The Ultimate Debacle
The Daily Reckoning
Paris, France
Thursday, 24 July 2003
The Daily Reckoning PRESENTS: Will stemming the flow of
American jobs going overseas save the American economy? Not
likely, says Marc Faber, but that probably won't stop
politicians from trying.
THE ULTIMATE DEBACLE
By Marc Faber
Riverside ConversationsThe other day, I received a three-page email from Klaus
Bockstaller, who runs the Baring Emerging Europe Trust. I
have to say that while I get at least 100 emails a day, the
issues that Klaus raised, his thoughts, and the resulting
questions, were some of the most interesting and challenging
that I have ever encountered. They have driven me along an
illuminating path of reflection, and given rise to some
interesting conclusions.
In essence, Klaus has the following theory. When, in the
future, Western political leaders realize that the Bernanke-
type monetary policies don't really work (or are doomed to
fail, as I would put it), but lead to inflation and a
depreciation of the dollar, they will increasingly pursue a
policy of protectionism, which will buy the developed
countries of the West some time and keep jobs from migrating
to low-cost service providers, such as India, and more
competitive manufacturing centers, such as we find in China,
Vietnam, and Eastern European countries, among many others. A
sharply depreciating dollar and import duties will lift the
price level in the U.S., but the disadvantage of higher
domestic inflation could be partially offset if production
and tradable services shifted back to the U.S..
The only remaining problem in this scenario (of depreciating
dollars) would be oil. But, according to Klaus Bockstaller,
the U.S. has wisely already taken steps to ensure that it
will have sufficient supplies at reasonable prices in the
future - by occupying Iraq.
Klaus concludes that while he agrees with me that the U.S. is
headed towards 'ein böses Ende' (disastrous eventual
outcome), he nevertheless feels that a country like the U.S.,
whose money is 'the' reserve currency of the world, can, as
Bernanke suggested not long ago, print money at practically
no cost.
If this policy does not work, however, Klaus suggests that
the U.S. can simply implement protectionist policies in order
to postpone for quite some time the 'ultimate debacle'. If
the U.S. succeeds in putting off its problems for quite some
time, then the equity markets could perform very well for a
while.
While I fully agree with Klaus Bockstaller's basic
presuppositions, I believe that the lease of life of economic
policies that are designed to postpone problems, rather than
to solve them - and to hurt competitors through competitive
devaluations and protectionist measures - is far shorter than
is generally accepted. As Mao Tse Tung wrote during the
revolutionary struggle to 'liberate' China, "a single spark
can start a prairie fire." Let me explain the reasons for my
somewhat less sanguine views.
More than two years after the Fed began to ease aggressively,
it is now becoming more obvious that the policy of
aggressively driving down short-term rates has failed to
produce any meaningful recovery. Consider, for instance, the
booming housing industry. Given the red-hot conditions in
this sector of the economy (don't forget that it is excessive
credit growth that drives residential house inflation), one
would assume that the furniture manufacturing industry would
also be thriving.
But, not so! Industrial production for furniture and related
products has been declining since 2000, while employment in
this sector has totally collapsed. Why? Easy money has led to
new capacities in the furniture industry - not in the U.S.,
but in Vietnam and in China, two countries from which
furniture imports into the U.S. are soaring.
So, it should already be obvious to U.S. economic
policymakers that in an environment of free trade and free
capital flows, monetary policies can stimulate borrowings and
spending in a high-cost country, but not capital spending and
production, which, given the highly competitive situation we
have, will naturally shift to the lowest-cost producers and
lead to the ongoing wealth transfer to Asia via the U.S.
current account deficit.
But what about protective duties, quotas, and regulatory
measures that would prevent service jobs from migrating
overseas? It is on this point that I disagree with Klaus
Bockstaller. Import duties and quotas will make matters
worse, not just in the long term but also immediately. Let me
explain.
First of all, import tariffs and quotas on a large scale
would increase prices for manufactured goods in the U.S. and,
combined with the ongoing inflation for services, would lead
to higher inflation rates across the board and, therefore,
depress bond prices further. In turn, rising interest rates
would bring the refinancing boom, which has kept consumption
up, to an abrupt end. In addition, selective tariffs, such as
were imposed on steel imports, will not create jobs.
Because of the steel tariffs, U.S. steel prices are now far
above steel prices in Asia, Russia, and Brazil. So, what is
the result? Manufacturers of goods with a heavy steel content
(such as car-part manufacturers) are shifting their
production overseas, where not only labor but also now steel
prices are lower. And if across-the-board import duties were
levied, such duties would not only hurt foreign
manufacturers, but also U.S. companies, which in the last few
years have set up production capacities overseas and import
their products back to the U.S. (I understand that about 50%
of U.S. imports originate from U.S. companies overseas).
In fact, under careful analysis, it should be obvious that
the lack of competitiveness of U.S. companies has led to the
shift overseas of goods production and the provision of
services. Import duties or restrictions will 'protect'
unproductive and uncompetitive industries and make them even
less competitive, since duties will now diminish the
competitive pressures.
For the U.S. economy, rising protectionism would also mean
far higher inflation rates, as well as a huge competitive
disadvantage on the global markets for U.S. corporations.
Sure, the lowest-cost providers of services and producers of
goods would temporarily be hurt, but the world's economic
geography is now mutating rapidly. Already, the Asian markets
combined are far larger than the U.S. economy in a number of
sectors. Consequently, American protectionism would merely
redirect trade flows, but not eliminate them. (As an example,
Thailand's exports were up in May year-on-year by 13.5%, but
exports to China soared by 82%.) I might add that the threat
of protectionism will actually make exporters in Asia and
India stronger, because they would then direct their efforts
to lowering their dependence on the U.S. market by looking
for customers elsewhere.
Lastly, rising protectionism in the U.S., which is already
evident in a number of industries where foreign firms are
accused of dumping, will probably mean the end of the WTO and
lead to retaliatory measures by foreign governments. This is
hardly a picture that would be very beneficial for economic
growth and financial markets, not to mention the negative
geopolitical consequences for the U.S.!
In sum, I suppose that American protectionism will be bad for
everyone, but especially so for the U.S., as it would not
cure the cause of job losses and the trade deficit problem
but, rather, would address only the symptoms of these
problems.
Regards,
Marc Faber,
for the Daily Reckoning
P.S. I also doubt that the financial markets would take a
rising tide of protectionism in their stride. As already
mentioned above, the U.S. bond market and the dollar would
likely react negatively because of rising inflationary
expectations and the fear that the Asian central banks would
dump their dollar holdings. Stocks would suffer because of
the damage that protectionism would do to the multinationals.
P.P.S. A last point that I am compelled to address is Klaus
Bockstaller's remark that the U.S. has, cleverly, already
taken steps to ensure that in future it will have sufficient
oil supplies at reasonable prices by having occupied Iraq.
But, isn't it highly uncertain how much oil from Iraq will
ever reach the world's markets? The occupation is going very
badly, and it increasingly looks as if the U.S. is bogged
down in a vicious guerrilla war that will be hard to win.
Just consider the arithmetic of the war. Let us be optimistic
and assume that only 5% of the Iraqi population wants the
U.S. to leave or has some grudge against the coalition
forces. In a population of more than 20 million, this amounts
to at least one million potential enemies, or at least
supporters of the guerrilla fighters, or 'terrorists', as
some may call them. One million invisible enemies, who can
only be identified as enemies during very brief acts of
sabotage and ambushes, is a huge numerical superiority
against a highly visible (uniforms) occupying armed force of
160,000.
I would not be surprised, therefore, if at some point the
financial markets were unsettled by the lack of progress of
the coalition forces in establishing law and order in Iraq.
Editor's note: Dr Marc Faber is the editor of The Gloom,
Boom and Doom Report. Headquartered in Hong Kong for the
past 20 years, Dr Faber has specialized in Asian markets
and advised major clients seeking down-and-out bargains
with deep hidden value, unknown to the average investing
public.
Looking ahead to where the real growth opportunities of the
next 30 years lie, Dr Faber has distilled his analyses into
the ground-breaking book, "Tomorrow's Gold" - a wake-up
call to Western investors. If you'd like to find out how to
benefit from hard assets in a way consistent with this
essay, see:
Tomorrow's Gold
[
www.amazon.com]