The Next Empire
The Daily Reckoning
Paris, France
Thursday, 25 September 2003
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*** Dow has a bad day... dollar falls... gold up...
*** Somebody hurts in America; Government moves... makes it worse
*** Seven old men... China's key vote... Hillary's call... and more...
"We have a responsibility," said the U.S. president on
Labor Day, "that when somebody hurts, government has got to move."
Judging from the unemployment, bankruptcy and foreclosure
numbers, there are plenty of hurting people in America. But not to worry; government is on the move, typically - in the wrong direction.
The source of the great stream of hurt that drains the
continental United States lies, we believe, in the Guns and Butter programs of the Johnson Era... followed by Richard Nixon's 1971 decision to break the world's monetay system away from gold. From these polluted headwaters comes the gush of cash and credit that now swamps low-lying consumers all over the 50 states - and beyond.
"I am more concerned about somebody finding a job than I am about a number on paper," George W. Bush said in August.
If the president really wanted to help people find jobs, he might want to concern himself with the following numbers:
Between 1997 and 2000, consumer debt grew by 27.3% - up
$1.5 trillion. Disposable income rose only $1.1 trillion.
In the 1960s, the ratio of new debt to new income was only
30%. In the 1980s it had grown, but was still below 50%.
But in this mad, late bubble world, debt rose 131% faster
than income.
The recession of 2001 should have forced a reduction in
debt levels; that is what recessions are for. People
typically pay down past borrowings, save their money and
get ready for the next growth cycle. The happy people who
describe the recession of '01 as the 'mildest recession in
the postwar period' miss the point - it was not a mild
recession, but a failed one.
Government moved. Dams were broken. Dikes cut. Sluices
raised. Locks and spigots opened. Soon consumers were not
just hurting, but drowning. Interest rates were cut further and faster than at any time in history. In just 6 quarters, the federal budget plummeted from a surplus of $306 billion to a deficit of $526 billion (annualized numbers).
Consumers and businesses were soon up to their knees... and then their necks... in new debt and credit.
"During the two and one-half years since end-2000,"
explains Dr. Richebächer, "indebtedness of the domestic
nonfinancial sector has surged by about $3.3 trillion and
that of the financial sector by another $2.3 trillion, in
total by about $5.6 trillion." During this same time, GDP
only increased $416 billion, of which $185 billion came
from government spending and another $100 billion from
statistical adjustment of computer numbers. "In other
words, more than two-thirds of it was rather phony growth," Richebächer concludes.
Consumers can barely keep their heads above water. Over the last 5 and a half years, they've added $3.3 trillion to their debts, while their incomes have risen only $2.15
trillion. And currently, debt is growing 3 times faster
than income.
So far, in the 4 years we have been writing the Daily
Reckoning, not once has a government economist called to
ask our opinion. We will give it anyway. Advice to the Bush Administration: stand still.
Eric Fry on Wall Street...
- Yesterday afternoon, the Ghosts of Septembers Past
finally emerged from their dank, eerie hollows... and
investors took fright. Even the most intrepid members of
the tech-stock-obsessed lumpeninvestoriat cowered at the
sight of minus signs and down arrows. The Dow Jones
Industrial Average slumped 150 points to 9,425 and the
Nasdaq tumbled more than 3% to 1,843. The dollar also
slipped again, falling nearly half a percent against the
euro to $1.147.
- "One of those idiotic talking heads on TV called today's
stock market selloff a 'healthy, orderly decline,'"
chuckled Michael Martin, a darn good stockbroker and darn
good friend of your New York editor. "But I can tell you
firsthand, for the folks with actual money at risk, today's decline felt very unhealthy and disorderly."
- 24 days into the accursed month of September, the worst
month of the year for stocks, the bulls have absolutely
nothing to show for their efforts. The Dow has gained a
whopping 10 points month-to-date, while the S&P is ahead
one meager point.
- Of course, the bears have nothing to show for their
efforts, either. Betting against this stock market has been even less rewarding than betting with it. However, the particular breed of bear that also buys gold stocks has plenty of cause for celebration. Since the last day of
August, the precious metal has tacked on about $12, and the XAU Index of gold stocks has surged ahead by 7%.
- Yesterday, gold gained another $1.40 to $388.40. Not a
spectacular showing, admittedly, given the stock market's
steep decline. But gold's steady march toward $400 has been impressive and has an air of inevitability to it.
- Furthermore, gold's resistance to selloffs is a victory
in itself. Remember, this is the same precious metal that
for two decades forgot what a bull market looked like.
- But the new millennium has been kind to the yellow metal.
A colossal stock market collapse helped to kick things off. And the ensuing dollar selloff - fanned by the never-ending stream of lame remarks by Fed governors and Treasury officials - has provided ample fuel for a sustained rally.
- Now that the yellow metal has soared more than $150 from
its lows of three years ago, the message from the gold
market seems pretty clear: avoid dollars. The dollar's
slide is becoming the investment story of the year, which
means that gold's rally is at least a fascinating sub-
plot... And this monetary drama is becoming more interesting - and frightening - by the day... Particularly since it has become so fashionable in the corridors of power in
Washington to advocate "market-based" exchange rates - code for "weak dollar". A weak dollar, it is widely believed, will lead to a strong economy. We have our doubts.
- Like a Greek tragedy come to life, the Fed and the
Treasury - by seeking to weaken the dollar - are rushing
headlong toward the exact fates they hope to avoid. As the
monetary tragedy unfolds, we dollar-holders will likely
avoid an Oedipal fate like sleeping with Mom or killing
Dad. But we will not avoid much higher inflation and much
lower economic growth.
- And the outcome could become even more tragic if, for
example, our foreign creditors were to curb their appetite
for American Treasury bonds. "Foreigners bought almost 80
percent of the net increase in Treasury and agency debt
during the quarter," notes Floyd Norris of the New York
Times. "They now own 38 percent of outstanding Treasuries,
more than double the figure of a decade ago."
- We can't know, or even imagine, what hardships may befall us if foreign investors like the Japanese and Chinese reduce their exposure to U.S. dollars... but the results wouldn't be pretty.
- "Seven old men sitting around the room playing a
sophisticated game of pin-the-tail-on-the-donkey can't make any of us richer," quipped Porter Stansberry in a recent essay for the dailyreckoning.com website. Porter was referring, of course, to the "old men" who comprise the Federal Open Market Committee.
- This august group of bankers, chaired by the esteemed Old Man Greenspan, has been praising the virtues of dollar
devaluation for months... and now they are getting their
wish. To be fair, the dollar's woeful condition is not
entirely the fault of the FOMC or Treasury Secretary Snow.
But it is not entirely NOT their fault either. The Fed and
Treasury are engaged in a kind of collusion to lower the
dollar's value. And that's a very dangerous game to play,
especially for a country like the United States that relies so heavily upon foreign capital to finance its economy.
- It's true that the old men at the FOMC can't make us
richer. But they are very capable of making us
poorer... unless we own gold. [Ed note: for an overview of
the argument in favor of the yellow metal, see:
The Case For Gold
agora-inc.com ]
--------------
Bill Bonner, back in Paris...
*** We remember urging you to buy gold when it fell below
$350. We don't remember buying it ourselves. Now we don't
know what to do. The price will go up and down. If it does
what we expect, buying at $388 - today's price - will turn
out to be a brilliant move; gold will go over $1,000 before this bull market is over. But if it falls back below $350, we will feel like idiots for buying at $388. On the other hand, we may never see $350 again.
*** Likewise, the euro. We suspect that the euro will rise
to $1.50 or $2.00 before this cycle is over. We feel a
little stupid buying euros at $1.14 when we could have
bought all we wanted at 88 cents. But how much stupider
will we feel when the euros hits $2.00?
*** Speaking of numbskulls, just how stupid are the
Chinese? We are told, by Treasury Secretary Snow as well as by a number of steamy politicians, that the Chinese are
shrewdly manipulating their currency (keeping it pegged to
the dollar for almost 10 years) in order to undercut U.S.
prices and steal American jobs. But what could be dumber?
It is like selling good whiskey for half of what it is
worth in order to get the business... or allowing a derelict to run up a huge bar tab for fear his will take his custom elsewhere.
The U.S. dollar has fallen sharply already. The price of
gold has risen. These trends seem unlikely to reverse soon.
Yet the Chinese central bank has only 2% of its reserves in gold. Nearly all the rest is in dollars. Holding the yuan down means that they still build up dollars in their
vaults, just not as many of them. If the Chinese central
bank calls us, we'll tell them it is dumb to hold so many
dollars and so little gold. It is dumber to continue
accepting dollars, in effect building up a huge credit with a country that can't possibly pay up. And it is dumberer still to take the dollars in at a fixed exchange rate, getting less for your products than they are really worth.
Some day, perhaps soon, Secretary Snow may get more than
hopes for. The Chinese may wise up.
If they do, investors who have managed to get in on the
Sino Bubble will watch their yuan holdings rise
dramatically. Until, of course, the Bubble finds its pin.
[Ed note: The Oxford Club's James Boxley Cooke thinks he's
figured out how best to profit from China's growth
machine...
See: The Single Biggest Investment Opportunity of 2003
oxfordclub.com
More below... ]
*** "My guess is that the Clintons encouraged Gen. Clark to run," began our friend Dan Denning as we sat together on the train to Cologne, "because they're beginning to realize that Bush is beatable. So they sent in Clark - who, from what I hear, is dangerously incompetent in any post - as a stalking horse. He breaks up the field of democrats and makes it tougher for Bush to posture as a military leader. If he does well, Hillary can join him on the ticket. If he does poorly, she can ignore him, and jump into the race at the last minute... making a grand and noble gesture out of it, saying that she is saving the party from certain defeat."
*** Who casts the key votes for next year's presidential
election? George W. Bush has placed himself in a very
unusual position; we can't think of any time in the past
when a U.S. president's career was more in the hands of
foreigners. His success next autumn depends on two things -
neither of which is under his control. If the Chinese or
Japanese want him out of office, all they have to do is
sell U.S. Treasury bonds. The bond market would collapse
overnight, interest rates would skyrocket. The U.S. economy would droop immediately.
In Iraq, it is the terrorists (often mis-identified in the
foreign press as guerilla warriors or even freedom
fighters) who may have the decisive vote. If they are as
organized and well-equipped as the Bush team warns, they
could mount a series of nasty attacks that might turn
American public opinion away from its Iraq adventure.
But even if terrorists have the decisive vote, how would
they use it? Terrorists might prefer to have Bush in
office; there is nothing like the presence of foreign
troops to radicalize an otherwise indifferent population.
The Daily Reckoning PRESENTS: Pao Mo! Pao Mo! Now that we
know the real way to say 'bubble' in Chinese, here's a way
for you to get in on it before it pops.
THE NEXT EMPIRE
By James Boxley Cooke
Everyone in the West has long talked about China in terms
of its massive potential. But the future is now.
Many different elements - as you'll soon see - are
combining forces. And China is beginning to realize its
potential as a world economic superpower. Let's take a
closer look at some promising developments in China over
the past several years...
We've seen diplomatic breakthroughs, such as the U.S.
designation of China as a "most favored nation," and its
entry into the World Trade Organization. And just as
importantly, we've seen Hong Kong's growing free-market
influence on the motley politics driving the mainland
economy. We've seen small businesses springing up from the
Chinese countryside like mushrooms. In fact, we've seen
every indicator that the people of China, including its
huge middle class, are ready for a full-scale economic
revolution.
China is not only the world's most populous nation, with
over 1.3 billion citizens; it's also Asia's fastest-growing major economy. And has been for over a decade.
Even with the current global economic slowdown, China is
still likely to grow at more than 7% a year. That's a huge
number for an economy this size. And it represents huge
potential profits for us as investors.
I think the potential for the newly capitalistic Chinese
economy is absolutely enormous. And while there are
certainly political risks to keep less intrepid souls at
bay, even a small investment in this region has the
potential to make a big impact on our portfolios in the
months and years ahead.
Take, for example, the thoughts of legendary hedge-fund
manager [and friend of the Daily Reckoning] Jim Rogers, who enthused last year that no country's economic prospects excite him more than China's. In a Barron's interview, Rogers said, "The 21st century is the century of China... Everybody should teach their children and grandchildren Chinese.
"There is no question China is going to dominate all of
Asia," Rogers added. "... and the whole world, eventually."
Strong words. But I think he's right. As I've said often,
the development of China may well be the single-biggest
investment story of the decade ahead. I suggest investing
now, rather than trying to play catch-up later.
One vehicle we recommend is the closed-end Templeton Dragon Fund, managed by Mark Mobius. It's traded on the New York Stock Exchange, and gives us broad diversification inside China with the best emerging-market manager in the business.
As Oxford Club advisory panelist Lynn Carpenter writes,
"One of the nice things about a closed-end fund is that -
unlike a regular mutual fund - the assets under management
don't fluctuate daily depending on contributions or
withdrawals. Since the assets are stable, the manager of
the fund can invest the assets for the long-term, without
having to worry about redemptions."
That's key. We want Mobius putting money to work when he
sees opportunities, not when retail investors decide to
send him cash. The same is true on the sell side. We don't
want him pulling the trigger just to meet shareholder
redemptions.
Yet for all its potential, many investors still blanch when it comes to investing in this part of the world, noting that China is still a communist nation with a notoriously corrupt bureaucracy and only a gradually evolving rule of law. Are there enough positives to justify risking his capital in this part of the world?
Yes, indeed.
Sure, China is an area fraught with risks. It's no place
for an investor for whom preservation of capital is
paramount. But for more aggressive investors, it is a
potential bonanza.
Let me start with the basics. In 2001, China grew at more
than seven times the rate of the U.S. economy, despite the
fact that the country's population is more than five times
as large. Yet the vast majority of U.S. investors remain
oblivious to the investment implications, even though the
economic story is front-page news.
According to Andy Xie, a leading economist at Morgan
Stanley in Hong Kong, "China's rise as a manufacturing base is going to have the same kind of impact on the world that the industrialization of the U.S. had, perhaps even
bigger."
In fact, China is already the world's fourth-largest
industrial base, behind only the U.S., Germany and Japan.
Already China makes:
* More than 50% of the cameras sold world-wide
* More than 35% of the televisions sold world-wide
* More than 30% of the air conditioners sold world-wide
* More than 25% of the washing machines sold world-wide
* More than 22% of the refrigerators sold world-wide
These numbers allow you to see the enormous impact that
China is already having. But that impact is only just
beginning. China's entry into the World Trade Organization
is accelerating these economic trends at light speed.
Why? World Trade Organization membership cuts production
costs, forces down tariffs, and removes obstacles to
selling overseas. That, in turn, is drawing record direct
investment in China.
Over $600 billion has been invested over the past two
decades. And while individual investors and brokers are
still asleep at the wheel, Fortune 500 companies are
falling over themselves to take advantage of what's
happening in the world's most populous country. For
instance:
* GM purchased more than $1 billion in spare parts from
China in the last few years and plans to increase that
figure dramatically in the near future.
* Ford announced recently that it plans to boost its
purchases of auto parts in China to as much as $1 billion
annually starting this year (2003).
* General Electric expects purchases from China - both
parts and finished goods - to hit $5 billion annually in
the next three years.
* Wal-Mart concedes that more than $10 billion in Chinese-
made goods are sold in its stores every year.
* Motorola says its total investment in China will hit a
record $50 billion this year.
As you can see, the biggest investors in the U.S. - the
Fortune 500 - are already plowing money into China.
With the exception of Hong Kong, however, markets inside
China are too wild, unregulated and risky for us to gamble
our capital there directly. For these reasons, the best
'safe' investment vehicle for our members remains the
Templeton Dragon Fund.
The fund is broadly diversified between Hong Kong, Taiwan
and China and, as I mentioned before, managed by the
world's leading emerging market manager, Mark Mobius. In my view, the Templeton Dragon Fund is the safest, most-liquid way to obtain a pure play on the growth of China.
I remember our Club's Investment Director, Alexander Green, speaking at an investment conference at which he called China perhaps the single-biggest investment opportunity of the decade ahead. At once, a hand in the audience shot up. "Everyone comes back from China awestruck about the growth that's occurring there. But, in my opinion, China will never become a real investment opportunity until it quits relying on exports and starts developing its own domestic market."
Tell that to General Motors, I say.
For the year ended December 2002, GM reported that it sold
over 264,000 vehicles in China, a 325% surge over 2001. And its goal is to have launched at least four new models in the world's fastest-growing auto market by the time this year is through.
"Growth potential remains enormous in China," said Phil
Murtaugh, chairman of GM China. "We will respond with an
unprecedented series of product launches and continue to
seek additional opportunities."
(Incidentally, industry experts estimate that GM's profit
margins are at least twice as high on cars it makes in
China as on similar models made in the U.S.)
For years investors have talked about the enormous
potential of China's gargantuan market. But, in the end, it always seemed to boil down to potential and little else.
There's a good reason for this. China has a well-deserved
reputation as a fickle and ornery place for foreigners to
do business. China's enigmatic legal system has only
recently begun to honor property rights. Chinese
entrepreneurs have often distinguished themselves primarily by aggressively pirating Western products like software, compact discs and cell phones. And foreigners have often tripped themselves up by overpaying for licenses, industrial land and office space.
But things are changing, rapidly and for the better. Just a year after China joined the World Trade Organization, and two decades after it began allowing foreign companies to invest locally, multinationals are quickly capitalizing on China's fabled market.
Chinese consumers - in droves - are now buying products
from both domestic and foreign manufacturers. As the NY
Times reported: "Already, the Chinese buy more cell phones
than consumers anywhere else. They buy more film than the
Japanese. They now buy as many vehicles as the Germans."
* For companies like Siemens and Motorola, China has become the single-most important market for mobile phone handsets and other equipment, accounting for billions of dollars in annual revenue.
* Japan's Toshiba now says it sells two-thirds of what it
makes in its 34 China-based operations to the Chinese.
Local sales were more than $2.5 billion last year.
* McDonalds and Kentucky Fried Chicken have 700 China-based restaurants between them and open scores of additional stores each year.
* Eastman Kodak controls an estimated 63% of the domestic
market in China for rolled film.
* Even Starbucks has found plenty of urban tea drinkers
ready to spend $2.50 for a latte.
Yes, foreign companies are doing very well in China. But,
for most of them, it's still a small percentage of their
total sales and profits. And the Chinese are too smart to
let foreign companies rake in all the dough. There is
tremendous opportunity for local Chinese companies as well.
And American entrepreneurs are rapidly moving in. The Wall
Street Journal confirms it. As Leslie Chang recently
reported: "Last year China became the biggest recipient of
foreign investment, for the first time surpassing the U.S.
Foreign investment jumped almost 13% in 2002 to $52.74
billion. Even SARS, of which more than 60% of all reported
cases worldwide appeared in mainland China, so far appears
not to have dented the country's essential appeal: cheap
labor, improving technology, and a fast-growing consumer
pool."
In the future there will come a day when investors
everywhere wake up and recognize China as "the opportunity
of a lifetime." Dozens of mutual funds will spring up,
offering myriad ways to capitalize on growth in China.
Stockbrokers will call their clients and pitch their new
China products with enthusiasm. "Business Week" and
"Fortune" will run cover stories about the phenomenal
growth in Chinese capital markets. Even your friends and
colleagues will start telling you about the unprecedented
investment opportunity they see in this nation of one and a quarter billion.
And that, my friends, is when we'll be getting out.
Sincerely,
James Boxley Cooke,
for The Daily Reckoning
Editor's note: James Boxley Cooke is a former executive
with T. Rowe Price, one of the oldest and most respected
names in mutual fund management, with over $200 billion in
assets under management. He is currently the Chairman of
the Oxford Club.
In addition to the fund he mentions above, James believes
he's uncovered a unique (but urgent) opportunity to
capitalize on China's incredible growth prospects... in
particular, its increasing demand for power. He's convinced that a small investment in this company will safely earn at least three times the amount originally invested within the next few years.
To learn more, read James' report:
The Single Biggest Investment Opportunity of 2003
agora-inc.com
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