Export Dependence

There seems to be so much to worry about in America today: Terrorists, the diminishing dollar, an ever-growing trade and current account deficits…just to mention a few. Instead of letting all of these problems weigh heavy on our brains, Gary Shilling suggests that we see the glass half-full.

Asian countries are getting worried because their export growth is waning, and countries in that region are highly dependent on exports. Exports account for more than half the GDP in a number of smaller ones, such as Vietnam (52%) and Thailand (55%). In Singapore, Malaysia and Hong Kong, the ratios exceed 100%, as their airports and harbors turn imports into exports.

These countries worry that high-energy prices and other forces are cooling the U.S. economy and, hence, demand for their exports. They also worry about the effects of high-energy costs on Asia and, more broadly, exports within the region.

Asian countries are also concerned about the strength of their own currencies against the dollar and the resulting negative effects on their exports-specifically, their exports to the United States since the lion’s share of their exports, directly or indirectly, end up in America.

Nevertheless, currency values and real imports have almost no correlation; the same is true of real exports and currencies. So if currency movements don’t alter trade flows very much, what does? Economic activity. When an economy is growing, consumers and businesses buy more of everything, especially imported goods and services. There is a close correlation between real imports and GDP in the United States. Statistical work shows that U.S. imports rise 2.9% for each one percent increase in GDP, but only 0.2% for each one percent rise in the dollar. Other major countries have similar relationships.

Asian concern over dollar weakness, then, is overblown, but worries over U.S. growth and American imports are well founded. The immense fiscal stimuli from earlier tax cuts and jumps in defense and Homeland Security spending are now fully absorbed. So, too, are the effects of the decline in interest rates, which spurred housing activity and cash-out mortgage refinancing.

Real Imports and GDP: Three Negative Forces at Work

With further big leaps in housing and consumer spending unlikely, many hoped that business outlays would surge and seamlessly continue robust U.S. economic growth. But those hopes have not been fulfilled. So, the U.S. economy lacks meaningful growth stimuli. At the same time, three negative forces are at work: First, the recent jump in crude oil prices is cutting about 1% off U.S. GDP growth. And it’s sobering to note that the last five oil price spikes were associated with recessions. Second, the Fed is in the midst of a rate-raising campaign, and it’s true that Fed rate hike efforts almost always end in recessions. And lastly, there is also the election year cycle. In the postwar era, a recession occurred in the first or second year after 10 of the 15 presidential elections.

So if the United States is no longer the destination for much of the world’s exports, who will be able to step in? China has become a big player on the global stage, and therefore important to the worldwide economic outlook. The concentration of global manufacturing in China has made her a huge consumer of raw materials and promoted rapid economic growth and leaping exports. But now China is trying to cool her overheated economy, and last month the central bank raised its benchmark interest rate for the first time in nine years. More increases are likely since that interest rate is still below China’s inflation rate.

The likelihood that China can let the superheated air out of her soaring economic balloon without a crash-landing is very low. In the United States, the Fed, with all its sophisticated monetary tools and experience, has tried to affect soft landings in the post-World War II era 11 times, but has only succeeded once, in the mid-90s. How can China succeed with her crude monetary and fiscal tools in an economy with only partly free markets?

A recession in China would wreak havoc on the rest of Asia, even Japan, which is just emerging from over a decade of deflationary depression and remains dependent on exports for growth. While America continues to be Japan’s prime market, exports are increasingly headed for China. Japan is increasingly dependent on capital spending in China, and her exports to China accounted for 79% of Japanese export growth last year. The bottom line is that Japan’s recovery is export-led, much of it due to China. So, if the Chinese economic balloon makes the hard landing I expect, Japan’s may fall back to earth without even having gained much altitude. And if the United States, China and Japan have weak economies, so does the rest of the world.

Real Imports and GDP: A Not Rosy Outlook

In the near future, the world will continue to depend on the United States to buy its excess goods and services, and the outlook for the U.S. economy and American imports isn’t rosy. Most foreign countries are running merchandise trade surpluses, the counterparts of the huge American deficit of more than $600 billion. In the longer run, however, the U.S. trade gap may reverse gears and shrink, but in a way that damages foreign exporters.

So, will another country replace the United States as the economic engine that absorbs the globe’s excess goods and services? Maybe, but none have yet volunteered for the job. It’s unlikely to be Europe, with its traditional disdain for imports in favor of job-sustaining local production. Ironically, though, the even more import-wary Japan may end up being the world’s next big importer. All major countries have rapidly aging populations, but Japan’s is the most extreme. One reason for this is the long life spans of the Japanese. In future years, Japan, like the United States, Canada and European nations, will face a dwindling number of workers to support retirees.

But due to decades of saving more than was needed for domestic investment, Japan has been exporting capital. Those outflows have cumulated into huge holdings of U.S. Treasury obligations, foreign real estate and other assets around the globe. Japan, in the decades ahead, can simply sell those piles of foreign assets and use the money to buy the imports needed to supply her retirees. No other major developed country that faces an aging population has that horde of foreign assets to cash in.

While Japan may replace the United States as the globe’s importer, developing countries like China are unlikely to fill that role. Sure, we know all the stories about big domestic spending in China on cell phones, cars and TV sets. But I suspect that that spending comes from export revenues and the direct foreign investment that continues to pour into China to build production facilities. With the next U.S. recession and global downturn, both Chinese exports and direct foreign investment there will dry up. So too will domestic spending – if I’m right.

More fundamentally, I believe that China, India, the Asian Tigers, Latin American lands and other developing countries are not yet industrialized enough to have the vast middle classes needed to create economies that are led by domestic spending. Today’s array of developing countries are probably decades away from achieving big enough middle classes to eliminate their dependence on exports for growth.

Many see the growing U.S. trade and current account deficits as menacing problems. I see the reverse, the dependence of the rest of the world on America to buy its excess goods and services, which can only be good for us in the long run.


Gary Shilling
for The Daily Reckoning
November 24, 2004

Editor’s Note: Dr. Gary Shilling is president of A. Gary Shilling & Co. Inc., an investment advisory and economic consulting firm and publisher of the monthly INSIGHT newsletter.

Prescience has empowered Dr. Shilling to beat the stock market by a wide margin over many years while providing consistently accurate forecasts to his subscribers. Twice ranked as Wall Street’s top economist by polls in Institutional Investor, Dr. Shilling was also named the country’s No. 1 commodity trader adviser by Futures Magazine. And last year, MoneySense ranked him as the third best stock market forecaster, right behind Warren Buffett.

A regular columnist for Forbes magazine, Gary Shilling appears frequently on radio and television business shows and has written six books, including Is Inflation Ending? Are You Ready? in 1983 and, more recently, two books detailing his forecast for the new world order and its consequences for your wallet.

"Traders see no halt in the dollar’s slide," says the headline in today’s International Herald Tribune.

Well, what’s the matter with these traders? Do they have no calendars? Does their language have no future tense? Can they not add and subtract? Do they not step out of the way when a train comes down the tracks?

If the dollar’s slide will not halt, it must continue. If it continues, the dollar will be worth less tomorrow than it is today. Why do they not look ahead and sell the dollar today?

Frankly, we’re puzzled. If everyone knows the dollar will be worth less tomorrow than it is today, why do people not rush to get rid of it? Something is wrong with this analysis.

"When everyone thinks the same thing, no one is thinking," is the old traders’ adage. Here at the Daily Reckoning, we don’t know what to think. That the dollar will fall, we do not doubt. As long as we were the only ones to think so, we were happy to believe it. But now that everyone seems to think so, we are nervous. Something is wrong. Traders are not stupid. If they were really sure the dollar would fall they would short it furiously. Trillions of dollars are at stake. And billions in profits for traders. Why do they not look ahead and take advantage of the situation?

Why don’t the holders of trillions of dollars worth of assets sell them now? Why do they stand still and let themselves be run over? Stock prices are at record highs. Bonds are near record highs. The five biggest tech stocks are said to be worth more than all the public companies in India (recalling so vividly when the grounds of the Imperial Palace in Japan was said to be worth more than all of California). Bells are ringing all over the place. (Or, is it just in our own ears?)

This is the time to sell! Defect from the Bush/Greenspan debt-and-deficits economy! Walk away from over-priced assets! Desert this Public Spectacle while it is still in the Farce stage…before it enters the third and final Tragic Loss phase!

"Economic Armageddon Predicted," was the Boston Herald’s headline. The paper caught up with Stephen Roach, who said he thought such an economic catastrophe was a 90% certainty. The United States needs $2.6 billion every day, just to keep going. But as the dollar falls, who’s going to want to get paid back in dollars? Especially at today’s low interest rates?

Already, even at today’s low rates, households spend a record portion of their income on debt interest. What are they going to do when rates rise?

Most likely, the dollar will fall…and consumers will be forced to cut back. There will be a spectacular wave of bankruptcies, he says.

If the dollar falls just 10% more…Americans will be 10% poorer in world terms. They will earn 10% less each hour they work. Their homes will be worth 10% less. Their stocks, too. Most will hardly notice. Some will be pushed into insolvency.

As we keep admitting, we don’t know what will happen. But we know that there is something wrong with this picture: Everyone knows the dollar will fall, but no one seems to want to do anything about it.

There was no break in the Dow yesterday…nor in bonds. Nor in any other dollar asset. The dollar itself melted away a little. But no one seemed particularly concerned about it.

Here’s our guess: Either the dollar won’t fall as expected…or all of the sudden people will begin to head for the exits. In the latter case, more than a few are likely to get crushed in the stampede.

And you, dear reader? We hope you have made your way to the exits in plenty of time to avoid the rush. Remember, the Public Spectacle should be amusing. But it is only entertaining if you’re not in the middle of it.

More news, from our team at The Rude Awakening:


Tom Dyson, reporting from chilly Baltimore…

"But concern for the dollar is not a preserve of the rich and powerful. Take Ms. Ge, a middle-aged woman waiting with her elderly mother in the lunch hour queue at a bank in Shanghai. ‘The dollar doesn’t mean anything anymore,’ she complained, while waiting for a wire transfer to hit the bank’s books. They immediately converted their money into renminbi, Bloomberg reports."

Seems that everyone is more than a little apprehensive about the dollar’s slide…


Bill Bonner, back in London…

*** Gold backed off a little. The old money seems to want to pierce the $450 level. But don’t be surprised if it corrects sharply, either before or after.

*** "Tensions rise as China scours the globe for energy," reads a headline in the Telegraph. Addison, who has just returned home from a tour of Shanghai, Beijing and the tropical island of Hainan, says the China "story" is a much bigger deal than even we in the newsletter industry have made it out to be… if that’s possible.

"Pao mo, baby…" Addison writes. Regular readers will recognize our handy use of the Chinese buzz-word for ‘bubble’. "I’ve developed an investment strategy for China. I call it ‘Hu, Hoa and Wen.’

"Hu (who) is the name of the president. China is a totalitarian society after all, and if your company doesn’t have government support, its stock isn’t going anywhere.

"Hoa (how) was our guide on the trip. As with any foreign country where they use symbolic characters to communicate…a good guide is a must. Companies with predominantly Chinese boards, but have hired a stalwart Western trained CFO, generally outperform.

"Wen…well, Wen was our interpreter on Hainan Island. He was helpful in explaining the intricacies of the Miss World 2004 contest that was being hosted at our hotel. But for the rest of the time…he wasn’t around. Hmmmn…

"Knowing when to get out of Chinese stocks is just as important as know when to get in. This is the great ‘pao mo’ after all. And while there’s a fervor for Chinese IPOs and private deals…these stocks are just as likely to go down as they are up."

*** Rumor has it that U.S. troops, after such a splendid success in Fallujah, may be on their way to Kiev. Making the world safe for democracy is not such an easy job after all. In the Ukraine, the official loser in recent elections decided to take office anyway. What we found most interesting were the before and after photos of Mr. Yushchenko. He said he’d been poisoned by the opposition. We don’t know what happened to him, but he seemed to get much uglier in a short period of time.

*** Here in London, the papers are full of fascinating items:

Page one of the Daily Express quotes Ozzy Osbourne: "It’s safer in Los Angeles." Crooks broke into his house in Buckinghamshire and stole $1.8 million in jewelry.

On page 3, we find a new trend: People are sick of doing it themselves. A new company, "Dial a hubby," sends out a handyman to fix whatever needs to be fixed around the house.

And then, on page 5, we find the naughty vicar story. The small-town clergyman seems to have had an affair – or so it is alleged – with the local undertaker. Something went wrong and she vowed to get revenge. This she did, with the help of her "partner," the local doctor. It is "the bizarre tale of a rural GP [doctor], his undertaker lover and an 8-month campaign of hate against the village vicar," says The Express.

*** Page one of the Times of London, meanwhile, tells us that the English are getting serious about crime and terror. "In politics," said Samuel Coleridge, "what begins in fear usually ends in folly." Here at the Daily Reckoning we say: Public spectacles begin as fraud and end as tragedy. The British government seems to be learning from its U.S. allies. Fear works. Britain survived bombing by the Luftwaffe and the threat of invasion by keeping a stiff upper lip and going about its business. But the fear of crime and terrorism seems to have made the Brits as weak-kneed and timorous as we Americans. Law and order is what voters on both sides of the Atlantic want. And if they don’t want it, they’ll get it anyway. In markets, investors get not what they expect but what they deserve. In democracies, citizens don’t get what they expect either; they get what their dopey neighbors deserve.

Under guise of fighting terror and crime, the governments of England and America are able to push through the most absurd and obnoxious legislation. Soon, everyone in England will have to carry an ID card and present it to the polizei whenever it is demanded. The winning formula seems to be: Spend your way towards insolvency, while restricting citizens’ rights in the name of "fighting for freedom."

*** "The turkeys look nervous," Pierre reported from the farm yesterday. "We don’t celebrate Thanksgiving here in France. I don’t know how they would know. But they seem more agitated than usual. Of course, they should be. Damien is going to kill one of them tomorrow so you’ll have it for the weekend."

*** "Jules," we intend to say, "you need to make an adjustment in your behavior."

This is the conversation we expect to have. We are not looking forward to it.

"Dad, you have to talk to Jules," Maria advised yesterday, after we told her what had happened on Saturday night.

"I mean, you should never have said anything to him on the dance floor. How is he going to feel? You humiliated him in front of his friends. And let’s face it, there wasn’t anything wrong with kissing a girl on the dance floor…"

"They weren’t just kissing, they were practically fused together…"

"Well, maybe it wasn’t appropriate. Especially in front of his mother. What was Jules thinking? He probably wasn’t thinking at all. But you probably don’t have any idea of what is going on. You know, everything happens in the bathroom. The kids go into the bathroom and smoke marijuana. And then they get pretty mellow. But don’t tell Mom. She’d get all worried about it. I mean, she’s going to all this trouble to try to get Jules in with the right crowd…"

"What does Mom think, by the way?"

"She thinks the girl was a hussy who shouldn’t have been invited."

"Ooh la la…"

The Daily Reckoning