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When my father returned from the Korean War in the early 1950's, he amazed his friends when he told them that the balance of industrial power was starting to move away from the 'West' to the Far East. Few believed him but, half a century later, most would agree he was right.
As this happened, Asian nations sold massive amounts of cheap, deflationary goods into Western markets, whose governments advocated free trade. On balance, this was largely a one-way trade as local Asian economies lacked the internal purchasing power to import consumer goods from the West. Asian countries, therefore, accumulated large balance of payments surpluses, particularly in U.S. dollars. They invested these dollars primarily in U.S. Treasuries.
American consumers and debt markets became so vitally important to the so-called 'Tiger' nations that their economies became what was called 'coupled' to the American economy. It was said that if the American economy sneezed, its trading partners would catch a cold.
Things have now changed. The 'coupling' of Asian economies to that of the United States are now threatened by 'decoupling'.
As the United States economy threatens to move into recession, the important question arises as to what degree the Asian economies are 'coupled' to the condition of the America's economic condition? If not tightly coupled, the Asian economies could represent a very profitable alternative to domestic U.S. investment, even in times of American recession.
In recent years, the American economy has undergone some fundamental changes.
In the 1970's the America consumer became the most important element of Gross Domestic Product (GDP). Today, U.S. consumers account for some 72 percent of GDP.
America changed from a nation of 'producers' to a nation of 'consumers'. As a series of massive trade deficits show, America has been dissipating its wealth at an alarming rate.
To finance its high standard of living, America borrowed vast amounts of capital from foreigners who used their surplus dollars to buy U.S. Treasuries. That is how America became the largest debtor nation on earth.
These adverse factors have not gone unnoticed. Since 1971, the U.S. dollar has dropped in value by some 80 percent, measured against the U.S. Dollar Index (a New York Board of Trade futures contract of a trade-weighted basket of six, freely floating major, foreign currencies comprising: 57.6% Euro; 13.6% Yen; 11.9% UK Sterling; 9.1 $ Canadian dollar; 4.2% Swedish Kronas and 3.6% Swiss Francs). It should be noted that most OPEC and major Asian currencies are pegged to the U.S. dollar and, therefore, are excluded from the Dollar Index.
This means that a person, having $100,000 in savings in 1971, now has purchasing power equivalent to only $20,000! And that assumes that the Dollar Index itself has not depreciated, which it has.
Since 2002, the U.S. dollar fell by some 18.45 percent against its Index. But the Index itself fell by some 32.49 percent. The 'true' fall in the U.S. dollar was some 24 percent, or a quarter of its value, in only six years!
All the holders of U.S. dollars, including foreigners, have suffered equally.
As Asian nations accumulated ever larger surpluses, they invested heavily in U.S. Treasuries. Today, China has some $1.5 trillion in its reserves. Japan has about $1 trillion.
On the one hand, therefore, it would appear that Asia is still very much 'coupled' both economically and financially to America.
On the other hand, having been surpassed by the European Union, America is no longer China's largest export customer. Furthermore, China now has eclipsed the United States as the world's largest exporter.
It appears that the concept of 'coupling' could be breaking down. But could it also be argued that the economies of other major players, including the European Union and Japan, are themselves coupled to the American economy?
With a GDP of some $14 trillion a year, the American economy is still massive. But the economic dominance of the United States is shrinking. The coupling concept also may be fading.
In most new and booming BRIC economies (Brazil, Russia, India and China), the initial trade surpluses were 'retained' by their governments and largely invested in U.S. Treasuries.
As the private sector grew in these countries, wealth was accumulated by the private sector, increasing potential domestic consumer demand. Over time, this internal demand has reached a level where it is reasonable to argue that that there is now significant 'decoupling' from the American economy.
As this 'decoupling' gains momentum, it will increase the ability of foreign companies to generate profits in the face of an American recession. Now, it may well require America to catch an economic cold before other important economies sneeze!
Many countries generating trade surpluses with the United States maintain or maintained exchange controls. As some 60 percent of world trade is transacted in U.S. dollars, some foreign governments, with exchange controls, had to buy U.S. dollars from their domestic merchants, in return for newly issued (inflationary) local currency. The governments accumulated yet more U.S. dollars and invested them mostly in U.S. Treasuries, enabling America to continue financing its massive deficits.
As the U.S. dollar depreciated, dollar inflation was imported into the economies of foreign surplus generating countries. It was a price of generating international dollar surpluses within domestic exchange controls. As exchange controls become less fashionable, this financial 'coupling' to the United States also may be eroded.
An erosion of this financial coupling may decrease the foreign appetite for U.S. Treasury debt adding a new and potentially dramatic downward pressure on the U.S. dollar. This will make profits generated in foreign currencies such as the Chinese Yuan, Indian Rupees and Brazilian Reals increasingly valuable to dollar-based American investors.
As the decoupling of BRIC and other Asian economies proceeds, internal demand for raw materials, including energy and food, is likely to increase markedly. This likely will boost the hard currency earnings of resources-rich nations such as Canada and Australia.
Appreciation of the true cost of sustained and deepening U.S. trade deficits leads to four important conclusions that should cause a revolution in conventional American investment strategies.
First, the generation of surpluses in BRIC and other mostly Asian countries, but including other resources-rich economies, probably will lead to a major accumulation of domestic consumer demand in those countries. It suggests an increasing 'decoupling' from the American economy and increased profit generation by local companies.
Second, as 'decoupling' increases, the performance of BRIC and Asian economies and domestic companies will be affected less by an American recession.
Third, as 'decoupling' increases, additional downward pressure is likely to be exerted on the U.S. dollar and upward pressure on the currencies of other 'producer' nations, making investment in the stocks of overseas corporations increasingly attractive to U.S. investors.
Fourth, in the event of a recession in the United States, investment capital is likely to flow increasingly from America to the 'producer' economies. This will tend to boost the price of foreign stocks at the expense of U.S. stocks.
These conclusions should lead the astute investor to increase exposure to overseas stock allocations, particularly those of producer countries with sound currencies.
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