Booming Trade Along the New Silk Road

Berkshire Hathaway’s Charlie Munger likes to point out that there are billion-dollar answers buried in history books. In the essay below, Chris Mayer proves that point by taking a look at a sort of new Silk Road – a kind of integrated economic bloc that stretches from the Mediterranean to the Sea of Japan.

Call it globalization, if you want. It’s the long and ongoing process whereby the world seems to shrink a bit every day. Its hallmarks are increasing trade between countries and a steady flow of people and ideas across blurred national borders.

This process of integration has been going on, in fits and starts, for centuries. Perhaps the most famous and influential trade routes in history were those of the old Silk Road. Now unfolding before our eyes is a sort of new Silk Road. Trade surges across the lands of Eurasia and the Middle East. This flow of trade creates important new opportunities for investors.

But before I get into how this is happening today and how you can take advantage of it, let’s look over our shoulders into the slipstream of markets past. Certainly, it’s not usual practice among investors to look to learn something from a man who has been dead for over 600 years. But as Charlie Munger, the witty vice chairman at Berkshire Hathaway, likes to point out, there are billion-dollar answers buried in history books.

In this case, the story of Ibn Battuta is one that informs. He led a truly amazing life. His tale is wonderfully retold in Ross Dunn’s book The Adventures of Ibn Battuta: A Muslim Traveler of the 14th Century.

Battuta’s story begins in 1325, when at the age of 21, he left his home in Tangier, Morocco. Battuta was off to make the pilgrimage to Mecca. But his journey would prove unlike any other.

Battuta did not see Tangier again until he was 45 years old. Until then, he chose to wander the globe. Battuta crossed over 40 modern countries and covered over 70,000 miles. He became one of the greatest travelers the world has ever seen. He left behind a travelogue of his life’s journeys filled with details on the places, people and politics of medieval Eurasia and North Africa.

His adventures reveal, as Dunn writes, “the formation of dense networks of communication and exchange.” These networks “linked in one way or another nearly everyone in the hemisphere with nearly everyone else.

“From Ibn Battuta,” Dunn continues, “we discover webs of interconnection that stretched from Spain to China, and from Kazakhstan to Tanzania.” Even in the 14th century, an event in one part of Eurasia or Africa might affect places thousands of miles away.

In reading the book, this multinational aspect of Battuta’s world really fascinated me. The Mongol states allowed merchants to travel freely in their realms, regardless of religion or origin. This led to the creation of a worldly, prosperous and traveling elite, transmitting ideas as well as goods across countries. For these traders, the focal point was not countries, but cities. They were also, in Dunn’s words, “free from the grosser varieties of parochial bigotry.” It is one reason why some historians say that during the medieval period, the Islamic cultures came closer than anyone else in creating a common social order.

Needless to say, it was a time of great growth and trade. Households enjoyed porcelain from China, pottery from South Arabia, gold and ivory from Africa, animal skins from India, rice from the Ganges Delta and much more. Ships sailed the Volga, their holds filled with grain from the steppes, timber from the mountains of Crimea and furs from Russia and Siberia, along with salt, wax and honey – all carried by a hodgepodge of peoples: Egyptian traders, Turkish nomads, Greeks, Circassians, Alans… even Florentines and Venetians.

China, too, played an important role. The huge Chinese junks, the ocean liners of the day, expanded trade across the Chinese seas to the Bay of Bengal. Populations soared. Cities multiplied, along with a vast network of canals and roads.

That, to me, is a beautiful portrait. I think the new Silk Road is a revival of that kind of period. It’s a kind of integrated economic bloc that stretches from the Mediterranean to the Sea of Japan.

Just look at the booming trade between China and the Middle East. It was a trickle of only $6 billion in 1995. By 2006, that number swelled to $69 billion. The numbers for 2007 are not in as I write these words, but my guess is we’re approaching $100 billion by now.

The story gets more powerful as you dig. Bloodless statistics take you only so far. But look at what companies are doing. Sinopec, a Chinese company, invested $100 billion in an energy project in Iran. That’s no two-week trade. That’s a marriage. Or look at Damac Holding, one of the largest developers in Dubai. It recently put $2.7 billion in a real estate complex in Tianjin, China. These things would have been unthinkable even 10 years ago.

The possibilities of today’s new Silk Road are sometimes mind-boggling. Consider this: There is huge demand for an overland route from Europe to Asia. Imagine it: a steady stream of trucks leaving the river towns of the Yangtze Delta, bound for the trading cities of Eastern Europe.

It’s not far-fetched. China is constructing 12 highways to link its western Xinjiang province with Central Asia, which could eventually link up with Europe. China plans to nearly double its highway system, from 28,000 miles to 53,000 miles by 2010 – that’s only two years away!

The ports, too, are busy along the new Silk Road. Global Insight says container shipping volumes between Asia and Europe grew 17% in 2007. Total volume was double the 2003 level. And the ships used today are, on average, 2? times the size of the largest ship a decade ago.

Many ports can barely handle the volume. “In about six years, the capacity of India’s ports needs to double,” says Amit Desai, executive director of Mundra Port in India. Mundra Port is the largest publicly owned port operator in India. Its shares doubled on its first day of trading in Mumbai. The offering was 100 times oversubscribed. That’s like having a line of people out the door waiting to buy your stock. It’s as if you were cooking the hottest tandoori this side of the Ganges.

Shipping companies are actively pursuing new routes. Perhaps through the ice-free Arctic passages, as I’ve written to you about before. Right now, Singapore is still king. It is the world’s largest container port hub. Singapore, sitting in the Strait of Malacca, is the hinge that links Asia’s shipping lanes with Europe. (I’d love to get to Singapore sometime in 2008.) Some of the excess may bleed into airfreight. China alone plans 48 new airports over the next decade, to add to its current total of 130. It’s been called the “Silk Road in the sky.”

It’s not all peaches and cream, of course. There is all of that pollution and environmental destruction, for one thing. It’s a concealed debt, to borrow author James Kynge’s expression. The region will have to deal with that eventually. Even in the cleanup, there will be opportunity for investors. Of greater concern are rising social tensions and political minefields. Mankind has often proved adept at getting in its own way.

Still, as an investor, I want to be a part of this new Silk Road. In my last two letters to you, I’ve recommended stocks in businesses that have no U.S. operations. This is not an accident. These companies service markets right in the heart of the new Silk Road. In addition to these, companies that own the commodities the new Silk Road needs should prosper. It will need lots of copper, iron ore, nickel… as well as oil, coal, natural gas and much more, including clean water.

Regards,

Chris Mayer
for The Daily Reckoning
February 13, 2008

P.S. In the past two years, I’ve traveled to India, China and the United Arab Emirates. I am planning to visit Eastern Europe, on the fringes of that great new Silk Road, sometime in 2008. Look for that and new investment ideas and insights in the year ahead.

In the meantime, check out why India is the place where you could make two times, five times…even 10 times your money in the next two or three years.

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.

The latest dispatches from the front lines give an edge to inflation. Yesterday, the Dow rose 133 points – putting it more than 500 points above its January low.

Commodities backed off, with the CRB down slightly…and gold off more than $15.

This was very good news to Ben Bernanke and his merry band of market manipulators. Mr. Bernanke famously remarked four years ago that the world was a better place because of “improved monetary policy.”

Monetary policymakers “will not forget the lessons of the 1970s,” he assured investors.

We wondered what lesson he was talking about. As near as we can remember, the lesson of the ’70s was that monetary inflation doesn’t always work. At some point, adding more money and credit becomes counterproductive… Or, to describe it in the language of classical economics…the marginal utility of greater and greater inputs of cash and credit falls into negative territory. Then, instead of producing the desired growth and prosperity, more inflation produces stagflation – rising prices without growth.

When that happens, the only way to deal with it is to bring in someone like “Tall Paul” Volcker, who stops waiting for the Humpty Dumpty economy to fall; he gives it a good shove…with interest rates over 15%.

Faced with what appeared to be a ’70s style slump, Bernanke rushed off in the opposite direction – offering lower interest rates and more cash. He hopes to avoid a recession and – who knows – this morning’s news suggests that he may have done the trick.

A regional Fed governor is in the news, saying he believes there will be no recession in 2008. And the papers are reporting a resurgence of inflation in consumer prices.

“Global inflation climbs to historic levels,” says a headline in the International Herald Tribune. Here in London, officially, inflation is running at a 7-month high. On the opposite side of the world, in Japan, inflation levels are higher than they’ve been in 27 years. And all over the world, prices are rising.

No wonder. The Fed’s key rate is only 3.5%. Whatever the real rate of consumer price inflation is, it is surely higher than 3.5%. Maybe 4.5%…maybe much higher.

And the US federal government’s Open Checkbook policy helps too. Business Week reports:

“The federal budget deficit is running at a pace that is more than double last year’s imbalance through the first four months of the budget year. In its monthly review of the government’s finances, the Treasury Department said Tuesday that the budget was in surplus in January, but totals $87.7 billion so far this budget year, double the $42.2 billion imbalance recorded during the same period in 2007. The new budget year started last Oct. 1.

“The Bush administration sent its final budget request to Congress last week, projecting that the deficit for all of 2008 will total $410 billion, very close to the all-time high in dollar terms of $413 billion in 2004.

“So far this year, federal spending is 8.3 percent ahead of last year’s pace, at $949.1 billion. That is far ahead of the 3.2 percent increase in revenues, which have totaled $861.4 billion in the current budget year.

“It is hoped the stimulus plan will keep the economy out of a recession or at least make the downturn milder and shorter than it otherwise would have been. The rebate checks are expected to start being mailed out in May with most Americans getting checks of $600 for individuals and $1,200 for couples filing their tax returns jointly. In addition, families with children will get an extra $300 per child.”

Do you see how wonderfully sophisticated this new “improved monetary [and fiscal] policy” is, dear reader? You jack up the whole economy with cheap money and credit…and then, when the thing starts to wobble, you put on another, bigger jack.

We don’t know what lesson Ben Bernanke drew from the ’70s, but the lesson we recall is that you can’t keep jacking an economy up forever. Eventually, you have to let it down, or it will fall on your head.

But central banking is not a science. At best it is one part bad theory, one part low art…and one part pure flimflam.

*** Sentiment in the housing market doesn’t turn on a dime. House prices made their biggest advance in history, between ’97 and ’06. It takes time for the momentum to exhaust itself.

Putting the question to homeowners, pollsters found that the 77% of them believed their houses had either stayed even or gained value in 2007. This result is completely at odds with the research results of the Case/Shiller Index, which puts the average house down about 10% for the year.

In Sacramento, the average house went down nearly 19% in the 12 months to the end of November ’07. In Las Vegas, the average loss was 17%.

*** Son Jules, at school in California, sends this little item:

“Exxon Mobil pays as much in taxes ($27 billion) as the entire bottom 50% of individual taxpayers, which is 65,000,000 people. The tax rate for the bottom 50% is only 3% of adjusted gross income; the tax rate for Exxon was 41%.”

Conservatives will be quick to spot the corruption. The people who pay little in taxes discover that they can vote themselves someone else’s money. Social Security…Medicare…education…protection – they want it all – as long as they don’t have to pay for it themselves.

But while the poor are trying to steal from the rich, the rich are doing their share of larceny too. Publicly-funded universities educate the sons and daughters of the well-to-do, not the poor. Retirement programs benefit those who live longest – again, the well-to-do, not the poor. Farmers want price supports…factory owners want tariffs…lobbyists want tax breaks hidden in the pleats of worthy legislation… And people with financial assets want protection from losses. In step the feds with money and credit – holding off crashes, avoiding bankruptcies and disguising losses with inflation…thus, shifting the burden of mistakes from investors to consumers.

As a democracy matures, the web of connivance and corruption becomes so tangled that people don’t know whether they come out ahead or behind. Then, the weight of it causes the whole society to sag.

*** Colleague Chris Mayer reports:

“China added more to global economic growth in 2007 than the United States. That’s the first time a country other than the U.S. pulled the bulk of the global economic sled since at least the ’30s.”

Buffett says it is not smart to sell the United States short. But selling the United States short has been a very good investment for the last eight years. Our guess is that it will continue to be a good investment, generally, over the next eight years too.

The United States is the General Motors economy – it is losing money on an annual basis, with high legacy costs, high debt, worn-out equipment, and a declining market share. Could it turn itself around? Yes. But not without a major upheaval – war…revolution…or bankruptcy.

Chris passes along another friend’s advice: “Get out of the dollar, teach your children Chinese, and buy commodities,” says Jim Rogers.

Until tomorrow,

Bill Bonner
The Daily Reckoning

P.S. You can read more from Chris, below. But first, be sure to check out his book: Invest Like a Dealmaker: Secrets from a Former Banking Insider, now available on amazon.com.