This week, I placed an investment buy order. In reaching this decision, my intuition says now is the time. I’m not suggesting converting one investment into another, that’s a different analytical exercise. But buying means taking available cash, delaying spending, and making an investment today.
As I consider the marketplace dynamics, we are at the stage, where foreign countries will begin to see internal infrastructure projects as a viable investment vehicle, superior to US government securities or US based assets. The results coming from the recent G-20 meeting hosted by President Bush, and China’s near simultaneous announcement that it was spending $568 billion on its infrastructure are significant events. China’s investment is 17% of its economy’s size. By comparison, the 700 billion TARP program pushed by the Bush Administration is 5% of US Gross Domestic Product. When congress approved the TARP program it was a wrangled mess (proposed, voted down, market crashed, approved). Therefore, expect in our near future politicized efforts generating a stimulus/investment package, which means unintended consequences, and ineffectiveness.
However, one distinction between China’s situation and the US situation is noteworthy. China has savings available for investment purposes. The US on the other hand must increase borrowing. When considering all securities, the ratio of US holdings of foreign securities to foreign holdings of US securities has held near 70% since 2001, or approximately a net 2.8 trillion holdings advantage for foreign investors. Thus, we cannot and historically have not financed our economy. Additionally, China’s investments in US assets, among all foreign countries, is the second largest (June 30, 2007 as reported in the Treasury Department’s Report on Foreign Holdings). Consequentially, the prospect of China reallocating money away from United States assets is particularly worrisome.
Amazingly, the press has repeated the term “flight to safety” at will when explaining depreciating emerging market equity values, commodities, and the rising US dollar during the last three months. As investors deleveraged and unwound their complex hedging transactions, and strengthen their balance sheet positions, US dollars denominated government debt purchases soared and correspondingly reflected lower interest rates. But what qualities indicate safety? US personal saving trends are in the toilet, the economy is declining and flirting with negative real growth, concern for deflation replaces concern for inflation in fewer than six months—proving simultaneously that the press has no sense for interpreting economic data—and industries are failing, or outright going away (investment banking, automobile manufacturing to name two). These qualities do not reflect a country with high prospects for paying back loans and producing positive real returns on investments.
When real returns start showing negative results, investors move their money—An axiom of human behavior we can count on. With Democrats in office, and aching to demonstrate that protecting the middle class is their mantra, rising government spending is highly likely. To finance the remaining TARP and short-term economic stimuli as proposed by the incoming Democratic congress, will add considerable debt. We can listen to the Obama administration’s economic sound bites for a strong clue about the future, “don’t worry about government deficits in the short term.” That’s why my earlier conclusion is so relevant. With China’s potential investment in internal infrastructure projects and the US needing more debt to revive its domestic economy, the US will have more difficult times raising cash. Which means higher interest rates, and stifling choices for the government. Not bankrupting choices, but stifling choices. Choices that produce negative real interest rates, and declining currency values.
So why did I make an investment you might ask, because with US interest rates low, and emerging market interest rates high, high expected return is available. As the US interest rates trend upward to attract more bond sales, real GDP growth rates will have to slow. Thus creating a difficult environment for businesses with US dominated sales and profits to generate adequate returns. High expected returns are with trading partners, except Japan, of China. The next few months will tell a good tale of macroeconomic interconnectedness.