A Congressional Tantrum
The Daily Reckoning PRESENTS: Is the Dubai port debacle is a one-off thing or does it signal a rise in protectionism? John Mauldin looks at the deal from the negative economic impact it could have on this country. Read on…
A CONGRESSIONAL TANTRUM
by John Mauldin
Long-time readers know that I do not think the world is going to devolve into a soft depression because of the imbalances in our trade deficit and our large and growing debt. Those will have to be dealt with, of course, but I think it will happen in the normal context of the business cycle. A recession here, a falling dollar there, and slower than trend average U.S. growth over the next five years or so and we get to where the re-set button has been hit. It will not be fun, but it will not be the end of the world. It is what I call the Muddle Through Economy. I am actually quite optimistic about the investment opportunities once we get through that period, with the usual caveats and asterisks.
Dubai Port Deal: Smoot and Hawley
But I have maintained for many years that the one thing that could change my basic optimism is a new wave of protectionism. Senator Smoot and Representative Hawley infamously sponsored a bill in 1930 that raised tariffs on a variety of products in order to “protect” American jobs. Of course, the rest of the world retaliated and soon we went from a recession into a global Depression. Unemployment soared and all those jobs we “saved” went away.
Recessions are part of the business cycle. The Fed cannot stop one, try though it might, nor can Congress write legislation outlawing recessions. And in the main, and with a few exceptions, they have not on balance been all that bad. One can make the argument that they are needed to correct imbalances and “irrational exuberances” here and there. Typically, unemployment rises a few percent but comes back in a few years, the stock market falls but comes back and profits fall but go on to make new highs after the “reset” button is hit.
I am not trying to be cavalier. If it is your job or investment or profits that get hit, it can mean some very long and sleepless nights. Been there. Done that. But for the vast majority of U.S. citizens, the last recession had little effect. Unemployment never rose above 7%, and corporate profits came back quite strong. The next recession may be worse, but it will end soon enough. That is the way of the business cycle.
But while recessions are part and parcel of the economic cycle, it takes a government to really mess things up and create a depression. Show me a depression (not a shorter term recession!) in a free society that was not the result of government incompetence or some form of direct government involvement. You can’t. Usually they are the result of multiple and coordinated government groups all working together to make things better and having the opposite effect.
Yes, I suppose you could say that Smoot and Hawley were just responding to the zeitgeist of the times, that the voters were demanding their jobs be protected, so that the American people got what they deserved, but Congress and the Fed aided and abetted. President Hoover should have used a veto. For that alone, he deserved to be defeated two years later.
Last week, an updated version of Smoot and Hawley’s Congress put together a veto-proof gaggle to stop the United Arab Emirates from buying a British port management company that ran six of our nation’s ports. Security was the ostensible reason, but anyone who did their homework knows that national security on any level was never at risk. This congressional tantrum bothers me on several levels.
Dubai Port Deal: Port Security
Our ports are run by a number of companies that are not U.S. based companies. Five ports have Danish firms running them, for instance. Two are run by the Chinese. Basically these companies move freight. Pick it up here and put it there. They have nothing to do with port security. Port security is the province of U.S. Customs and the Coast Guard. And they hire American union workers.
The U.A.E may be the largest non-U.S. port service for the U.S. Navy in the world, based in Dubai. They are a solid ally and a voice of moderation and stability in an area of the world where such is needed.
There is a process where foreign investments in the United States that have security implications are brought before the Committee on Foreign Investment in the United States (CFIUS). This governmental inter-agency group looks at foreign investments, and if one of them sees a red flag, they run it further up the command chain. This was an investment that, after being thoroughly investigated, caused no concern and was approved. And then some politicians saw an opportunity for political gain.
Now, someone in the administration at the middle levels should have seen the political implications of this deal. Sadly, the Bush administration does not do a good job of explaining their policies. This should have privately been run up to Congress and vetted there before the approval went through. So, a lot of the blame should be laid onto the administration for having a “tin ear.”
The next thing we know, talk radio is going over the edge, calls into Republican congressmen are running 9-1 against the deal in an election year that looks tough for them to begin with, Democratic Congressmen see a chance to appear concerned about national security and really tweak the President and before you know it, there is a move to stop the deal.
There is a reason for the CFIUS process. It works, and it keeps politics more or less out of business deals. But now, Congress has learned it can basically look at any deal and say that it’s against the national interest for some foreign company to buy a U.S. company. And every tin pot congressman who wants to posture in front of a camera and who has a company in his district that becomes a target will now want to get involved. Companies that lose a bidding war or that have an axe to grind will complain to Congress: “I don’t want that foreign company competing on my turf and taking U.S. jobs from my employees!” Shades of Smoot-Hawley!
We have spent decades persuading nations around the world to open up their countries to investment. And they have. We have over $10 trillion invested outside of the United States, which made American firms $500 billion last year, a little under 5% of our GDP! That is about $1,600 for every man, woman and child in the United States. That money gets paid out as dividends, gets invested in our economy, and goes to pay our workers.
Dubai Port Deal: Foreign Investment
Last year, foreigners increased their investments in the United States by $1.4 trillion, in a wide variety of investments. Without those dollars, the U.S. currency would have collapsed, interest rates would be through the roof and we would be facing (or in!) a REAL recession, not the garden variety ones we have had since 1990.
“A study by the Organization for International Investments finds that about 5.3 million Americans are directly employed by foreign owned firms with wages averaging $63,000, or about 50% more than the average U.S. wage. Foreigners are not buying up America’s wealth; they are investing in ways that add to it,” reports the Wall Street Journal.
That means that about 8% of American workers are employed by foreign-owned companies. You can bet they are happy they have the higher paying jobs. If not, they would simply leave. But the line for those high paying jobs is long.
But now, there are those in Congress who would like to stop that wealth and job creating foreign investment.
“In recent weeks Members of Congress have suggested that the foreign-ownership ban should apply to roads, telecommunications, airlines, broadcasting, shipping, technology firms, water facilities, buildings, real estate and even U.S. Treasury securities.” (The Wall Street Journal editorial, March 10, 2006)
How does this sound to those nations that we are trying to get to open up to U.S. investments? Why should they cooperate id we re not going to practice what we preach, when it is in our clear interest to do so?
If this was just the U.A.E. deal, I could rest easier. But last year it was the dust-up over China buying a mid-size U.S. oil company that had relatively little U.S. production. We have Senators Charles (Smoot) Schumer and Lindsey (Hawley) Graham cooperating in a bit of bi-partisan idiocy to try and put a 27% tariff on Chinese goods.
And let’s be blunt. To suggest such a thing demonstrates either astounding economic ignorance or simple political pandering of the worst kind. Probably both. Do we really want to raise the price of everything from China by 27%? On items that we no longer make here? Do we want to risk the start another trade war? Or have the Chinese stop buying U.S. Treasuries? Can you say recession, boys and girls?
for The Daily Reckoning
March 15, 2006
Editor’s Note: John Mauldin is the creative force behind the Millennium Wave investment theory, author of the weekly economic e-mail Thoughts from the Frontline, JohnMauldin.com, and a private letter for accredited investors. As well as being a frequent contributor to Capital & Crisis and Strategic Investment, Mr. Mauldin is a New York Times best-selling author with a unique ability to present complex financial topics and make them understandable to the lay reader with insights into the current economy and hedge fund industry. His latest book, Just One Thing, was released in December of 2005.
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“What can be avoided / whose end is purposed by the mighty gods?” asked Julius Caesar, before he was stabbed dead on the Ides of March.
Despite the omens, no history was made yesterday – at least, not in U.S. financial markets. At the close of the day, prices were not far from where they were when the first rays of sun struck Manhattan.
But, if we are right about the way the world works, history kept bumping and grinding anyway, perhaps in secret…grinding all human conceits exceedingly fine and exceedingly sure. Who knows what ends are purposed by the mighty gods? But, who doubts that they can be avoided?
In today’s Daily Reckoning, dear reader, we offer what you might call a General Theory of Grinding. We begin by insisting that every man needs a theory as much as he needs a pair of pants – perhaps more. Without it, he is ridiculous or at least semi-functional. All we humans have to judge the world around us are our eyes and ears, but what do these senses pick up? They pick up a rush of color, light, sound – raw data.
Without a theory, this “data” is meaningless. It is just “noise.” We need theories to interpret it and give it meaning. Theses theories transform the rising edges of a woman’s mouth into a smile and a growing complex of bright red light into a double-decker bus headed for Waterloo Station. How would we know what would happen if we stepped in front of it? We have never done it before. We’ve never seen anyone do it. Yet, we have a theory that tells us that if we position ourselves in front of a moving bus, we will be crushed by it.
More on the General Theory of Grinding below…
Among other things, the gods are currently grinding down the boom in real estate, support for the Iraq war, consumer incomes and spending power, the U.S. balance sheet…and the empire itself.
The Mortgage Bankers Association expects mortgage originations to drop off by 20% this year; it says refinancing should fall by 40%. Without easy finance, consumers have less to spend. Yesterday brought news that retail sales had fallen in February, for the first time in six months.
“Too many consumers have been attracted to products by the seductive prospect of low minimum payments that delay the day of reckoning, but often make ultimate repayment of growing principal far more difficult.”
Speaking was U.S. Comptroller of the Currency John C. Dugan, and what he was speaking of, specifically, was the way in which consumers took out interest-only or negative amortization mortgages.
“In the last two years, however,” Dugan continued, “we have seen a spike in the volume of payment-option ARMs which are no longer confined to well-heeled borrowers who can clearly afford them. Increasingly, they are being marketed as ‘affordability products’ to borrowers who appear to be counting on the fixed period of exceptionally low minimum payments – typically lasting the first five years of the loan – as the primary way to afford the large mortgages necessary to buy homes in many housing markets across the country.”
We already know what will happen. We see the signs before us. Foreclosures are rising. Households which bought more house than they could really afford are going broke. Consumer spending has become a little wobbly.
The expected effects on the housing market itself are starting to show up. Sales are down. Inventories are rising.
In California, the housing boom has raised prices to the point where the median wage earner in L.A. County can only afford one out of every 35 properties on the market. We wonder who, then, will buy the other 34? Other people are beginning to wonder, too. Transactions in January fell 24% from the year before.
Speaking of prices, “I would expect a general decline of 5% to 10% throughout the country, some areas 20%…and in areas where you have had heavy speculation, you could have 30%,” says Angelo R. Mozilo – a man who ought to know. Mr. Mozilo is the CEO of the nation’s largest mortgage lender, Countrywide. While we have no reason to doubt Mozilo’s words on the subject, it is his actions we’d bet on. According to Grant’s Interest Rate Observer, Mozillo “has been a steady and heavy seller of Countrywide common for two years.”
We recall an estimate reported in these epistles a few months ago. Fully 40% of the job growth since 2001 is said to be the fruit of the housing boom. If that is so – and if despite these new jobs, real wages have gone down during this period – we can’t help but wonder what will happen to wages when the boom ends. It seems likely that they will go down further. And, it seems likely that consumer spending will fall, too. Is that when history starts up again?
Yes…or maybe even sooner.
[Ed. Note: The authorities are getting nervous. They’re afraid of what could happen as these marginal buyers have to pay up. Regulators are stiffening lending rules and pressuring mortgage companies to be more careful with their money…and yet, the amount of defaults will still rock these lenders…and everyone in the United States will feel the aftershock.
More news from the pundits at The Rude Awakening…
Eric Fry, reporting from Wall Street:
“The quest for alternative energy sources has gained increasing urgency. This quest is no longer the exclusive domain of science geeks. $60 crude oil has contributed a tangible profit motive to the search for viable alternatives.”
Bill Bonner, back in London with more views on various things…
*** Support for the war in Iraq is deteriorating. A new poll shows two-thirds of Americans already think the war was a “mistake.” History is grinding away, slowly but surely, at our war president.
When the war was first announced, Americans were fully behind it, and suspicious of anyone who wasn’t. We lost a good number of dear readers because they couldn’t put up with our standoffish attitude to the war. One wrote to say he wished U.S. bombers would drop a load on our Paris office on their way to Baghdad!
But, we were never really “against” the war. That suggests a degree of earnest do-goodism of which we are incapable. We take the world as we find it; we let the gods do their work. We only try to understand what they are up to, not stop them. Maggie Thatcher said an attack against Iraq was too “uncertain.” She argued against British involvement. The cynical French remembered Algeria; they wanted nothing to do with it.
While we shared many of their views, we saw the war as a historical necessity. Every empire needs to find a way to look ridiculous; it has to lose its pants, in other words, when the theory holding it up finally disintegrates. Nature loathes a monopoly. A successful empire has a monopoly on the use of organized force. Nature conspires against it, tries to undermine it and eventually ruins it. Every great empire also needs to take Baghdad at one time or another. The English took it. The Mongols took it. The Romans took it several times. Why shouldn’t we?
Wouldn’t that be a good way to weaken the empire, too? It would cost a fortune, stir up enemies, and tie up the imperial army in a futile campaign against nobody of importance. If you wanted to destroy the U.S. Empire, it would seem to be the perfect project. All nature needed to accomplish her dirty plans was an American administration foolish enough to undertake it. In Bush, Cheney and Rumsfeld, she found her stooges.
*** Back to the General Theory of Grinding…
Against the theory that modern American democratic capitalism always makes things better, we offer our own theory: Things don’t get better at all. Technology improves. Material living standards get better. But, down in that old “rag and bone shop of the heart” – where central bankers toil, politicians despoil, lovers and history grind away – things remain same.
We hold this truth to be self-evident: Everything degenerates, everything breaks down and everything is born again to new life.
“Wait a minute,” you say, “things are getting better.”
We expect you might toss the Great Crusades in our face, the Hundred Years’ War, or the Aztec butcheries.
“See, we don’t do things like that any more,” you say. But, we offer this rebuttal: Auschwitz, the 20th Century, the War on Terror!
Last night, we read an account of the Soviets’ advance on Berlin in World War II. Was it much different from the Mongol invasion of the 13th century?
If there has been any progress in human affairs, dear reader, it has been very slow, very slight and very fragile.
What we see when we look around is a constant upwelling of institutions and ideas, and then, a constant wearing away, erosion, and degradation of them. That is history grinding away – churning, burning, turning everything up and down, over and around. Stock prices rise – only to fall again. Empires flourish – only to degenerate and make way for a new empire. Currencies, companies, economies…all have their moments of glory – and their moments of sorrow.
Even modern democratic capitalism gets ground down by history, as we will see tomorrow, when we take up the General Theory of Grinding further.
*** Flash Tip: here’s how to make some money. Sell short the Gulf! The Egyptian stock market has gone ga-ga – up over 1,000%. Stocks throughout the Gulf area are selling at 44 times earnings. Dubai is in a property bubble; they’re putting up the Burj Tower, intended to be the tallest building in the world.
Sell! If it doesn’t work out, please forget we suggested it.
*** And here is one of our colleagues, Justice Litle, with another way to make some money:
“Three words: ‘Buy the tropics.’
“It’s sort of a conundrum why the tropics have fared so poorly, in economic terms, over the past hundred years. There is a band around the equator that practically guarantees squalor if your country falls within it.
“The Economist recently talked about a theory for why this is so. Basically, the colder northern regions had to innovate in order to deal with harsh living conditions, and thus ‘necessity as mother of invention’ led to the implementation of industrial society and all that came with it. In the tropics, life was good mon – as the Jamaica commercials say – and no one had to do much to get ahead. And so, they didn’t; the tropics became mired in relative poverty.
“But all that industrial revolution in the northern climes has hit an apex – the next phase being a tearing apart of the social fabric as knowledge economies stride forth from the ashes.
“So now, in the 21st century, the mega-trend industrial-political shoe is on the other foot: ugly for the northern climes, perfect for the tropics.
“Over the next 50 years, that whole band-around-the-equator area, long neglected except as a vacation spot, is going to become a hotbed of knowledge migration, capital migration, technology implementation, passport arbitrage, tax treaties…you name it. Technology enables all this, as does the fall of the welfare state via capital and physical flight…and the relatively pristine state of the tropic – their lack of industrialization – is suddenly a major advantage.”
*** Yesterday’s excursion to Paris did not go as planned. Your editor stepped into the apartment his wife had chosen and his face gave him away immediately. It was dark. We looked out the window and saw only our own face reflected in the glass of a similar apartment building right across the narrow street.
“You don’t like it,” said Elizabeth.
“I didn’t say I didn’t like it. It’s fine, really,” we replied.
“You don’t have to say anything. You’re no good at poker and no good at pretending,” responded Elizabeth.
Elizabeth has decided to buy an apartment in Paris. We did the math. It doesn’t seem to make sense. We can rent a nice apartment for half as much as we pay in London. And the same apartment that we can rent for $5,000 costs more than $1 million – not to mention another couple hundred grand for a new kitchen and new bathrooms.
“Why put in a new kitchen?” we wanted to know. “This one looks perfectly fine. And what’s wrong with the bathrooms?”
Elizabeth looked at the young woman who was showing the apartment to us. Both of them rolled their eyes. Some instinct seems to tell women when they need new bathrooms and new kitchens; it was not evident to us.
And, some instinct seems to lead them to want to buy an apartment in the first place. If we were able to earn even a modest return on the money we would otherwise use to buy an apartment, we’d have enough income to pay the rent and have a little left over to go out to dinner. Buying doesn’t seem to make sense.
“I’m tired of paying rent,” said Elizabeth. “Besides, I want to be able to fix it up in my own way.”
She is still looking.