January 21, 2004

The New (Year) Economy

The Contrary Investor has a nice roundup of the pitfalls in the US economy for this coming year. There are the obvious caveats about one-shot tax rebates, record low interest rates which can only go up, and the craziness that is real estate. However, they also give a good explanation of the apparent paradox between the decline in the value of the dollar and the continued support of the US financial market by foreign money. The US has been printing dollars at a furious pace ($800 billion rise in M3 over the last two years), so simple supply-and-demand dictates that the value of the dollar will fall relative to hard goods like commodities and more stable currencies. However, other countries, especially in Asia, have been inflating lockstep in order to suppress their own currencies vs. the dollar. This has created a global rise in liquidity which is inflating the current runup in the financial markets.

For now, there is really only one thing going down - the US dollar.  So although history suggests that at some point a declining dollar will negatively affect US equities and fixed income markets, is excess liquidity holding back or delaying this assumed rational reconciliatory path?  As we look ahead into 2004, which of the following three will be the most powerful in terms of influencing the pricing of various asset classes - a declining dollar, excess global liquidity, or foreign flows of capital into US dollar denominated fixed income assets?

It's commendable that they don't try to answer the question with pat textbook theories.

Massive global liquidity creation and the continued significant flows of foreign capital into US dollar denominated assets have largely offset the negatives for US financial assets.  And of course the Catch-22 is that our large trade deficit has supported the flows of foreign capital back into US dollar denominated financial markets.  As crazy as this may sound, if our trade deficit were truly to contract meaningfully ahead, we would expect foreign flows of capital into the US to likewise contract, clearly pressuring US fixed income prices.

Low cost global sources of labor have been a big factor behind this ability of foreign exporters to conceptually ignore the dollar decline, but that only goes so far.  At some point the declining dollar will cut into the foreign corporation profitability bone.  As we move through 2004, we suggest keeping a very sharp eye on global capital flows, US import prices, and global money supply growth.  We believe changes in these factors will foreshadow an end to the in place lag between a declining dollar and levitating US financial asset prices.

Whatever it takes to raise the crappy interest rates on my money market account, damn it.

It's not just random websites that's worried about the effects of foreign capital on the US market. The Wall Street Journal has an anecdotal look at the mindset of the foreign investor. Interesting that three out of the five people/businesses profiled were from Asia.

A couple of years ago, clients of Goldman Sachs & Co.'s private-wealth-management business in Asia — which accepts no accounts under $10 million — invested 50 percent to 70 percent of their assets in the U.S., says Gary Giglio, who runs the business. "If you look at those same accounts today, you're talking anywhere from 20 percent to 40 percent in U.S. assets," he says. Mr. Giglio says a lot of Asian investors were spooked by the recent, two-year bear market in the U.S.

We know folks who used to run that division of GS. They know what they're doing. So it looks like it's the Asian governments that's doing most of the dollar-buying for now. Anyway, the smart cookies at Goldman will find a way for their $10-million-plus clients profit from this inequity, most likely at the expense of the governments who are fighting to keep their export-economies competitive. Looks like they're doing alright, if Christmas sales figures were any indication. On the other hand, the buy-dollars strategy seems to be working for China, too. So everybody wins, right?

On the micro-micro-economic scale, there's the story of Caroline Payne, a woman whose income has stagnated between $8,000 and $12,000 a year for almost 30 years. It's like a Calvin & Hobbes story, except we're not talking about Bill Watterson here. Instead we have a hard-working woman pre-destined to live a nasty, brutish, and short life.

Caroline's is the face of the working poor, marked by a poverty-generated handicap more obvious than most deficiencies but no different, really, from the less visible deficits that reflect and reinforce destitution. If she were not poor, she would not have lost her teeth, and if she had not lost her teeth, perhaps she would not have remained poor. Poverty is a peculiar, insidious thing, not just one problem but a constellation of problems: not just inadequate wages but also inadequate education, not just dead-end jobs but also limited abilities, not just insufficient savings but also unwise spending, not just the lack of health insurance but also the lack of healthy households. The villains are not just exploitative employers but also incapable employees, not just overworked teachers but also defeated and unruly pupils, not just bureaucrats who cheat the poor but also the poor who cheat themselves.

Her employers (WalMart and friends) sure weren't going to do anything to help her out.

Indeed, this solemn regard for the employer as untouchable and beyond the realm of persuasion unless in violation of the law permeates the culture of American antipoverty efforts, with only a few exceptions. The most socially minded physicians and psychologists who treat malnourished children, for example, will advocate vigorously with government agencies to provide food stamps, health insurance, housing and the like. But when they are asked if they ever urge the parents' employers to raise wages enough to pay for nutritious food, the doctors express surprise at the notion. First, it has never occurred to them, and second, it seems hopeless. Wages and hours are set by the marketplace, and you cannot expect magnanimity from the marketplace. It is the final arbiter from which there is no appeal.

Not that she's some saint or anything. Why the fuck would anyone making <$12K a year smoke is beyond comprehension. Of course, once addicted it's hard to kick the habit without any help, and the story was crystal-clear in establishing that no help was forthcoming.

And finally, in the who-gives-a-fuck-about-ugly-poor-people department, Cree had a kick-ass 2nd quarter, which is good news in that they're a bellwether for the LED business.

"Our (results) were driven by strong LED sales as we benefited from increased demand for LEDs in mobile phone applications," Chuck Swoboda, Cree's chief executive, said in a statement. He added that the company now targets "an even stronger second half."

LEDs in mobile phones requires exactly the sort of miniaturized, surface-mount packaging that we do well.

If you were afraid that the Bay Area was still hurting, it was the only region in the US where the BMW 325 made the top-10 bestselling cars list, not to mention the Mustang.

Posted by mikewang on 11:09 PM