 Great Expectations
Dan Denning
The Daily
Reckoning
Jan 6, 2006
The Daily Reckoning PRESENTS: We mentioned in yesterday's issue
that this week is packed with data that could be very telling
about the health of the nation's economy in 2006. Dan Denning
explains what we should really be examining...
A whole raft of economic data
is supposed to tell us this week what we can expect from stocks
and the economy. New construction spending, the Fed's last meeting
notes (what will they do next?), auto sales, payrolls, factory
orders, hourly earnings...all new grist for our analytical mill.
And all a waste of time. Mostly.
You can learn everything you
need to know about the American economy by sitting at the gate
of a terminal at Los Angeles International Airport for two hours.
On the one hand, diversity. You'll hear Chinese, Spanish (seemingly
the co-official language of California), French, and dialects
from the subcontinent that sound musical. A lot of people are
coming to America, or at least passing through it and spending
money.
But don't expect to find any
good service. The bars and pubs were packed with people and trash,
much like the concourse. The service everywhere, almost without
exception, was uninspired and shoddy. Now, don't get me wrong.
I've not become an elitist in my travels. After all, you're reading
a scribbler who paid his way through college manning the till
at a Texaco station.
What I'm getting at are the
extraordinarily exaggerated expectations in America over what
it takes to get and stay ahead. "States Take Lead in Push
to Raise Minimum Wages," reads a New York Times headline.
Do these states not know that 3 billion people are competing
with Americans for jobs? Can't they understand that by that math,
wages will fall until Americans catch down with their global
brethren?
As a would-be economic missionary
over the last few years, I've found that the American economic
gospel is flawed, maybe even heretical, if you ask Dr. Kurt Richebächer.
The economic pagans of the world do not worship the god of consumption.
No American will be left unchanged by our inevitable encounter
with the ambitions of the rest of the world.
Granted, not all jobs can be
outsourced. But what's really amazing when you travel outside
America and then come back is the expectation that the American
standard of living is a birthright that doesn't have to be earned
by hard work. I'm generalizing. Of course, there are exceptions.
Lots of people work hard every
day. But I wonder if most people have any inkling of the great
global wealth migration I described in The Bull Hunter, the one
that will punish nonsaving, nonindustrious, debt-laden consumers,
but reward certain investors.
Take a look at the world's
stock markets and you'll see what I mean. The Dow finished down.
Up was the Nikkei by 40%. Up was the FTSE by 17%. Up was Australia's
ASX 200 by 17%. Up were France, Germany, and Switzerland.
Say what you will about Old
Europe politically. Economically, there are still problems too,
namely a lack of consumer spending to drive growth. But maybe
most consumers in Europe are less sure than their American cousins
that the future will be infinitely better. They are less willing
to pile on credit today and pay the interest on it with declining
real wages. Americans feel no such compunction, and finance their
high expectations with rising interest rates.
But borrowing money does not
create wealth automatically. Business investment generally does.
And in 2006, like in 2005 and 2004, a lot will come down to whether
businesses invest. "U.S. growth may hinge on business."
Duh. The story goes on to point out that with falling house prices,
business investment should step in to fill the breach and drive
the economy. New investment will create new incomes and everything
will be fine.
But wait, there's more! "Despite
high debt levels," we are told, "it is still safe to
say that Americans will somehow continue to buy on credit, and
with energy prices falling, wages now diverted to gasoline purchases
should be freed up to spend on the array of goods and services
that drives the economy."
That's right. Energy prices
will fall. Higher interest rates will not dent consumer spending.
What's more, higher interest rates will not deter businesses
from borrowing either. Quite the contrary. Businesses will spend!
Spending and consuming rather than saving and producing will
be vindicated as the surest way to wealth in a competitive world.
People who think like this
are the same kind of people who took videos of the 2004 Boxing
Day tsunami as it rolled toward them. They are doomed.
Now is a good time to become
an exception to the rule. If American markets are down, look
to foreign markets. If real wages are falling in America, look
to higher stock market returns from overseas to drive your portfolio.
And when all else fails, buy gold and energy investments. They
are going up as a consequence of the tectonic shifts in the global
economy.
The yield curve - the spread
between short-term and long-term interest rates - inverted briefly
last week. No one much seems to care, though. It used to be that
an inverted yield curve predicted a recession. Anyone demanding
higher interest rates for, say, a two-year loan than for a 10-year
loan has some pretty serious concerns about the immediate future.
To ease those concerns, they demand compensation through a higher
yield on their short loan.
None of that matters anymore,
we are told. Why? Well, long-term interest rates are being kept
down by foreigners who simply adore U.S. Treasury bonds. This
steady bull market in long-term U.S. bonds keeps long-term rates
down, while the U.S. Fed raises short-term rates. If it's a conundrum
- as outgoing Fed Chairman Alan Greenspan once described it -
surely it must be a pleasant one. Will it end anytime soon?
Yes. There are two reasons
why. First, Asian central banks have supported the dollar by
buying U.S. bonds and keeping rates low. They've done this to
recycle trade profits back into the American economy and to keep
Americans solvent. They also had the nagging problem of what
to do with huge dollar trade surpluses.
As the returns on U.S. investments
decline (stocks, bonds, trade profits that fall as interest rates
rise and consumer spending declines), it will make more sense
to begin investing in their own markets. That kind of investment
will do what it always does: create demand, i.e., spending. In
other words, the whole purpose of Asian macroeconomic policy
will shift from producing cheap goods for America to promoting
more balanced growth at home (the Money Migration again).
Why bonds when you don't need
to support the dollar anymore? Why, indeed. Long-term rates will
move up as the world's dependency on U.S. growth wanes. And then
there's OPEC.
As you may know, huge petrodollar
surpluses have supported the U.S. bond market - and more and
more of them are being directed toward investment in local markets,
not the U.S. bond market. Granted, building a city from scratch
in the middle of the desert, as the Saudis plan to, might not
be the most efficient kind of investment. But then again, what
do I know about Saudi investment needs?
I do know that the rest of
the world often looks at America with a suppressed and knowing
grin. They know the gig can't last when it's financed with their
money or borrowed money. They know living standards aren't a
cultural birthright. And many of them are willing to work harder,
for less, and for longer.
You can't make easy generalizations
about how an entire country or region behaves economically. But
if there is any use of statistics, they at least tell us what
people are doing with their money. That, in turn, tells us what
kind of choices they're making. And if we can go one step further,
we can try to figure out why a person makes one kind of choice
rather than another.
We won't get very far doing
this, of course. Why does a housewife in L.A. buy a second SUV
instead of buying Japanese banking stocks? Why does a merchant
in Bombay buy a gold bracelet instead of Google? We can't know
their intimate motives. But we can know that some people find
consumption to be the natural role at the top end of the global
food chain, while others delay consumption, save, and invest.
What does all this mean for
the bond market, the yield curve, and the stock market? It means
that competitive firms listed on U.S. exchanges that derive profits
from a growing global market will be great investments. It means
firms that rely on continued American consumption and low energy
prices will not be great investments.
It also means that there is
an inherent spring-like nature to long-term rates right now.
They are coiled for a rise. It's as if a benign-seeming fat man
has been sitting on them, looking for a cool place to rest after
a hot day toiling in the sun.
The man knows he can't sit
there forever. That he must get up and find more productive things
to do with his time and his money, take them places where they
can keep his wealth growing and his children prosperous, or at
least better off than he.
When he gets up - when the
deliberate foreign buying of long-term U.S. bonds slows down
or dries up - then rates will skyrocket. The spring will be sprung.
This is an ugly proposition for those who have a lot of debt.
And if you've read Empire of Debt by now, you know who I'm taking
about. It is a beautiful proposition for gold, however.
Regards,
Dan Denning,
 for the Daily Reckoning
Editor's Note: Dan Denning,
editor of Strategic Investments, is one of America's most respected
"big picture" analysts working today.
In his book The Bull Hunter,
Dan lays out all the details of how to profit in ways most investors
never imagined just five years ago. What's more, he'll show you
why it's never been more dangerous to put all your investment
eggs in the basket of the U.S. economy. It's a timely warning,
along with an exceptional opportunity.
You can buy The
Bull Hunter at Amazon.
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