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The Fall of Empires (Part 1)

Since January this past year (2009), I have been having strikingly similar conversations with many clients and non-clients. Everyone (pretty much unanimously) is cynical and skeptical of the effects of Obama’s bailout plan, healthcare reform, and George Bush’s bailout plan before that. There seems to be a deeply ingrained belief that politicians of both parties are untrustworthy and equally likely to sell out to deep-pocketed corporate interests. As someone once said, the definition of an honest politician is one that when bought, stays bought. Most of the conversations then digress to the “fat-cat” bankers on Wall Street pocketing enormous profits while enjoying the full backing of the U.S. government, insider trading scandals seemingly popping up every week and Madoff-like Ponzi scheme frauds occurring in our backyards. Some of them point to Tiger Woods, Jonathan Edwards and Mark Sanford (Governor of South Carolina) as examples of the weakening “moral fiber” of this country where the measure of a man seems to be how wealthy and powerful he is. Indeed it often seems that the U.S. is crumbling all fronts: political, economic and social. Combine that with seemingly unstoppable economic growth from developing countries such as China and India and many people are implicitly asking, whether they realize it or not, “Is the U.S. the prudent place to invest my money for the next 30 years?”
 
The first part of the answer to that question, lies in the answer to a similar question: “Is the U.S. economic ‘empire’ in decline?” By this I mean to ask whether the U.S. economy will continue to drive growth around the world or will it take a “backseat” to other developing and developed countries.  Empires in decline* share a number of traits, some of the most common are:
 
1. Loss of territory and influence
Although the U.S. has not lost any territory over the last 30 years, it is hard to argue that U.S. global influence has not diminished. Most casual observers would tell you that U.S. influence reached its peak under President Clinton and they would be correct when looking at U.S. influence relative to other countries at the time. The unprecedented levels of international cooperation (regardless of whether it was willing or unwilling at the time) for the Bosnian and Kosovo conflicts would seem to mark a high point for U.S. influence. In the Kosovo conflict, both Greece and Russia who had opposed military intervention were involved in “peacekeeping” operations under NATO command. China, whose embassy was hit by a cruise missile, protested but took no other action. Out of 50,000 NATO ground troops, the U.S. supplied only 7,000. This is in comparison to the war in Afghanistan where the vast majority of troops have been supplied by the U.S. (~35,000), and the U.K. (9,000) with other European countries and Canada supplying most of the remainder of the 73,000 total troops. The war in Iraq has been even more lopsided with ~80% of the initial 250,000 troops that invaded Iraq provided by the United States. Currently the U.S. is the only foreign country with troops in Iraq (the U.K. and Australia withdrew the last of their troops in July 2009).


2. Redistribution of wealth from poor to rich and oppression of the poor
Besides the moral implications of an increasing gap between the rich and the poor, common sense tells us that excessive income gaps lead to increased social instability – something that no one wants except those with nothing to lose. Over the last 30 years the incomes of the top 3% of Americans have increased by 300% while the remaining population’s incomes have only increased by about 50%. The disparity between the “haves” and the “have-nots” has widened considerably in the past 30 years. As shown in the table below, as incomes have grown, the wealthiest have received a disproportionate share.
 
Percentage of Total U.S. Income
 
1979
2008
Poorest 20%
4.1%
3.4%
Richest 20%
44.2%
50.0%
 
Since 1979 average wages have increased by ~30% after inflation (1% per year) but worker productivity has increased by 60%. As the nation’s economic pie has grown, corporations have increasingly held back from giving their workers a bigger piece – keeping much of it for their executives and shareholders.
 
3. Devaluation of its currency
 
Since January 1979, the U.S. dollar has lost 22% of its value. Since the “dot com bubble” burst in 2001 and the U.S. government lowered interest rates to stimulate the economy by printing dollars, the dollar has declined in value by almost 35%. If the U.S. continues to devalue its currency, foreigners will be more reluctant to buy U.S. government bonds, pushing up the cost we pay to support the debt that we have borrowed from the rest of the world. In many ways, the value of the dollar is the ultimate gauge of the confidence that foreigners have in strength and stability of our economic and political systems. These systems operate in a world in where perception often matters more than reality and the breakdown of which can easily result from self-fulfilling prophecies.

4. Protectionism / breakdown of well-functioning markets
Whether as a result of the recent financial crisis, or as a reaction to its diminished role in the world economy, the U.S. has increasingly taken a protectionist stance when discussing global trade. Some examples of this are:
 
-the U.S. government’s “Buy American” provision in the fiscal stimulus package
-Restrictions on Mexican trucks operating in the U.S.
-Potentially imposing tariffs on countries that do not place a price on carbon emissions
-The U.S. International Trade Commission’s decision to place import duties on Chinese steel pipe
 
Even more concerning, however, has been the breakdown in previously well-functioning markets. Right now, government sponsored entities like Fannie Mae and Freddie Mac own or guarantee almost half of the $11.8 trillion of residential mortgages and in 2009 those 2 entities accounted for 75% of new mortgages given out. While we can speculate whether or not the mortgage market would be even be working right now without their assistance, it is hard not to believe that the outrageous lending behavior that drove the mortgage markets to the brink of collapse earlier this year was not driven in part by the willingness of these quasi-governmental agencies to guarantee almost any questionable mortgage. Some of the more colorful descriptions of the types of loans they had purchased or guaranteed: “Liar’s Loans” (where the borrower only had to state his/her income without providing documentation), “Teaser Loans” (which qualified the borrower for a loan based on an artificially low interest rate without having sufficient income to make the monthly payment when the interest rate would be reset to the higher level) and my personal favorite “NINJA Loans” (No Income, No Job). 
 
The U.S. is currently playing a gigantic game of musical chairs, shuffling around the bad loans – effectively buying them from the banks and guaranteeing them via the U.S. government (a.k.a. our tax dollars). If the banks had kept the bad loans then the “poor” stockholders and bondholders would have been forced to take the losses for the bad mortgages. Instead, the stockholders and bondholders have been able to recover 100 cents on their dollars while the U.S. taxpayer will be ultimately holding the bag for any losses. This type of massive government intervention and reallocation of wealth (most owners of stocks and bonds are relatively well off while the majority of working class Americans have a minimum of investments) does not bode well for either the social or the economic stability of the U.S. in the future.


Disclosure: No positions