We spoke with Greenwald on November 4. This installment of the interview covers his macroeconomic forecast, and next week’s will detail how he has positioned First Eagle’s portfolio.
I’d like to understand your economic forecast, and specifically I’d like to focus on the question of unemployment. At what point you believe it will stabilize? I see a lot of attempts to forecast unemployment using a technical approach based on past statistical patterns, undertaken without regard to the structural problems in the economy. What are the structural issues that will govern when unemployment will reach equilibrium?
To answer that, you must first understand why this situation has been so bad and so prolonged – and I think it’s going to be much more prolonged. The first evidence that you have to think about is that while this is the first occurrence of problems this severe in the US, these problems have been around in Asia, Argentina, Mexico, Russia – and Japan, of course, most obviously – for many years. This is not new.
You want to go back and think about what is going on. In a sense, you are seeing issues that are going to take a long time to fix and are similar to what happened in the Depression. Basically, in the Depression a huge sector of the economy that everyone had always regarded as central, died. And it dies for an almost virtuous reason.
That sector of course is agriculture.
Since about 1870, productivity growth had been 4% to 5% and demand growth had been 1% to 2%. Agricultural prices had been up before and during the first World War, and then they were down. But the inexorable trend had been down, with all this growth in productivity and limitations on demand, and sooner or later prices were going to collapse. Approximately 35% of the US population was either in farming or in farm towns or were supporting a farming enterprise, and they were going to be marooned.
So when you look at the countries that suffered the worst as a result of the Depression, they are the big agricultural producers: the US, Australia, Canada, Germany, France, and most of Europe, but not the UK or other countries that were less agriculturally dependent. Japan was very agriculturally dependent, and they suffered terribly and quickly in the early 1930s, but fortunately for them they started a war in China and entered the second World War right away. The country that never recovers is Argentina.
When the Depression happens, the challenge becomes how to get that portion of the population that is trapped – because their housing, jobs, and capital are in agriculture – to the manufacturing enterprises. The answer is that is very hard to do.
The conventional wisdom is that World War II ended the Depression. Is that correct?
The reason why World War II got us out of the Depression, and the reason that Argentina suffered because it didn’t participate, is that it is actually industrial policy that gets everybody off the farms.
That policy also accumulates purchasing power, so that when people are in the cities, there is demand for appliances and cars. They have moved and they are now part of the productive economy. So the demand is sustainable.
One of the great concerns at the end of WWII was that everyone thought we were going to go back to the Great Depression. In Argentina, of course, that happened. In the US and everyplace else, everyone was surprised and relieved. But the reason is that you’ve gotten everyone off the farms and into the cities. It was through both the war industries and in the army._
How does this relate to today’s problems?
The comparable thing that is going on today is that manufacturing is dying, and it is dying for exactly the same reason, which is productivity growth is 5% to 6% a year and demand growth is 2% to 3% a year.
That’s why Japan has had such a difficult long-term problem. They are manufacturing-driven, and they think of themselves as a resource-poor country, where their imports of food, energy, and raw materials are absolutely essential. They want a huge margin of safety of exports over imports. The only way you can do that is by manufacturing. That’s harder and harder to do as manufacturers die. So they’ve basically done a little bit of what was done in the Depression, which is that you’ve got to employ these people. And many countries, like Japan, try to do it through exports.
China has decided to grow, and they can’t grow based on domestic demand, so they have to do it through international demand, and that’s of course demand from manufacturing. They have exactly the same problem as Japan. They have a command economy, and they have sort of kept their workers busy, but they are heading for big trouble. Manufacturing employment hasn’t grown for three years in China, and that’s a huge problem for them, despite the fact that, like Japan, they are manipulating their currency, which is just a modern version of protectionism. And they’re generating exports.
Japan and China are in the same situation. Germany is too; they have powerful unions and powerful firms, and basically those who they are undermining – because they have fixed the Euro exchange rate – are the other European countries. Overall, the Euro should go to $2.50. But there is no way they will let that happen, because they would go from surplus to deficit, and all their manufacturing jobs would be gone.
Then you’ve got Korea, Thailand, Indonesia, and Malaysia, all of whom used to run deficits. The problem was that they had to borrow in foreign currencies to finance those deficits. Everyone got nervous about the deficits. Their currencies collapsed. The burden of debt destroyed the manufacturing countries predominantly. But they went from deficit to surplus because their imports collapsed and their exports took off. They’re never going to run deficits again, and you see it in the data. They’ve been there and don’t like it and they’re not going to do it. Brazil, which had the same experience, is pretty much in the same place.
So you’ve got these enormous trade surpluses as a result of countries trying to sustain in various ways their manufacturing bases, partly because they have people marooned there. But also, like with agriculture, they think they can’t have a successful economy if nobody makes anything.
You go into a Japanese factory, by the way, and nobody makes anything. There are more people on the loading dock, which is a service function, than there are actually in the factory. That’s why they are a hopeless enterprise.
Click here to finish reading the complete Bruce Greenwald interview at [www.advisorperspectives.com]
Robert Huebscher
[www.advisorperspectives.com]
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Mr. Huebscher is the founder and CEO of Advisor Perspectives, a web site and newsletter that provides investment strategy analysis for financial advisors and wealth managers. In 1982, he founded the investment software division of Thomson Financial, where he created the PORTIA product, a portfolio management system for institutional investors. In 1990, he founded Hub Data, a market data redistribution service, which he sold to Advent Software in 1998. He has also worked in the account aggregation field, as a consultant to both vendors and wealth managers. He is a graduate of the Harvard Business School (1982) and Connecticut College (1976).
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User Comments:
1. Sivaram says on Nov 10, 2009 at 7:39 PM:
Although I don't agree with everything Bruce Greenwald is saying (e.g. I don't believe his view that the Great Depression was due to the decline in farming--the shift had been going on for 50+ years so why the 1930's all of a sudden?), this is a great interview for those who are macro-oriented. I should thank Robert Huebscher for conducting this interview and making it available free of charge.
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