September 19, 2012 7:13 pm

Analysis: China’s unlikely challenger
Latin America’s second-largest economy has emerged as a powerful exporter
Plugged in: Mexican workers, such as these working on a Bombardier jet at a factory in Querétaro, are now leading suppliers to the US Bloomberg

At Siemens’ high-voltage equipment plant about two hours’ drive from Mexico City, workers move about the polished floor, assembling and testing parts of circuit breakers for use in electrical substations.

Until a few months ago, the 160 parts for these enormous devices, with protruding poles that give them the appearance of stage props from a set of Frankenstein’s workshop, were assembled in India or China.

But today, the assembly is carried out in Mexico. By March next year, most of those 160 parts, which currently come from Germany and Asia, will be produced there too. The company has also chosen Mexico as the location for a new surge-arrester project instead of investing to expand production in China.
“We are moving towards local hubs,” explains Claude Steffen Raab, general manager of the German company’s high-voltage division in Mexico. “The idea is to respond more quickly to each of our markets.”
The shift in production at Siemens is part of a little publicised manufacturing revolution in Mexico taking place across a range of industries from cars and aircraft to refrigerators and computers. For the first time in a decade, Latin America’s second-largest economy has become a credible competitor to China.
During the first half of this year, Mexico accounted for 14.2 per cent of manufactured imports into the US, the world’s largest importer. In 2005, Mexico’s share was just 11 per cent.

Surprisingly, China, which gained huge chunks of the US import market for many years, has started to lose ground. From a high of 29.3 per cent of the total at the end of 2009, it has now shrunk to 26.4 per cent.
While winning a bigger slice of the US market, Mexico has diversified its customers. A decade ago, about 90 per cent of the country’s exports went to the US. Last year, that figure fell to less than 80 per cent. Suddenly, it seems, Mexico has become the preferred centre of manufacturing for multinational companies looking to supply the Americas and, increasingly, beyond. Today, Mexico exports more manufactured products than the rest of Latin America put together.
The result of this turnround can often seem counter-intuitive. Chrysler, for example, is using Mexico as a base to supply some of its Fiat 500s to the Chinese market. During last year’s inauguration of the US company’s $500m investment in Mexico, Felipe Calderón, the country’s president, told the nation: “I think it is the first time that a Mexican vehicle, at least in recent times, is to be exported to China ... we always thought it was going to be the other way around.”
But the US car manufacturer is not alone. Audi, the German carmaker, is deciding whether to use a factory in Mexico to manufacture the kits for Q5 cars that are assembled in China to supply the domestic market.
Mexico’s new-found competitiveness has become so clear that Marco Oviedo of Barclays concludes: “After lagging Chinese manufacturing exports for a decade, Mexico has taken the lead post-2008-09. We believe this change is likely to be structural and persistent.”
Go back to the beginning of the century and none of this seemed possible. Back then, as China burst on to the global stage following its accession to the World Trade Organisation in 2001, Mexico seemed to be in serious trouble.
For much of the rest of Latin America, China was a voracious customer of agricultural and mineral commodities. By contrast, Mexico saw China as an unstoppable competitor that produced exactly the same sorts of cheap manufactured goods at a tiny fraction of the cost.
Against that backdrop, it is hardly surprising that Mexico was the last WTO member to vote for China’s accession – a vote that it gave only after a long and bitter negotiation.
But several important shifts have taken place since then that have improved Mexico’s comparative advantages, giving it a new and dynamic role as a global manufacturer. The first is that Mexico has embraced trade and openness like few other countries in the world.
Its free trade agreements with 44 countries more than twice as many as China and four times more than Brazil – have given companies based in Mexico the ability to source parts and inputs from a wide range of nations, often without paying duty.
Partly as a result, the sum of Mexico’s imports and exports as a percentage of its gross domestic product, a strong indicator of openness, rose to 58.6 per cent in 2010. In the case of China, it was 47.9 per cent, and just 18.5 per cent in the case of Brazil. HSBC in Mexico City estimated recently that the figure for Mexico could increase to as much as 69 per cent this year.
There is also an increased confidence inspired by agreements, particularly the 1994 North American Free Trade Agreement, which binds Mexico with the US and Canada.Nafta creates a rule of law, which is not perceived to be a particularly Mexican concept ... it forces you to do what is right, and to do it for ever, ” says Luis de la Calle, an economist and trade expert who helped negotiate Nafta for Mexico.
As if to prove the point, Mr de la Calle devised an unorthodox index based on how many alphabetical letters appear about a given country in the US Trade Representative’s annual report on barriers to US exports and investment, divided by US exports to that same country. Last year, from a list of 22 countries, Mexico beat Canada to the top place of best-behaved countries. Pakistan was the worst offender and China was 10th worst.
. . .
Of course, Mexico is not without its problems. While the country is making strides in its attempts to diversify, it is still heavily beholden to the ups and downs in the US.
But perhaps the most alarming concern of foreign investors and the general population alike is the deterioration in security.
The murder rate has almost tripled to about 22 per 100,000 inhabitants from just over eight when Mr Calderón declared an all-out offensive against the country’s drug cartels at the end of 2006. The war, which has claimed at least 55,000 lives over the past six years, has dominated headlines about Mexico as the press reports on a seemingly endless flow of horror stories involving beheadings, kidnappings and massacres.
This year, it also prompted the US state department to issue a travel advisory telling US citizens to put offnon-essential travel” to many areas of Mexico, and warning that nearly half of the country’s 31 states are so dangerous that travellers should avoid them if possible.
So far, the violence has had little impact on multinationals, which generally operate in safe industrial parks around the country. But there are no guarantees that organised crime will not start to try to extort large foreign companies in the future – and in the same way it has been doing with smaller, domestic companies.
Until that happens, foreign companies continue to eye Mexico – in part because China has not turned out to be quite the manufacturing nirvana that it once appeared. While executives long complained of Chinese red tape and the threat to intellectual property there, they were willing to balance those risks against cheap labour and transport.
But rising wages and higher fuel prices have made it increasingly expensive to export from China to the US market. This is all to Mexico’s advantage. In 2009, Mexico overtook South Korea and China to become the world’s leading producer of flatscreen television sets. The bulkier the item, the more Mexico makes sense. According to Global Trade Atlas, the country is also the leading manufacturer of two-door refrigerators.
Thanks to a 2,000-mile border with the US, and extensive rail and road links, it is not only cheap but fast and easy to ship goods north. Shipments from China to the US typically take between 20 days and two months. From Mexico, they take a week at most and usually just two days.
For many industries operating in today’s cost-conscious environment, “Made in Mexico” is becoming a serious consideration in their attempts to shorten supply chains, which potentially allows them to cut costs because quicker delivery times mean that they can minimise the amount of money invested in inventories. As Bruno Ferrari, Mexico’s economy minister, told the Financial Times recently: “The proximity that Mexico offers industry allows companies to reduce their financing costs.”
Rising labour costs in China have presented Mexico with an additional opportunity. According to HSBC, Mexican wages were 391 per cent higher than those of China a decade ago. Today, they are just 29 per cent more. Experts predict that Chinese wages will even overtake those of Mexico within five years.
Mr de la Calle argues that demographics are behind this. While China is experiencing a squeeze in its working-age population.
By contrast, more than half Mexico’s 112m population is under 29, so there will be an abundance of cheap labour until at least 2028. Right now, you have to look at Mexico and conclude that it has the best demographics in the world,” says Mr de la Calle.
At the same time, Mexico’s plentiful working population is becoming more skilled. According to Unesco, the number of engineers, architects and others in disciplines related to manufacturing graduating from Mexican universities has risen from almost 0.4 per 1,000 people in 1999 to more than 0.8 today. To set that in a regional context, the number for the US over the same period has remained roughly flat at 0.6 per 1,000.
Skilled workers are providing an increasingly attractive environment for high-tech companiesMexico has in recent years become a world leader in the production of computers and mobile telephones – as well as for car companies, almost all of which are now using Mexican engineers to design parts.
. . .
None of this means that Mexico is going to replace China as the world’s first choice for manufacturing. With more than a quarter of the share of US imports, the Asian colossus outpunches Mexico in terms of volume.
It also has deeper supply chains than Mexico. From the manufacturing hub of Ciudad Juárez on the Texan border to Querétaro in central Mexico, international companies say that they have trouble finding local suppliers for parts and packaging.
Siemens, for one, says that it has been trying to source its pressure-tight aluminium castings from Mexico but is still using companies based mainly in Europe because of the difficulty in finding local partners.
But from what appeared a dark future just over a decade ago, Mexico has moved into a position that, for now, has made the next few years look potentially very bright.
As Mr de la Calle says: “Things are good and they are going to get even better.”
Copyright The Financial Times Limited 2012.

Markets Insight

September 19, 2012 1:20 pm
Fund managers must break their silence

While it has been little remarked on and even less analysed, the nature of stock ownership has experienced a sea change since the second world war. Ownership of US stocks by financial institutions has leapt from 8 per cent to 70 per cent. A similar trend has prevailed globally.

US financial institutionsmutual funds, pension funds, endowment funds, and bank trusteeshold more than two-thirds of the shares of virtually every publicly held US corporation, giving them total voting control.

The ownership is concentrated among a few giant money managers. Of the $9tn of stocks held by the 300 largest US money managers, some $6tn are held by the 25 largest managers. The five largest firms aloneVanguard, BlackRock, State Street Global, Fidelity, and American Fundshold almost $3tn, or fully a third of that total.

Remarkably, these giant firms have been conspicuous by their absence from exerting significant influence on the companies that they collectively own. “The silence of the funds” has been, well, deafening. In the proxy process, these managers overwhelmingly support existing boards of directors and management pay plans, rarely giving strong support to shareholder proposals on remuneration. I know of not one of these big managers that has submitted a proxy proposal in the face of management opposition.

In 2003, when the Securities and Exchange Commission proposed to facilitate more access to the then essentially closed participation in the proxy process, no large fund manager called for greater access. In fact, several managers actually argued for more stringent limitations.

Part of the reason for this “hands-offattitude is that the stock market is dominated by short-term speculators. These “renters” of stocks don’t give a hoot about governance. But how does one explain the hands-off attitude of long-term investors, “owners”, and especially index funds with essentially infinite time horizons?

The answer has to do with three factors. First, a profession that focused on stewardship and investment management has become a business focused on salesmanship.

Governance activism attracts attention and controversy and has no marketing value. It probably has negative value, impeding the asset-gathering goals that money managers hold pre-eminent.

Second, the ownership of these large money managers has become dominated by groups that are publicly held. Such fund managers are duty-bound to serve the fund shareholders and pension beneficiaries by optimising the return on their capital. They also have a duty to serve their public shareholders, largely giant conglomerates in business to earn maximum returns on their own capital – a clear conflict of interest and a violation of the Biblical warning “no man can serve two masters”.

Third, the money managers owe their profitability largely to the giant corporations whose retirement plans they manage. There seems little interest in “biting the hand that feeds you”. As it is said, there are only two kinds of clients money managers do not want to offend: actual and potential.

Today, the silence of the funds is particularly troubling. For both of the major issues that confront our corporations are slanted in favour of managers rather than owners. One issue is executive remuneration. This deeply flawed approach results, in part, from a system that focuses on peer remuneration rather than corporate performance, producing “a ratchet effectyear after year.

Management remuneration is based on raising the short-term price of the stock, labelled “increasing shareholder value”, rather than building intrinsic corporate value over the long term. What’s more, corporate executives get away with murder, figuratively, with pay plans that kick in without requiring a certain return on capital.

The second issue is corporate political contributions. While the demand for full disclosure of political contributions is growing, mere disclosure doesn’t go nearly far enough. Corporate shareholders should have the right to decide if their corporations can make any contributions. But our corporate managers have no interest in facilitating corporate democracy and our institutional owners even less interest in exercising their voting rights.

It is time for fund managers to honour the rights of, and assume the responsibilities for, corporate governance. Institutional investors must break their long silence and make their own proposals for inclusion in corporate proxies. These steps toward greater activism in corporate governance by our giant investor/agents, who are fiduciaries for their shareholder/principals, are essential to sound long-term investing, to our system of modern capitalism, and to the national interest. The mutual fund industry should be in the vanguard of this movement.

John C. Bogle is founder of US fund manager Vanguard and author of The Clash of the Cultures: Investment vs. Speculation

Copyright The Financial Times Limited 2012.

Charting The Liquidity Trap: The Deleveraging Cycle Has Just Begun

September 18, 2012

by: Plan B Economics 

We are in a liquidity trap. But what does that really mean?

The term "liquidity trap" sounds like a nebulous reference to a meaningless economic paradigm; or an excuse to confuse the layman. But to understand that we are in a liquidity trap is to understand the economic chasm we must cross today. It is to understand why central banks around the world are powerless, yet will continue to pump trillions into the global markets.

In summary, a liquidity trap describes the situation in which new money entering an economy (e.g. via central bank money printing) is sucked back into the banking system as deposits, thereby having little effect on real economic activity.

The liquidity trap can be visualized using the following two charts. Chart 1 shows the new money entering the financial system, while Chart 2 shows the growth in excess depository reserves.

In other words, money is entering the system, but is cycled back to financial institutions and the Federal Reserve as deposits. Consequently, expansionary monetary policy is ineffective as new money is not leading to growth in final aggregate demand.

(click images to enlarge)
US M2 Money Stock (Weekly) Chart
US Excess Reserves of Depository Institutions Chart

Another way to demonstrate the impotence of monetary policy is to look at the speed at which money cycles through the economy -- money velocity. This is simply another way to show how likely people (and businesses) that receive cash are to store it in a bank deposit (i.e., it measures the strength of a liquidity trap).
Currently (chart below), money velocity is at a record low, suggesting the liquidity trap is stronger than at any time during the last 40+ years.

Velocity of M2 Money Stock in the US Chart

So why are we in a liquidity trap? Why are people and businesses (even financial institutions) socking away every penny they get?

Take a look at the following two charts. The financial sector and household sector are deleveraging. This is a rare occurrence, but the declining use of credit in these sectors suggest participants are trying to shrink, build fortress levels of capital and/or don't see profitable opportunities.

This is precisely what happens after an economy extends beyond its normal capacity. Until the 2008 collapse, we were simply buying too much stuff, employing too many people and living far beyond our means. Now it's payback time -- reversing a credit bubble takes years of painful deleveraging. This is why we're in a liquidity trap.

US Total Credit Market Debt Owed by Domestic Financial Sectors Chart
US Total Credit Market Debt Owed by Domestic Nonfinancial Sectors - Household Sector Chart

Given the liquidity trap and deleveraging household and financial sectors, what's keeping the economy from totally imploding?

Answer: the massive expansion of government debt (chart below). By pumping money into the liquidity trap, central banks are keeping the system alive. But central banks -- by buying bonds -- are indirectly monetizing government debt keeping interest rates low.

We have entered a new status quo, but one should not become complacent. For this new normal comes with massive risks. If the new cycle comes to a stop, governments, businesses and consumers around the world will be in for a massive shock.

US Total Credit Market Debt Owed by Domestic Nonfinancial Sectors - Federal Government Chart