THE UNINTENDED CONSEQUENCES OF
GLOBALIZATION
By Dan Denning
I'm
often asked why I'm so bearish on financial markets right now. The answer is that man
behaves even more poorly as a political animal than he does as a rational economic one.
And the world's financial markets are more and more driven by politics... on a global
scale. It's a trend, unfortunately, that's gathering momentum, from bombings in Madrid to
assassination attempts in Taiwan to successful assassinations in Gaza. None of this is
good for markets.
But
political change doesn't happen haphazardly. It's driven by economic change. And some
regions are going to do better than others in the future. The questions are: which
regions, why, and how do you profit?
To
answer those questions, you've got to understand who's winning and losing out in
globalization.
The
globalization process of the '90s used to look like nothing but good news for the affluent
West. Western economies outsourced the production of manufactured goods
to Asia and got lower prices in return. And for a while, this had no immediate effect on
Western job markets, or the direction of global capital flows.
In
fact, capital flows favored the West, too. High-saving Asian countries loaned us capital
on the cheap or bought our financial assets and supported our bond prices. And
every so often, Western capital poured into an emerging market, created an asset bubble,
took profits, and moved on for the next high yield.
But
the unintended consequences of globalization are only now making themselves apparent. And
if I'm right, they are not good for the unprepared investors. Falling financial asset
prices, rising prices for commodities and raw materials, lower average incomes, and a
much, much more competitive world appear to be on the horizon.
Globalization
has already begun to redistribute relative economic advantages from West to East. Asia,
especially Japan and China, enjoys a competitive advantage in
manufacturing because of abundant labor and high-tech know-how... in fact, it has become
the world's factory for durable and mass-produced goods. Meanwhile, India, with the
world's largest educated English-speaking population, is capable of providing professional
services to the world at comparatively low prices.
By
contrast - and whether it's true or not - the rest of the world perceives America as a
hotbed of technology-driven research and development. As such, America will continue to
attract capital and interested risk-takers, as well as new technology businesses. But
given Asia's manufacturing advantage and India's ability to provide low-
cost professional services, the U.S.'s role in these two areas is coming under pressure.
These
are generalizations, of course. But if market forces hold sway, I think these trends will
more or less hold true for the next 50 years.
Shifts
like these cannot help but lead to, and in fact have already begun to create, significant
social and political disruption. I believe this will be an increasingly determinant factor
in understanding global markets. But more important in the United States today is
financial disruption - that's going to come first. In fact, I think the wave of selling
that came after the Madrid bombings and Israel's assassination of a Hamas political figure
indicated just how tenuous the investing public's confidence is.
The
economic position of America appears to be untenable. The culprit, of course, is debt.
Enormous, overwhelming, totally out-of-control debt. Government debt. Mortgage debt.
Credit card debt. Debt, debt, debt.
And
in some ways, expectations are also to blame; the U.S. is still locked into a culture of
'getting something for nothing.' Americans still expect wealth as their political
birthright. But as CEO Carly Fiorina told Hewlett-Packard shareholders, the days of
enjoying privileged economic status because you were born American are over.
We
live in odd monetary times. In America, there is a growing divergence between the value of
tangible real assets and the value of financial assets and derivatives.
Because of that divergence, and because of the tremendous industrial-productive capacity
in the world today - as well as the intense competition for jobs, fomented by
globalization - I think you'll see both deflation and inflation in short order.
How
can you have both? Well, the inflation in tangible assets (commodities) is fairly easy to
identify. Commodity prices are determined largely by supply and demand. Demand for
tangible assets and raw materials is obviously growing, driven by Asia, and
notwithstanding the languid economic growth in Europe, the United States, and Japan.
Supply, however, is not keeping up. Add to that years of underinvestment in productive
capacity, and you have all the elements for rising raw material prices - even if the
dollar weren't falling off a cliff. We are at the start of a major, multiyear bull market
in commodities.
But
the dollar IS falling hard (or so I believe). And because of that, it's possible that even
as commodity prices rise on the cheaper dollar, you'll also see deflation in assets whose
value depends on the dollar itself as a source of value.
For
the last five years, American financial assets have enjoyed enormous capital flows. Global
money went to buy American stocks and bonds, not to build factories. That
money, which was borrowed at low interest rates, has created a huge bubble in financial
assets (brokerages, banks, and REITs, to name a few). It's also made those assets
extremely risky.
Anything
bought with money borrowed at low interest rates is susceptible to a sudden decline in
value if that money becomes worth less. That money is the dollar. As the dollar declines,
it makes financial assets bought with borrowed dollars virtual locks to deflate in value.
It's
an odd world where you can have debt deflation (falling prices for assets bought on
credit) and inflation in natural resources and raw materials (as central banks
print more money to devalue the nominal value of the debt) - AT THE SAME TIME.
We
may soon see falling prices for houses, stocks, cars, and bonds... even as prices for
precious metals, oil, and raw materials continue to rise. The dollar will lose
purchasing power against tangible assets (assets not purchased with debt) while
debt-financed assets will fall in value.
The
implications for investors are clear. Beware the U.S. 'financial economy.' Decrease your
exposure to debt. And if you've got money left over... the commodity bull market might not
be a bad long-term place to be.
Regards,
Dan Denning
for The Daily Reckoning of April 8, 2004
NOTE: To subscribe to The Daily Reckoning e-mail
service, visit www.dailyreckoning.com.
to Home