Automatic Job Storm Coming

 
Image: Cristian Eslava

US trade problems begin at home not abroad

If the White House wants a fix, it should compare its mistakes with China’s strategy

Rana Foroohar



Here’s a statistic that tells you much of what you need to know about the US trade debate — only 1 per cent of US companies export. It’s a figure that I uncovered recently in a McKinsey Global Institute report on the state of US manufacturing, which confirmed much of what my own reporting has informed me about US trade problems.

They begin at home, not abroad. That is not a line you will hear over the next few days, as negotiators meet in Mexico for the latest round of North American Free Trade Agreement talks.

The Trump administration is likely to point fingers and threaten again to pull out of the whole agreement. But if the White House wants to fix trade, it would do better to look at three crucial mistakes that have been made at home — and then compare them with opposite strategies in China, the world’s biggest manufacturing country.

The first mistake was to starve manufacturing of investment. Private sector investment in the sector in the US is at 30-year lows; the ages of the average factory and piece of machinery are 25 and nine years, respectively. The McKinsey Global Institute report estimates that about $115bn of investment would be required annually over the next decade to fix this problem.

But trade and tax policy in the US does almost nothing to provide an incentive for that investment. Companies talk a good game about repatriation, but privately admit that the bulk of any money brought home will go into share buybacks and dividend payments. Gary Cohn, President Donald Trump’s economic adviser, last week appeared surprised (or perhaps feigned surprise) as three hands went up when, at a conference, chief executives were asked how many would invest at home if tax reform were passed. Why should they, when there are no quid pro quos of repatriation in exchange for equipment investment, training or the funding of an infrastructure bank?

As the past two decades have shown, supply side economics alone does not result in a productive use of capital, particularly when it comes to global multinationals; sometimes, you have to push investment to the areas where it is needed. That’s exactly what China is doing with its $1tn infrastructure investment plan.

Second, the US trade debate has focused far too much on the largest domestic companies, which are doing quite well, in terms of share price, profit margins and sales growth. Yet the vast majority of the 250,000 manufacturing groups in the US employ fewer than 100 people.

The current zero-sum game global trade debate hardly applies to them at all. Most do not export, not because they cannot but because access to capital has been tighter for them relative to their rich country peers since the Great Recession (that lack of investment creates a 40 per cent productivity gap between small and large businesses). Reconnecting the dots between the largest exporters and the supply chain could fix that.

Regionalisation is the new globalisation — the largest firms in the US should be given explicit government incentives to work with local suppliers, which would do much to address the president’s trade deficit obsession, since 70-80 per cent of the value of a finished product is in the supply chain.

Again, this is something that China has prioritised in its 2025 development plan, which states explicitly that the country wants to minimise dependence on foreign markets and technologies.

Finally, the US desperately needs to connect Silicon Valley and the rust belt. High-tech manufacturing — 3D printing, the internet of things, sensors in products that create business opportunities in data analytics and services, rather than just goods — may well be the future.

Yet, shockingly, roughly half of US manufacturing companies have no digital strategy whatsoever, according to an MGI survey.

Meanwhile, the technocrats in the Chinese Communist party are giving speeches about the integration of the physical and digital worlds that would leave many people in US boardrooms scratching their heads.

Of course, it’s easier to do economic-dot connecting in an autocracy. No one is arguing for that, but it does speak to the core problem — the Trump administration is trying to push “America First” without any clear and coherent plan of what that means, or how to make an industrial strategy succeed.

“You look at the current trade debate and you just think, ‘What a lost opportunity’,” says MGI director James Manyika.

The countries that the US left behind when the administration pulled out of the Trans-Pacific Partnership — high-growth emerging market nations with expanding middle classes that are engaged in major infrastructure building works — are exactly those with the largest demand for the US’s most valuable exports, such as high-tech products, pharmaceuticals and heavy machinery.

Pulling out of Nafta, particularly without any kind of homegrown industrial policy, would be an equally big mistake. Economic nationalism with no economic plan will not make America great again. In fact, it may be worse than the laissez-faire alternative.

Why the Next US Recession Could Be Worse Than the Last

By Jacob L. Shapiro


Before we begin, I’d like to offer a hearty thanks to the thousands of you who responded to the survey we issued last week. If you haven’t responded yet, don’t worry – there’s still time. The goal of the survey is to figure out what you, the readers, want to read. At the end of the month, we’ll produce a video series addressing the top three topics you have chosen. You can access the survey and let us know what’s on your mind by clicking here. Thank you in advance for your time and your thoughtfulness, and to those of you celebrating in the US or in the world, Happy Thanksgiving.

Though the frontrunners are becoming clear, there are several other subjects many of you have expressed interest in that we don’t want to ignore. One of these topics is the US economy.

Specifically, some of you wanted us to analyze the economy in the context of George’s forecast in “The Next 100 Years”: that a major economic and social crisis revolving around the decline of the American middle class will happen sometime in the early to mid-2020s.

In truth, we had planned to dive into this subject before we even issued the survey. For all the optimism surrounding low unemployment rates and record-high real median income, there are some signs that something is rotten in the US economy. This isn’t wholly surprising – economic health tends to be cyclical, and the US is due for a recession. But when the next recession comes, there’s reason to believe it won’t be business as usual. The structural problems that led to the 2008 financial crisis haven’t been fixed. If anything, they’ve gotten worse.

In January, we forecast that the signs of just such a recession would emerge by the end of the year. And emerge they have. The yield curve between short-term and long-term US Treasuries is the flattest it has been at any point in the past 10 years. One of my colleagues, Xander Snyder, wrote an excellent piece last week on this very subject, and I encourage you to familiarize yourselves with it if you have not already done so.

A flattening yield curve, as he points out, is a problem in its own right, as is a declining prime-age labor force unable to secure adequate wages. But there are other longer-term forces at work that threaten to make what should be a minor cyclical recession a much more painful and prolonged affair. The two most consequential of these forces are increases in total household debt and the continued growth of wealth inequality within the US economy.

Household debt in the United States is now almost $13 trillion. That figure exceeds total household debt at any point during or in the recovery period after the 2008 financial crisis. Housing debt has creeped back to pre-2008 levels. Credit card debt has reached pre-2008 levels too. Student loan debt has skyrocketed by 134 percent since the first quarter of 2008 (about 9 percent on average per year).




Increased household debt, though, doesn’t mean the end is nigh; it just means people are borrowing more money. Still, problems arise when people default on credit card and consumer loans. In the second quarter of 2017, the delinquency rate on credit card loans was 2.47 percent and on consumer loans was 2.21 percent. Low though these rates may be, they are trending upward. Last month, shares of JPMorgan Chase and Citigroup fell on the news that both banks had increased their reserves for consumer loan losses – just under $300 million for JPMorgan Chase and just under $500 million for Citigroup. Put simply, American consumers are beginning to spend beyond their means.




More serious than higher household debt, though, is increased income and wealth inequality in the United States since the 1970s. In 2015, the top 10 percent of all US earners accounted for just under 49 percent of total income – a share greater than at any time during the Great Depression. The top 1 percent accounted for 20 percent of total income. This kind of disparity is a refrain in US economic history. It characterized the Gilded Age of the late 19th century as well as the decade or so before the Great Depression. Both were eras of immense wealth generation that benefited only the top, and both were rampant with speculation – the railroads and oil in the Gilded Age, the stock market in the Roaring Twenties. Today’s inequality is statistically more pronounced than during both of those times in history.



Wealth inequality was already increasing before the 2008 financial crisis, but what happened in 2008 has exacerbated the problem. According to the Pew Research Center, only upper income families have recouped the wealth they lost during the financial crisis. Median wealth was roughly 40 percent lower for lower-income families in 2016 than it was in 2007. It was roughly 33 percent lower for middle-income families. The median wealth for upper-income families, however, grew by 10 percent. The US economy may have recovered in terms of top-line figures, but middle- and lower-income families have not. For those hardest hit, the tales of recovery ring hollow.



If that is the case, then how is it that real median income – one of the most important economic indicators we use to assess the health of the US economy – is so high? When we first forecast the coming crisis of the American middle class in 2011, median household income, adjusted for inflation, was lower than it was in 1989 or in 2000. The subsequent rise in real median income is a sign that the middle class has stabilized, right? Well, not really. Real median income can rise even as the gap between those above and below the median widens. For example, the share of adults living in middle-income households has fallen since 1970. That year, 61 percent of adults lived in a middle-income household. In 2015, that number had fallen to 50 percent. The share of those living in a low-income household increased by 4 percent, and the share of those living in an upper-income household increased by 7 percent. The underlying problem is wealth inequality, and real median income does not necessarily capture wealth inequality.





And in 2017, real median income doesn’t go nearly as far as it used to. In the 1950s, the median cost of a home was a little more than double a family’s average annual income. A car was just under half of a family’s average annual income, according to data from the US Census Bureau and the US Department of Commerce. Today, it costs an average family about four times its average income to buy a house, and almost two-thirds its annual income to buy a car. A majority of households in the 1950s, moreover, were single-income households. By the end of that decade, the husband was the sole income generator for 70 percent of American households.

Analysis performed by Pew in 2015, based on the last US census, estimated that in 2012, 60 percent of American households were dual-income households. The purchasing power of the real median income has decreased even as US households have added a second breadwinner to the home.

For the past 40 years in the US, the rich have been getting richer, the poor have been getting poorer, and the middle class has been disappearing. The crisis of 2008 was a global phenomenon, but in the US, it was also an episode in an era of increasing inequality that began in the 1970s. The American dream was never about just making ends meet – it was about social mobility and giving your children a better life than you had growing up. That is beyond the means of an increasing number of US households. When the next recession comes, it will come as inequality reaches new heights, and if US history is any indication, that will translate into massive political change.

The Biggest Bubble Ever, In Three Charts

To the naked eye, percentage debt growth figures for the most part don’t appear alarming. But there’s several unusual factors to keep in mind. First, the outstanding stock of debt has grown so enormous that huge Credit expansions (such as Q3’s) don’t register as large percentage gains. Second, overall system debt growth continues to be restrained by historically low interest-rates and market yields. Debt simply is not being compounded as it would in a normal rate environment. And third, it’s a global Bubble and a large proportion of global Credit growth is occurring in China, Asia and the emerging markets. U.S. securities markets continue to be a big target of international flows. 

With global Bubble Dynamics a dominant characteristic of this cycle, it’s appropriate to place Rest of World (ROW) data near the top of Flow of Funds analysis. ROW holdings of U.S. Financial Assets jumped $724 billion (nominal) during the quarter to a record $26.347 TN. This puts growth over the most recent three quarters at a staggering $2.124 TN (16% annualized). What part of these flows has been associated with ongoing rapid expansion of global central bank Credit? It’s worth recalling that ROW holdings ended 2007 at $14.705 TN and 1999 at $5.639 TN. As a percentage of GDP, ROW holdings of U.S. Financial Assets ended 1999 at 57%, 2007 at 100%, and Q3 2017 at a record 135%. 

Meanwhile, the Fed’s Domestic Financial Sectors category expanded assets SAAR $2.841 TN during Q3 to a record $95.213 TN. In nominal dollars, the Financial Sector boosted assets a notable $5.085 TN over the past three quarters, almost 8% annualized growth. Notably, the sector’s holdings of Debt Securities surged a nominal $775 billion in three quarters to a record $25.425 TN. Pension Funds were a huge buyer of Treasuries during the quarter (SAAR $1.075 TN). Over the past three quarters, the Financial Sector boosted holdings of Corporate & Foreign Bonds by nominal $427 billion to $8.026 TN. More very big numbers.  

One doesn’t have to look much beyond the booming Rest of World and Domestic Financial Sector to explain ongoing over-liquefied securities markets. The numbers confirm a historic financial Bubble. 

Total Equities Securities jumped $1.229 TN during the quarter to a record $43.969 TN, with a one-year gain of $5.923 TN (16.4%). Equities jumped to a record 224% of GDP, compared to 181% at the end of Q3 2007 and 202% to end 1999. Debt Securities gained $171 billion during Q3 to a record $42.385 TN, with a one-year gain of $1.080 TN. At 217% of GDP, Debt Securities remain just below the record 223% recorded in 2013. 

This puts Total (Debt & Equities) Securities up $1.400 TN during the quarter to a record $86.080 TN. Total Securities inflated $7.003 TN, or 9.1%, over the past year.  

Total Securities experienced cycle tops of $55.261 TN during Q3 2007 and $36.017 TN to end March 2000. Total Securities ended Q3 2017 at a record 441% of GDP.  

This outshines the previous cycle peaks of 379% for Q3 2007 and 359% at Q1 2000.  

One more way to look at post-crisis securities market inflation: Total Securities ended Q3 $30.819 TN, or 56%, higher than the previous cycle peak in Q3 2007.

Buttonwood

The markets believe in Goldilocks

But the bears are out there


ANOTHER week, another record. The repeated surge of share prices on Wall Street is getting monotonous. The Dow Jones Industrial Average has passed another milestone—24,000—and the more statistically robust S&P 500 index is up by 17% so far this year. Emerging markets have performed even better, as have European shares in dollar terms (see chart).




Political worries about trade disputes, the potential for war with North Korea and the repeated upheavals in President Donald Trump’s White House: all have caused only temporary setbacks to investors’ confidence. No wonder the latest quarterly report of the Bank for International Settlements asked whether markets are complacent, noting that “according to traditional valuation gauges that take a long-term view, some stockmarkets did look frothy”, and pointing out that “some froth was also present in corporate-credit markets”.

The authors of the BIS report are not the only ones to worry that markets look expensive. The most recent survey of fund managers by Bank of America Merrill Lynch found that a net 48% of them thought equities were overvalued, a record high. Despite that, a net 49% of managers had a higher than normal allocation to stockmarkets.

How do fund managers rationalise this apparent discrepancy? First, they are more optimistic than usual about the economy, with a record number believing in a “Goldilocks scenario” of above-average growth and below-average inflation. Second, investors are even more worried about bonds, the other main asset class; a net 81% think bonds are overvalued. In short, they are piling into shares because they see no alternative.

Improving economic data have driven the most recent spurt of enthusiasm. Alan Ruskin of Deutsche Bank points out that, in the manufacturing sector, South Africa is the only country where the purchasing managers’ index is below 50—the dividing line between expansion and contraction. Another boost is the expectation that America’s Congress will pass a bill that will cut taxes for corporations, allowing them to pass more cash to shareholders.

Confidence was also lifted by a decent third-quarter results season, which showed that companies in the S&P 500 managed annual earnings-per-share growth of 8.5%, according to Société Générale, a French bank. But long-term profits expectations are “ridiculously high”, says BCA Research, an advisory firm, with earnings forecast to grow at 14% a year in both America and Europe. That would imply an ever-greater share of GDP going to profits, and an ever-lower share for workers. If that were to happen, support for populist parties would go through the roof.

Analysts rarely tend to forecast falls in profits. But Andrew Smithers of Smithers & Co, a consultancy, points out that the earnings per share of quoted companies have become far more volatile since 1992, compared with the volatility of profits in the national accounts. One reason for this is the much greater importance of foreign profits in the figures reported by US-quoted companies; the overseas portion rose from 18% in 1982 to 38% in 2015.

Even allowing for this, reported profits are more volatile than they used to be. Mr Smithers argues that it is in the interests of managers to present higher profits when share prices rise and to understate profits in bear markets. In the former case, higher profits will allow executives to meet targets and exercise their lucrative share options. Conversely, in a bear market, it is worth managers taking a “kitchen-sink” approach—getting all the bad news out of the way so the next set of performance targets will start from a lower base.

Share buy-backs add another factor to the equation. Companies tend to be trend-followers rather than bargain-hunters when purchasing their own shares. Since early 2005, the only two quarters when corporations have not been net buyers were the second and third quarters of 2009. That was the period when valuations were cheapest.

All this suggests that there is a risk that when the market does at last turn down, the decline will be exaggerated. Share buy-backs will stop and profits will decline sharply.

But judging when that moment comes is another matter. While the economy is improving and interest rates are low, it is hard to foresee the next downturn. As one fund manager says, investors feel like Chuck Prince, a former head of Citigroup, who was asked why the bank was still lending in mid-2007, just before the financial crisis. “As long as the music is playing, you’ve got to get up and dance,” he said.

Chile learns to harvest its formidable solar power opportunities

Fossil fuels shortage stimulates unprecedented boom in renewable energy investment

Benedict Mander in Vallenar


A shortage of fossil fuels has stimulated a boom in investment in solar energy in Chile © FT montage; Getty Images


The silence at El Romero is deceptive. Broken only by the ambient hum of transformers and with almost no humans in sight, there is nevertheless plenty going on beneath the surface of the giant solar panels that cover 280 hectares of the arid mountain landscape of northern Chile.

About 200 megawatts per hour pulse from Latin America’s largest solar power station into nearby transmission lines that stretch more than 600km south to the capital Santiago from its location in the Atacama Desert, one of the driest and sunniest places on earth.

“This is the face of the future of Chile,” says José Ignacio Escobar, general manager in Latin America for Spain’s Acciona, which built and operates El Romero. “Chile may be poor in old energy, but it is very rich in renewables. Can you see a single cloud?” he asks, gesturing towards the indigo sky that is so clear that the world’s most powerful telescopes are built in the Atacama.

It is only recently that Chile began to harvest the formidable power of the Atacama’s sun. Just five years ago, the country produced negligible amounts of renewable energy and was heavily dependent on imports from its unreliable neighbours, suffering from blackouts and some of the highest energy prices in the world.

But this shortage of fossil fuels has stimulated an unprecedented boom in investment in renewable — and especially solar — energy since then, despite a contraction in investment in almost all other sectors during a period of economic stagnation at the end of the commodities boom.





Chile is now producing some of the cheapest energy in the world, fuelling hopes that it will become a solar version of Saudi Arabia. Having joined Mexico and Brazil among the top 10 renewable energy markets in the world, Chile is leading the clean energy transformation in Latin America, where investment in renewables has grown at double the global rate over the past decade.

“It’s the great silent revolution of [Michelle] Bachelet’s government, which she will be remembered for later,” says Eugenio Tironi, a sociologist, referring to Chile’s outgoing president who will be succeeded by the winner of presidential elections on December 17.

Although the rapid introduction of renewable energy in Chile using market incentives is arguably Ms Bachelet’s greatest achievement, the leftist leader has preferred to trumpet reforms at the core of her agenda that are widely criticised for being poorly designed and implemented, and stifling investment.

“The hallmark of our government is the reforms aimed at reducing inequality. Most of the debate has been around education and labour reforms, but if we hadn’t solved [our energy] problem, it would have been more difficult to implement the social reforms,” says Andrés Rebolledo, energy minister, who claims that energy is no longer a barrier to growth.

After introducing regulations that opened up Chile’s oligopolistic energy sector to competition, it only took until October this year for the government to reach its target of generating 20 per cent of electricity with renewable sources by 2025, mostly with solar and wind power.

It is a measure of how far Chile has come that the pledges by candidates in the presidential election campaign for the country to produce 100 per cent renewable energy by 2040 were taken seriously, and considered feasible by experts.

“I don’t think anyone thought [that Chile’s transformation to renewables] would happen so quickly — and it happened without subsidies as they don’t believe in market intervention here,” says Bart Doyle, who runs the operations in Chile for the Irish company Mainstream.

“It was a straight fight between renewables and everything else. Not only did renewables win, but they won hands down,” he adds, pointing out that most other countries provide incentives to companies generating electricity through renewable sources.

Although Chile’s energy auctions to supply the grid are open to all companies on equal terms, thanks to improving technology and Chile’s renewables potential, they are able to produce solar energy at about half the cost of coal-fired power stations.

This was made possible by perhaps the most effective regulatory change under Ms Bachelet’s government, which was to divide the day into thirds, making solar power especially competitive for companies bidding to provide energy in the middle third during only daylight hours.

In Chile energy costs have fallen 75 per cent since auctions began three years ago, with the latest producing the second-lowest bid in the world for solar power of 2.148 cents per kilowatt hour. But prices have fallen so low that Mr Doyle warns of the “bleeding edge” of cutting edge technology, arguing that companies may get caught out by bidding below the cost of production.

“Not all that glistens is gold,” cautions Mr Escobar, who believes that new regulations dealing with longer-term issues now need to be put in place. “We can’t allow this marvel to become a nightmare.”

Commodity Bulls Ignoring a Few Large Elephants

Commodity markets see no evil, hear no evil—that’s not necessarily comforting

By Nathaniel Taplin


RED ALERT
Commodity price indexes vs China real estate

War, Nuclear War and the Law

By George Friedman

Sen. Bob Corker (C) (R-TN), chairman of the Senate Foreign Relations Committee, confers with Sen. Ron Johnson (R) (R-WI) during a committee hearing on Nov. 14, 2017, in Washington. WIN MCNAMEE/Getty Images