Economic Dinosaurs

Thinking, not sweating has proved to be detrimental to the U.S. economy. In fact, as Dan Denning points out below, America may turn into to a "has-been of industrial power."

Apparently, boring old-economy dinosaurs going to outperform this year. Why? There are two simple reasons and one slightly more complicated one. The first reason is that these companies have tangible assets. When you sell paper and buy stuff, you buy assets that have enduring value and that don’t fluctuate in perceived value when interest rates rise (as financial stocks, REITs, and some mortgage lenders do).

The second reason is that certain industrial stocks are in sectors of the American economy that are ALREADY running a trade surplus. That’s right, a surplus! If the dollar falls even more in 2005 (in the second half of the year, I’m forecasting), these firms will become even more competitive. If the current account deficit comes back into balance, or even adjusts below 6% of U.S. GDP, it will do so through a falling dollar, reduced imports, and rising exports. It’s these industrial exporters that will generate the largest trade surpluses on dollar weakness.

However, the biggest reason industrials are set for a revival is a rediscovery of an economic truism: You make money selling things you produce, not buying things other people sell. Manufacturing – and not services – has tremendous economic multiplier effects. It creates higher employment, higher incomes, more efficient use of savings, and trade surpluses.

But the point is not without some controversy. Nor is it well understood. And until it’s understood well, America’s economic competitiveness will continue to go the way of the dodo. America will turn into a has-been industrial power with weakened economic and military influence across the globe. The latter side effect of American decline might be good. But the former isn’t. Not for working Americans. And not for investors.

The Goods Deficit: Which Deficit Is Likely to Fall?

It doesn’t have to be that way. We’ll begin at the beginning and with a simple question: What American firms profit more when the dollar declines?

Everyone knows and says America’s twin deficits must fall for the dollar to find a floor. But which deficit is more likely to actually come down? And will it actually arrest the dollar’s fall?

President Bush says he can halve the federal deficit in four years. Because we’ve done the math on this before – the difference between discretionary and nondiscretionary (indiscrete?) spending – we’ll simply leave it alone and assume the president is either counting on a huge surge in revenues (despite the tax cuts) or has a plan to eliminate Social Security that he hasn’t told us about yet.

So that leaves the trade deficit. It’s widely assumed the United States is content to let the dollar fall, believing it will make American exporters more competitive; raise the price on foreign goods at home; and over time, through market mechanisms, painlessly adjust the trade deficit, restore balance to the American economy, and make everything right with the world.

But does a falling dollar really make America any more competitive? Will it actually reduce the trade deficit? The quick is answer is no, for two reasons.

First, as long as the Chinese yuan is pegged to the dollar, then Chinese goods fall in price along with American goods in the rest of the world’s export markets. American and Chinese goods get absolutely cheaper, but American goods don’t budge an inch relative to their Chinese competition. This, incidentally, is awful for the European exporters, who face price competition from American firms and, because of the Chinese peg, even more price competition from Chinese firms (and other Asian currencies linked to the dollar).

But let’s explore the issue a little more. Assuming America was making refrigerators and exporting them to Europe, you’d think it would be great news for American refrigerator makers: a weaker dollar translating into cheaper American refrigerators for European refrigerator consumers.

Wrong again. If the American fridges are cheaper in Europe, so are the Chinese fridges. No net competitive gain in the fridge market…or perhaps in ANY market for manufactured goods. And herein lies the fundamental competitive problem, one of the "unintended consequences of globalization," as I’ve called it before.

Even with a stronger Chinese currency, American manufactured goods can’t compete in price with Chinese manufactured goods, at least in industries in which the Chinese are engaged in competition. In aerospace, American goods are competitive because the Chinese don’t DO aerospace…yet. It’s an industry that requires highly skilled labor. It’s capital intensive and requires complicated machine tools.

The Chinese do better competing in low-skilled labor industries, although they are moving into the auto-parts business aggressively. An article in last week’s Wall Street Journal showed how China’s Wanxiang Group is moving into the U.S. auto-parts business, buying up rusted-out Rust Belt manufacturers that have fallen and can’t get up. It’s another example of Chinese capital migrating back to the West, to buy out the bankrupt and downtrodden assets of American industry.

This comes after the Chinese have put U.S. firms out of business by producing at below cost, via state subsidy or simply winning the global manufacturing war on the back of low wages. And whatever the reason, it has reduced America’s competitive advantage – if not outright eliminated it – across a broad swath of industries, especially in manufacturing.

The Goods Deficit: The Open Sore of American Trade

The open sore of American trade is the deficit in goods. Services of late have been running a surplus. But in any event, services are a smaller percentage of total trade volume than goods. In 2004, from January-September, total trade volume (total exports in goods and services plus total imports in goods and services) was over $2.1 trillion. Two-way trade in services accounted for $468 billion of the total volume, with service trade generating $37 billion in the first nine months of the year.

This is consistent with trade figures from both 2003 and 2002. In 2002, services rang up a $61 billion annual surplus and accounted for 22% of total trade volumes. And in 2003, services trade racked up a $51 billion surplus and again accounted for 22% of total trade volume.

In both years, the goods deficit was responsible for the trade deficit. In 2002, the goods deficit was $482 billion, with the services surplus bringing the overall trade deficit down to $421 billion for the year. In 2003, the goods deficit grew by 13% and topped half a trillion dollars, at $547 billion. Only a surplus in services of $51 billion kept the annual figure just below the $500 billion mark, finally settling at $496 billion.

With three reporting months left in the calendar year, it’s all but certain that the goods deficit will again top $500 billion. At $481 billion, the goods deficit is already 18% higher for the first nine months of the year than it was at the same time last year, thanks again to imports growing more quickly than exports this year (15% and 13%, respectively). The services surplus is nearly the same, around $37 billion, $20 million higher than last year.


Dan Denning
for The Daily Reckoning

January 25, 2005 — London, England

Dan Denning is the editor of Strategic Investment, and he recently returned from a three-month investment research mission in Asia.
As Mr. Denning stated above, America’s days as economic superpower are numbered…and 50 years from now, China will have edged us out as the richest and most powerful nation in the world.

50 years may seem like a long way into the future, but the Chinese takeover is starting now. Mr. Denning says, "China is growing at a blistering pace – and growing at the expense of the American economy."

Gold – the money with no one’s picture on it – rose again yesterday, to $427. It’s the money that no central bank promotes…and none destroys. It’s the money that exists only in its tangible form – a real metal; you can find it on the Periodic Table. It’s a real thing…real money.

"Gold goes up and down, just like other kinds of money," say economists. Which is true. "You can protect yourself from inflation in other ways," say the speculators. True again. "Gold pays no dividends or interest," say the investors. Also true.

Nor will gold cure baldness or add inches to your most private part. Even as money, gold may not be perfect. But we do not argue that it should be worshipped, only that it should be bought. As money, nothing is better.

Gold was around a billion years before the U.S. dollar was invented. It will probably be around a billion years after. This longevity is not in itself a great recommendation. You will not need it for that long. It would be like buying a suit with a 100-year guarantee; it would last longer than you do. But the reason for gold’s longevity is also the reason for its great virtue as money. It is inert; it yields neither to time, technology nor vanity.

Yesterday, we wandered toward what really drives the world improvers: Not charity, we said, but vanity. Paper money was a creation of the world-improvers, of course. The reason they prefer it to gold is exactly the reason that gold is better money; paper is ready to do their bidding…gold is not.

The world improvers are not interested in private acts of kindness or innovation that might actually make their world better. Instead, they want to remake the world, by staging great public spectacles that flatter their own amour propre. They propose a ban on world hunger – without planting a single turnip. They take up the cause of "freedom" in other countries – and force the liquor store next door to close on Sunday. They insist so strongly on better treatment for women in the Islamic world, they forget to kiss their wives. Like Alexander the Great, they stare out the window at the big, wide world and wonder how they can make it more appealing, while their closest friends drop dead unnoticed. "Thy love afar," as Emerson put it, "is spite at home."

Yesterday’s newspapers brought in a bumper crop of world improvements. We mentioned eliminating poverty and forced conversion (to democracy) in yesterday’s remarks. On the very same page of the International Herald Tribune, David Brooks takes up the cause of spreading "freedom" and "reform" throughout the planet. From this day forward, said Brooks, speaking of last Thursday, when George W. Bush announced his aim of "ending tyranny in our world," the American president "will not be able to have warm relations" with dictators.

We don’t know what air Mr. Brooks breathes, but we suggest he open the window. He may need oxygen. Skeptics will say that Mr. Brooks is being unrealistic. Already, our president is a tea-totaler. If the poor man couldn’t slap a dictator on the back, he would be as worthless in foreign affairs as Woodrow Wilson. As for ending tyranny, Mr. Bush might just as well have pledged to ban bad taste…ugliness…or death itself. In the contest between tyranny and George W. Bush, we have seen no odds. But we wouldn’t put our money on the president. Mr. Bush has only four years of practice in high office. Tyranny has been rehearsing for centuries.

But it is not idealism that animates the columnist; it is vanity. When Brooks urges G.W. Bush to put a new face on the world, the face he hopes to see is his own. His ideal is a world that looks as familiar as his own boudoir, just the way he wants it to look. If other people have other tastes and other ideas, well, they must be uneducated…or evil.

Brooks thinks, "It’s the ideals that matter." Private ideals do matter. Honesty, integrity, honor, love, service, dignity, frugality, industry, self-discipline, sobriety…no, forget that one…charity; these are the qualities that make the world a better place. Mr. Brooks’ crowd ideals, on the other hand, are merely excuses for vain meddling. If fox hunting is banned in England…or an election is held in Iraq, will the world be a better place? No one knows. What is really behind them is vanity; and what makes the world improvers so obnoxious is that they give in to it so readily.

But it is a lesson for us. Paper money is handy a tool for the world improvers. They use it like politicians use civil service jobs and generals use heavy bombers – to get their way. Whatever the vapid ideal du jour, it can usually be bought at some price. The poor can be fed and housed. The middle classes can be given free medical care and low-cost house loans. The upper classes can be given contracts and favors. Enemies can be summoned up…bombed…and reconstructed. All this costs money – more money than they have on hand.

How to get more money for these great new programs…these marvelously worthwhile ideals…these fabulous public spectacles? Gold flatly refuses to cooperate. It doesn’t even give a reason. Instead, it stays as mute and reticent as a dead man in front of a television. No matter how persuasive the advertising, the man is not going to go for it.

Paper money, on the other hand, barely needs encouragement. Start up the presses! Lower the Fed Funds rate! Relax reserve requirements and lending standards! Sell more bonds! Create more paper! Paper money is ready to go along with anything. It is like George W. Bush, himself. It seems never to have met a boondoggle it didn’t like…and never could tell a phony ideal from a real one.

More news, from our team at The Rude Awakening:


Eric Fry, reporting from Wall Street…

"We do not know if the NASDAQ’s steep 8% drop year-to-date is the beginning of an even bigger sell-off. But it ought to be. Two weeks ago, Federal Reserve Bank of New York President, Timothy F. Geithner, highlighted four of the major macroeconomic trends that may be worrisome for a few experienced investors."


Bill Bonner, back in London:

*** Tom Dyson, roving ne’er-do-well from the Rude Awakening, is still hot on the trail of a bull market in gold, silver and rare coins.

Last week he was at the 35th Annual Numismatic Convention in New York, he proudly recounts. Yesterday he went back in time to January 1980 – month of the great metal crash – using microfilm at the Enoch Pratt library in Baltimore.

"You’ll never guess whose name kept cropping up…Paul Sarnoff! He was all over the press back then as the NY Times’ expert on commodities trading…"

"Although gold fell $160 in one day, and silver was down $12, and commodities hogged all the headlines, the ads interested me most. If you want to know where NOT to put your money, read the ads. ‘Are you trading in America’s industrial wealth and forgetting America’s natural wealth?’ asks one commodity broker at the time. ‘Simple statistics prove that the profit potential is greater in commodities than in stocks…’"

"There were hundreds more, just like that one…"

*** "It was great," said Henry, 14, after participating in his first stag hunt.

"We all got on our horses early in the morning. You know, there is a lot of ceremony. Everything has to be done just right. Then we all took off. It was a pretty fast ride, up and down hills…but we usually stayed on the trails.

"Then the hounds chased the stag into the lake. It was a small lake. The stag tried to swim to the other side, but the hounds ran around, so he had to keep swimming. He went back and forth for a long time, then the ‘pikeur’ – I don’t know what that is in English…he’s the guy who kills the animal – got in a boat and rowed over to the stag and put a knife in his throat. When that happened we all took off our hats in respect for the animal.

"They towed the stag to land. We stood around for a long time as they cut off the head and the skin. And then they laid the carcass on the ground with the skin on top of it. They also cut off one of the feet, which they gave to Mom; I guess she was a kind of guest of honor since we’re new to the hunt club. Then the horns played…it’s called a "fanfare" in French. When that was over, they took the skin and the head off the carcass and let the hounds have it. They all attacked it. You couldn’t see anything of the deer, the hounds were so thick. All you saw was their tails and hindquarters. They moved it all around, like in rugby…what do you call that, a skirmish or something….and when they were finished there was barely anything left of the animal. And all the hounds were half red."

*** Our old friend Gary North on why a crowd is different from a collection of people.

"A crowd is a great tool for comics. Laughter is contagious. That’s why there are laugh tracks.

"Demagogues love crowds: fear and loathing are contagious in crowds. So is rhetoric.

"Markets are not crowds. They are impersonal auctions in which monetary bids are registered. Whenever people think of the markets in which they are bidders or would-be bidders as if markets were crowds, they start losing money. Auctioneers know this, which is why they prefer the bidders to be present. It’s why they hire shills.

"When greed or fear turns a market into a crowd, losses lie ahead."

*** What did God mean? One reader replies to another:

"Daily Reckoners,

"If I am going to be lambasted as a ‘poor deluded individual’ and a ‘so-called Christian hypocrite who feels like blowing some people up’ by some benighted soul who was obviously near hysteria as they sat in front of their computer to compose their attack – though I myself attacked no one – I would like a chance to briefly reply.

"Who needs to get their facts straight? The other fellow. He is obviously a rabid Bush hater whose abundantly obvious vitriol has blinded him to the simple point I was making: not all killing is proscribed by the Bible, including killing of combatants that takes place during warfare. I was not addressing the deaths of innocents, which remains a deplorable side effect of warfare. If my accuser would take his blood pressure pills and then look more carefully at his King James, he could read Matthew 19:18: ‘He saith
unto him, Which?’ Jesus said, ‘Thou shalt do no murder…’ Jesus understood the commandment correctly, as did the KJV translators here.

"The author points out Proverbs 20:18: ‘[Every] purpose is established by counsel: and with good advice make war’ and Proverbs 24:6, ‘For by wise counsel thou shalt make thy war…" War is not necessarily wrong; there is such a thing as ‘just war,’ such as freeing Europe from the Nazis during WW II.

"Finally, in telling me to ‘think again before [I] quote the Prince of Peace as [my] justification for senseless wholesale killing" (which I never did), I recall that the Prince of Peace Himself is coming to make war someday.
Revelation 19:11, 15: ‘And I saw heaven opened; and behold, a white horse, and He who sat upon it is called Faithful and True; and in righteousness he judges and wages war…And from His mouth comes a sharp sword, so that with it He may smite the nations…’"

In short, war is hell – but not all warfare is of the devil. The trick is to discern the difference.

The Daily Reckoning