The Daily Reckoning PRESENTS: 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." Read on...
ECONOMIC DINOSAURS
Dan Denning
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.
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 (renminbi) 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 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
30 January 2005
Editor's Note: 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.
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