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Economics: Running on Empty?
New York: April 11, 2005
By John R. Stephenson

The global economy is starting to sputter and may well be running on empty. For far too long the engine of global economic growth has been the American consumer. With unemployment in Europe and Japan hovering near World War II highs and the U.S. experiencing the weakest period of job creation in modern times, can an economic slowdown be close at hand?

For the past decade, the U.S. consumer has been the demand driver for economic growth throughout the world. The consumer has continued to spend in spite of both weak job and wage growth. The rest of the world has been more than willing to go along for the ride. First, by acting as vendors and then, as financiers, by providing the necessary financing for a savings starved consumer. The hope throughout this nearly 40-month economic recovery was that the U.S. labor markets would suddenly spring to life which would drive the necessary income growth to fuel continued domestic consumption. No such luck. The latest job report has only served to highlight that the pace of the recovery is lagging far behind the consensus estimates of most economists.

With crummy job growth and ever increasing worker demands, the average American is more financially stretched than at any time in recent history. Over the last four years, (2001-2004), real wage growth per hour has risen at a dismal 1.2% per year while productivity has grown over the period at 3% and inflation has averaged 2.1%. In other words, the average American is working harder for less.

Throughout the western world, wage growth appears to be slowing. According to the OECD, the wage share as a percentage of business sector GDP for the 30 leading developed nations has fallen to an average of 49.5% from 53.2% in the mid 1980's. Everywhere you look, the story appears to be the same - stagnant wage growth for workers. The likely culprit? Outsourcing of employment to low wage countries.

With a national savings rate stuck at a dismal 1.5%, an international labor arbitrage underway, ever-increasing debts and an ever-widening current account deficit (exports less imports), U.S. economic growth may be close to stalling. Add to this a protectionist Senate, which seems hell bent on blaming China for all of the nation's self-induced problems. Just last week, China Currency Bill (S. 295) hit the floor, which calls for a levy of 27.5% tariffs on all Chinese products sold in the U.S. While this bill might make political sense, it doesn't make a whole lot of economic sense.

Figure 1: The US Current Account Deficit Balloons

Source: M. Murenbeeld and Associates

For starters, the concern over China and its export-led growth may well be overblown. The bulk of the Chinese export surge has been dominated by Chinese subsidiaries of global multinational corporations and cross-border joint ventures. While the dollar volume of exports over the last eleven years has surged from US $91.7 billion to US $593.4 billion in 2004, the vast majority of this trade (62%) is through these offshore Chinese outposts, which are owned by investors throughout the world. But the real crux of the problem has been a Federal Reserve that was so spooked about the possibility of deflation (falling prices) after the collapse of the tech bubble that they pumped the system full of easy money - thereby encouraging the consumer to spend. With little or no domestic savings, the American economy had little choice but to import the savings surplus from abroad and to run massive trade deficits in order to attract foreign capital and to keep the economy growing.

But a tax on China could ultimately backfire. Sure, their currency is undervalued, but the solution to an undervalued currency is not a massive tax on Chinese goods. A tax on Chinese goods would mean that Chinese products would become more expensive for U.S. consumers - the functional equivalent of a tax hike. With domestic savings so low, it makes sense for Americans to be able to buy the highest quality goods at the lowest possible cost. It is precisely because of this fact that such a strong trading relationship has developed with China in the first place.

If the bill passes or the U.S. turns more protectionist in nature, then China, whose trade with the U.S. accounts for fully 33 percent of their total trade, might have little or no choice but to retaliate. If China chooses to retaliate by slowing their purchases of U.S. Treasuries, the U.S. dollar could start to swoon with dire consequences for the global economy. With massive trade deficits and a falling currency, the government would have little choice but to ratchet up interest rates in an attempt to shore up the dollar and to attract capital.

Investors looking to weather this potential storm should consider lightening up on U.S. equities and bonds and should consider investing in foreign markets such as Canada and Australia whose currencies and products will fair much better if the U.S. economy continues to stumble.

StephensonFiles is a division of Stephenson & Company Inc. an investment research and asset management firm which publishes research reports and commentary from time to time on securities and trends in the marketplace. The opinions and information contained herein are based upon sources which we believe to be reliable, but Stephenson & Company makes no representation as to their timeliness, accuracy or completeness. Mr. Stephenson writes a regular commentary on the markets and individual securities and the opinions expressed in this commentary are his own. This report is not an offer to sell or a solicitation of an offer to buy any security. Nothing in this article constitutes individual investment, legal or tax advice. Investments involve risk and an investor may incur profits and losses. We, our affiliates, and any officer, director or stockholder or any member of their families may have a position in and may from time to time purchase or sell any securities discussed in our articles. At the time of writing this article, Mr. Stephenson may or may not have had an investment position in the securities mentioned in this article
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