the US Become a Banana Republic?
Friedman expressed the view that if the Republicans had remained
in control of the House and the Senate, the US would have become
a banana republic. But a banana republic isn't characterised
only by a rotten political system, ruled by a small, wealthy, and
corrupt clique usually put in power or supported by foreign interests
(in the 20th century, in the case of several Central and Latin American
countries, by the US), but also by huge wealth and income inequities,
poor infrastructure, backwardness in many sectors of the economy,
low capital spending, a reliance on foreign capital, money printing
and budget deficits, and of course a weakening currency.
banana republic is also characterised by a ruling class that curtails
people's personal freedoms and is moving towards a heavyhanded military
dictatorship under the excuse of fighting guerrilla (or terrorist)
opposition groups or enemies. Moreover, the fact that the ruling
class or the elite comes from different political parties isn't
a relevant factor in classifying a country as a banana republic;
what is relevant is the determination of the elite, irrespective
of which party its members belong to, to shift wealth from the majority
of the people (the masses) to themselves, usually through simply
printing money and incurring chronic budget deficits, and frequently
also through senseless warfare.
I am not insinuating that the US is already a banana republic, but
the trend is undoubtedly there. The physical infrastructure is more
often than not totally insufficient. Not a single flight I took
in the US was on time, with one arriving 10 hours late, another
12 hours late, while two were cancelled altogether, resulting in
delays of more than 4 hours. In Philadelphia, my US Air flight was
delayed by three hours. The plane was on the ground in front of
us, the pilots were all present, as well as one flight attendant
(air hostess). But because a second flight attendant was unavailable
in Philadelphia, one had to be flown in from Washington, so delaying
my flight. Since there was no service provided on the flight, I
wondered what purpose the additional attendant might have served.
stayed at five different hotels on this trip. In three of them they
couldn't locate the FedEx box that my assistant had sent me from
Hong Kong and which had been signed for as having been received
by the hotel. As I have written before, the productivity of corporations
has risen, but the productivity of the consumer is down as he is
constantly waiting in lines and has to suffer from insufficient
service and support staff. Also, compared to Asian and European
cities, the streets tend to be filthy, except, of course, in the
"ghettos" where the super-rich live.
the meantime, members of the American elite are enjoying the asset
inflation, the printing of money, and the trade and current account
deficits, because they keep the "lower classes" reasonably happy
and content by allowing them to continue to consume and buy "cheap"
foreign goods. In turn, this excessive consumption and lack of capital
spending boosts corporate earnings and cash flows, which then benefit
mostly the elite, through rising stock prices. Moreover, the weakening
currency, which is also brought about by capital flight another
characteristic of banana republics doesn't bother the elite
much because they have the ability to easily transfer their wealth
overseas or to fully hedge their exposure to the declining foreign
exchange rate. (The aristocrats of banana republics are usually
Swiss banks' best customers.)
is particularly true in the case of moneyed elites, which are relatively
fixed asset poor and hugely financial asset rich. Let me explain.
Compare, say, a farmer who cultivates land that has been in his
family for generations with a money shuffler on Wall Street. The
farmer is far more tied to his land by tradition, and by his inability
to transfer that land and his familiar environment overseas, than
is the money shuffler, who will feel equally comfortable whether
he lives in New York's Park Avenue, London's Belgravia, or Singapore's
Nassim Road. Basically, what I am suggesting here is that the financial
sector and there are exceptions really doesn't care
much for the overall long-term health of an economy; it is only
interested in asset prices moving up no matter how unsound
the economic policies might be that inflate those asset prices.
when things really turn bad and to use Senator Webb's words
the "bifurcation of opportunities and advantages" along class
lines leads to "a period of political unrest", the money shufflers
like so many former leaders of banana republics have done
before them just pack their bags, hop in their private jets,
and move to another society where they can start playing the same
game all over again! Now, this is not to say that there are no responsible
people among the money shufflers, but the immense pressure to perform
in order to make money as quickly as possible, and hence to enjoy
a "high esteem" among their peers, which is now based solely on
how much money an individual makes, has shifted the priorities of
the money shufflers and the chief executive officers of companies
in a way that is regrettable.
I was very gratified to see that there are still some socially responsible
companies in the US, and this is the second good news I have to
report about the US. On my trip I stayed twice at Marriott hotels,
where I found the staff to be extremely friendly and helpful. In
New Orleans, at a private party hosted by David Tice, I spoke at
length to two Marriott employees who were attending to the bar.
One of them had been with Marriott for over 20 years, the other
for eight years, and both of them couldn't praise the management
enough for "caring" for its employees.
happy were they, they assured me, they wished to work for Marriott
until they retired. Not entirely believing what I was hearing, I
asked my cleaning lady at the San Francisco Marriott how she enjoyed
working for the chain. Again, she had only positive things to say.
She smiled and said that she was "very happy" to work for the company,
where she cleans 40 rooms a day. And although I don't agree with
some of the Marriott's policies (no smoking facilities in their
US hotels, and in San Francisco patrons are prohibited from bringing
their own alcoholic beverages into the hotel), it is encouraging
to see that successful and profitable companies can also treat ordinary
third good news is that although there are ominous signs of the
US drifting towards the status of a banana republic, the polarisation
of wealth isn't due only to appreciating asset values, inheritances,
and the disproportionate growth of the financial sector compared
to the rest of the economy. The five richest Americans all made
their money themselves, and while money managers, real estate moguls
(including hotel and casino owners), and leverage buyout artists
are very predominant on the Forbes list of the 400 richest
people in America, there are also a large number of "new economy"
entrepreneurs on the list, such as the founders of Yahoo, eBay,
Amazon, and Google.
goes to show that there is still ample social mobility in American
society. Still, what is striking about the list of America's richest
people is that most of the wealthy people (inheritances aside) are
involved in some form of money management, consumer finance, real
estate, oil and gas, or anything that has to do with consumption,
such as casinos, hotels, retail, advertising, fast food, media,
entertainment, sport, cosmetics, and health care. This gives me
the impression of a relatively lopsided economy consisting of asset
inflation beneficiaries and entrepreneurs who know how to encourage
and capitalise on Americans' seemingly insatiable appetite for consumption.
I also have to point out that there are two socially different Americas:
there are the money and asset shufflers in the coastal areas; and
then there is the conservative, but extremely friendly and hospitable,
inland and southern population. Tennessee was an eyeopener for me.
Although I had travelled around the South in the past, the contrast
between Tennessee's social fabric and that of New England or of
California's coastal regions could hardly be more striking. And
while in earlier reports I have been very critical about the Southern
states that supported the Bush administration, I also have to admit
that the types of Americans who live outside the coastal regions
are also those most likely to retard the process of American society
sliding into the state of a banana republic.
people tend to have high ethical values (although admittedly sometimes
misdirected), and they are very concerned about and proud of their
small communities. I came away with the impression that people in
these communities help and support each other, and are also
in a positive sense patriotic and proud to be Americans.
I was also pleasantly surprised by Tennessee's scenic beauty (there
are some magnificent homes along the Tennessee River) and its low
price level. In a bar in Knoxville, where a band (unfortunately
without Dolly Parton) played hillbilly rock, a pint of excellent
local draft beer cost just $2. In fact, I found wages for less-skilled
workers in the US to be extremely low when compared to wages for
similarly skilled workers in Switzerland and most of the EU.
builder from Baltimore, whom I met on the street in New Orleans,
told me that he pays his foreman according to him, a highly
qualified worker just $18 per hour, while all his other staff
earn between $10 and $12 per hour. (Baltimore, by the way, has the
highest murder rate in the US.) A New Orleans waitress told me that
her basic wage was $2 an hour, but of course she earned tips on
top of that. A taxi driver in Knoxville told me he earns between
$300 and $400 a week. Compared to wages in Switzerland, these amounts
are extremely low. They are also very low compared to prices of
US assets (real estate and equities). Based on the low level of
wages compared to both Western European wages and US asset prices,
I am inclined to think that either US wages might continue to rise
or asset prices could adjust down to the wage level. Also, whereas
the US dollar may adjust on the downside against Asian currencies
and precious metals, it may be less vulnerable against the Euro.
the expense of being called anti-American, I found that, with the
exception of the areas where the wealthy people live, as I mentioned
above, the streets are filthy. The French Quarter in New Orleans,
which escaped being flooded during Hurricane Katrina, may not be
entirely representative of inner-city areas in the US, but on an
early morning walk, Bourbon Street looked as if hordes of Vandals
had just ridden through! The streets around the Marriott hotel in
San Francisco (located on 4th Street adjacent to Market Street,
and a block from Bloomingdale's and thus not exactly a slum
area) weren't much better. (Compared to, say, Japan, the streets,
clothing, and food in the US are, to put it bluntly, schmuddelig
tacky or filthy.) I have also never seen anywhere in the
world as many police cars as I saw patrolling the streets of New
Orleans. (The more police cars required to patrol the streets, the
closer a region or a country is to being a banana republic.)
I referred to the insufficient physical infrastructure in the US.
Not only are airlines late, but the types of old aircraft that are
frequently in service wouldn't be used by even budget Asian air
carriers. Airports are mostly inefficient (there are long lines
and long waiting times for luggage delivery) certainly compared
to Asia; and there are no transit facilities at US airports for
foreign visitors en route to another country. So, if a passenger
from Asia transits in Los Angeles on the way to Mexico, he or she
needs to clear US immigration and customs in LA. This increases
the workload of immigration and customs officers for no purpose
unreliable, and uncomfortable flights, as well as poor airport facilities,
then motivate wealthy people, corporate executives and, of course,
politicians to travel by private plane. This increases the amount
of airline traffic and clogs air space. In turn, this causes even
more flight delays. In addition, and this should be understood very
clearly, if the wealthy, corporate executives, and especially politicians
increasingly live a life of their own (private jets, private schools,
private clubs, personal drivers, and high-end living compounds),
they frequently fail to notice the poor state of affairs in, and
also begin to care less and less about, the rest of the country
and its physical, security, and educational infrastructure, which
then creates a huge gap between social classes (another characteristic
of a banana republic).
am not suggesting that we don't have huge wealth and income inequities
in Asia, but whereas in Asia people are accustomed to these conditions,
in the US this growing two-class system will lead to disappointed
expectations and, at some point, in all likelihood, to social strife.
I have explained above, however, not all is rotten and bad in the
US. There are many pockets of incredible inventiveness, innovation,
technology, research and development, education, knowledge, and
high moral and ethical values. But the trend I am observing, after
having been a regular visitor to the US since 1970, is certainly
not very encouraging. It will take very strong determination and
sacrifices by all classes of the American nation to reverse this
relative social and economic decline when measured against the newly
emerging economies of the world.
THE US ECONOMY ROLLING OVER?
is growing evidence that US consumption is slowing down, based on
the weakness in the housing industry and slower credit growth. In
fact, the August 8, 2006 GBD report, entitled "Increased Recession
Risks!", alerted our readers to the possibility of the US economy
entering a recession in late 2006 or early 2007. However, there
are a few issues we need to address. First, it is far from certain
that the US consumer will cave in; and second, we will need to address
the investment implications of a slowdown or decline in US consumption.
I mention this because it is one thing to forecast economic trends,
and another to draw the correct investment conclusions.
strategists and economists correctly forecasted the global economic
expansion, especially the strength in Asia, following 2001, but
they totally failed even to mention industrial commodities as the
preferred asset class for capitalising on such a global economic
recovery. Others were misled into believing that strong corporate
profit growth in the US would lead to a strong US stock market performance,
when in fact the increase in US equities in the last four years
significantly lagged the performance of emerging market and European
equities and was flat in Euro terms, as rising US financial asset
prices were offset by a weak dollar not to mention the continuous
decline of US asset prices in gold and silver terms. So, to conclude
that a weakening US consumer will inevitably lead to a lower stock
market is tenuous at best.
is no doubt that, as David Rosenberg pointed out, US retail sales
growth has slowed. An especially sharp slowdown in sales growth
occurred in housing-related retail sales. Whereas last March housing
retail sales were growing at an annual rate of over 17%, in the
three months ending October they rose year-on-year by only 4.5%.
But, considering the weak housing environment, I find the current
growth rate in this sector to be quite remarkable. Moreover, the
slowdown in housing retail sales doesn't tell us anything about
whether we should be long or short Home Depot.
as David Rosenberg also pointed out, many strategists have expressed
the view that, based on slower bank consumer and mortgage
credit growth, the economy will weaken further. This may be the
case, but the fact is that while consumer loan growth (ex auto leases)
has slowed, it is still positive. Moreover, even if consumer loan
growth turned negative, as it did in 1997, it wouldn't mean that
a recession is just around the corner. After all, the 2001 recession
occurred almost four years after consumer loans turned down, and
actually at a time when consumer loan growth had recovered. Obviously
Mr. Greenspan's money printing, post the 1998 LTCM and Russian crises,
and ahead of Y2K, had a positive impact on equities and consumption.
am not trying to downplay the significance of slower consumer credit
growth; I wish only to point out that easy money and rising equity
prices can postpone a consumer downturn. Furthermore, banks' real
estate loans, as well as commercial and industrial loans, still
seem to be growing rapidly. I concede that banks' real estate loans
could be increasing because of still-strong non-residential construction
activity, including construction for commercial buildings, hotels
and amusement parks. (Amusement park construction leading to more
consumption is, of course, exactly what the US needs at present!)
But also home mortgage borrowings are still rising, although obviously
at a far slower rate than a year ago.
factor that needs to be considered when making predictions based
on a decline or slowdown in bank credit growth is, of course, that
bank lending is only part of credit growth, as consumers and businesses
can increasingly borrow money outside the banking sector through
bond issuance and all kinds of other asset-backed and collateralised
debt securities. According to Doug Noland of PrudentBear.com, total
commercial paper issuance is up, year-to-date, by 20%, and while
asset-backed security issuance is running 6% below the 2005 record
pace (home equity loans are down 5% y-o-y), collateralised debt
obligations issuance is running 80% ahead of 2005. Moreover, international
reserves (ex gold) a reliable indicator of international
liquidity are up year-to-date by 18% annualised!
am aware that bank loan officers are reporting that households and
corporations are slowing down their borrowings. In fact, Albert
Edwards of Dresdner Kleinwort recently published a report entitled
"Almost unnoticed, one key part of the liquidity cycle turns downward",
in which he makes the case that,
corporate and household appetite for debt is deteriorating at
the same time, in contrast to say, 1994 and 2001, where weakness
in credit demand in one sector was counterbalanced by strength
in demand by the other sector. What does it mean if the credit
cycle is turning down when, at the same time, the US private sector
has been borrowing heavily to finance its yawning funding gap
(the excess of spending over income)? Any cessation of borrowing
appetite can only mean one thing a sharp retrenchment
in spending must now be underway and with it comes the risk of
a hard landing. There is no way around it as we are working within
National Income Account identities.
to Edwards, "the liquidity lake is drying up at the same time as
the fundamentals are deteriorating.... When prices swing in the
other direction and investors begin to feel the pain, 'liquidity'
will suddenly evaporate as either investors end speculative excesses
or alternatively banks pull the plug."
have no doubt that Albert Edwards will be right at some point. The
question, however, is whether reduced appetite for debt by the household
sector can be offset by an increased appetite by investors (including
foreigners) and whether the corporate sector has indeed less appetite
for debt. After all, commercial and industrial loans growth is still
well and alive (also confirmed by the credit growth figures provided
by Doug Noland). Reduced demand for funds by the corporate sector
could also be the consequence of corporations being flushed with
cash. Moreover, as long as the US current account deficit doesn't
contract, foreign net financial investments into the US won't contract.
As Bridgewater Associates pointed out recently in a piece entitled
"What To Do With All of the Money?", the resilience of the US economy
can largely be explained by foreigners loading up on US government
bonds and the diminished demand by the government and by cash-rich
businesses that don't need to borrow at all. According to Bridgewater's
Bob Prince and Jason Rotenberg,
the past year, foreigners plowed 6.4% of GDP into US financial
assets (entirely debt), business provided another 0.6%,
saver households provided 4% and the government only needed 2.8%
to finance the deficit. The total financing was 8.2% of GDP. This
financing was essentially thrust upon the remaining households,
who were then forced to borrow it, which means that they were
forced to spend it, which required output and employment.
have to say that I am not entirely in agreement with the analysis
by Bridgewater. I could argue that ultra-expansionary US monetary
policies after 2001 led to excessive US consumption. In turn, excessive
consumption led to a growing trade and current account deficit,
which then forced foreigners to plough back funds into the
US equivalent to the current account deficit. Last month's GBD was
entitled "No Chain is Stronger than its Weakest Link". I'm not sure
what the weakest link is in the equation: consumption in the US,
or the appetite of foreign central banks for continuing to finance
this consumption through enormous net financial investment flows.
have to confess that I am at a loss to see exactly what event will
act as the catalyst to unravel this admittedly unstable and, in
the long run unsustainable, equilibrium. It could be accelerating
inflation, a total loss of confidence in the US dollar, or, as Albert
Edwards suggests, a sharp retrenchment in consumption. It could
also be an exogenous event such as war, the interruption
of oil supplies, a major terrorist attack (it is only a matter of
time before terrorists will be in possession of nuclear or biological
weapons) or a pandemic that derails the Goldilocks scenario.
Something is bound to happen, but then we also have to take into
account that Mr. Bernanke and Mr. Paulson will be standing by with
their money printing machines and "extraordinary monetary policy
measures" to bail out their bodies on Wall Street and in government.
is one last point I wish to make and this concerns the recent improvement
in the still-negative saving rate and, as David Rosenberg puts it,
the net paydown of consumer credit. From the figures provided by
Bridgewater, we can see that although the average household isn't
saving, there are still a huge number of US saver households that
are lending money through the financial system. These household
savers provided 4% of GDP to balance the financial gap (see above).
Now, in an economy where wealth is shifted from the masses or the
median household to the Wall Street bonus recipients and other asset
shufflers, the saving rate does increase: the average household
may not save out of current income, but people earning in excess
of US$50 million a year may have a 90% to 95% saving rate.
a result, the overall increase in the saving rate for the economy
as a whole may be due not to the typical household's willingness
to increase its savings and rebuild its balance sheet, but to his
complete inability to spend. In this instance, the growing income
and wealth inequities lead to some form of "forced saving" and can
contribute, as some economists maintain, to an economic slump. (The
Great Depression of 19291932 is explained partly by rising
income inequity: the masses want to spend but cannot afford it,
while the rich can spend but already have everything and therefore
don't spend enough.)
our remarks about the polarisation of wealth in the US, one could
construe that the typical household in the US is vulnerable, whereas
the type of people who make the Forbes list of the 400 wealthiest
Americans will continue to thrive. (I could also be labelled as
a socialist.) This would imply avoiding stocks such as Wal-Mart
and Home Depot, and buying any company that has to do with the economy
of the superrich, such as auction houses, brokerage stocks, publicly
traded hedge and LBO funds, luxury goods retailers, and high-end
hotel chains, or investing in top-end properties around the world.
Indeed, if we compare the performance of luxury department stores
to the performance of low-end stores, it is evident that the economy
of the super-rich has done far better than that of the median household.
when payback time comes, it is likely that the economy of the super-rich
could be hurt rather badly. This would certainly be the case if
Albert Edwards is correct and the "credit cycle is turning down".
In the mid-1990s, Stephen Roach frequently wrote about a "workers'
backlash". His view was that, in time, wages would rise, lifting
the rate of inflation and depressing corporate profits. While this
view was premature then, I wouldn't be surprised to see wage inflation
accelerating and shifting some income back from Wall Street and
corporations to the labour force. Such a shift would lead to higher
inflation and have a negative impact on corporate profit margins,
and on the valuation of bonds and equities.
is another point I should like to make about the economy of the
super-rich. In the late 1980s, the super-rich did very well in Japan.
In the mid-1990s, the super-rich creamed off all the money in Southeast
Asia. Both periods were characterised by asset accumulators becoming
rich and being highly leveraged. In both cases, subsequent events
the bear market in asset prices in Japan, and the Asian crisis
hurt the asset shufflers the most; ordinary people, especially
those living in the countryside, were hardly affected. I suppose
that if you have nothing, you have little to lose! Therefore, as
a contrarian bet, I would look at shorting at some point companies
that have benefited the most from the shift in wealth from the masses
to the asset shufflers. Such a list would obviously include luxury
retailers, the brokerage industry, asset management companies, and
custody banks, all of which either arranged or benefited from this
transfer of wealth and the asset inflation.
last few weeks have been characterised by a weak dollar and rising
equity, bond, and commodity prices. As we move into 2007, the pattern
will be the same. Either the Fed will finally decide to implement
tight monetary policies, which would strengthen the US dollar and
weaken all asset prices except bonds, or it will continue with its
expansionary bias. In that case, asset prices will continue to rise
and the dollar will continue to weaken. However, it should be understood
that under easy monetary policies, dollar assets (US equities, bonds,
and real estate) will, as has been the case for the last few years,
underperform foreign assets and commodities. Since Mr. Bernanke
was appointed Fed chairman, the S&P 500 is up by 14.6% in dollars,
but only by 7.5% in Euro terms. Over the same time frame (November
1, 2005 to November 27, 2006), gold is up 40%, silver 80%, and copper
68%. Year-to-date, the S&P is up 11% in dollars but only up
0.2% in Euros and, of course, it is down against gold and silver.
The worst investments were US dollar cash and bonds, both of which
declined in value in both Euro and gold terms. Therefore, I advise
investors who wish to have an equity exposure to overweight foreign
markets, especially the Asian stock markets, and to significantly
underweight US assets.
term, asset markets are mostly over-extended and the contrarian
play is to reduce exposure to all asset markets. Moreover, after
its recent weakness, the dollar could stabilise, but a strong rally
shouldn't be expected. Euro-area monetary and debt growth has been
strong over the last 12 months and may force the European Central
Bank to increase interest rates, which should support or even strengthen
the Euro. Also, given the record short positions that exist in the
Japanese Yen, I would consider buying Yen against the US dollar.
of late November, asset markets became extremely overbought. I recommend
deferring any buying and to await the shape and the severity of
the expected correction.
I wish my readers a Merry Christmas and a Happy New Year. I would
like all my readers to travel often to new places to see the world,
to learn about other cultures, and to take an interest in other
people's lives. I also hope that my more affluent readers know that
giving money away isn't the only way to help those who are less
fortunate. As the author Han Suyin (
Many Splendored Thing) observed, "There is nothing stronger
in the world than gentleness." And as Abigail Van Buren remarked,
"The best index to a person's character is how he treats people
who can't do him any good, and how he treats people who can't fight
back." At the same time, I hope that my readers enjoy their lives
and have some fun and laughs. The famous and extremely popular golfer
Chi Chi Rodriguez once said: "I was born broke, so I want to live
like a millionaire and die poor; I don't want to live poor and die
a millionaire." Mark Twain believed that, "Twenty years from now
you will be more disappointed by the things that you didn't do than
by the ones you did do. So throw off the bowlines. Sail away from
the safe harbor. Catch the trade winds in your sails. Explore. Dream.
the same time, on a more sobering note, don't forget the words of
Mahatma Mohandas K. Gandhi: "The things that will destroy us
are: politics without principle; pleasure without conscience; wealth
without work; knowledge without character; business without morality;
science without humanity; and worship without sacrifice."
Marc Faber lives in Chiangmai, Thailand and is the author of Tomorrow's
Gold. This article first appeared in whiskeyandgunpowder.com.