Unless developed economies learn to compete the old-fashioned way – by making more goods and making them better – the smart money will continue to move offshore to Asia, Brazil and other developing economies, both in asset and in currency space.
~ Bill Gross
Bill Gross of Pimco was out Wednesday with his monthly investment outlook, and I thought it was worth highlighting. Entitled Allentown, the letter refers to the 1982 Billy Joel song of the same name. If you don’t remember it, the song was about the economic hardship of unemployed steel workers in Allentown, Pennsylvania. Mr. Gross asserts that the same factors that led to the closing of factories in the 80s have continued to wreak havoc on the global economy, especially in the developed world.
You’re Going the Wrong Way!
Perhaps my Canadian roots are showing, but I couldn’t help thinking of a scene from the John Candy/Steve Martin classic comedy Planes, Trains, and Automobiles. If you know the movie, there’s a scene where Candy’s character ends up traveling the wrong way on a divided highway. Other motorists try to point it out to him, but he doesn’t realize they’re right until he comes face to face with two oncoming tractor trailers.
Like the motorists on the other side of the highway, Mr. Gross seems to be telling policymakers in the developed world that they’re going the wrong way. As he sees it, the current problems with the global economy are fed by the lack of two essential ingredients:
- Global Demand: People just aren’t buying and consuming as much stuff as they used to.
- Competitive Policies: Laborers in developing countries work for a fraction of the cost of those in developed nations, and they often produce superior products to boot.
I would add that the reduction in consumption is a natural result of the over-consumption of the past 20 or 30 years. We have in effect pulled a few decades’ worth of purchases forward and we are now stuck with the bill in the form of lopsided balance sheets. We have too many expensive liabilities to service, so we can’t think about new asset purchases for a while.
The policy responses to these economic problems have been a cluster of band-aid solutions, easily sold to the electorate, but completely ineffective in bolstering long-term economic viability. Tax cuts, low interest rates, and corporate balance sheet bailouts placate investors, but do little to enhance the real economy:
These policies only temporarily bolster consumption while failing to address the fundamental problem of developed economies: Job growth is moving inexorably to developing economies because they are more competitive.
So how can we, as developed economies, compete with the developing world?
Easy Street or Buckle Down Road?
According to Mr. Gross, “it can be done with sacrifice and appropriate public policies that encourage innovation, education and national reconstruction, as opposed to Wall Street finance and Main Street consumption.” That’s what he means by “stop making paper and start making things.” It’s the difference between the “Easy Street” choices we’ve made so far and the “Buckle Down Road” route we should be taking. We need to focus on real economic innovation and manufacturing things we can use rather than financial innovation and synthetic products that pad the profits of financial institutions.
The problem is that “political and financial chicanery” in the form of currency devaluation, trade and immigration barriers, and expensive military action to secure foreign oil, are easier to sell to the electorate than policies that work in the long-term, but require sacrifice in the short-term. We do not elect people who run on a platform that asks us to sacrifice.
And yes, policymakers at the Fed write trillions of dollars’ worth of checks under the guise of quantitative easing, a policy which takes Charles Ponzi one step further by purchasing the government’s own paper in a last gasp effort to support asset prices.
We saw asset prices rise by a lot Wednesday, mostly as a result of news that the U.S. would be willing to back a larger European stability fund. So the boat tipped the other way – again. While it’s nice to see the market recover from recent weakness, it would be more believable if it was the result of real economic progress rather than papering over problems with printed and/or borrowed money. It just looks like another endorsement of the “Easy Street” policies that Gross criticizes.
Why Easy Street Won’t Be So Easy
The problem with Easy Street is that near-zero nominal interest rates coupled with any amount of inflation will lead to negative real rates. This, in concert with currency devaluation and trade barriers, will erode the purchasing power of dollar-denominated investments across the globe. Gross levels a pretty poignant criticism of this track by calling it “confiscatory”, using an Ivy League vocabulary to insinuate that the government is effectively confiscating the wealth of its people by choosing this path.
Buckle Down Road, on the other hand, might mean a little short term pain as the economy is restructured, but longer term, Gross thinks it’s definitely the way to go. We need to get back to an economy that makes innovative things we can use in the real world rather than one that fabricates financial products for a virtual reality inhabited by a select few. I couldn’t agree more.
Although I do agree whole-heartedly with the thesis advanced by Mr. Gross, I would be curious about how he would approach the prospect of bondholders buckling down and taking some necessary haircuts in order to restructure the global debt morass. Does his position at Pimco clash with his ideals, or is he willing to put Pimco’s money where his mouth is? I don’t mean for that to sound as sardonic as it does when I re-read it, and maybe he has clarified his position elsewhere. I would just honestly like to understand his thoughts on that issue as I do respect his opinion.