Asia: The Mother of All Incumbent Advantages

Independent hedge fund managers, e.g. Raptor last week, are following me out of the business. In a market in which the government tells everyone what things are worth, the fine judgement of bond analysts is worthless. I used to manage a department with dozens of high-paid credit analysts trying to figure out the price of seniority or subordination down to the last basis point. After Chrysler and GM (GMGMQ.PK), the issue is moot. But there is money to be made, and it will be made by money managers tied to the federal government, through TALF and similar subsidies. As a matter of fact, the only sort of money that anyone will make in the US economy will come from things that the government subsidizes, or approves, or funds, or otherwise sponsors.

An enormous drop in economic efficiency is inevitable, along with a vast increase in the power of incumbents, starting with the federal government. Obama out-spent McCain by an enormous margin in the last election, and he is almost certain to outspend any conceivable Republican opponent by a much wider margin in the next election. The independent base of Republican financial support has disappeared during the past few months. Local boosters, in particular the local banks and real estate developers, are now in the pocket of the federal government, or out of business. Independent finance is finished. The independent broker-dealers (like the staunchly Republican Bear, Stearns) as well as the independent fund managers are flattened. What will flourish amidst the general destruction of wealth will be parasites on the federal treasury.

That cannot be a good story for the United States. President Obama is accumulating power, not promoting economic welfare. If, as I believe, the administration is optimizing its own position rather than economic efficiency, then it has little interest in high rates of economic growth. Rapid growth and the animal spirits that attend it are grist for the Republican mill. When Americans feel bumptious and risk-friendly, they are more likely to vote to get government out of their hair. It is when they feel beaten, weak, and dependent that they will sacrifice economic freedom for government backing.

Emblematic of the change in the character of the American economy is the arrival on the scene of Carlos Slim, now the largest shareholder in the New York Times (NYT) and the subject of an adulatory profile in the New Yorker. Slim’s telephone monopoly in Mexico is the reason that a phone call costs five or ten times as much there than here, and why the third richest man in the world hails from one of the world’s poorer countries. Slim artfully ingratiated himself into the Mexican body politic through the judicious use of what we euphemistically might call diplomacy and public relations, such that his telephone monopoly became unbreakable. Very little in Mexican business goes past him. Mexico’s economy failed of its promise, and twenty million Mexicans have left their homes to seek work in the United States. The fact that Slim now finds the United States a hospitable place in which to do business speaks volumes.

What worries me more than anything else is that America’s young people, who offered such overwhelming support for Obama, may continue to huddle underneath the federal umbrella as times get tough. A self-feeding problem may ensue as Asia decouples from the American economy and opportunities for wealth creation in the United States shrink. Americans are facing a degree of competition from Asian university graduates on a scale they never before encountered, and cannot possibly imagine. One example: China has 40 million primary and secondary school students studying classical piano, a hallmark of the hot-housed, tutored, overachieving character of Chinese youth. America has just 30 million primary and secondary school students.

During the next generation, talented young Asians won’t start their businesses in the United States. They still will learn computer science at Stanford and international law at Yale, but unlike the 1980s and 1990s, they will not leave their families behind to put roots down in the US. Asian capital markets are sufficiently developed to provide them an adequate platform at home. Young Americans, who used to think that a business or law degree was a ticket to prosperity, will find the pickings all the slimmer in the new global competitive environment. They may look to the federal government for protection, much like their European counterparts.

America’s economic decline relative to Asia is not baked in the cake — yet — but the cake batter is in the pan, and the pan is en route to the oven. And the administration is more concerned about consolidating its own power than promoting economic efficiency. In third world countries, economic weakness increases the power of the comprador elite, because it leaves economic factors all the more dependent on the combination of government and oligopoly. It is possible to foresee a long and self-inflicted American economic decline.

I expect global commodity stocks, especially agribusiness, to outperform, along with Asian equity markets.

Comments

[User 353732:]

Thirty to Forty years ago,parents would tell their chiidren " finish your food; children ae starving in China" . This was both literally true and short hand for communicating all our bounty of political and economic freedom , opportunity and great achievents in almost every aspect of human endeavor. Our national values and resulting successes were based on optimism, personal responsiblity, hard work, savings, risk taking and innovation.
We thought our model was the best(it was) and would endure forever and the Chinese(together with the Indians and Asians and Africans in general) were doomed to being miserable third class citizens of the world forever.We pitied their culture of dependence, passive acceptance of the rule of a tiny but all powerful, merciless and corrupt elite . We rightly said that the poor , unfortunate Chinese(and even poorer Indians) were enslaved by a system that ensured backwardness and even repeat famines.

As we have discovered to our astonishment nothing endures if there a national will to change. The Chinese and Indians decided that the core of the American dream was ,in fact, both right and attractive and procceeded, in important ways to adopt and adapt our economic model, especially for their young people and young citizens. Meanwhile, we decided to gradually but inexorably abandon our own model and ,for reasons that can be debated for a long time, become more like them.
No surprise, that after copying the old American Way, the Chinese(and many other Asians) are succeeding. No surprise either that after stumbling towards the old Chinese Way, we are experiencing stagnation, pessimism and forsaking self reliance. The Chinese young incresingly realize the old American Way works : they are not overachieving but achieving . Our young people have only a dim and distorted view of the true American Way and many prefer dependence and entitlements to self reliance and responsiblities.

Millions of young Chinese are not over-achieving;rather, millions of young Americans are underachieving.

Today parents who are care and can still see clearly tell their children "Finish your homework. Children in China already have".
The good news is that in a rather short time the Chinese(and to a leesr extent Indians and other Asians) massively changed their system and their young people are now accelerating this change. We, too, can change. Our ascent was not inevitable nor forever. Our descent is not inevitable nor forever.

Jun 08 08:36 AM

[Kapurnickus:]

David,

This is a tired argument--one that is sufficiently unoriginal. Read Fareed Zakaria's "The Post American World." He raises all of these points (2 years ago mind you) and then advances the logic much farther.

You're not wrong, but you're just not thinking downstream enough.

Nick

Jun 08 08:37 AM

[Danny Furman:]

Thought inspiring stuff, thank you Mr. Goldman. I found the following to be particularly eloquent:

"When Americans feel bumptious and risk-friendly, they are more likely to vote to get government out of their hair. It is when they feel beaten, weak, and dependent that they will sacrifice economic freedom for government backing."

Jun 08 08:38 AM

[Alphameister:]

Insightful article and comments. I'm putting my $$ where there is dynamism and rising excitement about entrepreneurial opportunities.

Jun 08 08:59 AM

[Mad Hedge F...:]

You see it in stock performance. If you need further proof of where the future growth in the global economy is coming from, take a look at Bidu (BIDU), the Google of China, which I strongly recommended on March 6 (www.madhedgefundtrader...). It has jumped 280% from the lows to $280, and has been one of my better calls of the year. In the meantime, our Google (GOOG) rose by only 48% to $435, just 8% more than the S&P 500. These hedge fund darlings are best of breed companies, but the Chinese one outperformed the American counterpart by a factor of 6:1. This is the consequence of the US economy making a permanent shift from a 5% growth rate to 1.5%-2%, and is a pattern you can expect to see repeated around the world for the next decade. The cruel truth here is that American companies, with the drag of a mature economy, will never command the same multiples of Chinese ones. When looking for long equity exposure, always look for Chinese ones first. Expect huge growth of the four horsemen of the Chinese Internet sector-Netease (NTES), Sina (SINA), and Sohu (SOHU), and BIDU- who are going to eat our lunch.

Jun 08 09:56 AM

[ArtfulDodger:]

DG:

Very good article. I hate to agree with most of it, but I do.

For the first time in over forty-years of investing, I own a large position in only one US stock: General Dynamics (GD) and a small position in DOM.

This is because I have no faith at all in what's going on in the States, either with monetary policy or fiscal policy or regulatory policy.

This Administration frightens to constipation everyone I know who values freedom. It has two answers to every perceived, contrived, and real problem: taxation and government control.

How can a government that can't balance its own books and has run the nation $12t into debt have the nerve to demand that its citizens allow it to take over whole industries, such as health care?

How can a bunch of controllers, such as Obama, Geithner, Pelosi, Reid, Frank, Rangle, Kennedy, Emmanuel, and the rest, who've never run a business, who've never hired or had to fire workers, who've never dreamed of balancing a business balance sheet, who've never had to sit back and wonder what its government is going to do to its sector next, have the nerve to tell private citizens what they should drive, wear, eat, live in, heat and cool with, who their businesses should hire, what materials they must use, and on and on?

They have this nerve because government propaganda bloviated mostly through the Fourth Estate and the school system has brainwashed half the nation into believing that no one can figure out which way to drive to work or where to park their car after arriving without the Federal Government guiding them.

Until this changes, and I see no sign of that occurring, I'll remain cynical about the USA.

Jun 08 10:11 AM

[ArtfulDodger:]

Mad Hedge Fund Trader:

You wrote: "When looking for long equity exposure, always look for Chinese ones first. Expect huge growth of the four horsemen of the Chinese Internet sector: Netease (NTES), Sina (SINA), and Sohu (SOHU), and BIDU- who are going to eat our lunch."

Well said. I agree totally. Long NTES, SOHU, and PWRD, and other Chinese stocks.

Also long FTE, SBS, & VALE.

Jun 08 10:16 AM

[Sovestor:]

Emerging markets are likely to outperform developed markets in near-term and long-term. Investing has never been so simple. This trend is so obvious.

Jun 08 10:29 AM

[Genesis:]

Sadly, as long as the Republican Party is captive to the neocons and corporate interests, I don't think they have anything better to offer. The problems in this country transcend party politics.

Jun 08 11:09 AM

[Soldalma:]

Excellent article. Obama will follow Lula's lead in polarizing society between an immense majority of miserable beggars and an oligarchic elite. No wonder he called Lula "My man." In Brazil now one in every three families receives handouts through a program (Bolsa Familia) designed to help people in extreme poverty. Of course it is absurd to say that 1/3 of Brazilian families are in extreme poverty. Most families in the program are receiving the handouts without qualifying for it. And studies showed many stopped working to qualify for the handout.

It works, Lula's popularity is at 80%. Obama will see that as a model. His steadfast refusal to help the little man with his mortgage and to pump money towards his Wall Street cronies shows clearly what kind of society he wants to engineer.

Jun 08 11:11 AM

[parv:]

the above post sounds like what happened in the 80s when politicians, journalists and analysts stressed the rise of Japan and the fall of the US.

Jun 08 11:16 AM

[john redmond:]

David, a very fine and truthfull article. I have lived long enough to see giants returning from Europe after defeating Hitler, and turning this country in the best promise the world has ever known. As I enter into the sunset of my life I see that great hope cast into the trash heap and this land turned over to a gaggle of deadbeats, educated on MTV etc, who only want to grab as much for themselves as they can before the ship sinks.

Jun 08 11:45 AM

[wtp:]

Genesis is right -- and polite. We didn't hear much about this when previous administrations were taking most of us from feeling "bumptious and risk-friendly" to "beaten, weak, and dependent." And tell us again, what turned out so beneficial for the average citizen about the government's encouragement of bumptious risk-taking for the few and well-placed?

Jun 08 12:05 PM

[conceptwizard:]

Bloomberg ran a fairly balanced take on China on June 1. After reviewing all of the bullish indicators, Bloomberg noted:

China’s banking sector is facing “grim credit and market risk” as corporate earnings fall because of an over- concentration of lending in certain industries and regions, the China Banking Regulatory Commission said today in its 2008 annual report.

Real estate is among industries that may default on loans, causing growing pressure on Chinese banks after economic growth dropped to the weakest in almost a decade, the statement said.

That's not all. In a statement released June 06, a Chinese government official noted signs of trouble in a key sector. Vice Minister of Commerce Zhong Shan warned "exporters were facing 'unprecedented difficulties' at present and that the situation would not improve amid the global economic downturn," Reuters reported. 'It is increasingly difficult for us to make a quick turnaround, and the trade situation will not be optimistic in the second half of this year,' Zhong said in a statement on the ministry's website."

In addition, "nationwide electricity consumption via major grids had fallen 4.3 percent in the first 10 days of May, also 0.7 percentage points sharper than that for the last 10 days of April, it said, confirming earlier local media reports. The power data is considered by some as more of a leading indicator than manufacturing and export data."...

A leading energy analyst found strong evidence that the run-up in oil prices in recent weeks stemmed from stockpiling, or hoarding, by the Chinese. Neil McMahon of Bernstein Research concluded that the rise "'reflects not strengthening demand, but rather China's efforts to boost its strategic petroleum reserve."

These factors are an indication that China may not be the place the recovery plants its first seeds.

Jun 08 12:09 PM

[Jason722:]

That's a good point, but the two scenarios have different roots. The fear of Japan in the 80's was really economically based. People feared that Japan's economic model using highly-educated and dedicated labor would trounce the US. Those who understood economics always saw the flaw in this argument. Japan would never have had the resources to overtake the US economy and all the bluster was just about a closing of the economic gap as Japan finally recovered from WWII.

Today's issue is different because it is political-economic. The US has drifted farther from a free market and China has crept towards it. The threat of the US economy collapsing on its own bloated self is much more credible today and becomes more plausible with every freedom taken from the productive portions of the citizenry.


On Jun 08 11:16 AM parv wrote:

> the above post sounds like what happened in the 80s when politicians,
> journalists and analysts stressed the rise of Japan and the fall
> of the US.

Jun 08 01:48 PM

[Danny Furman:]

Thanks for explaining HOW to invest in China. Of course Chinese people have no interest in consuming the crap they've been pushing to us and Europe, they know the huge margins and the absence of quality in those products! Investing in China should not revolve around GDP growth, it's all about consumption. Infrastructure, commodities, medicine and technology (not electronics, duh, for anyone who can't distinguish) investments in China have less downside than any single sector in either American continent. Worst case for China investors is that people there start to consume like Americans and discontinue producing altogether. With the commodities they are stockpiling and the 1 child law (which has 75%+ support, obviously indicating the desire to consume that so many ignorant folks doubt), Chinese people will be able to consume for decades in ways no more developed nation will.

Analysts are salespeople paid by corporations they rate. Taking their advice means admitting incapability to analyze information. It's all out there, use your brains people.


8 12:09 PM conceptwizard wrote:

> Bloomberg ran a fairly balanced take on China on June 1. After reviewing
> all of the bullish indicators, Bloomberg noted:
>
> China’s banking sector is facing “grim credit and market risk” as
> corporate earnings fall because of an over- concentration of lending
> in certain industries and regions, the China Banking Regulatory Commission
> said today in its 2008 annual report.
>
> Real estate is among industries that may default on loans, causing
> growing pressure on Chinese banks after economic growth dropped to
> the weakest in almost a decade, the statement said.
>
> That's not all. In a statement released June 06, a Chinese government
> official noted signs of trouble in a key sector. Vice Minister of
> Commerce Zhong Shan warned "exporters were facing 'unprecedented
> difficulties' at present and that the situation would not improve
> amid the global economic downturn," Reuters reported. 'It is increasingly
> difficult for us to make a quick turnaround, and the trade situation
> will not be optimistic in the second half of this year,' Zhong said
> in a statement on the ministry's website."
>
> In addition, "nationwide electricity consumption via major grids
> had fallen 4.3 percent in the first 10 days of May, also 0.7 percentage
> points sharper than that for the last 10 days of April, it said,
> confirming earlier local media reports. The power data is considered
> by some as more of a leading indicator than manufacturing and export
> data."...
>
> A leading energy analyst found strong evidence that the run-up in
> oil prices in recent weeks stemmed from stockpiling, or hoarding,
> by the Chinese. Neil McMahon of Bernstein Research concluded that
> the rise "'reflects not strengthening demand, but rather China's
> efforts to boost its strategic petroleum reserve."
>
> These factors are an indication that China may not be the place the
> recovery plants its first seeds.
>

Jun 08 02:19 PM

[Random Number:]

Mr. Goldman: Your writing would improve if you left out the political ideology. I hate to waste my time reading an article when half way through I discover that the author is promoting ideology. I read articles on Seeking Alpha for one reason only: to make money.

Jun 08 03:24 PM

[Alphameister:]

Ideologies are at the heart of making money in today's market when the primary choice is between investing in increasingly socialist developed economies or increasingly capitalist emerging economies.


On Jun 08 03:24 PM Random Number wrote:

> Mr. Goldman: Your writing would improve if you left out the political
> ideology. I hate to waste my time reading an article when half way
> through I discover that the author is promoting ideology. I read
> articles on Seeking Alpha for one reason only: to make money.

Jun 08 05:07 PM

[AlexS:]

They said we were so worried about Japan in the 80s and look what happened. But I would point out that GM and Chrysler have gone under, Toyota and Honda are doing very well. So did we really worry about nothing?

Jun 08 10:50 PM

[Paul from C...:]

Great article. Although I didn't read "The Post American World", Mr. Goldman hits it right on the head upstream or downstream. As an American born chinese, I've seen these social, cultural and economic changes happening in the USA with disbelief. What's really sad is that if this letter was published in the main stream media, Mr. Goldman would be blasted as being racist and a bigot. I've been moving my funds into asian/commodity currencies and some China EFT's. But I'm not all in because I smell a major correction starting in September when investors realize that there are no earnings, PE's over 20, and unemployment goes over 10%. Not even the plunger team can rig this market up forever. Even Asian equities will be dragged down.

Jun 14 12:32 AM