The global economy and capital markets are benefiting from the most open and fluid trade the World has ever seen. The recent failure of the Doha round of trade talks, however, has highlighted deep and fundamental differences between WTO members. Some of these differences go beyond trade matters. In last week's article, I outlined my view on the growing risks of deflation and the implications for the U.S. economy. As a follow-up to last weeks article, I will outline how a deflationary spiral, or fears of one, could act as a catalyst to growing NATIONALISM.
The global economy (and capital markets) have benefited from the establishment of several international organizations formed out of the conflicts of the last century. Organizations like the United Nations (UN), General Agreement on Tariffs and Trade (GATT) which was replaced by the World Trade Organization (WTO), International Monetary Fund (IMF), North Atlantic Treaty Organization (NATO), Group of Seven Nations (G7), World Health Organization (WHO) and many more have all combined to achieve a more secure, open and fluid system that has expanded trade and generally increased global wealth. However, there are cracks in this system that seem to be growing. The current round of WTO talks is officially dead. The Doha round, which began more than 5 years ago and was primarily a discussion on removing trade-barriers in the agriculural industry worth an estimated $96 billion by the World Bank, has failed. The European Union blames the U.S. for being inflexible and the Americans point the finger at the developing countries for not opening up access. The developing countries in turn blame the developed world for keeping them in poverty. In many ways, the failure was political as democracies depend on votes and agriculture is a grass-roots issue. Farmers are particularly vocal about protecting their livelihood. It is unlikely that discussions will resume anytime soon. In fact, it appears more likely that these divisions will only deepen, threatening existing trade agreements. This could begin a process of retaliatory and protectionist behaviours. The failure of the Doha round was treated with near indifference by the markets. Let us not forget that it was the Smoot-Hawley tariff, imposed by the U.S. in the early 1930's, that initiated a decline in trade every single month throughout the 30's. This perpetual contraction in trade is seen by some as one of the key reasons the Depression, initiated by the Crash of '29, became Great.
The events of 9/11 have certainly polarized ideologies and contributed to growing nationalism. One only has to recall the UN debate leading up to the Iraq invasion. The divisions were deep. Traditional allies were strongly opposing each other. Frankly, the U.S. and Britain stand accused of manipulating the democratic process of the UN and eventually ignoring it altogether. The UN looks increasingly like a redundant organization. The current recommendation to use the UN to broker a cease-fire agreement between Israel and Lebanon and to install UN peacekeepers in a de-militarized zone is largely ignored by both sides in the conflict and many of their respective supporters. Iran is currently facing UN security council resolutions. No doubt, the divisions between nations will be revealed again.
As I outlined in last week's article, the U.S. consumer is under pressure. The open global economy has kept real wages from rising while the competition for resources (oil in particular) has driven-up primary costs. The increase in global liquidity following the Japanese deflation and NASDAQ collapse flowed into the real-estate market. Consumers tapped into the rising value of their homes to sustain their standard of living. Previously, income grew more or less in step with household wealth. From 1962 to 1966, a period of low inflation and robust economic growth, real private sector wages rose 27.5 percent while real net worth increased 23.6 percent, according to Bloomberg News calculations based on government data. In the five-year period ending in 1996, real net worth gained 15.6 percent while private wages grew 11.3 percent. More recently, the gap between household net worth and wage growth has widened. From 2001 to 2005, the value of household assets minus liabilities rose 16.6 percent after inflation. Private sector wages rose just 2.7 percent. In some sense, U.S. policy makers are confronted with the results of their own success at reducing trade barriers and keeping inflation low. This positive wealth-effect is now starting to reverse as house prices begin to decline. The middle-classes are being squeezed and there is now some evidence of increasing wealth concentration. The rich/poor divide is widening. The divide is reviving protectionism in Congress, awakening a debate on the minimum wage, and making the FED more sensitive to the risks of causing a collapse in financial and housing markets. The increasing concentration of wealth has preceded economic collapses in the past. Furthermore, wealth is also being transfered from America to Asia. The U.S. has a huge trade and current account deficit. The U.S. is heavily dependent on foreign savings. The largest holders of U.S. dollars are, with the exception of Japan and the U.K., not exactly allies. Countries like China, Iran, Venezuela and Nigeria hold large amounts of U.S.$ in their foreign reserves in the form of U.S. Treasuries. Thanks to imports of Chinese goods and Mid-East oil, the U.S. is now dependent on these countries to finance its Government and economy. Talk about irony. It may also explain why U.S. interest rates may stay higher for longer. I used to think the 25 bps rises in FED rates was an attempt to monetize the debt by stealth. Effectively building-in inflation expectations under the illusion of tightening monetary policy. Something happened this Spring that caused Bernanke to lose some credibility as he appeared to switch from hawk-to-dove-to-hawk. I wonder if there were material concerns that these creditors were going to dump their U.S. dollars or at least stop re-financing the debt.
U.S. consumers, wage-earners, voters will increasingly point the finger at their Government for their declining standard of living. This is not productive in a democratic country like America. The U.S. Government will be under pressure to provide a quick fix rather than let the free market sort things out. Especially if the free market benefits foreigners at the expense of U.S. voters. These foreign holders of U.S.dollars are increasingly attempting to diversify away from U.S. treasuries. Part of this diversification process is the accumulation of U.S. assets. This process has drawn alot of public attention lately with several high profile cases. For example, Dubai was forced to seek a U.S. buyer for its U.S. port-terminals. As a result, the U.S. House and Senate passed measures recently to change the way foreign purchases of U.S. companies are reviewed and approved, requiring greater notification of proposed acquisitions to lawmakers and lengthier reviews in some cases.
In conclusion, it appears that protectionist sentiment and measures will continue rising as the U.S. economy slows and the average American sees his standard of living decline. This process will also have a growing impact on another major risk facing the capital markets...WAR. I will dicuss this horseman next week.
The global economy (and capital markets) have benefited from the establishment of several international organizations formed out of the conflicts of the last century. Organizations like the United Nations (UN), General Agreement on Tariffs and Trade (GATT) which was replaced by the World Trade Organization (WTO), International Monetary Fund (IMF), North Atlantic Treaty Organization (NATO), Group of Seven Nations (G7), World Health Organization (WHO) and many more have all combined to achieve a more secure, open and fluid system that has expanded trade and generally increased global wealth. However, there are cracks in this system that seem to be growing. The current round of WTO talks is officially dead. The Doha round, which began more than 5 years ago and was primarily a discussion on removing trade-barriers in the agriculural industry worth an estimated $96 billion by the World Bank, has failed. The European Union blames the U.S. for being inflexible and the Americans point the finger at the developing countries for not opening up access. The developing countries in turn blame the developed world for keeping them in poverty. In many ways, the failure was political as democracies depend on votes and agriculture is a grass-roots issue. Farmers are particularly vocal about protecting their livelihood. It is unlikely that discussions will resume anytime soon. In fact, it appears more likely that these divisions will only deepen, threatening existing trade agreements. This could begin a process of retaliatory and protectionist behaviours. The failure of the Doha round was treated with near indifference by the markets. Let us not forget that it was the Smoot-Hawley tariff, imposed by the U.S. in the early 1930's, that initiated a decline in trade every single month throughout the 30's. This perpetual contraction in trade is seen by some as one of the key reasons the Depression, initiated by the Crash of '29, became Great.
The events of 9/11 have certainly polarized ideologies and contributed to growing nationalism. One only has to recall the UN debate leading up to the Iraq invasion. The divisions were deep. Traditional allies were strongly opposing each other. Frankly, the U.S. and Britain stand accused of manipulating the democratic process of the UN and eventually ignoring it altogether. The UN looks increasingly like a redundant organization. The current recommendation to use the UN to broker a cease-fire agreement between Israel and Lebanon and to install UN peacekeepers in a de-militarized zone is largely ignored by both sides in the conflict and many of their respective supporters. Iran is currently facing UN security council resolutions. No doubt, the divisions between nations will be revealed again.
As I outlined in last week's article, the U.S. consumer is under pressure. The open global economy has kept real wages from rising while the competition for resources (oil in particular) has driven-up primary costs. The increase in global liquidity following the Japanese deflation and NASDAQ collapse flowed into the real-estate market. Consumers tapped into the rising value of their homes to sustain their standard of living. Previously, income grew more or less in step with household wealth. From 1962 to 1966, a period of low inflation and robust economic growth, real private sector wages rose 27.5 percent while real net worth increased 23.6 percent, according to Bloomberg News calculations based on government data. In the five-year period ending in 1996, real net worth gained 15.6 percent while private wages grew 11.3 percent. More recently, the gap between household net worth and wage growth has widened. From 2001 to 2005, the value of household assets minus liabilities rose 16.6 percent after inflation. Private sector wages rose just 2.7 percent. In some sense, U.S. policy makers are confronted with the results of their own success at reducing trade barriers and keeping inflation low. This positive wealth-effect is now starting to reverse as house prices begin to decline. The middle-classes are being squeezed and there is now some evidence of increasing wealth concentration. The rich/poor divide is widening. The divide is reviving protectionism in Congress, awakening a debate on the minimum wage, and making the FED more sensitive to the risks of causing a collapse in financial and housing markets. The increasing concentration of wealth has preceded economic collapses in the past. Furthermore, wealth is also being transfered from America to Asia. The U.S. has a huge trade and current account deficit. The U.S. is heavily dependent on foreign savings. The largest holders of U.S. dollars are, with the exception of Japan and the U.K., not exactly allies. Countries like China, Iran, Venezuela and Nigeria hold large amounts of U.S.$ in their foreign reserves in the form of U.S. Treasuries. Thanks to imports of Chinese goods and Mid-East oil, the U.S. is now dependent on these countries to finance its Government and economy. Talk about irony. It may also explain why U.S. interest rates may stay higher for longer. I used to think the 25 bps rises in FED rates was an attempt to monetize the debt by stealth. Effectively building-in inflation expectations under the illusion of tightening monetary policy. Something happened this Spring that caused Bernanke to lose some credibility as he appeared to switch from hawk-to-dove-to-hawk. I wonder if there were material concerns that these creditors were going to dump their U.S. dollars or at least stop re-financing the debt.
U.S. consumers, wage-earners, voters will increasingly point the finger at their Government for their declining standard of living. This is not productive in a democratic country like America. The U.S. Government will be under pressure to provide a quick fix rather than let the free market sort things out. Especially if the free market benefits foreigners at the expense of U.S. voters. These foreign holders of U.S.dollars are increasingly attempting to diversify away from U.S. treasuries. Part of this diversification process is the accumulation of U.S. assets. This process has drawn alot of public attention lately with several high profile cases. For example, Dubai was forced to seek a U.S. buyer for its U.S. port-terminals. As a result, the U.S. House and Senate passed measures recently to change the way foreign purchases of U.S. companies are reviewed and approved, requiring greater notification of proposed acquisitions to lawmakers and lengthier reviews in some cases.
In conclusion, it appears that protectionist sentiment and measures will continue rising as the U.S. economy slows and the average American sees his standard of living decline. This process will also have a growing impact on another major risk facing the capital markets...WAR. I will dicuss this horseman next week.
