No Wrench

Warren Buffet exemplifies many of things that I find good and respectable about the American business community. He’s a shining example that you can run companies in a legal, above-board manner and still make ridiculous profits. He’s also dedicated his entire holding in Berkshire Hathaway to charity after his death, which will probably be the largest bequest ever. Considering his unsurpassed success as a business leader, when he speaks about the economy, it is usually a good idea to listen and his annual report to the shareholders of Berkshire is now up on the company’s website. A little more than two-thirds of the way through, Buffet discusses the US trade imbalance:

As our U.S. trade problems worsen, the probability that the dollar will weaken over time continues to be high. I fervently believe in real trade – the more the better for both us and the world. We had about $1.44 trillion of this honest-to-God trade in 2006. But the U.S. also had $.76 trillion of pseudo-trade last year – imports for which we exchanged no goods or services. (Ponder, for a moment, how commentators would describe the situation if our imports were $.76 trillion – a full 6% of GDP – and we had no exports.) Making these purchases that weren’t reciprocated by sales, the U.S. necessarily transferred ownership of its assets or IOUs to the rest of the world. Like a very wealthy but self-indulgent family, we peeled off a bit of what we owned in order to consume more than we produced.

I want to emphasize that even though our course is unwise, Americans will live better ten or twenty years from now than they do today. Per-capita wealth will increase. But our citizens will also be forced every year to ship a significant portion of their current production abroad merely to service the cost of our huge debtor position. It won’t be pleasant to work part of each day to pay for the over-consumption of your ancestors. I believe that at some point in the future U.S. workers and voters will find this annual “tribute” so onerous that there will be a severe political backlash. How that will play out in markets is impossible to predict – but to expect a “soft landing” seems like wishful thinking.

Over the next ten to twenty years, it is pretty likely that per-capita income in the US will increase. However, I would say that it is a fair bet or better that inflation adjusted median income is going to drop. In short, there are going to be more poor people and the rich people will have more money. This is part of the inevitable backlash that Buffet is talking about (or at least it is in my mind).

The interesting dynamic to watch, though, is what starts to happen in America as the dollar declines. The single largest reason for the dearth of American manufacturing jobs is the relative strength of the dollar to the Asian currencies. It costs so much less to manufacture things in China and ship them here that there is little to no financial incentive to actually having manufacturing jobs here. That’s one of the large reason that China is so willing to soak up American debt. In order to grow the Chinese economy they need a market that can afford to pay for their cheaply-produced goods. If the US stops buying Chinese goods, then China’s economy is going to have a hard time growing any more.

Well, the US dollar is currently dropping pretty hard against world currency, in part due to the excessive trade deficit that this country insists in maintaining. (As Buffet points out above, it is 6% of out total GDP a year). If the trend continues and if world financial pressure prevents the Chinese from re-pegging their currency (a favorite trick of theirs to maintain their cost edge), then all of a sudden the US manufacturing industry may be facing a new economic reality, where they can compete on price with the Chinese. It would be interesting to see. It would also be interesting to see how much that would effect the ‘soft landing’ chance that Buffet is talking about.

A strong manufacturing economy is what built the American middle-class in the first place. It would be highly ironic if manufacturing’s re-emergence due to currency fluctuation and the seemingly inevitable decline of the US dollar helped save it as well. Just all idle food for thought.

This entry was posted on Monday, March 5th, 2007 at 12:03 am and is filed under Finance. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.