Make Way for the Emerging Consumer
Courtomer, France
Thursday, June 12, 2008 --------------------- *** China’s tiger economy is burning bright...excitement in the Indonesian coal industry... *** Americans get a break from the hard work of consuming...the world’s money machine is slowing down... *** A list of top performers for the long-term...the four things we do with our loose change...and more! --- Special Offer --- What Car Will You Drive in 2015? With gas prices at record highs, the scramble to find what will fuel the car of the future is on... Discover the fastest-growing energy source in the world. Also the cleanest and safest. America may miss out, but you can still profit. Keep reading to discover a “secret play” on the winning car technology of the future. --------------------- Finally, Americans are getting some relief. They no longer have to carry the whole world economy on their shoulders... But we’ll come back to this.... First, a look at Wall Street. The Dow tumbled more than 200 points yesterday. Oil rose $5. The euro rose against the dollar – to $.155. Gold shot up $11. And the yield on the 10-year note fell to 4.07%. No biggie. So, let’s go to today’s two top stories: The first from Bloomberg: “China exports unexpectedly grow 28%.” And this from the Wall Street Journal: “Global inflation’s bite worsens.” What is going on? The world economy is supposed to be slowing down. Inflation rates should be going down, not up. China’s exports too – they should be falling, not increasing. D-E-C-O-U-P-L-I-N-G say the pundits. The widespread view is that the emerging markets are separating – at least partially – from the developed markets. America cools...but China’s tiger economy burns bright. And not just China. India...Russia...Brazil...and dozens of other emerging economies are on the prowl. India’s exports are increasing even faster than China’s – up 32% at last count. Is it possible? Well, yes...and no. Some emerging markets produce stuff for the developed countries. Some produce stuff for themselves and other emerging markets. Here, we defer to colleague Manraaj Singh, who follows the emerging markets for a living: “...[With] all the talk of a global economic slowdown, China is still booming. Its economy grew by a white-hot 10.6% in the first quarter of this year. And that’s despite all the efforts of the Beijing government to slow things down... “So, the commodity-rich Asian countries that supply China’s industrial machine, like Malaysia, Indonesia and Thailand, are surviving the global economic downturn well enough. In fact, they’re seeing exports boom... “But not every Asian country is benefiting. The Asian countries that rely on electronics shipments for the bulk of their exports, like Singapore and the Philippines, are being hit by the US slowdown. “Just look at the figures. This week, Malaysia announced a 21% jump in exports in April from a year earlier. What are they selling to the rest of the world? Let’s see...palm oil exports are up by 71%, crude oil exports by 53% and exports of natural gas by 26%. Electronic-component exports were up by just 12.5%. The electronics industry used to be the crown jewel of Malaysia’s export industry. And most of those components used to go to the U.S. We’re seeing a massive shift in the centre of economic gravity here. “Same thing in Thailand. The country’s exports jumped 28% from a year earlier. And a good part of that comes down to the soaring prices of rice and other agricultural products. “Indonesia’s monthly exports have just hit a new record of $11.9 billion in March, as well. No prizes for guessing what they’ve been selling...crude palm oil (Indonesia is the world’s biggest producer), natural gas, timber, coal... “Coal is the new gold. And Indonesia has some of the most exciting coal companies on the planet.” If these economies can continue growing at this pace, perhaps they will spare the United States a serious correction. American consumers will finally be able to relax. The whole world economy will no longer rest on their backs. Someone else can do the hard work of consuming. While exports from India and China are increasing, the U.S. trade balance is actually improving. From a negative $150 billion in 1995, America’s trade deficit grew to more than $700 billion in 2006. The latest figures show it finally contracting – towards $600 billion. But you can look at these numbers in a variety of ways. As mentioned above, it means Americans no longer have to do all the work of consuming. Now, others will have to take a turn. Another way to look at it, though, is that Americans will get less of the world’s output. This is a trend you can bet on, dear reader. Americans have earned a disproportionate share of the world’s income...and spent even more...for a very long time. Now, the average American earns less...and is beginning to spend less. His standard of living – compared to the rest of the world – is going down. Like it or not, he’s going to have to live with less energy...probably with a smaller car...probably with a downsized house...and probably with less money to spend. Still another way to look at it is this: the world’s money machine is slowing down. When Americans cut back, they export fewer dollars abroad. You’ll remember how the global financial system works, dear reader. The U.S. emits dollars. Other central banks have to buy up the dollars, by emitting their own currencies. The effect is a global tide of paper money – none of it backed by anything other than faith – which has caused bubbles in dotcoms, housing, finance, and most recently, in commodities. It has also left huge piles of dollars in the exporting countries. By some estimates, this money, invested through Sovereign Wealth funds, has held up the U.S. stock market for the last six months. Now, the rising price of oil and the falling price of housing are forcing the U.S. consumer to ease off. He buys fewer exports and less oil. The U.S. trade deficit goes down. Foreign central banks have fewer dollars to buy up...and less need to print their own money to buy it with. Implication: less currency in circulation...lower commodity and consumer prices...a stronger dollar...fewer bubbles and declining asset prices. But as we explained, the U.S. consumer is no longer carrying the whole world economy on his shoulders. Now, Indians...Chinese...Russians and Brazilians seem to be picking up the load. It’s their turn to buy automobiles, air-conditioners and filet mignon. It’s their turn to keep the factory wheels turning...and the currency printing presses hot. *** How are we doing? So far this year, dollar-based investors have lost about 7% from the decline of the buck. As of the end of last month, they were down another 5% or so on stocks. Equities, in practically all the world’s regions are down for 2008...only Japan is ahead, and just barely. Looking at a longer term, U.S. stocks have gone up at only a 2.5% rate for the entire last 10 years. Europe did a little better – up 4.3% per year. But emerging markets have done much better – up 12.3%. And some of the emerging markets did spectacularly well – with Russia as one of the top performers with annual returns over 23%. *** What are we doing with our own money? We have no secrets here at The Daily Reckoning. When we have some real money, we prefer to invest it in the only business we know anything about – publishing. We’d rather take a long shot in a business we understand than buy a “sure thing” in one we don’t. Recently, for example, we invested in a publishing business in India. And we’re starting a financial magazine in France. Not only do we have a fair chance of making money, we also learn something – which, in the long run, may be even more valuable. But when we have some loose change, what do we do with it? When we looked at our account last week, we decided to make some adjustments. Readers should be aware, however, that we invest for a very long time. We have no intention of drawing on this money for the next 10 years. First, we divided it into four parts. The first quarter we put in gold – for all the reasons you have read about here. Then, the next quarter we put into natural resources – with a smart, long-term-oriented manager who will avoid buying at the top. Commodities may be in bubble, but after the bubble bursts, there will be some good opportunities. Another quarter is invested in non-U.S., Warren Buffett-style stocks. Since most of our family assets are invested in the financial publishing business in the United States, we look upon this as diversification, managed by a trusted friend. Finally, the last quarter is invested in emerging markets – with an emphasis on Vietnam and India. We don’t know what the future will bring, but our guess is that these emerging markets will do better than the United States in the ten years ahead. Until tomorrow, Bill Bonner
The Daily Reckoning --- Special Offer --- Get all of Agora Financial’s best research and investment newsletters – for life. But you have to act quickly...entrance into this elite circle of investors is limited. See here for all the details: The Agora Financial Reserve – Open for a Limited Time --------------------- The Daily Reckoning PRESENTS: In the conclusion of this two-part essay, Dr. Marc Faber discusses what America needs to do to truly fix its energy consumption problem – a long-term solution, not a temporary Band-Aid. Read on... NATIONAL POLITICAL BROWNOUT, PART II
by Dr. Marc Faber As Mark Gongloff noted in a column for the Wall Street Journal, “...what the U.S. really needs, if it seeks a real fix to its energy consumption problem, is less demand, not more. Mr. Market says there’s a simple way to do that. Jack up the gas tax. Don’t lower it. Economists call it a ‘Pigovian Tax’, in honor of the English economist Arthur Pigou, who early in the 20th century examined economic activity that hurts innocent bystanders. To stop behavior that’s not in the public good, you tax it more, not less. “Of course, a higher tax would hurt working-class Americans who rely on their cars, though other taxes, like the federal payroll taxes or state sales taxes on food, could be lowered to offset it.” Gongloff then explained that Harvard economist Gregory Mankiw, President Bush’s former chief economic adviser, has proposed increasing the “gas tax” by ten cents a year for ten years in order to give the economy time to adjust. According to Professor Mankiw, who belongs to the Pigou Club, a pro-“gas tax” group, higher gasoline taxes “should lower world oil prices”, as higher prices would curtail demand considerably. Despite my usual serious reservations about increasing taxes in order to curb demand, I would support higher gasoline taxes in the US (or tax incentives for energysaving engines and heavy penalties for gas-guzzling vehicles) because its implementation would be simple and the revenues obtained from higher gas taxes could be used to improve the entire transportation infrastructure. In particular, a better public transportation system would improve the energy efficiency of the country and lessen its addiction to imported oil. It should also be noted that the US has one of the lowest gasoline taxes in the world In addition, opinion leaders are increasingly skeptical about the lies dished out by the government. Thomas Friedman opines that Americans “need a president who is tough enough to tell the truth to the American people. Any one of the candidates can answer the Red Phone at 3 a.m. in the White House bedroom. I’m voting for the one who can talk straight to the American people on national TV – at 8 p.m. – from the White House East Room.” And Gongloff concludes that, although higher gas taxes would have all sorts of desirable effects, unfortunately, increasing them “doesn’t win elections. And the only market that matters now is the one for votes.” At the same time, investors and strategists are becoming more and more skeptical about the economic statistics published by the various agencies. The employment, inflation, and GDP growth figures are highly suspect. According to Martin Feldstein, a former chief economic adviser to President Reagan and now a Harvard economist, “misleading growth statistics give false comfort” because “monthly data since January indicate that economic activity and GDP have been declining since the start of the year” (Financial Times, May 7, 2008). Feldstein opines that “...although the tax rebates now underway may provide some temporary help, the combination of falling real incomes, declining household wealth and a dramatic drop in consumer confidence suggests further falls in consumer spending and GDP. But the most serious risk is that the rapid fall in house prices – down 12% in the past year and falling at a 25% rate in the past three months – will raise the number of negative equity mortgages, leading to widespread defaults and foreclosures. Because US mortgages are “no-recourse” loans (lenders have no recourse to the house’s owner beyond the value of the house) individuals with negative equity have an incentive to default. There are now an estimated 8 million negative equity mortgages – more than 15% of all outstanding mortgages. Defaults are rising and foreclosures are now at twice the rate of a year ago. A downward spiral in house prices would cause a fall in household wealth and in the capital of financial institutions, potentially resulting in a deeper and longer recession than any seen in the past several decades.” According to Feldstein, the government should intervene to “prevent positive-equity mortgages from becoming negative-equity mortgages”. In other words, Feldstein proposes that the government should support the real estate market “by providing low interest loans with full recourse that would allow any homeowner to pay down a significant fraction of his mortgage. Homeowners would be in effect giving up the potential to default on their mortgage loans in exchange for lower interest costs.” There are, however, some problems with Feldstein’s proposal. For one, it is likely that the majority of homeowners who are burdened with the estimated 8 million negative-equity mortgages (I have seen figures which suggest that there are 15 million negative-equity mortgages outstanding) also have negative-equity car loans and large credit card debts – in short, they have no equity to start with. So, in these cases, “full recourse” loans wouldn’t serve their purpose and would instead amount to a marketdistorting direct government subsidy of imprudent borrowers at the expense of taxpayers. Second, I wonder how Mr. Feldstein would propose supporting the market for unsold condos. In buildings with five to nine units – like a large number of garden apartment buildings – the condominium vacancy rate is at an unprecedented 15.2%. That is up from 12.2% at the end of 2007; whereas prior to 2006, it never exceeded 10%. (For rental units, the vacancy rate is even higher. According to Floyd Norris, chief financial correspondent with the New York Times, 25.2% – one in four – of the housing units built since 2000 are vacant.) Finally, I very much side with Mrs. Moneypenny who, in a witty Financial Times column dated May 3, 2008, argued that the UK government should not intervene in the housing market, because falling home prices “might be painful for some but what about the benefit for many others? What nurses and teachers and first-time buyers need is for prices to come down.” According to Mrs. Moneypenny, it is not an acceptable excuse from investors that they had not read the disclaimers. “I suspect that borrowers of 110% mortgages are in many cases young and naïve and, in their enthusiasm to buy property, had not read the disclaimers. That’s not an acceptable excuse either. Husbands should carry disclaimers. Your marriage may be at risk if you insist on rationing golf, or some such incomprehensible activity.” Mrs. Moneypenny then explained that a friend of hers wanted to leave her husband because she found him irritating and because he hardly ever had sex with her. However, “if irritation with one’s husband and a lack of sex were reason enough to walk out, the divorce rate would go through the roof,” she wrote. She told her friend to “hang in there”, because if she went back to the open market and found another husband, how would she know that he would be less irritating and would want to have more sex? “[M]arriage is frequently embarked upon when you are young and naïve and don’t weigh the risks,” she wrote. “But there is no regulator or government that will save you from the pain if it goes wrong. And neither should there be. Any more than for people who take out 110% mortgages.” Well put! Governments and their agencies around the world – not just in the US – have created asset bubbles by keeping interest rates artificially low and through lax regulatory oversight, which has encouraged the purchase of all sorts of assets with high leverage. These governments should not now compound their earlier mistakes by supporting asset markets with even lower interest rates and fiscal measures in order to prevent the market mechanism from clearing properly at the lower prices. After all, and as Mrs. Moneypenny suggests, there is usually no – or little – mention in the discussions of markets that “inflated asset markets” are making it expensive and difficult for first-time buyers to acquire assets without high leverage. In this respect, I should like to point out that throughout the 1970s and even most of the 1980s, less than 30 hours of work (total private hourly earnings of production workers) were required to buy one S&P 500. Now, however, despite some decline in this number from its peak in 2000, it requires 78 hours of work to buy one S&P 500. I suppose that, over time, the S&P 500 and other asset markets will adjust to the downside and again become more affordable, or that hourly earnings will increase significantly (inflation). I would also like to make the point that if the government and its agencies support the equity and residential property markets, a case could be made for it also to support, in future, the prices of commodities, commercial properties, and art and collectibles. In fact, I am concerned that investors haven’t paid sufficient attention to the problems that could arise should these markets decline meaningfully. Regards, Dr. Marc Faber
for The Daily Reckoning Editor’s Note: Dr. Marc Faber is the editor of The Gloom, Boom and Doom Report and author of Tomorrow’s Gold, one of the best investment books on the market. Tomorrow’s Gold Headquartered in Hong Kong for 20 years and now based in northern Thailand, Dr. Faber has long specialized in Asian markets and advised major clients seeking bargains with hidden value, unknown to the average investing public. Back to Top | 
