav populations of Russia and the Balkans. That fear led the Austrians to want to take the excuse to crush Serbia in 1914. The French and British feared the Germans. Only the Americans were too far away across the Atlantic to fear anybody in particular.

We all know that Asia did not come to dominate the world of the 20th century. There was a decline of the West, in that Europe started two World Wars and was a major victim of both of them. But the rising power turned out not to be Asia but the United States, which became the leading world power during the Second World War, replacing the British Empire, and the leading technological power even earlier, from the rise of the twin giants, electricity and the automobile.

To the historian of 500 years’ time, there may well seem to have been a nearly continuous period of English speaking world leadership, which will probably be dated from the Seven Years’ War, when France lost Canada and India and failed to crush the rising power of Russia under Frederick the Great. The British period lasted from 1759 to 1914 — despite the separation from the American colonies after 1776. The baton was passed between 1914 and 1945, and the United States has carried the baton since 1945. The combined period of English speaking hegemony has been about 250 years, and all forecasts of the decline of American power have thus far proved premature.

In the first half of the 20th century, Asia notably failed to take advantage of the decline of Europe, though between 1900 and 1945 Europe manifestly did decline. Between 1945 and the present day, Europe has recovered to a certain degree, but there is absolutely no sign of Europe regaining the relative position of 1900. The European Union is a big economy but has high costs, middle-rank technology — most of Europe’s exports are of products invented before 1900 — and very limited defense capacity. Yet Asia, like Europe, has so far been developing under the ultimate security of the U.S. defense umbrella.

Russia proved that the communist model, though quite efficient at the task of fighting the Second World War, was not sufficiently variable or competitive to be economically viable in peacetime. China made the same mistake. The Japanese invasion cost China one generation of development, and the victory of Chairman Mao and the Communist Revolution cost another. China is still 50 years behind where she should have been if development had not been interrupted.

Japan’s great mistake was Pearl Harbor, and it set back Japanese development, which was well ahead of the Chinese before 1900, by a generation. For these reasons the major Asian powers, as well as India, which had adopted a relatively benign form of British Social Democracy, failed to take advantage of the opportunity that was presented by Europe’s acts of powerful self-destruction.

However, both demography and arithmetic are on Asia’s side, as they always were. The combined population of China, India, Russia and Japan, the big four of Asian powers, amount to about 2.6 billion people, close to half the world’s population. The combined population of the European Union and the United States, even if Canada and Mexico are added in, comes to less than a billion. The North Atlantic powers have a population that is not more than a third of the Asian four. The European population is relatively elderly, and birth rates in Europe are extremely low. These are factors of decline. For the next 30 years at least, the major Asian countries will have much lower costs than the North Atlantic group, though at some still-distant point, they will catch up, as Japan has already done.

The educational standards of the brightest and best students in the Asian countries are extremely high. China has always believed in educating an elite — the Mandarin class in the old China — and that policy has been followed again. These Chinese students are privileged, extremely well taught, and strongly motivated. The top 10% of Chinese high school students are probably well ahead of their U.S. or European counterparts. The same may be seen in other Asian countries, as it would most notably be in some small countries like Singapore. All four of the big countries have developed a substantial middle class that is still growing in number, and, as in Western democracy, governments have to be able to satisfy the wants of these middle class people, as consumers as well as citizens. Only China is still a directed society, and the conditions on which the Chinese Communist Party holds power are those of performance. Only so long as they satisfy the Chinese people will they be able to remain in office.

The next 50 years will see the great Asian advance, unless it is interrupted by political divisions, war, or other disasters. The Chinese economy will be generally comparable to the United States by 2050. Japan, which is a more advanced economy, is the major external investor in the development of Chinese industry. The Chinese economy will grow about twice as fast as the American. India will take longer but is already a major exporter of IT services.

Inside Asia the growth potential will probably be led by China, with India second and Russia and Japan third. In global competition, the order will be Asia first, America second, Europe third.

Unless Europe can find a way to become more competitive, which is proving very difficult on the continent, European living standards may actually decline from high costs, fixed regulations, and an ageing population. Asia is a major area of investment opportunity. The United States is likely to keep the technological and defense lead.

Best regards,

William Rees-Mogg
for The Daily Reckoning

October 22, 2003

Leading political editor William Rees-Mogg is the former Editor-in-Chief for The Times of London and a member of the House of Lords. He is a frequent contributor to: Strategic Investment.

It is almost like a vacation here at the Daily Reckoning headquarters. We still come to office early in the morning and leave late at time…but our work has grown easier.

Our labor consists of ridiculing the conceits and foolish ideas in the investment media. Though stocks are selling near all-time highs, pundits, economists and analysts have ceased trying to explain it with comic hypotheses. Gone are the absurdities of the late ’90s…that the Dow will go to 36,000….that the Information Age will make us all rich….that Greenspan won’t permit a bear market or a recession. All that is left is the illusion of productivity and growth….and the bedrock belief that God shines his light upon stocks, the dollar, and the American system of consumer capitalism.

Why a dollar’s worth of earnings in America should be worth more than a dollar’s worth in other countries is never explained. And why should a dollar’s worth of earnings be worth more today than it was in 1990….1980 or 1970 or 1960? No one even tries to offer an explanation. That’s just the way it is. Period.

Not that we know anything different, but we have observed that when people come to believe they bask in God’s special light, they begin to do odd things. They give away their money, for example. We recall that religious zealots gave away their farms and houses in the early 19th century, during what was called ‘the Great Awakening.’. Moved by a prophesy, they gathered on hilltops and roofs, expecting to be taken up to heaven all at once.

In today’s world’s, people are no less credulous. The prophets of CNBC have told them that a ‘recovery’ is here….and that ‘stocks always go up in the long run.’ And so they give their money away, trusting that they will soon be sunning themselves in paradise, or Florida.

Back in the late ’90s, investors gave their money away to dot.com hustlers. Today, they give it away to tech companies trading at 40 times earnings…if they have earnings at all.

"Tech companies never have free cash flow, never make any money and have competitors all over the place," explained Seth Klarman in Grant’s Interest Rate Observer. "So, I think they’ll be some carnage there…"

Foreign central banks are giving away money too — by buying Bush-era U.S. treasury bonds at Eisenhower-era rates. With the U.S. budget deficit rising to 5% of GDP….and the current account deficit approaching 6%,, who can doubt that buying T-bonds (by foreigners, especially) is a form self-sacrifice?

"A situation like this which has emerged over the past few years implies an increasing financial vulnerability of the United States," explains Antony P. Mueller. "If the busying spree by foreign central banks should stop or even reverse, the impact would affect the dollar exchange rate, the treasury market and the domestic price level with the consequences of a sinking dollar, a sharp rise of domestic interest rates and an increased inflation rate. It is highly unlikely that the American economy would prove resilient enough to withstand such a triple blow."

Who else is giving away money? Sellers of gold? Buyers of the dollar?

But what of us? Is it wrong for us to take advantage of these poor pilgrims? Is it immoral for us to take these naifs’ money….by selling them tech shares or Treasury bonds?

Au contraire, we feel we must be doing God’s own work. Bearing no false witness and holding no gun to their heads, we help separate fools from their money. Besides, only God knows who is the fool…and only in time will He tell.

Over to you, Addison, for more news:

———————-

Addison Wiggin, ridiculing the pundits from about 6 feet away…

– Nothing but good news from the great River-Of-No-Returns, Amazon.com last night. After the close of the stock market in New York, Amazon reported a ‘small’ profit for the third quarter. We quaffed the announcement with satisfaction, noting that the third was the same quarter our book Financial Reckoning Day debuted at Bezo’s store, and surely it’s brisk sales help to tip the scales from ‘minuscule’ to ‘small’ small. (As always, we’re eager to help…)

– It’s a shame, though, we had grown used to calling it the River-Of-No-Returns. Looks like we may have to knock it off, eh? Wait… what’s this? Maybe we won’t.

– Even with annual sales in the vicinity of $4 billion this year, Scott Rothbort from Lake View Asset Management, by way of USAToday, says Amazon is not likely to "post a full year’s worth of profit anytime soon." Yesterday, we Dailyreckoneers, were in awe to discover, having bothered to take a look, that Amazon’s shares had skyrocketed from a $6 low to a 52-week high of nearly $60 – a 900% gain. Yet, to the casual onlooker the still have no clear plan for profits.

– "Amazon is wildly overvalued," says Rothbort. You don’t say… "River-Of-No-Returns" it is! Amazon’s share price fell 2% on the news.

– Marketwide, the rally kept on a steamin’ forward… even if supplies of coal appear to be running low. The Nasdaq and the S&P both posted gains of 15 and 2 points, respectively. The Dow being the only exception. The grand old iron horse of Wall Street slowed… and eventually through the throttle in reverse for a 30 point loss to 9747.

– "Congratulations on the brisk sales of the book," writes a reader. "Unfortunately, if it climbs any higher in the charts, my contrarian discipline will require me to discount everything it says." We note with satisfaction that sales have been rather steady, both on Amazon (you’re welcome, Jeffrey) and at bn.com. We’re told there is a table top display at a Borders in Lower Manhattan… in fact, the book is now widely available at Borders and brick and mortar bookstores across the country.

– Another reader, who identifies himself as a private futures and stocks trader, calls attention to a fact that has made us somewhat un-easy about the book ourselves. "I have read 421 books in the last 11 years," he writes "And since 1996, I have read 59 books about economics and investing, a couple written back in the mid and late-1800s. – "Of all those books, I just completed what I view as the most important book I have ever read about economics, investing and the most likely future of the US and world economies. Important in the sense, and on a personal level, that it will likely make a big difference in my own family’s financial survival and future progress.

– "If I could change one thing about the book," [ahhh, we knew there would be a catch] "it would be the title. [Financial Reckoning Day] sounds as if it is an emotional effort to sensationalize the U.S. and world economic problems of the last 3 years. It is nothing of the kind.

– "It is a serious, thorough and thoughtful history and analysis of economic, political and military history and most importantly, human behavior since the French Revolution. It dissects and analyzes the Japanese economy since 1980, enlightens and clarifies the actions of Alan Greenspan since 1987 and specifies in detail the coming ‘deleveraging of America.’ It is well written, and even humorous at times. More importantly, Bonner and Wiggin’s effort will, in my opinion, be proved all too accurate."

– And that’s just it… "Financial Reckoning Day" is gussied up like a teenage librarian on her way to the senior prom without a date; it’s been packaged for the market as though it were sexy, but in reality it would prefer to be snuggled at home in a terry-cloth robe finishing its homework.

– One of the major themes, of course, is the deleveraging of America, our trader friend refers to above. We recall, a few weeks back, attending a luncheon in London offered by the folks at Arbor Research, with their hotshot analyst Jim Bianco. Our friend and colleague, Dan Denning put the question to Jim: "What would happen if the credit quality of US government debt were to be downgraded?" citing as possible causes, the Treasury’s exposure to derivatives risk at the behest of Fannie Mae and Freddie Mac.

– "It would never happen," came Bianco’s reply, "That would mean the end of the modern financial system." The answer was, of course, both matter-of-fact and shocking all at once. While, Bianco didn’t see the possibility, Denning got to work figuring out how he could judge the quality of US debt versus that of the banana republic kind.

– Using a calculation he calls the BED Spread, Denning notes that the Morgan Stanley Government Income Trust – a trust containing a basket of US government debt, such as Treasuries and Fannie and Freddie bonds undefined has converged with a similar basket of emerging market debt, each of the last three times he’s made the calculation. In short, the yield on debt issued by Uncle Sam is rising, meaning the market believes it’s becoming more risky, while yields on emerging market debt are falling… or becoming less risky. (More from Denning and the Bed Spread… in tomorrow’s guest essay. Look for it…)

———————-

Bill Bonner back in Paris, fresh off the Eurostar from London…

*** We quote from London’s MoneyWeek, edited by our new friend Merryn Somerset Webb:

"There will be no robust recovery, [according to Nobel-prize winning economist Joseph Stiglitz], and much of the fault lies with Alan Greenspan, the chairman of the Federal Reserve…."

"’More jobs have been lost under Bush than since Herbert Hoover and the Great Depression,’ Stiglitz told The Observer. ‘In the private sector more money has been wasted though misallocation of capital in the stockmarket bubble than the government could ever manage.’ Neither the recent tax cut, nor the increase in military spending, will give the US economy the stimulus it needs.

"The trade deficit has the underlying problem of what will happen when foreigners decide to stop funding the US deficit…"

Then, what will Mr. Greenspan do? More rate cuts? More liquidity? More talk of productivity increases and New Eras?

No, it will be time for Mr. Greenspan to express his regrets, blame the Chinese and retire….

*** ‘Royals at War!’ screams a London tabloid headline this morning. The battle rages, according to press reports, over the latest revelations brought to us from a former butler to Princess Diana. This war has been going on for a long time, we note. But the British never seem to get tired of it. In the latest news, letters from Prince Philip tell us that he thought his son was mad. Only a ‘crazy man,’ he wrote to Diana, ‘would leave you for Camilla.’

*** Here’s a sad item. "Man who survived Iraq is gunned down in LA" says a TIMES headline. "With an annual murder rate of about 653 — up 11.1% on 2001 — the sprawling slums of Los Angeles are arguably as dangerous a place to live for young Americans as Baghdad. The murder rate is 4 times the national average and double that of Bogota, the Colombian capital."