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Our December 15, 2007 Newsletter
Edition
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EDITORIAL: THE
NEW TRADE PARADIGM
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A local Dominican Republic University economics professor was giving a
lecture to his graduate students here in Santo Domingo recently, and
one of the students called me afterwards, because he knew I would have
an interest in what was being said. The professor began by
discussing the current state of the US economy, explaining what a mess
it currently is in (certainly not any new information). However,
what really caught my attention were some comments he made about
Dominican consumers and American made products. Which is to say,
he went on to discuss how Dominican shoppers in the past would often
purchase products made in the USA, despite the fact that these items
were more expensive than locally made items. Why? Because
even though there are plenty of local industries here in the Dominican
Republic making everything from cosmetics, to shampoo, to washing
machines - the thinking was that the American products were of higher
quality, and thus probably worth the higher price. Today, the
professor went to explain, even though a product may still have the
American brand name on it, chances are, it is made in China. And
so, the professor said, we as Dominican consumers continue to pay a
premium for American Brands, that are no longer made in the USA.
My mind began to become intrigued by this comment because here we have
a university professor that has asked the theoretical question:
Are American products still worth it to us, as consumers in a Latin
American country, considering these products also are now being made in
another developing market? In other words, why are we still
paying a premium for American products, not made in America
anymore? Think about this for just one moment, and what this
means, as I already have (we will come back to this in just a moment).
.
As a possible long time reader of our newsletter, you will recall our
comments about the so-called third world or developing markets becoming
directly integrated with each other, in terms of trade (and leaving out
the so-called modern industrialized nations in the process). This
is a trend we took notice of previously. In other words, we see
Brazilian companies selling industrial products (such as high voltage
electrical transformers) directly to the Dominican market. We see
LG consumer electronics, a Korean Company founded in 1958 (what used to
be called Lucky Goldstar, that used to make a previously low end
television set, as just one product example, that you only bought
because it was cheap, not because it was considered to be a high end
item) now dominating the market in Latin America, in terms of
refrigerators, plasma televisions, air conditioners and even cell
phones. And now in the Dominican Republic, we have six (count
them, six) Chinese vehicle brands selling pick-up trucks, heavy
duty trucks, mini-vans and some SUV models. And this scenario is
quite common through-out the developing world, or what are often called
emerging markets.
.
I started to think about this phenomena with the car industry
specifically, and especially since most Americans have no idea this is
going on, simply because many of these brands, coming out of emerging
market countries, are now heavily sold in the other growing developing
markets and not necessarily in the so-called industrialized
nations. This is an important point, because why would any
manufacturer prefer to be positioned in these so-called poorer markets,
and not say, for example, in the US? Is it because there is more
competition in the US or Europe? Not really, as all the major car
manufacturers or other imported brands are already present in these
other markets. Is it because of some kind of strategy to get into
these growth markets first? Regardless, what does this tell you,
if consumers in these developing or emerging markets would possibly now
prefer to buy the lesser known brand from China (or where-ever) and not
the US or European brand? If this is indeed a new trend, what
does this mean for US or other companies from the industrialized
nations?
.
To highlight an example, one Chinese brand offers an almost exact copy
of an Isuzu pick-up truck. Another, a copy (and using the
technology of) of the Toyota, and so on. HOWEVER, the Chinese
Brand of the Toyota, Isuzu or Mazda is HALF the price. And so,
you have a choice. Pay thirty thousand dollars for an Isuzu, or
pay about sixteen thousand for the Chinese brand (all vehicles are more
expensive in the Dominican Republic, than in the US, because of the
government taxes or duties). Of course, some consumers are still
skeptical about the quality or the ability to get spare parts for these
vehicles, but slowly you are seeing quite a few of these on the
road. After all, if Toyota helped with the technology and it's a
Toyota motor under the hood - who cares if the name plate on the grill
says Foo Yuck? At the end of the day, it's a Toyota, made in a
Chinese factory, selling for half the price. How bad could it
be? After all, LG or Lucky Goldstar, was considered a
manufacturer of junk electronic products 30 years ago. Not
anymore. They now have a very large portion of the market, and
the quality is considered to be very good (at least by
consumers). Same can be said about Hyundai and Kia, two
noteworthy car brands from Korea.
.
With that said, I started to think about the fact that American (and
Japanese) manufacturers started to move factories, the technology, and
now research and development, over to Korea, China, Malaysia and other
places in order to cut labor costs. What they got in return was
local manufacturers in these markets, who can NOW make the same product
and sell it directly to consumers, without the use of an American (or
Dutch, or Japanese) company brand name or middle-man to do so (and sell
it for less in the process). In other words, these factories no
longer need to make things for the foreign brand name. They can
sell directly to consumers under their own names now, and cut off the
foreign company altogether. Consumers in Ecuador, India, South
Africa and so on, will buy a Foo-Yuck, if the darn thing works, and it
is cheaper. This is common sense and goes without saying.
And so, these companies (the Foo Yucks of the world) are positioning
themselves in these new growth markets, so much so, that local cash
paying consumers are beginning to ask: What really is the difference
today between a GE and an LG? GE may bring good things to life,
but so does LG, and it's much cheaper (and they are both made in the
same country regardless, often enough, down the corridor in the same
factory).
.
Many American companies thought they were slick or smart by moving the
production abroad. Of course, we know the added profits gained
from lower labor costs went upstairs to the corporate suite, to US
executives making unfathomable salaries, while domestic American jobs
were lost in the process. However, it has dawned on me that all
of these over-paid corporate American executives may just find
themselves Foo Yucked also. Why? Simply because they ARE
possibly loosing market share, regarding their brands, in the growth
markets they really cannot afford to be out of, if they want to stay in
business (considering the fact that the American consumer is becoming
tapped out, the only markets left with cash paying consumers happens to
be in the developing countries). And if those new consumers in
the emerging markets prefer to buy the domestic Chinese brand because
it is just as good, and cheaper - this is going to be a problem going
forward for the US and EU companies. Something to think about as
far as your investment decisions are concerned.
.
The recent devaluation of the US dollar certainly has made American
products less expensive abroad, but is it enough to reduce the prices
that much to make such products as cheap as the Chinese made items
(sold outside of the US)? And so, if the goal by the US
bureaucrats is to devalue the dollar on purpose to help US
manufacturers (as a side benefit to supposedly assuaging the so-called
mortgage credit crisis), does this really offer any benefit to the
average US citizen regardless? We think the answer is no.
We also think, once again, it is a clear case of government policy to
help business interests at the expense of the average citizen (nothing
wrong with helping business, provided you are not putting your
citizenry in the poor house at the same time). Which is to say,
devaluation of the US dollar and resultant inflation will wreck havoc
on the financial well being of many individuals, even though
corporations might get a boost from exports or foreign sales.
Also, with US corporate income tax rates the lowest they have been in
three decades, we do not see this added boon translating into
exponential increases in US government tax revenues necessarily. In
fact, since many of these US companies have set up offshore or non US
operations, chances are the US Treasury may see almost none of it (or a
minute share), as it is logical the revenues will flow back to the US
owned joint venture factory in Shanghai and not necessarily to
Ohio. The result is, we believe, a double whammy on the
individual US citizen, from higher cost of living due to inflation, and
a higher taxation burden, on individuals and not corporations, to fund
the welfare state going forward. How did we get all this from a
seemingly innocuous comment by a economics professor in the Dominican
Republic? All these issues are inter-related, and once you
connect the dots and follow it on through, one can get certainly
predict the possible
outcomes.
.
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IN THE NEWS:
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EUROPE TRIES TO
CATCH UP WITH AFRICA
By Stephen Castle - December 7, 2007
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Since a meeting in Cairo in 2000, Europe's worries about human rights
abuses in Africa have derailed plans to hold another summit gathering
of European and African leaders. In the intervening seven years,
China has showed no such qualms. When Chinese and African leaders met
in Beijing in November 2006, they agreed to deals valued at an
estimated $1.9 billion. Since then, a Chinese bank has bought 20
percent of Standard Bank, the largest African lender, for $5.4 billion,
and an industrial giant from China is buying a majority stake in the
largest ferrochrome producer in Zimbabwe.
.
Confronted by China's growing economic influence in Africa, the
European Union has finally cast its reservations aside to stage a
summit meeting, opening Saturday, with representatives of 53 African
countries. Europe remains Africa's most important trading
partner. But it is unclear how the meeting this weekend can stem the
growing Chinese influence in Africa.
.
Up to last year, 800 Chinese companies invested $1 billion in Africa,
establishing 480 joint ventures and employing 78,000 workers from
China, according to the European Commission. Beijing imports 32 percent
of its oil from Africa, and oil-related investment in recent years
amount to $16 billion, according to commission estimates.
.
Joseph Bonesha, Rwanda's ambassador to the EU, said that although
Europe's historical ties left it well placed to develop its ties with
Africa, there was no denying China's popularity as an investment
source. Their prices are usually more competitive than the
Europeans', their contracts for construction are often subsidized,
their aid is not tied to conditions, and when they offer credit, it is
interest-free or at very low rates, he said as he arrived for the
two-day meeting. The Chinese have a clear and direct interest in
securing supplies of commodities and opening up new markets to which
they can export their goods.
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http://www.iht.com/articles/2007/12/07/europe/union.php
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EDITORS NOTES:
Regarding our Foo Yuck theory, we rest our
case. Also, you should take careful note of the outcome from this
recent meeting. The African nations are not so dumb, and the
Europeans did not get the red carpet they were hoping for in terms of
trade agreement issues. If the Chinese are selling decent
products in Africa at half the price, AND if the Chinese government is
providing economic aid with no strings attached as another political
benefit - if you were such an African country, who would you side with?
.
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ECONOMICS: FUTURE
DEPENDS ON FREEDOM FROM THE US
By Ralph Atkins in Frankfurt - December 4, 2007
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Turmoil has hit financial markets around the world, but amid the gloom
there have been some bright spots. Behind such optimism lies hope
that European economies will de-couple from events across the Atlantic.
To an extent that has already happened. The outlook for the US has
taken a clear turn for the worse, with a recession next year a clear
possibility, but Germany is still notching up some of its best growth
rates for a decade. While business opportunities might be lost in the
US, other markets are compensating. German exports to the Brics:
Brazil, Russia, India and China in the first half of this year were
almost as large as exports to the US, says Dirk Schumacher, economist
at Goldman Sachs in Frankfurt. German plant and machinery remains in
demand across fast-expanding emerging economies.
.
http://www.ft.com/cms/s/2/7a5e8e7c-a142-11dc-9f34-0000779fd2ac.html
.
EDITORS NOTES:
According to a December 4, 2007
news article from
Bloomberg titled: U.S. Losing to
Foreign Stock Markets, it is
reported: A growing number of international companies are leaving
U.S. stock markets, the group said. A record 56 firms, or 12.4 percent
of all foreign companies listed on U.S. exchanges, had left as of
October, the report said. That compares with 30 de-listings, or 6.6
percent of all foreign companies, in 2006. Gothenburg,
Sweden-based Volvo AB, the world's second- largest truck maker, said
Dec. 3 it was filing for de-listing from the Nasdaq Stock Market to
concentrate trading on the OMX Nordic Exchange in Stockholm (end of
quote from news article).
.
Let us try and connect the dots here. First, we have the
Financial Times of London saying, Europe should disconnect their
economic future from the US, and rather look to other emerging markets
instead, in terms of new sales and growth. In addition and
regardless, Europe wants to distance themselves as far from the US
contagion as possible, if they can (although, birds of a feather, as
seen with the European Central Bank pumping money into the system as
urged on by Ben Bernanke). Secondly, as reported by Bloomberg, we
see European companies that want to get the heck out of the US stock
markets, or otherwise stated, they don't want their shares traded
inside the US anymore. Why? What do you think are the
future prospects specifically for US companies and the US economy when
you add all this up collectively?
.
Another semi-related new and interesting trend is forming with recent
illegal immigrants who now think that better economic opportunity is to
be had back home. In other words, illegal immigrants are now
heading back to their native countries, with the thinking that the US
economy is done for, and the economy in their home countries much
better.
.
A December 4, 2007 article
from the New York Times is titled: Brazilians
Giving Up
Their American Dream. The article says:
.
In the last half year, the reverse migration has become unmistakable
among Brazilians in the United States, a population estimated at 1.1
million by Brazil's government, four to five times the official census
figures. To explain an often wrenching decision to pull up
stakes, homeward-bound Brazilians point to a rising fear of deportation
and a slumping American economy. Many cite the expiration of drivers
licenses that can no longer be renewed under tougher rules, coupled
with the steep drop in the value of the dollar against the currency of
Brazil, where the economy has improved. You put it all together,
and why should you stay in an environment like that if you have a place
like Brazil, where there is hope, a light at the end of the tunnel and
it's not a train to run you over? said Pedro Coelho.
.
http://www.nytimes.com/2007/12/04/nyregion/04brazilians.html
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HOW HIGH IS
INFLATION? THE ANSWER IS ALL AROUND YOU
By Avner Mandelman - December 1, 2007
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Good investors check things out for themselves as Ronald Reagan
recommended when he dealt with the Soviets: Trust, but
verify. Yet the mindset of checking-things-out-for-yourself isn't
just for individual stocks. It is also good - especially good - for
larger questions. To take a concrete example: What do you think
is the level of inflation? This is critically important, both if you
invest, and if you plan for your retirement. In the case of investing,
the rule of thumb is that the proper market price-to-earnings multiple
is 20 less the inflation rate. So if inflation is 3 per cent, a PE of
17 times is reasonable. On the other hand, if inflation is 10 per cent,
as it was in the late '70s and early '80s, then even a PE of 11 or 12
would be too high. As for retirement, no need to elaborate on the need
to figure just how far your dollars would go in your golden years.
.
So what is the real inflation level, and how to find out? Why, by
keeping track of how much you paid for things a year ago, five years
ago, and 10 years ago, then comparing it to how much you are paying
today. Simple. The airline ticket to Paris I had bought in the
'80s was 3.5 times cheaper than today. That's about 6.5 per cent a
year. The lunch I had at Simpson's in the Strand in 1982 cost $8 for
two. Today it would be about $50, or 7.6-per-cent inflation a year.
Again close to 8 per cent.
.
Now, this 8 per cent a year is a very high inflation number - but is
still not derived from critical items: You don't have to buy a fancy
recliner, and you don't have to fly to Paris. But you do need to eat.
Therefore, the best indicator for food inflation I have found is the
price of yogurt. Yes, that simple, plain food item that - unless you
buy it flavored - is about the same everywhere. Since I have a good
memory for prices, I know that eight years ago my family paid 29 cents
for one of those little plastic containers of yogurt. Today we pay 79
cents. (You'd probably pay $1.29, but I am a value buyer.) This comes
to 2.7 times the price in eight years, or a growth rate of 13.2 per
cent a year!
.
http://www.theglobeandmail.com/
.
EDITORS NOTES:
Holy cow curd. Yogurt inflation is at 13
percent annually? The author of the above article goes on to
point out that the Government of Canada produces its own inflation
related statistics. The author then goes on to ask: What's wrong
with taking the Canadian Governments consumer price index figure? That
number usually ranges between 2 per cent and 3.5 per cent. But is this
the real inflation figure? No it isn't. In fact, the government says so
specifically - although in very small print: The CPI is merely a
measure for indexing civil service employees' pensions (end of quote).
.
And there you have it. The government produces low ball figures
to keep cost of living increases down for government salaries AND
government pension benefits (such as Social Security cost of living
increases). And so, should you trust Yogurt instead of the
Government? Maybe.
.
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INNOVATING OUR WAY
TO WAY TO FINANCIAL CRISIS
By Paul Krugman - The New York Times - December 3, 2007
.
The financial crisis that began late last summer, then took a brief
vacation in September and October, is back with a vengeance. How
bad is it? Well, I've never seen financial insiders this spooked - not
even during the Asian crisis of 1997-98, when economic dominoes seemed
to be falling all around the world. This time, market players
seem truly horrified - because they've suddenly realized that they
don't understand the complex financial system they created.
.
Credit - lending between market players - is to the financial markets
what motor oil is to car engines. The ability to raise cash on short
notice, which is what people mean when they talk about liquidity, is an
essential lubricant for the markets, and for the economy as a
whole. But liquidity has been drying up. Some credit markets have
effectively closed up shop. Interest rates in other markets - like the
London market, in which banks lend to each other - have risen even as
interest rates on U.S. government debt, which is still considered safe,
have plunged. What we are witnessing, says Bill Gross of the bond
manager Pimco, is essentially the breakdown of our modern-day banking
system.
.
But what has really undermined trust is the fact that nobody knows
where the financial toxic waste is buried. Citigroup wasn't supposed to
have tens of billions of dollars in sub-prime exposure; it did.
Florida's Local Government Investment Pool, which acts as a bank for
the state's school districts, was supposed to be risk-free; it wasn't
(and now schools don't have the money to pay teachers).
.
http://www.truthout.org/docs_2006/120407H.shtml
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AMERICA MUST LIVE
WITH BEING A BARGAIN BASEMENT
By John Gapper, Financial Times - November 30, 2007
.
It is the holiday season in New York City. Thanksgiving is over, the
decorations are up on Fifth Avenue and the Christmas tree in
Rockefeller Plaza has been lit - this year with energy-efficient
light-emitting diodes rather than the traditional light-bulbs. All that
remains is for New Yorkers to spend money. To shop in New York
this year, however, is to hear a rich array of European accents. In
Bloomingdale's the other day, two French women were debating the
quality of Ralph Lauren towels. As I crossed Avenue of the Americas
this week, I heard a British family complaining about the eggs they had
for breakfast.
.
These days, with oil approaching $100 a barrel and the Middle East once
again overflowing with petrodollars while the US frets over the
possibility of recession next year, America is being sold by the
dollar. The shopping surge is due to the weak dollar, which is
approaching 1.50 Euros and is above two dollars to the pound. It is
cheaper for Europeans to take a flight to New York for their Christmas
shopping than to do it in their own countries. The effect is a
bit insulting: the Ugly American of the 1958 novel, who swaggered
around the world with a strong dollar and inviolable set of beliefs,
has given way to picky French and shirty Brits.
.
But what can the US expect if it lives beyond its means in the way it
has in recent years? Its consumption patterns and use of energy have
turned other countries into its piggy bank. The credit squeeze has left
its financial institutions with weakened capital and in need of equity
that Arab funds can provide. If US consumers had saved more,
spent less, and filled up their SUVs less frequently - and US financial
institutions had not embarked on their own credit binge - they might
not be in such an embarrassing condition. But they acted as they did
and must live with a weak dollar.
.
http://www.msnbc.msn.com/id/22043719/
.
EDITORS NOTES:
Ouch.
Some rather scathing and demeaning
comments by the Financial Times towards the colonials, even though what
is being said may be true. The UK also is in a banking, housing,
mortgage mess of its own - and speculation is that the pound could take
a shaving in 2008. Also remember the very recent statistics
indicating that British citizens have been fleeing the UK at a rate of
one every 3 minutes, with many of them heading to Spain. I doubt
it is because a large number of Brits all of a sudden have been craving
for paella. Something is going on in the land of fish and chips
as well. In fact, some will say that the British banking lending
practices were even more irresponsible than those of the Yanks.
Alan Greenspan calls this the age of turbulence. Could be. Scones
anyone?
.
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SHORT GOLD IN '08,
GOLDMAN SAYS
By Angela Barnes - November 29, 2007
.
Gold bugs have mostly had it all their own way this year, but that
won't be the case next year, Goldman Sachs Group Inc. believes. In
fact, the big brokerage firm recommends in its top 10 trades list for
2008 that investors short gold next year. Goldman had recommended
investors go long gold in its top 10 trades list for 2006 and bullion
went from around $500 (U.S.) an ounce to $650 at the end of that year.
Bullion has continued to climb since. This year it rose from $636 at
the beginning of the year to as high as $845 on Nov. 7 and is currently
changing hands at around $795 on the London Metal Exchange.
.
But the 2008 top trades list, drawn up by Goldman's global markets
team, suggests investors short gold priced in U.S. dollars in order to
capitalize on a gradual relaxation of credit concerns in the financial
sector over the coming months and as an avenue to benefit from the
prospect of the U.S. dollar stabilizing. Bullion has been one of the
main beneficiaries of the financial turmoil that began in August as
investors sought alternative stores of value to the weakening U.S.
dollar.
.
http://www.reportonbusiness.com/
.
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GOLD VERSUS GOLDMAN
SACHS & THE DOLLAR
By Julian D W Phillips - December 1, 2007
.
Forget what Goldman Sachs thinks; the Gold Price is not yet discounting
the death of the Dollar. Goldman Sachs believes the Gold Price has come
up too far, too quickly. This week it forecast a 15-20% setback, driven
by a bounce in the US Dollar. But making money in the foreign
exchange markets is not solely about watching exchange rates.
.
It is about values, smooth flowing of international trade, about trust
and reliability. And the sight of the US Dollar falling over a long
period of time, with bounces and recoveries that don't change the
downward trend, is far more than simply a drop in value! The
Dollar is steadily weakening, undermining much besides the Dollar's
international value. The loss of confidence in the US currency and with
it, the broader financial system is accelerating every time the USD
slips one or more percent on a persistent basis, with small and
short-term recoveries only coming in the midst of this decline.
How important is this loss of confidence? It's critical, we believe
here at the Gold Forecaster, for it precedes policies which will
long-term only lessen the role of the Dollar as one of the world's top
5 currencies.
.
http://www.commodityonline.com/news/
.
EDITORS NOTES:
So there you have it. Goldman Sachs says to
dump gold in 2008 and some forecasters say, not so fast. Who is
correct? Interesting enough, a recent report from Goldman Sachs
(November 2007) says losses from sub-prime exposure could be much
larger than recently assumed, hitting as much as $400 billion. Goldman
said the full impact on the economy could be even more substantial,
because the losses could compel banks and other lenders to curtail
lending by as much as $2 trillion. So, how could it be that
Goldman issues this kind of report, and then turns around to advise
clients to sell their gold? Could it be that Goldman Sachs has,
shall we say, an inside agenda in advising clients to dump gold?
Are they worried about covering their shorts? Mr. Robert Chapman
thinks so, and goes on to suggest:
.
There are now about 250,000 February contracts which represent nearly
800 metric tons of gold. A demand for that amount alone could put
the once dreaded cartel deeply underwater in the gold department. They
might well have to scramble to buy gold in the open market, thereby
driving its price into the ozone, because they do not have enough left
for sale in deliverable form as required by their futures contracts in
the event delivery is demanded. Wouldn't you just love to
liquidate Goldman Sachs if they couldn't deliver, as would be your
right under your futures contract in the event of default? And
won't they think twice before they pile up another mountain of shorts
if they know that delivery will be demanded! It's time to call their
bluff!
.
http://news.goldseek.com/InternationalForecaster/1196956980.php
.
Certainly, we commented already that gold and the Euro has had a
healthy run up, and one may argue that the time to buy in was
before. On the other hand, if you did buy gold at between US$300
and US$600 an ounce, or maybe got into Euros between US$1 and US$1.20 -
are you in any peril by holding even if there is a temporary pullback
or profit taking? The argument seems to be for price decline (by
Goldman), and that may occur temporarily (caused by central banks even,
looking to liquidate their gold holdings and turn it into cash to pay
bills, or large sales meant to simply suppress the price of
gold). All well and good, but then where do you go from
there? Do you put it all back into US Dollars?
.
The real focus should NOT be
on short-term trading, but rather trying
to decipher what the overall long-term trend is. In this regard,
we would be curious to know - is the debt being paid down? When
Bush leaves, it will be up to US$10 Trillion. Has the social
welfare system all of a sudden become solvent? Medicare is
actually insolvent already, in 2007 (see below). Are the
factories and jobs moving back?
.
For the last three years, the average American citizen is NOT saving
any money, and the national savings rate has been negative. This
is a new record folks, a first to occur within our recent 100 year
history (for three years in a row). The last time the US national
savings rate turned negative was during the Great Depression (during
the early 1930's), but even then, the statistics would indicate it did
not last for three years running. How do we stand today in
comparison to the situation in the 1930's?
.
According to another recent December
3, 2007 news article (see link
below), it is reported that: Like a ticking time bomb, the
national debt is an explosion waiting to happen. It's expanding
by about $1.4 billion a day - or nearly $1 million a minute. Even
if you've escaped the recent housing and credit crunches and are coping
with rising fuel prices, you may still be headed for economic misery,
along with the rest of the country. That's because the government is
fast straining resources needed to meet interest payments on the
national debt, which stands at a mind-numbing $9.13 trillion.
.
So long as somebody is willing to keep loaning the U.S. government
money, the debt is largely out of sight, out of mind. But the
interest payments keep compounding, and could in time squeeze out most
other government spending - leading to sharply higher taxes or a cut in
basic services like Social Security and other government benefit
programs. Or all of the above. A major economic slowdown, as some
economists suggest may be looming, could hasten the day of
reckoning. The national debt - the total accumulation of annual
budget deficits - is up from $5.7 trillion when President Bush took
office in January 2001 and it will top $10 trillion sometime right
before or right after he leaves in January 2009. The government
is in the same predicament as the average homeowner who took out an
adjustable mortgage, said Stanley Collender, a former congressional
budget analyst and now managing director at Qorvis Communications, a
business consulting firm.
.
http://www.truthout.org/docs_2006/120307J.shtml
.
EDITOR:
Interest payments alone, on the US Government national
debt, is already the third largest budget expense of the federal
government (the top two are welfare programs and defense). If the
debt keeps going up, and the government has to allocate even more of
the budget to cover interest payments - where is this money coming
from? The 2007 GDP (Gross Domestic Product), or we can say the
annual value of the US economy, is estimated to be US$13
Trillion. If the debt estimate is correct, in that the
indebtedness of the US Government is approaching US$10 Trillion, then
the annual debt to income ratio is 80 percent. However, the
long-term liabilities are now calculated out to be approaching US$55
Trillion (the debt - which we know about, plus the rest of the
government costs or expenses regarding welfare promises involving
currently un-funded liabilities, which will be a changing number
upwards as inflation and increased health care costs for the elderly
escalate). With this in mind, now we are talking about a possible
debt to income ratio of more than 400 percent (and growing). If
this were a company or individual with this kind of balance sheet,
would you be willing to loan your money in such a case? Since the
US has become a net debtor nation, you had better believe that foreign
lenders are studying these equations.
.
For example, one of those un-funded liabilities is Medicare.
According the CBO (Congressional Budget Office), government expenses
for this program alone has been increasing by 9 percent annually, and
is schedule to go up by 12 percent annually in coming years. But
never mind about the future, as the program is already broke. The
CBO reports that: net outlays will total $370 billion in 2007,
including discretionary outlays of about $5 billion for Medicare's
administrative costs. Roughly $60 billion will be offset by premium
payments (mostly from participants in Parts B and D), by
payments from
states, and by recovery of improper payments to providers. In the next
few years, Medicare enrollment and its cost will expand substantially
as the first members of the baby-boom generation become eligible
because of age or disability. In simple English, they pay out
US$370 Billion and are taking in US$60 Billion, a net loss of more than
US$300 Billion dollars per year - right now in 2007, and we have not
even gotten into the thick of things whereby almost 80 Million Baby
Boomers will be tapping into these programs (a group of people who will
be living on a fixed income, which means reduced income tax revenue
from this very large group as a result, which will NOT offset
it). Regarding spending on Medicare and other social programs,
the Whitehouse says in their 2006 budget report:
.
Spending on mandatory programs is more difficult to restrain because
these programs generally operate based on formulas that are not subject
to annual review. Consequently, when these programs grow faster than
originally envisioned, which is often the case, there is no automatic
mechanism to impose restraint. The only way to constrain the growth of
mandatory spending is by enacting new laws that change the rules
governing
spending.
.
http://www.whitehouse.gov/omb/budget/fy2006/outlook.html
.
But wait, the economy will grow every year, and everything will be fine
- no? Maybe, assuming the US economy grows faster than the rate
the politicians are spending money, and assuming tax revenues go up,
and assuming they cut expenses, and assuming they stop printing money
or expanding the money supply by 20 percent a year annually (Ron Paul's
recent estimate). In summary, you can do the math yourself, but
if expenditures are growing anywhere from 5 to 12 percent annually, and
the economy is only growing at 2 percent - you do not need a PHD in
economics to figure it out.
.
Some other information worth looking at is provided by Global
Policy: US Trade and Budget Deficits, and the Fall of the
Dollar.
.
http://www.globalpolicy.org/socecon/crisis/tables.htm
.
.
INVESTORS REDUCE
BETS ON FURTHER DECLINES FOR THE DOLLAR
By Bo Nielsen - November 30, 2007
.
The dollar rose the most in more than two weeks against the euro and
the pound Thursday on concern that the reluctance of banks to lend was
being felt in Europe, and after Goldman Sachs said the dollar's decline
might be ending. The U.S. currency gained as the cost of
borrowing in euros for one month posted a record increase and dollar
loans increased the most in more than a decade, as banks sought funds
to cover their commitments until the start of next year. Goldman said
the risk premium on bank credit could ease and that the dollar would
stabilize.
.
Selling the dollar has been one of the easiest trades this year, but
it's not a one-way bet at the moment, said Mark Meadows, a strategist
at the currency trading firm Tempus Consulting in Washington.
You're starting to see evidence that the sub-prime crisis is spreading
and that other central banks may have to hold, or even cut, interest
rates. Jim O'Neill, chief economist at Goldman Sachs, said the
dollar's slide could soon end. It's fallen a long, long way,
O'Neill told academics and students at Oxford University late
Thursday. I personally think that a year from today the dollar
will be quite a bit stronger.
.
http://www.iht.com/articles/2007/11/29/bloomberg/bxbux.php
.
EDITORS NOTES:
Merrill Lynch now says in a very recent article: A
dollar crisis that causes stock, bond and other asset prices to fall is
a bigger risk now than at any time over the past decade.
Listening to Goldman Sachs and Merrill Lynch is sort of like getting an
opinion from two different psychiatrists, which ends up leaving you
even more confused (and you still are not sure if you truly are going
crazy or not). See the Merrill Lynch comments in a news article
link directly below.
.
RISK OF DOLLAR
CRISIS HIGHEST IN A DECADE - November 26, 2007
.
http://www.reuters.com/article/ousiv/idUSN2639543620071126
.
Indeed the US Dollar has already taken a pounding, and some will
question as to how much further it can possibly fall. Gold has
indeed been on quite a run up already. On the other hand, gold
bugs point to the still exorbitant deficits and debt. One
argument is that misery loves company, and other central banks will cut
interest rates in tandem with the US Fed, but is this true? Will
central banks in other countries allow inflation to ravage their own
domestic economies, or will they sacrifice their own currency for the
sake of helping out Ben Bernanke? Where is the sub-prime crisis
spreading to, in that other countries would need to cut interest
rates? Certainly some European banks were duped into buying some
of this toxic mortgage paper and have some problems as a result, but
one can argue that the mortgage and current credit crises are really
unique and limited to the US (and the UK to some extent, which were
copying the colonials). The middle class in India have bought,
and still buy, for cash. Even the Vietnamese are buying Gucci and
BMW's - but with cash. So, where is the real consumer crisis
limited to? Primarily the US, whereby consumers were using their
houses as ATM machines, which is something that has NOT happened in
many other countries of growing importance (in the developing or
emerging markets, where consumers still are saving money, in some cases
at double digit rates, as opposed to the American consumer, who is
saving nothing and is in debt).
.
Certainly a very expensive Euro is great for European tourists looking
to snap up Christmas bargains in New York, but not such a good deal for
European manufacturers with an eye on exports. And so, will the
European central bank cave in to pressure from exporters and push the
Euro down (and the dollar up) - or will they raise rates in order to
put inflation in check? As of very recently, the US Fed has
seemed to have strong armed some G-7 central banks to pump money into
the pipeline, but more important is the LIBOR rate. Which is to
say, regardless how far central bankers cut rates (if they cut rates),
a widening spread between central bank rates and the LIBOR rates will
tell the real story about business sentiment (the Central Banks could
theoretically cut rates to zero, but what is the difference, if no one
wishes to lend or borrow regardless?)
.
Indeed, much of this all comes down to how important the US economy is
to these other nations (or thought to be, longer-term), in terms of
world trade. The US economy is currently the second largest of
all so-called wealthy industrialized nations (the European Union is
actually number one). Then again, China and India (and let us not
forget Brazil), with their own huge consumer populations and aspiring
middle-class could conceivably leave the US in the dust, in the coming
years. And so, if you are a foreign country (non US), where do
you hedge your bets?
.
I am not so sure it is an automatic given that all other countries will
throw themselves in with the Americans, in terms of economic or fiscal
policy (they may very well decide to run like heck in the other
direction). We can see this in terms of the oil exporting nations
that have been discussing decoupling their own nations currency peg
away from the USD. In addition, more important than what the G-7
countries are doing (which is to go along with the US Fed, tepidly for
now), China, India, Brazil, Russia, the Middle East, and the developing
or emerging markets are the countries to watch. It may come down
to two camps, those countries in favor of inflation (because they are
some how affected from this sub-prime issue) and those countries that
are not (because they are isolated from the sub-prime crisis, and do
not wish double digit inflation in their respective home
countries). It is true American consumers were buying in the
past, making it a good market to sell your products in
previously. However, the borrowing binge seems to have run its
course. The Europeans seem to be cognizant of this, which is why
the argument is to forget about the US and focus on the emerging
markets, where there still would seem to be solvent buyers - or at
least, this would seem to be the private business sentiment regardless
of what the G-7 Central Bankers are doing.
.
.
READERS WRITE IN:
.
John--I have read your stuff for 8 years. I have one question for
you, sparked by this latest newsletter. My wife and I were
thinking of taking out a home equity line on our house and purchasing a
property in the Dominican Republic. We come to the DR regularly
in summer. The home would be about $70,000 to build. Once
built, the house would sell for much more than that if we chose to sell
because of the improvements in that project, and its unique views
compared to all else in the DR.
.
We just backed out, though, for this reason - the mortgage market is so
unstable in the US and the possibility of massive decline (as you have
documented in many ways). So we might get into a negative equity
situation, in other words, we build this DR house on an equity line,
but when we sell the house that equity line is based on, its way less
than what anybody thought. Do you think we should still go
ahead with the DR investment?
.
EDITORS REPLY:
This is an interesting question, and the answer
all depends upon your personal goals, and what you plan to do going
forward. Meaning, are you buying real estate in the DR for
speculation, or are you doing so in order to have fully paid for
retirement home to escape to? I would not go into debt in order
to speculate in anything, you are only asking for trouble if you do.
.
While it is true that real estate has already appreciated by double
digits in the DR recently, it is not carved in stone that this will be
the case over the next few years or indefinitely. However, it might go
up 5 percent, it might go up 10 percent, it might indeed appreciate 20
percent again in 2008, and then it might go into a holding
pattern. BUT, in the least, I do not think Dominican Real Estate
is going to decline, which is the entire point for Americans looking to
dump Dollars in exchange for some other hard asset. The dynamics
and fundamentals are there (Europeans looking to buy Caribbean property
and get away from the high taxes in Europe, the estimated 10 percent of
the 77 Million American baby boomers, which comes out to a whopping 7
or 8 Million of them, who will most likely leave the US as a retirement
option over the next few years, etc.) to be positive about the real
estate market in countries such as the Dominican Republic going
forward, and I am generally enthusiastic in this regard (because of a
number of other reasons as well). On the other hand, it could be
the case that a severe US recession could curtail the plans of some of
these potential buyers, not the ones paying cash, but certainly those
trying to bet on the proceeds of a home sale to fund their retirement
or make an out of country property purchase.
.
Is it a smart idea and of value to get a fully paid for home in the
Dominican Republic for $70K? The answer is YES, especially when you
qualify for zero annual property taxes, and especially considering that
house may cost you or may be worth US$135,000 down the road (so better
to buy or build at the lower price). However, it all depends upon
your willingness and where with all to possibly manage the additional
debt over the next five years IF you would prefer to take a loan and
wait in order to sell your home (at the price you want), and IF you can
comfortably manage the extra monthly mortgage payments while you
wait.
.
One benefit is that the US Fed looks like they plan on keeping interest
rates low, and this is a plus in terms of mortgage rates for someone
like yourself taking a loan. I do not think the US real estate
market is going to disappear completely, but the problem is, no one
really knows where the bottom is, or how some of these other issues
will play out (and there is a glut of foreclosed or abandoned homes
right now). Remember that the US did eventually pull itself of
the 1930's depression, but it took over ten years to do it (those
people with cash, that had no debt, that owned their own homes mortgage
free survived quite well). I am not suggesting this will be the
case in the US today for certain, but it could be the case you have to
wait awhile to sell your home, or that you may have to do some creative
things, such as rent out your US property, hopefully with the rental
income covering the mortgage payments - or do a rent to own deal with
the new buyer. In any event, you know your own financial
situation better than I do. Calculate all of the worst case
scenarios, and if you can handle or live with any one of those negative
possibilities without a problem, then that should determine your
decision.
.
.
ANOTHER READER
WRITES:
.
Your insert about Australia is not correct. The average
Australian is as heavily in debt as the average US citizen. The
newspapers are not reporting what is really going on. All the
talk about capital spending is really limited to a few sectors of the
Australian economy which are capital intensive. There
was an interest rate hike in Australia in November during the federal
elections. The previous Treasurer MR Costello (of 11 years but
one wonders if he knew what was going on!!) believed the Reserve Bank
of Australia would not increase rates during an election campaign
because it had never been done before. The RBA
ignored that why? Because inflation is really out of control and
worst of all these small increases are not solving the problem because
if interest rates were increased in line with real inflation many would
be bankrupted and the consumption driven western society cannot handle
that!
.
EDITORS REPLY:
I said nothing about personal debt or the personal
finances of the average Australian citizen, but instead I had
specifically talked about exports (and more specifically the fact that
Australia has a positive balance of trade, rather than a negative one,
as is the case in the US). What does this mean to the overall
economy in general? It means that wealth overall is flowing into
the country as opposed to flowing out. This is a separate and
distinct matter from consumer issues, in terms of the affect on
currency valuations (which was my point). However, I have printed
your letter so other readers may be aware of your comments on the
personal debt and inflation situation in the land down-under.
However, to revisit my previous comments regarding Australia's Trade
Situation, here is a December 3, 2007
news article by Shane McLeod
titled: Australian Wheat Fuels
Japan Noodle Boom, where he goes
on to say:
.
Australians know a lot of their economic good fortune comes from
exports, and when it comes to markets Japan is one of the
biggest. But it is not just coal and gas that is being loaded on
to ships, as Japan is also a big market for Australian food.
.
http://www.abc.net.au/news/stories/2007/12/03/2107474.htm
.
In summary, any country that exports more than it imports, is a country
that has a favorable trade balance, and is a nation that should see its
national currency either increase in value or at least hold its
value. China is the notable exception as they are for sure are
artificially keeping the currency undervalued, but if it were allowed
to float freely in the currency exchange markets, that is a currency I
would like to own. In the meantime, Aussie Dollars are just one
idea as a hedge against a devaluing Yankee Greenback (plus the Aussie
money is waterproof, literally).
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