Forecast: The Next Ten Years
by John Mauldin
April 16, 2005
European Uncertainty
Sinking Globalization
Smoot-Hawley is Alive in the Senate
Stratfor Decade Forecast
The China Meltdown Syndrome
The Russian Orthodox Church Leads the Way
The Collapse of the European Political Union
La Jolla and Houston
This week we look at how politics and geopolitical events can affect our investments. We look at a decade-long forecast from one of my favorite information services: Stratfor.com. I change my view on the euro, talk about a possible Chinese recession and look at uncomfortable analogies between 1900 and today. There's a lot of ground to cover so we will jump right in.
I have had the relative value of currencies on my mind every day for the past two weeks. I have been in London, where the pound sterling is at a staggeringly high level, almost two dollars to the pound. Prices in London have always been high, even when the dollar was at its peak. Now they border on the absurd, at least to someone used to the economical confines of Texas. Admittedly I was in a high rent district (Mayfair), but a simple round-trip subway ride was $8. From my viewpoint, it seemed that the price of everything was almost double and sometimes triple what it is for me locally in Texas. There are no cheap drunks in London. Expensive drunks, maybe, but no cheap ones (and no decent steaks).
London is a very civilized place, and quite fun to visit. I enjoyed meeting with clients and business associates, but it was hard to get used to the prices. And the sad thing is that it is likely to get worse over time before it gets better.
While I was there, I watched the polls from France. Last fall, it looks like 70% of the French voters would approve the new to European constitution. If the vote were held today it would fail, and the polls continue to get worse. This has the elite of Europe in quite an uproar. It also looks like the Netherlands could vote no even before the British get a chance to object.
European voters are being asked to accept an 800 page constitution that almost no one has read and which would create a powerful new bureaucracy in Brussels, as if Europe doesn't have enough bureaucracy as it is. The left in France is worried that the welfare state could be changed and the right is worried that even more regulations and nonsense could come down from Brussels. There are both right to worry.
Will a "no" vote be the end of the European Monetary Union? No. Will the euro go away? No. Will it to force the Euro-politicians to become more realistic about the pressures facing Europe, especially demographic and economic issues? Yes.
But it will also create a great deal of uncertainty. And the one thing we know about uncertainty is that the markets don't like it. I have been bullish on the euro for over three years, almost from its bottom. In the medium-term (five years) I am still bullish. But right now, I am simply nervous. I think I want to find other ways to bet against a falling US dollar. Looking around the world my eyes rest on Asia as the next region to see its currency's rise against the dollar. I would expect the euro to rise as well, but now there is a cloud of uncertainty, so I suggest we sit on the sidelines until we can be more confident about the euro.
For several years, I have been recommending that investors who want to play the currency can do so by investing in FDIC insured accounts and CDs at Everbank. You can purchase a CD in almost any currency you can think of it. I know that many of you have bought euro-denominated CDs. What I would suggest you do, is that when the maturity on your CDs come up, that you roll it over into their new Asian Tiger Index CD. This is what my good friend Chuck Butler recently wrote:
"I am very happy to announce that Everbank World Markets is now offering a new 'Asian Tiger Index CD'... We're going to originate a CD that will be made up of the currencies from Japan, Thailand, Singapore, and New Zealand. Ok, we don't need a geography lesson... We have added New Zealand, because it is 'Pan-Asian,' it exports mainly go to Asian countries, and it pays the interest! If you're interested, call the desk (1-800-926-4922) for the details... The interest rate will be 2% for both a 3 and 6 month CD... I've done this because I continue to believe the next big leg down in the dollar will have to come from the Asian currencies that, to date, have not participated, in a big way, in the dollar's weakness... And where are the majority of our IOU's held? Asia... So... If the global imbalances created by the dollar and these weak Asian currencies are going to receive any correcting, the Asian currencies must rally VS the dollar." Ask for Chuck and tell him I sent you. (I should note that Everbank is a sponsor of my publisher.)
Sinking Globalization
Niall Ferguson is Professor of History at Harvard University. He recently authored an essay which appeared in Foreign Affairs (Volume 84, No. 2) entitled "Sinking Globalization." (There is no free link but you can subscribe if you like at http://www.foreignaffairs.org/.) I would like to recommend this essay to you, and quote a few paragraphs as a way to introduce today's main topic:
"From around 1870 until World War I, the world economy thrived in ways that look familiar today. The mobility of commodities, capital, and labor reached record levels; the sea lanes and telegraphs across the Atlantic had never been busier, as capital and migrants traveled west and raw materials and manufactures traveled east. In relation to output, exports of both merchandise and capital reached volumes not seen again until the 1980s. Total immigration from Europe between 1880 and 1910 was in excess of 25 million. People spoke euphorically of 'the annihilation of distance.'"
Then came World War I, eventually the Great Depression and an even larger WWII. Dr. Ferguson compares the last great period of globalization with today and wonders if we are being complacent.
"The last age of globalization resembled the current one in numerous ways. It was characterized by relatively free trade, limited restrictions on migration, and hardly any regulation of capital flows. Inflation was low. A wave of technological innovation was revolutionizing the communications and energy sectors; the world first discovered the joys of the telephone, the radio, the internal combustion engine, and paved roads. The US economy was the biggest of the world, and the development of its massive internal market had become the principal source of business innovation. China was opening up, raising all kinds of expectations in the West, and Russia was growing rapidly.
"... the end of globalization after 1914 was not unforeseeable. There was no shortage of voices prophesying Armageddon into prewar decades. Many popular writers earned a living by predicting a cataclysmic European war... Yet most investors were completely caught off guard when the crisis came. Not until the last week of July 1914 was there a desperate dash for liquidity; it happened so suddenly and on such a large-scale that the world's major stock markets, New York's included, closed down for the rest of the year."
There were five factors which helped precipitate the global explosion of World War I. The British Empire was over-extended; there was a significant rivalry between the great powers; unstable alliances (think NATO, he says); a rogue regime sponsoring terror; and, "the rise of the revolutionary terrorist organization hostile to capitalism turned an international crisis into a backlash against the global free-market."
Ferguson notes the parallels between the former period and today. I can think of a number of significant differences. For one, there are no nations with the military power to rival the United States, and there will not be for a long time. The rise of free markets and free people is a calming factor. That does not mean the world is without problems. We all know, as Ferguson points out, that a nuclear device planted by Al Qaeda in London or civil war in Saudi Arabia would disrupt the world order significantly. We could spend the next three or four pages listing possible doomsday scenarios, however unlikely.
However, it is not Al Qaeda, Saudi coups, the US trade deficit or a crisis over Taiwan that worries me. I am far more concerned about politicians creating an economic trade war which would destabilize the global economy. For new readers, my long-term view is that we are in what I call the Muddle Through Decade. I expect a series of recessions over the next ten years to provide the impetus to deal with the US trade deficit, consumer debt levels and rebalance global trade into a more sustainable model. It will also be a period of slower than usual growth, thus "Muddle Through."
This is not gloom and doom. It is a simple recognition that the current trends cannot continue and we will have to get back to a more stable economic situation. In the past it always required multiple recessions to be the motivating factor for people to get their house in order. I see no reason why that should change in the future. Most of us with a few gray hairs have lived through numerous recessions and while it may have forced a few uncomfortable changes, our generations are no worse for the wear.
The one thing which could derail my rather benign scenario is a trade war. A real trade war, in my opinion, would lead us to a global depression which would take us decades from which to recover. Sadly there are significant forces in both the United States and Europe which would like to see a rise of protectionism, tariffs and trade wars. These politicians pander to voters who would like to see the status quo maintained. "Protect my job, welfare, benefits and lifestyle," they cry.
However, one of the things that we can confidently predict in a world of accelerating change is that the status quo will not be maintained. The status quo will be increasingly under assault from all directions, not the least of which is the demographic imperatives of an aging developed world. The developed world (the US, but especially Europe and Japan) simply cannot afford to maintain their welfare states over the coming decades. Yet that is precisely what the voters will ask them to do.
Politicians will never admit that the problem is with the systems they have created and which are essentially bankrupt. The voters don't want to hear that their benefits are at risk. They will blame others and pursue policies which will have negative economic consequences. This will of course make the situation worse, but it will be too late.
Smoot-Hawley is Alive in the Senate
Such a scenario does not have to happen. Calmer, wiser heads should prevail, as most sane people realize that a trade war would devastate the world. Yet there are times I get nervous and last week provided just one of those examples.
Senator Charles "Smoot-Hawley" Schumer of New York is sponsoring a bill which would slap across-the-board tariffs on imports of Chinese goods unless China agrees to revalue its currency. The Senate failed to kill the legislation last Wednesday on a vote of 67-33. Never mind that such legislation would be a huge tax on the American consumer, would signal to the world that free trade is no longer the policy of the United States, and would have an almost immediate affect of raising interest rates, causing a drop in housing values and a recession. By the latter, I mean that if the Chinese were not buying our US debt interest rates would rise.
Pardon me a moment of cynicism, but I don't think there are 67 senators who are that economically illiterate (perhaps 40 or so, with Schumer being chief among them!). What I do think is that they see this as a free opportunity to pander to the voters in their states. They know that the President Bush would veto such a bill so they vote for the bill with the comforting knowledge that they will never have to deal with the consequences. They get to have their cake and get to eat it too.
We see the same sentiments echoed in Europe. In next Monday's Outside the Box we will read an essay from those very smart guys at GaveKal Research discussing the dismantling of the European Growth and Stability Pact last week. They note "In Brussels, we saw a French president [Chirac] give echo to the more protectionist thesis of the greens, the reds and other fruitcakes. We saw a French president blame Europe for 'dumping social, dumping fiscal, dumping ecologique'."
Stratfor Decade Forecast
Everyday I eagerly read an e-mail from Stratfor.com. Stratfor is described by Barron's as "a private quasi-CIA [which] has enjoyed an increasing vogue in recent years as a result of its heady forecast and many news breaks. It is a private intelligence and security consulting organization based in Austin, Texas with a global network of intelligence sources. They provide corporations, governments, financial institutions and individuals with geopolitical analyses and forecasts that assist them in managing risk and helping them to anticipate political economic and security issues vital to their interest. George Friedman runs the firm, and I consider his essays on the world political situation to be some of the more insightful I read anywhere. He is one smart gentleman.
While their services can be quite expensive, their daily e-mail is somewhat more affordable. I consider it a must-read. Every five years they produce a 10-year geopolitical forecast. In 1995 they predicted the meltdown of Asia, which happened in a 1997. They have been consistently right in their analysis of Russia and Europe. I could go on for pages about all the correct calls they have made, (along with a few misses, of course), but let's go ahead and look at a partial summary of what they predict for the next 10 years. The entire report is 45 pages, but we will cut it down to the main points in the next few pages. Quoting from their introduction:
"A decade forecast is the longest we attempt at this time, because anything greater than a 10-year forecast encounters history's tendency to have wild discontinuities. Even a 10-year forecast has discontinuities built in. A 10-year forecast in 1980 would have had to forecast the collapse of communism in Eastern Europe. A forecast in 1910 would have contained World War I.
"The art and science of forecasting requires that you recognize that the least likely outcome is simple extrapolation. You can draw straight lines for a year, but drawing them out for 10 years is dangerous. A decade forecast, therefore, is about predicting the unexpected. [emphasis mine] But it is precisely the wildly unanticipated that a decade of history throws up at you. Predicting in 1995 that the United States would invade Afghanistan in 2001 would have been enormously difficult. It would have been far easier to draw a straight line showing that the post-Cold War interregnum would be eternal.
"It follows from this that expecting the U.S.-jihadist war to continue to dominate the world in 2015 - 14 years after the war started - is fairly unrealistic. If the Islamic world remains the focus of the international system, it will be on very different terms than today. In fact, it is our view that the jihadist issue will not go away, but will subside over the next decade. Other - currently barely visible - issues are likely to dominate the international scene."
I should note that their forecast, while having some disconcerting elements, is nowhere near as pessimistic as the Ferguson essay mentioned above. Indeed, compared to that essay, it is quite reassuring. And they are at their most (relatively speaking) optimistic when looking at the United States.
They see the focus of the US going from the Middle East to East Asia. They expect the US to disengage from Iraq and the Middle East in general, as we essentially minimize the risk from the jihadist movement by the end of the period. Interestingly, they expect a decline in US foreign involvement in the years around 2010, followed by increased involvement in Asia. They see increasing coalitions uniting in an effort to resist American power, primarily in East Asia, which will require our attention
In summary on the economy: "It is our expectation, based on our Asian forecast, that pressure on the trade deficit will subside before the end of the decade. At the same time we continue to forecast productivity growths and smoothed demographic curves throughout this period. We expect two or more recessions during the coming decade - at least one of which will be triggered indirectly by Chinese problems. When China's own version of the Asian model falters, China's export sector will cease its current red-hot growth. This will gut Chinese exports to the United States, thereby removing China's need to heavily invest in American government debt.
"For the past two years, China has not only been a leading source of U.S. trade deficit, it also has been a leading purchaser of U.S. government debt to finance that deficit. The Chinese crunch and step-back from U.S. debt purchases will cause the U.S. dollar to plummet on international markets, most likely triggering a recession until the U.S. economy's inherent efficiencies allow it to regain its strength. We do not expect to see a return to 1990s growth rates. At the same time, we regard the American economy very positively indeed."
Maybe I like this because it sounds almost exactly like my Muddle Through scenario, but I think there is much to commend this.
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broke off from election campaigning at home to press his G7 colleagues to back 
