The Illusion Of Wealth: Never Has The Prosperity Of So Many Been Reliant On So Few

For the first time in history, we have the majority of the world's population experiencing unprecedented economic opportunity and wealth creation. With China, Russia and India joining the world's economies in some level of free market reforms we now have the majority of North & South America, Asia and Europe participating in global growth. Even many of the economies which are yet to really embrace reform are enjoying the wealth created by a industrial commodities and energy boom. I would estimate off the top of my head that approximately five of the six billion people on earth are enjoying some type of new or continued prosperity. So, why worry? Things are great!

Are they really? Today the economic miracles of developing countries are less than miraculous in my opinion. They are more of a mirage. The miracle is really one of America's ability to consume so much of the world's output. Today, America consumes over $1.4 trillion dollars worth of goods produced outside of the United States according to statistics provided by the U.S. government. We are the largest trading partner for nearly every major economy on earth and we run a current account deficit with all of them. ie, We are the world’s consumer. Even if we aren’t everyone’s largest trading partner, we likely are in the final analysis. As an example, China has replaced the United States as South Korea’s top trading partner. But, since China’s economy is almost exclusively reliant on exports to the U.S. for its continued success, China is just a mid stream stopping point for South Korean investment on the way the U.S. Ditto with Germany, Japan and even the U.S. selling technology and infrastructure into China. It is being used to modernize their infrastructure that, you guessed it, is eventually the platform for more exports to the U.S. (Although most of that investment is by non Chinese companies taking advantage of cheap labor as opposed to Chinese companies becoming dominant international players.)

So, the American consumer has spent and spent and spent for decades without much of a break. People say never bet against the American consumer. I tend to agree with a few exceptions. Historically, we have not faired well when stocks and homes were falling in value. There are studies that have been done which show Americans cumulatively spend 3-4% less when the stock market is dropping. The range is very similar as it pertains to home values. So, if both start dropping due to overvaluation or an economic slow down, Americans could cumulatively spend 6-8% less? Where will that drop in spending come from? Education for their kids? Gasoline for their cars? Heating for their house? Food for their family? Insurance for their investments? More likely, the spending will be less for imported discretionary goods from China, Japan, Korea and on and on. What if the economy really slows and consumers cut off spending by 10-20%? Or, what if Americans truly are overextended and start saving instead of spending much at all? Some surveys show they already are cutting their spending. None of this takes into account a weakening dollar which, if that trend continues, will work to cut off demand for foreign goods by making them more expensive and possibly leading to more inflation. This might cause the Federal Reserve to raise interest rates even higher.

What has really changed to cause the economic miracles called Venezuela, Brazil, Mexico, Indonesia, Saudi Arabia, Russia and others who are benefiting from the commodity boom? Not a lot. What really happened is American and European liquidity has looked for a home with American and European stocks overvalued from a big run ending in 2000. So, where did it go in the last four years? It went into commodities and hard assets which were comparatively cheap. So, what reforms did Russia or Mexico institute to stimulate their economies? Uh, nothing. Hot money drove commodity prices up creating a perceived wealth in countries that were rich in raw materials. So, what happens when those assets become overvalued and likely collapse or significantly correct as they have every single time in history? Were those countries as rich as they thought they were? Not likely. More likely that they will once again become the same marginal economies they were before unless they undertake significant domestic reform. Will the consumers of these countries keep spending when their wealth is threatened by weakening demand and weakening prices for their raw materials? Or, what if you are a Chinese citizen and you see reduced demand for goods made in your country? If you are a citizen of China or India or Brazil where there has been tremendous instability, if your paycheck goes away (exports to America or American liquidity driving commodities dries up) are you going to keep spending? For that matter, was the wealth you felt actually wealth at all? Or was it simply a mirage that was the reflection of America’s appetite? An appetite that will likely be replaced with a reversal of trend and a return to savings in the U.S. Something good for us but bad for all of those countries relying on us spending indefinitely. Marginal countries have not transformed their economies into domestically driven consumer based economies because they thought they had found the pot of gold at the end of the rainbow in the form of the American consumer. Why undertake painful reform when things are going so well?

We are seeing this global economic boom through the entire supply chain. The end of the supply chain for the entire global expansion ends with the American consumer. With China, India, Europe, Canada, Mexico, Japan, Korea, Vietnam, Cambodia, Taiwan, Thailand and a few others all expecting to provide the US with finished goods (In addition to American companies) and Brazil, Russia, Australia, Canada, Mexico, Malaysia, Venezuela, Saudi Arabia, Kuwait and Indonesia providing the raw materials to all of those countries to make their finished goods to sell to the US, is there some slight chance someone along the line is overbuilding capacity? Are we being realistic here? What does overcapacity lead to? Inflation or deflation? To much supply means prices go…………down? Throw in the inflated global real estate froth and commodities at one hundred year highs. Any chance asset prices may go down?. Any deflationary pressures there? Any chance that is why long term interest rates might be so low when everyone is squawking about inflation? Any chance we can't buy all of the garbage from every country on earth gunning to supply us more and more and more? With real estate slowing or worse, the American economy slowing and stocks falling, will the global boom continue? Trends never last forever. I’m quite confident this one is about to change and because the developing countries have been too busy printing money and not busy enough getting their own houses in order, they will likely suffer disproportionately. The only question is how much. There is ample evidence much of their wealth was created on a bubble and those situations don’t end very quietly.

So, what does all of this mean? I believe many of the best performing international markets are fraught with tremendous risk. Just at the time all of the financial advisors are telling people to invest overseas. Gold is to be printed in international investing. Indeed it has been a good investment for the last four years. That is because the American consumer was still spending heavily and their homes were exploding in value. Remember, many of these countries have historically had corrupt governments, lax business controls and Enron type blow ups as a way of life. Are they really a safe haven for your money? High quality, high dividend “A” rated companies in Europe, maybe. Mexico, Brazil, Russia, China, Indonesia? You must be kidding. In times of high risk, would you put your money in Enron?

How does this all end? When the liquidity is withdrawn or even destroyed, where is the inflation? There likely isn’t any. With hard assets all at very elevated and long term unaffordable levels, short term liquidity driven inflation fears could be superceded by longer term deflationary pressures soon enough. The future may not have a worst case outcome but even a best case outcome is awfully risky for the global population.

The real question is if 140 million working Americans can support the economic well being of 5 billion people indefinitely. Well, can they? Never has the prosperity of so many been reliant on so few.