Journalists and investors breathed a big sigh of relief today, as GDP numbers showed a growing economy (example). As noted in an earlier posting, an economic statistic that includes government spending is not necessarily indicative of sustainable growth. The data available from bea.gov (click on “NIPA tables”) show that in constant 2005 dollars, government spending has reliably expanded from $2.1T per year in 2000 to a rate of $2.6T in Q3 2009. How about private investment? It was $2T in 2000. Last quarter, it was $1.5T, down from a peak of about $2.25T in 2006. Despite an expanding U.S. population and workforce, private investment is much lower than it was a decade ago.
One problem with the private investment statistic is that it includes things that are essentially unproductive, such as the real estate bubble. A new house, once finished, does not generate jobs for workers in the same way as a factory expansion. Fortunately, the BEA breaks out “equipment and software”. This excludes commercial real estate and concentrates on machines used by business. Such investment was $0.9T in 2000, peaked at $1.1T in 2007 and has fallen back to a rate of $0.88T per year in recent months.
What happens with a fixed level of private investment and a growing population and workforce? If the effectiveness of the investment is held constant, you’d expect either (1) workers to become less productive and receive lower hourly wages, or (2) existing workers to remain equally productive and receive the same wages, but new/young workers to be unemployed (or some combination of the two).
Could we paint a rosier scenario with the same numbers? Sure. We can say that investment has become more cost-effective. In the expensive old days a small company would need to buy a copy of Microsoft Office for every employee and purchase Exchange to run email. Now they can use Google Docs and Gmail. In the expensive old days a company would need to buy new tools when it changed a product design; now the tools are numerically controlled and can be reprogrammed cheaply (this is a problematic argument because CNC dates back to the 1950s). We’ll be able to grow because we are investing smarter, not harder. A potentially stronger argument is that we’ve moved beyond manufacturing. We’ll let the Chinese and Germans build solar energy systems while we concentrate on services. A service business requires much less capital investment than a manufacturing business.
A year ago I wrote my economic recovery plan, saying that the key to recovery for the U.S. would be creating an environment favorable to business investment. The global crisis is over and companies are investing, but they are mostly investing in other countries (example from NYT: “India Finds Itself Awash in Foreign Investment”). Whatever it is that we’ve done is getting a thumbs-down vote from business executives who decide where to create private jobs.
It sort of makes sense when you think about all of the weight that an investment in the U.S. has to carry. In the last year alone, we’ve added some substantial new obligations. A company will have to pay not only for its own workers but, through taxes, also for the pensions and health care of retired 48-year-old GM and Chrysler workers. A U.S. employer will have to pay the world’s highest prices for health care for its workers, just as in mid-2008, but also will have pay for health insurance for Americans who don’t work or who work for other companies. An investor in the U.S. will find his returns reduced by whatever additional and ongoing amounts the government decides to hand out to Wall Street banks (the handouts started just over a year ago). An investor in the U.S. will have to pay for a factory, as in 2008, but also gold-plated pork barrel “stimulus” spending.
Philip,
I love your blog. But I don’t know if I can continue reading it… I agree too much and am left wanting to drown my sorrows and cry a little bit.
Do you think there is realistically any hope for change? We can all complain and discuss these things, but inaction won’t change things until it is too late and we are owned by our comrades in China!
These updates are so often bleak that I wish each had a link to your plan.
I refer, of course, to your plan for what to do about this. It seems like staying in the United States is an unsustainable decision, given the direction we are moving. Or have you done research and as bad as it is it is not as bad as, say, Canada (or Canaduh).
I have read your economic plan, but until I am anointed, I cannot implement it. Under King Obama, should I be moving my assets offshore? Learning Hindu? Digging a bomb shelter in the back yard? (That last one has a lot of retro appeal.)
Jeff, Colin: I don’t think that our problems will or have reached a crisis In a way that is itself the problem. Because we can muddle through mushing sideways (like the U.K. from WWII through Thatcher) there is a danger that we will. Sort of like the Iraq and Afghanistan wars. Because we did not suffer immediate defeat or the loss of tens of thousands of American lives, we have de facto decided that we can afford to lose thousands of lives and trillions of dollars over a 20-year period.
Stagnation means that for a young person, staying in the U.S. could be a very poor career decision. An older person with a job or a pension won’t be at as much of a disadvantage. But a young person who emigrates to a high-growth country may find much better opportunities than if he or she stayed here, just as people who emigrated from the U.K. early in their careers have generally done better than those who stayed.
Is there hope for political change? England did change, sort of, after three decades of stagnation. Argentina never really changed. Japan, despite having the world’s most skilled people, hasn’t been able to shake off its belief that it can cheat its way to growth via stimulus projects (meanwhile the private sector in Japan invests its money in China). I’d say that it is an open question. I’m somewhat optimistic that we will eventually turn things around, but I think that I’m biased from having grown up in the U.S., a country that has always eventually turned things around.
Okay, so make sure your children have a view of the world that allows them to emigrate (I’m pointing mine at Sydney, where there is no language barrier and they are guaranteed to work harder than the locals).
But what else are *you* doing in a plan to personally make sure you aren’t in the sideways slide along with the rest of our sorrowful-and-not-unlike-our-parent-(once)-Great-Britian nation? Invest heavily in Emerging Market Index Funds? Move some assets to the Caymans to avoid the socialist redistribution of your hard-earned wealth?
I am disgusted, and therefore paralyzed, by a lot of it.
–Colin
Colin: Seven years ago I put about 20 percent of my investments into foreign stocks, not because I had a belief that the U.S. economy would underperform, but because I thought that I might want to spend up to 20 percent of my time traveling in foreign countries. If the U.S. economy did collapse, I wanted still to have enough money to pay for the basics when abroad. Due mostly to the collapse of the U.S. Dollar, I think the foreign stocks are now closer to 40 percent of my (somewhat shrunken) portfolio. Unless I’m planning to spend 40 percent of my time out of the U.S., I really ought to be rebalancing by selling some of the foreign stocks and buying more domestic, but the U.S. economy scares me too much!
I think that it would take another 5 or 10 years of rough sledding before the federal government would impose the kinds of currency controls that are typical of Third World countries. So far the only wealth tax in the U.S. is property tax and I think we’ll get a value-added tax before a wealth tax, if only because VAT is so much easier to compute and collect.
If I needed to work to put food on the table I would be striving right now to get a passport or other entitlement to work in one or more other countries. An EU passport, for example, would be a terrific hedge against exposure to the U.S. employment market.
For a kid, I think the best advice is to get as much formal education as possible. The immigration systems in the most successful countries strongly favor those with advanced degrees.
Personally, I think the problem is structural. People in China and India makes $1 per day for unskilled labor, $3 per day for skilled labor, and $30 per day for engineering labor. People in the US make $60 per day for unskilled labor, $120 for skilled labor, and $200 per day for engineering.
On the other hand, transporting information is now essentially free, while transporting goods is increasingly cheap. We are in an open, global economy.
This is not economically sustainable. Those wages must equalize. US labor is more productive than Indian labor, but not by a factor of 10-60x. So long as there is the cost imbalance in labor costs, investors will go for China and India over the US. In the meantime, the US will have increased pains as income disparity rises, and unemployment remains high as people refuse to take jobs at 1/10-1/60 of their current income (until the exchange rates equalize).
Do you see any alternative? The macroeconomic forces appear to be such that government policy (short to otherwise disastrous choices like entirely closing our borders to imports, and symmetrically having other countries close to our exports).
Pete: Advanced countries such as Germany, Japan, and the U.S. have coexisted for many decades with countries where wages are low. The labor cost differences that you cite existed in 1890 and yet India and other low-wage countries did not attract 100 percent of private capital. Apparently, at the time, our combination of workforce education, natural resources, taxes, and government regulation made us competitive. The investment attracted by that competitive environment resulted in productivity growth, which enabled the payment of high wages. The basic principles of economics have not been altered. If you’ve been on the phone with a company’s offshore tech support staff you know that the bar for effective competition is not set very high.
If we were serious about attacking the challenge, there is no reason that the U.S. could not become competitive again. However, I can’t remember the last time that I heard anyone with political power in the U.S. discuss seriously the possibility that investors might choose to go elsewhere.
It is true that workers in India and China are satisfied with a pretty low salary and a lot of them have faster Internet connections than the 40 percent of American households without broadband. We did not have to respond to that challenge by taking 50 percent of our GDP and handing it out to public employees, 41-year-old Boston transit system retirees, 48-year-old GM and Chrysler retirees, the world’s most expensive health care system, an attempt to turn Iraq and Afghanistan into Belgium, etc.
@Jeff
Here’s what Switzerland’s oldest bank thinks about the US future:
http://bit.ly/2GRVST
I personally have little hope for a bright US future (or, as someone living in Spain, a bright European future for that matter). In that regard, I intend to move our family to Singapore for at least a year, so that our kids (6 and 8) can get a head start in learning Mandarin.
(And what I often find myself mulling over these days, is what to recommend to my children when they turn 18, at which point they must decide to keep or drop their US citizenship. In keeping it, they, like me, will be forever liable for US taxation, regardless of where they reside.)
@Colin
If you’re concerned about your investments, you might be interested in checking out the “Permanent Portfolio” concept. Craig Rawling maintains the authoritative blog on the subject:
http://bit.ly/2Y8ST5
@Phil, if you every have time to study the Permanent Portfolio, it’d be great to hear your thoughts on it.
Matt: That letter from Wegelin is distressing. The most authoritative link is http://www.wegelin.ch/download/medien/anlagekommentar/kom_265en.pdf
I don’t think that their advice, targeted at non-Americans, should necessarily be followed by an American. Some of their advice is based on avoiding U.S. taxes that are among the world’s highest and likely to become much more onerous as the U.S. government expands while the economy shrinks. An American living in the U.S. can’t avoid those taxes, regardless of what he invests in. An American intending to stay in the U.S., where presumably most of his friends and family reside, should not be exposed to the risk that the U.S. economy and dollar greatly outperform the rest of the world. Suppose that one had all of one’s assets in Chinese and European currency and it turns out that the U.S. does much better than China and Europe over the next 50 years. One’s ability to spend in retirement would thus be impaired. Even if you think there is a 50 percent chance that the U.S. will become a write-off and that you’ll have to flee to a sensibly governed country, you should probably still have close to 50 percent of your assets in U.S. dollar investments.
I have looked at the Permanent Portfolio. Let’s take as a given that the backtesting was done correctly and that it would have been a good strategy for the past few decades. I’m psychologically unable to accept it because of my faith in business. I always think that an investment in a productive enterprise will yield a higher return than parking the money in a non-productive asset such as gold or cash. The actual numbers show that I’m wrong. Stock market investments have not done very well, especially when adjusted for risk and when looked at over the last 10 years.
As a younger investor I underestimated gold’s long-term value. Countries that are only recently prosperous, e.g., Turkey and India, generate a lot of demand for gold. People can remember when times were tough and will pay a lot for gold jewelry for a combination of reasons including potential resale value if times went back to being tough. I still don’t like gold because there is a potentially unlimited quantity in the Earths’ crust. Suppose that a huge new deposit were found somewhere? Or the technology for refining very low grade ore were improved? Those are investment risks that are very tough to understand. On the fourth hand, diamond values should have collapsed when northern Canada was found to massive quantities of the gems, but as far as I know they did not change much.
The Permanent Portfolio has the investor put 25 percent of his or her money into cash. This is by definition unproductive. I think it is tough to believe that this is optimum. A rental apartment near a university would be a better investment. Ownership of a foreign stock. Almost anything should outperform cash.
In the past, my investment approach involved identifying an asset allocation of stocks and bonds based on my self-assessed appetite for risk. The year 2008 pretty much killed my confidence in my ability to assess my own level of acceptable risk. Separately, reading John Norstad’s “Risk and Time” paper lowered my hopes on relying on time to mitigate investment risk.
http://homepage.mac.com/j.norstad/finance/index.html
In that context, I found the permanent portfolio appealing. It doesn’t attempt to optimize performance, but rather attempts to achieve stable growth, with strong protection. (It gained 1% in 2008, on the strength of the long-term government bonds — an asset class that I was strongly and specifically recommended to avoid.) It doesn’t change over time, and doesn’t require a self-assesment of risk.
Since its asset composition is tied to economic conditions, I believe the role of cash (in addition to providing spending reserves) is to provide protection during recession, when most other asset classes would likely underperform.
BTW, for anyone interested, there’s a long thread on the Bogleheads forum about the permanent portfolio, in which many PP-related issues are discussed.
http://www.bogleheads.org/forum/viewtopic.php?t=15434
All that said, I, similarly to you, can’t psychologically escape the draw of investing in what I believe will do well in the future. (Right now, that’s natural resources and emerging markets — particularly China, Brazil and Chile.) But I’m trying, over time, to shift more of my investments into the PP.
I hadn’t really considered the idea of currency/country allocation based on where I’m likely to retire/spend. But that certainly makes sense.