It’s a known fact that we are in the midst of a global recession…and U.S. trade figures are beginning to reflect as such. And, as Chris Mayer explains below, a falloff in trade is one of the looming threats in 2009. Read on…
Where trade flourishes, business is good. But trade does not always flourish. The linked forces of globalization move in fits and starts.
The authors of Power and Plenty, a new book on trade over the last thousand years, tell us as much. "If anything," they write, "history suggests that globalization is a fragile and easily reversible process."
One of the looming threats in 2009 is the reversal in trade flows and increasing barriers to trade.
For the first time since 1982, The World Bank predicts global trade volumes will shrink in 2009. Undoubtedly, global trade enjoyed a boom over the last two decades or so. The global slump, though, is taking a bite out of that happy ride. Already, through November, exports from China, Taiwan, Chile and South Korea plunged by 20% or more.
The falloff in trade is worrisome enough as a globe-trotting investor. In the last several years, companies with operations overseas did much better than those confined to North America. In 2008, though, that wasn’t true. According to Bespoke Investment Group, stocks of companies that booked more than 50% of their revenues abroad fell 46% on average in 2008, versus a drop of 38% for those with no international revenue.
But there are signs that things could get much worse. Because like tea leaves steeping in a pot of hot water, the longer the economic slump persists, the more likely political trouble is to brew. The rise of barriers to trade is a particularly bitter brew of political trouble.
Already, a number of countries have taken actions to close their markets or protect domestic industry. Consider:
– Indonesia – new restrictions on over 500 goods as well as new fees for imports
– Russia – new tariffs on imported cars, poultry and pork
– France – a new state fund to protect French companies from foreign takeovers
– Argentina and Brazil – new tariffs on imported wine, leather goods, peaches and more
– India – a new 20% duty on imported soybean oils.
And then there is the U.S. bailout of the automakers, seen as an unfair subsidy by foreign competitors. This is only a partial list involving some of the bigger economies. However you view these moves politically, there is a good reason we should keep an eye on these things: They will affect how you invest.
For example, Russia is Europe’s largest car market. But now there is a tax on foreign cars of as much as 35%. Moscow wants to protect its automakers. The Russian people are poorer because of it. But as an investor, your favorite automaker, which may have had a nice business selling cars in Russia, may now find it tough going.
Moscow also put high imports on poultry and pork. Russia is the largest market for U.S. poultry. If you own a chicken producer, this is not good news. Your potential profits in a big foreign market are cut, and such tariffs could result in excess poultry staying in the U.S., leading to falling prices and lower profits at home.
All of these kinds of moves tend to happen when economies weaken. They can also bring about nasty trade wars.
In 1930, America passed the Smoot-Hawley Tariff Act. It raised tariffs on a number of imported goods. As the authors of Power and Plenty contend: "It triggered a wave of tariff increases." By 1931, "average tariffs on foodstuffs had risen 53% in France, 59.5% in Austria, 66% in Italy, 75% in Yugoslavia, more than 80% in Czechoslovakia, Germany, Romania and Spain and to more than 100% in Bulgaria, Finland and Poland."
These were hard to unwind. It took decades to reverse these anti-trade policies. They certainly didn’t help resolve the Great Depression.
I don’t think it is a coincidence that global trade expanded nearly fourfold since 1990, during a time when the average tariff fell from 26% to 8.8% by 2007.
A reversal of that trend spells bad things for investors. So far, we’re OK. Most of our companies sell goods that other countries can’t get enough of – things like fertilizers, road-building machines and power equipment. In many foreign countries, there is little domestic supply. China, for instance, it is trying to keep fertilizers in, not out. In fact, the Chinese have made it easier to import goods such as potash.
Still, it’s something to watch.
for The Daily Reckoning
January 06, 2009
Chris 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 & Crisis – formerly the Fleet Street Letter.
Chris also recently wrote a book: Invest Like a Dealmaker: Secrets from a Former Banking Insider.
Captain’s Log: Year of our Lord 2009, 6th day…
We have landed on a strange and wonderful watery planet – the third planet in orbit around the sun, a minor star in the Milky Way galaxy. Well, they say it is watery planet. Where we are, it is icy. But the locals say it warms up and the ice melts. We’re suspicious; maybe it’s just hype to attract tourists.
But what is strange about this planet is that its inhabitants all seem to play a game of make-believe, in which they all agree to believe things that every one of them knows is untrue. What is wonderful about it is that it seems so easy to make money here; there’s a fool on every corner just waiting for the chance to get rid of his wealth.
Recently, humans – the race that inhabits this place – believed that their lodges and living quarters would become more and more valuable – even though it was obvious that their houses deteriorated every day, as a consequence of solar radiation, wind erosion, liquor spilt on the carpets and other natural phenomenon. Then, on the back of this remarkable delusion, they built an entire world economy…including extravagantly complex financial instruments which the wisest among them called "weapons of mass financial destruction."
Someone seems to have cut the power to that illusion a few months ago, so now they are taking up a new one: that if people are given more pieces of green paper they will all be richer.
Yesterday, the Dow – which measures stock prices in the United States – fell 81 points. But analysts say the technical indicators are still almost all positive; they think the US is beginning a major rally…or perhaps a new bull market.
The auto industry, meanwhile, reported terrible news. Sales fell 36% in December; GM sold fewer vehicles than in any December in 49 years.
Oil rose $2 yesterday; amid all the gloom and doom, the oil price is moving up to nearly $50. Bond yields are rising too, along with the dollar. And gold fell $4 yesterday – for no particular reason.
Today’s press – the means by which delusions are shared and propagated – tells us that the government of this world’s richest nation, called the United States of America, is planning a "stimulus package" of something on the order of $1 trillion. What’s the package expected to stimulate? The idea is to get more of these pieces of paper into citizens’ hands, so that they will be encouraged to act as though they were wealthier. It doesn’t seem to bother anyone that the source of the misery of which so many now complain was the fact that, in the past, so many acted so much wealthier than they really were. Nor does it seem to disturb the collective fantasy that this stimulus plan is being created, more or less, by the same class of people who neither saw anything wrong with the last fantasy nor mentioned to anyone that it was going to collapse.
"Hopes pinned on rate cuts and fiscal packages," says the headline in the Financial Times, a leading source of financial hallucination. It explains how the aforementioned U.S. government intends to cut taxes in order to put those aforementioned pieces of green paper into consumers’ hands.
Further in the paper, another headline – "Reports of $300 billion Obama tax cuts lift mood" – tells us that the public is getting in the spirit of the new fantasy even before it is officially launched.
"Optimism about central bank and government efforts to revive the global economy helped improve investor risk appetite yesterday," continues the article.
"Fed Officials Endorse Big Stimulus to Battle US Recession," adds another source – Bloomberg.
What a marvelous place! Every day is magic on this planet. Every day is a new day…with no memory of what happened the day before…nor any thought to what will happen tomorrow. People are ready to believe whatever makes their day more enjoyable…no matter how absurd.
Anyone who bothered to think about this ‘bailout’ plan for two seconds could see that it is a hoax and a scam. Those pieces of paper are not really wealth…they merely represent wealth. But since the U.S. government has no wealth in reserve – indeed, it is famously borrowing to make ends meet already – it can only pass out wealth to one person by taking it from someone else. It talks of ‘tax cuts,’ but we have heard nothing of spending cuts. So, what the global consequence must be is an increase in pieces of green paper – or let us say, demand for wealth – with no actual increase in wealth itself. It is just a shared illusion, in other words.
But we have to say too, after visiting this planet for a few weeks, we have fallen in love with it. We feel so superior. Almost everyone we talk to is a dope.
Besides, where else in the universe is it so easy to make money? As you know, dear reader, the easiest way to make above-market profits is to help the fools part company with their money. What other planet has so many fools?
We paraphrase one of the smartest of the humans, George Soros, who puts it this way: ‘The way to make profits is to find the premise that is wrong and bet against it.’ As far as we can tell, almost every major premise is wrong…or at least the over-arching premise of this new post-bubble era is as loony as the one that preceded it. Just as you can’t really get rich by borrowing and speculating… you can’t recover from a bust-up by borrowing and speculating more.
But heck, we don’t make the rules down here on Planet Earth…we just try to have some fun with them.
*** As we were saying, making money seems so easy here…especially now. There are companies that are in the business of pulling valuable minerals out of the ground that you can buy for less than the resources they own – even at today’s depressed prices. There are companies that drill and pump oil – still the major source of energy on Earth – you can buy now for only a couple times their annual profits. In Germany and Japan – two of the most productive and competitive nations on the planet – companies sell for what would normally be bargain prices… significantly less than book value. And emerging markets can now be bought at giveaway prices; considering that these economies still expect rapid rates of growth over the next 10-20 years, these could turn out to be fortune-builders for the next generation.
One of the easiest, surest ways to make money now is to buy high yield corporate bonds and sell low-yield U.S. Treasury bonds. When their last fantasy crashed, earthlings rushed to the apparent safety of U.S. government debt, forsaking the debt of their private enterprises. This pushed yields on the government debt to such low levels as had never been seen before…while yields on bonds rated C or worse rose over 30%. Of course, we have no particular opinion on what these yields should be, but it seems very likely that the "spread" between the two debt classes – now at a 100-year high – will narrow.
"If you’re looking at junk bonds," adds Jim Paulsen of Wells Cap Management, "you have never had this kind of value before."
But while we are talking about the bonds, an even surer bet to us is that U.S. government debt will decline in value. There is no theory that we know of that allows Treasury bonds to go up while the supply of them increases at such a rapid rate. Next year, the feds will borrow between $1.5 and $2 trillion – as much as 4 times the largest previous deficit in history. That means there will be a lot more U.S. Treasury bonds offered for sale. This increased supply is bound to put downward pressure on bond prices.
And we’re suspicious of those little green pieces of paper too. When you turn in a government bond, they give you green pieces of paper. But those are the same pieces of paper that they’re handing out all over town. According to the only theory we know, as supply increases – ceteris paribus – prices decrease. In this case, as they increase the number of those pieces of paper each one represents less and less wealth. The more pieces of green paper, the less each one is worth, in other words. And as we understand the earthling’s current delusion, they will intentionally increase the number of pieces of green paper until they go down in value. Yes, that is the purpose too, not only to put more ‘money’ in consumers’ hands…but to put out so many pieces of green paper that they go down in value. Why? They want to make sure consumers won’t be tempted to save them. Weird, huh? But it’s just another peculiar feature of the present dementia universalis on Planet Earth; humans believe they will all be richer if people spend their money, rather than hold onto it. Of course, every one of them knows it isn’t true; but they believe it anyway: that the more they consume their wealth the more wealth they will have. Like we said: super weird.
But it leads us to an investment that – under the circumstances – seems like a no-brainer. The only thing that bothers us is that so many earthlings seem to favor it too. Since humans are so prone to error, it makes us question our own judgment.
"US Treasuries are my least favorite asset," says Mohamed El-Erian with Pimco. "My least favorite asset is US Treasury bills…and I don’t like the dollar either," say Tim Bond of Barclay’s Capital. "Outside of a Treasury bond," adds the aforementioned Jim Paulsen, "it is a remarkably good time to buy risk assets."
Yet despite the agreement of these humans, we still think most of the species have seized onto a premise that is wrong – that dollar-based U.S. Treasury debt equals financial safety.
How do you bet against that premise? Probably the easiest way is to buy a more traditional form of money – which humans place at number 79 on their periodic table, gold. Believe it or not, over a long, long time gold has been extremely reliable. An ounce of it buys about as much bread in A.D. 2009 as it did in A.D. 9. As this present delusion blows up, humans will probably turn back to gold to protect their wealth.
As we said, the U.S. government is determined – ‘hell-bent,’ some would say – to keep consumers spending those little green pieces of paper. They have a plan to bring this about – at a cost of a trillion or so more of them. If this plan does what they hope it will do, prices will begin to rise. In fact, almost all asset classes will rise in price – especially gold. Shrewd investors will seek protection from inflation by buying gold – causing the price of the yellow metal to rise.
If the plan fails to work, on the other hand, the feds will continue emitting pieces of green paper, which will eventually call into question the value of the paper itself. Either way, probably the surest bet on the blue planet is that the price of gold will go up.
How high? Who can say? But we will be very surprised if it doesn’t at least equal – on an inflation-adjusted basis – its highest price ever, set in January of 1980. Then, it sold for $875. Adjust that price to today’s consumer price level and you get a price over $2,400.
Daily Reckoning readers who wish to take advantage of this terrestrial phenomenon should buy gold. If you wish to increase your risk and profits, you could buy the double ETF, giving you twice the gain from each dollar gold goes up. After all, this will probably be the last bubble…the biggest bubble of our lifetimes. For gold bugs, it is now or never. Those who really want to go for broke should mortgage their old houses and sell their young children to raise extra cash.
This advice is free. Of course, it is worth no more than you paid for it. All we ask is that if it doesn’t work out, please don’t rub our noses in it. We’ll feel bad enough.
The Daily Reckoning