"Here: If you have a milkshake… and I have a milkshake… and I have a straw - there it is, that's a straw, you see? - watch it now. My straw… reaches acroooooooss the room… and starts to drink your milkshake."
"I… drink… your… milkshake! I DRINK IT UP!"
~ There Will Be Blood
Noted Yale professor Robert Shiller called efficient market theory "one of the most remarkable errors in the history of economic thought." In similar fashion, underestimating the health, strength and resilience of the United States economy is perhaps the most persistent error in the history of global macro. One can argue (as we already have) that the shale boom was a "game changer" in America's favor, and that without it who knows how the USA would have fared. Even so, shale testifies to American ingenuity… and here we are.
The world is orienting to a new era of American dominance. Really, who else is there at this point?America is well and truly an "empire," not unlike the Roman or British empires. But the implications of such are actually quite favorable. The typical lifespan of empires is multi-centuries-plural, not century singular. If America is an empire in the tradition of previous empires, then the USA's power is still "adolescent" as George Friedman of Stratford puts it. Young America is a rich multi-hyphenate superpower in control of two oceans, dominating the world's energy, agriculture, tech and real estate markets. The USA's asset base is so deep, its cash flows so strong, it could likely handle a multiple of its current debt load (though don't tell the Calvinist doomers that).
Among the great powers - and mostly everyone else too these days - America has the strongest economy in the world, in both absolute and relative terms. The idea of China dominating, apart from sheer size metrics, has joined the "commodity supercycle" as punchline to a joke. Jim Rogers, the most famous of the die-hard China bulls, waves off the threat of upcoming China panic as simple growing pains, not unlike what the USA felt in, say, the panic of 1907. And yet, as evidence mounts, something big becomes clear to us: China is not the "next big thing" for the 21st century. America is the next big thing for the 21st century. The champ is positioned for a repeat. As such, perhaps the pain of 2007-2008 was a 1907 echo for… drum roll please, the USA.
This may sound hard to believe. But that is mainly because of persistent pessimism conditioning, mostly to do with the popular attraction of "going to hell" type predictions and all-too-common misconceptions as to USA indebtedness. Let go of the party line on debt for a minute, and one is reminded that the truly big advantages do not just disappear. In fact they are more likely to persist for an incredibly long time.
That is why true "empires" are not fly-by-night affairs - here one century, gone the next - but rather tend to persist for multiple centuries, as America's is wont to do. Like a sports team on a dynasty run, they need time to gel and warm up.
Truly, too, the United States holds so many natural, built-in advantages it is almost ridiculous. Consider the following, for example, from Fareed Zakaria via the Washington Post:
Peter Zeihan [in his] "The Accidental Superpower" [contends] that the United States is the world's largest consumer market for a reason: Its rivers. Transporting goods by water is 12 times cheaper than by land (which is why civilizations have always flourished around rivers).
And the United States, Zeihan calculates, has more navigable waterways - 17,600 miles' worth - than the rest of the world. By comparison, he notes, China and Germany each have about 2,000 miles. And all of the Arab world has 120 miles.
One can imagine the Big Lebowski expounding on American dominance: "And that's just the rivers, man! They've also got more energy and food and 21st century technology and kick-ass companies than anyone else… to tie it all together…"
China, meanwhile, is largely land-locked and river-barren (while America controls two oceans, as Friedman points out, and has a currency that dominates more than 80% of world trade). At the same time, vast quantities of Chinese soil are polluted beyond usability. A majority of wealthy Chinese reportedly wish to leave the country. Pollution is so bad, an eight-year-old contracted lung cancer. And China's long-held low-cost labor advantage is threatened by the up and coming Asian tigers (Vietnam, Thailand, etc.).
Worse still, China's own store of foreign reserve riches may yet hamper growth. Consider the possibility that, because China's banks are largely puppets of the state, the Chinese government can simply "buy off" massive quantities of NPLs (non-performing loans), perhaps to the tune of trillions. And yet, this is a prescription for prolonged sickness, not a return to real health. The virtue of a crisis, or a quick, sharp recession, is the beneficial cleansing effect. The cost of avoiding such, on the other hand, is dragging out a malingering illness for years - often at greater total cost!
Look what happened to incredibly rich Japan after their insane 1980s bubble. Deflationary pain persisted, more or less unabated, from 1990 onward. Nearly a quarter century's worth of doldrums took place, in part, because Japan's own wealth was wielded against it. Untold trillions were poured into useless construction projects. Existing bad debts were repeatedly rolled over. Profitless companies propped each other up like drunks. It might in fact be preferable for China to "crash." The Japan "zombie" experience could be worse!
What are the implications of China's economy crashing in the near to medium-term future… or worse yet, of a crash-avoiding China in Japan-style "zombie mode" for the next twenty years? Commodities will do terribly, for one thing, as China has long been the source of marginal buying demand. In the base metals complex, for example, marginal buying pressure led to substantial overcapacity that producers are now loath to cut back (for fear of losing market share). When that marginal demand is taken away - as we now see happening as the China real estate bubble sags - supply over-takes demand to the point of broad price collapse. And this could go on for a while: Rescue or no rescue, the pain of roll-over in China's ponzified construction market is nowhere near done. (Two China-based researchers recently estimated an investment "waste" factor of $6.9 trillion since 2009… you could slash that number by half or two-thirds and it would still be mind-blowing. Bridge to nowhere anyone?)
As such, we think bottom buyers of commodities are "too clever by half" at this point: Starved so long for anything "cheap," they fail to heed the awful macro outlook. What, pray tell, is going to turn the commodity ship around in an oversupplied world where marginal China commodity demand is either 1) slow-motion imploding or 2) fast-motion imploding, even as the US dollar gets stronger all the while? It's relatively simple to be a "value investor" based only on valuations (as benchmarked against the medium-term past). It's another thing to be aware of cyclical macro drivers - especially when attempting to catch a falling knife (versus buying something that has been "dead money" for a while).
Similar logic applies to emerging market equities… not as hammered as commodities, but having a rough go of it. In a world where commodity prices are falling (and the US dollar is relentlessly rising), emerging market countries with heavy exposure to dollar-denominated debts are vulnerable, as are countries with commodity-driven cash flows. Within China itself even, commodity-producing regions with high reliance on oil and coal (China is a top producer of both) are facing insolvency as a result of prices at multi-year lows. With the possible exception of India, to buy EM here seems foolhardy. Why should things improve before growing notably worse?
Oh, and about those "shale wars" between Saudi Arabia and the USA: This fight, too, shows America's dominance (and resilience) on a massive scale. Consider that OPEC is now in dire straits, fighting to maintain what relevance it has left. The Saudis have had to gut their oil-exporting brethren as collateral damage in attempt to hurt the "shale boys." Those shale boys, meanwhile, may create trouble for high yield credit markets but will likely keep pumping, even with West Texas Intermediate at fifty dollars a barrel. This is wonderful news for US consumers and businesses… and horrible news for Vladimir Putin, fallen so far from the TIME "man of the year" status he enjoyed seven years ago. In its capacity as swing producer for the world's oil supply, the Saudis had one big thing. If the USA takes that away - becoming the de facto swing producer of record - it will be just one more dominant advantage in a trophy shelf chock full of them.
To be clear, we are no fans of American government. As Warren Buffett quips: "Buy into a business that's doing so well any idiot could run it, because sooner or later, one will." America has been run by "idiots" for quite some time, and yet the inherent competitive advantages are too deep and structural for even Washington to destroy. To make a stock market analogy, consider Microsoft (NASDAQ:MSFT) under the tenure of one of the most value-destroying CEOs of all time, Steve Ballmer. The decisions made by Ballmer were so awful, Microsoft would have been better off shrink-wrapping pallets of hundred dollar bills, trucking them into the desert via fleet of 18-wheelers, and setting them on fire; and yet Microsoft was strong enough to survive one of the worst CEOs in history (while continuing to gush cash in his aftermath). America is in similar position… though this is hard to see via the fogged lens of ideological hatred for central bankers and politicians.
Does American exceptionalism, then, extend to ongoing rampant bullishness for US equity markets? No, not at all. The belief that equity market upside correlates to economic growth is actually an old wives' tale, for developed and emerging markets both. Stocks can rise when growth is flat or declining, just as stocks can fall when growth is rising. This is because the core drivers for earnings, profits, and credit booms or busts are different than those for GDP growth. A market that has undergone a credit boom, for example, can be subject to credit bust consequences, and over-valuation mean reversion, even as GDP growth rises. Indeed this is a hidden message of America's "best jobs report since 1999." Excellent vitals mean a stepping up of the rate hike timetable. Wage hikes filtering down to the "little guy" mean erosion of corporate profits. Severe market corrections come from places of equity over-extension, following behind euphoria. A good old fashioned equity correction of 30% to 50% would not necessarily "hurt" the USA (though many a yield-reaching investor would feel a world of pain).
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.