The American manufacturing renaissance that never was

by
Chris Matthews

@FortuneMagazine

January 7, 2015, 2:14 PM EST

President Obama is spending Wednesday in the Detroit area, visiting a Ford assembly plant and touting his auto-industry bailout and other efforts to spur a comeback in American manufacturing.

Manufacturing has long been a top priority of the Obama Administration. Beginning with the auto bailout, which the administration now claims cost taxpayers $9.3 billion but saved more than a million jobs, Obama doubled down on his commitment to manufacturing, setting a goal of doubling American exports between 2009 and 2014.

But according to Robert Scott of the Economic Policy Institute, the U.S. economy will fall well short of that goal, as exports only increased by 48.4% over that five-year span. Not only did the U.S. economy fail to meet that goal, but the rise in exports between 2009 and 2014 was actually smaller in percentage terms than it was in the five years following the 2001 recession. Sure, declines in manufacturing employment have reversed, but total manufacturing employment remains far below levels seen ten or fifteen years ago:

US Manufacturing Employees data by YCharts

While the president might deserve credit for preventing the liquidation of General Motors GM and Chrysler FCAU , there’s little evidence that his policies have helped spawn a manufacturing renaissance in America.

But with the country growing ever closer to full employment and the economy finally seeing the kind of economic growth that suggests a strong recovery, should we focus on the manufacturing sector at all?

First, there is a positive correlation between a healthy manufacturing sector and export growth. Sure, you can export services, and foreign tourists spending money stateside can help narrow the trade deficit as well. But without a robust manufacturing sector, a country will not be able to export a ton of goods. And while trade isn’t a zero-sum game—Americans aren’t necessarily worse off because they have access to cheap foreign products—importing more than you export leads to a gradual erosion of wealth.

Policy makers favor the manufacturing sector because it has historically provided good paying jobs for middle-skill workers, or those folks who have more than a high school education but not a four-year college degree. The single biggest problem facing the American economy today is stagnant wages for the median worker, and, the thinking goes, a resurgent manufacturing sector could allow a greater share of the population to enjoy the country’s economic gains.

But this notion is flawed. First of all, you could argue that America’s manufacturing sector cannot come back because it never went away at all. After all, the share of GDP that comes from manufacturing has been remarkably steady over the past 50 years. Rather, it’s the share of workers employed in the manufacturing sector that has declined.

The above chart, excerpted from a study on the American manufacturing sector by economists Martin Baily and Barry Bosworth, shows that manufacturing is going through the same transformation that agriculture underwent a century ago. At the beginning of the 20th century, roughly 40% of Americans worked on farms. Today, less than 2% do. But it’s not like we’ve stopped growing massive amounts of food; it’s just that we’ve figured out how to do it with far fewer workers.

The manufacturing growth that the U.S. is experiencing, according to Baily and Bosworth, is overwhelmingly concentrated in the computer and electronics industry. At the same time, the manufacturing jobs that we have added in recent years aren’t the kind of middle-skilled, high paying jobs that politicians covet. According to a recent study by the Brookings Institution, wages for workers in the manufacturing sector fell faster than wages in the private sector overall from 2009 to 2011, and wage growth in the sector has remained just as stagnant as overall wages since that time.

Even manufacturing powerhouses like China are shedding jobs in that sector. Even as millions of Chinese citizens leave the farm and flock to cities looking for work, there are fewer manufacturing jobs in China than there were 20 years ago. And so, even if the president could force through changes like lower corporate tax rates for manufacturers, the global trend in manufacturing is all about doing more with fewer workers. Even if you set the issue of employment aside, the U.S. trade deficit over the past five years increased, meaning that the rest of the world was more successful at selling us more stuff than vice versa.

To make matters worse, economists cannot agree on what has caused America’s manufacturing malaise or why the trade deficit is so persistently large. Some argue that we should blame large government deficits, which have pushed up the value of the dollar and made U.S. manufacturers uncompetitive. Others point the finger at China’s efforts to keep its currency artificially low. But without a consensus from the economic community, it would be unwise to risk stamping out the economic recovery by sparking a trade war with China over currency disputes or drastically reducing the budget deficit.

So, while politicians might enjoy scoring cheap political points by making speeches at manufacturing plants, the data show that there are no easy solutions to the country’s persistent trade deficit or its stagnant wages.

Why the dollar will spoil the 5% GDP party in 2015

@FortuneMagazine

December 23, 2014, 4:35 PM EST

All of a sudden, the U.S. economy appears to be cashing in.

On Tuesday, the government reported that GDP rose 5% in the third quarter. That is 1.1 percentage points better than the government’s earlier estimate, and it was the fastest rate of quarterly economic growth in more than a decade.

The report was yet another sign that the U.S. economic engine, after years of just barely making it up the post-recession hill, is finally chugging along.

And there was indeed a lot of good news in Tuesday’s report. Consumers were opening up their wallets wide again. Corporate profits grew more than previously thought. And corporate spending, what the government calls non-residential investment, was up a good amount as well.

That had a lot of people cheering that the prospects for the U.S. economy in 2015 were looking good. “The risks are around,” says Robert Eisenbeis, a top economist and Fed watcher at Cumberland Advisors. “But we have been living with these risks for a while and doing just fine.”

The economy is certainly better than it was just a year ago. But does it really feel 5% good? So far this year, the U.S. labor market has created an average of 240,000 jobs a month. That’s impressive, but it’s not 5% impressive. An economy growing consistently at 5% would be creating more like 575,000 jobs a month. We are a considerable distance away from that. And 5% GDP growth would put the U.S. in spitting distance to China, which, despite recent growing pains, is undergoing a major economic transformation.

And that’s the problem. A major contributor to the third quarter GDP growth figure was business from abroad. A smaller trade deficit—more exports and fewer imports—added 0.8 percentage points to GDP in the third quarter, or nearly 20% of the growth. It’s hard to believe the U.S.’s good trade news will continue, especially once we get into 2015.

First of all, the rest of the world’s economies appear to be slowing. And while the U.S. has continued to grow despite that, it’s hard to believe we can keep growing, especially at 5%, if the rest of the world is shrinking.

The dollar could pose an even larger problem. Over the past six months, the U.S. dollar has been up by more than 12% compared to a basket of international currencies. That makes it harder for U.S. companies to sell their goods overseas. That was a little bit of a drag in the third quarter, when the dollar started to appreciate, but it could turn into a major headwind in 2015.

The one piece of good news is oil prices, which dropped nearly 30% in the fourth quarter. Cheaper oil significantly reduces the costs of our imports, lowering the trade deficit. Lower prices at the pump also puts more dollars in the pockets of U.S. consumers, who can use that cash on other things. That should provide an economic boost, but perhaps not as much as some people think. If U.S. consumers spend those extra dollars on goods from abroad, which are now relatively cheaper, that will add to the U.S. trade deficit, making our 5% growth hurdle even harder to achieve in the coming months and years.

The case for a global recession in 2015

by
Chris Matthews

@FortuneMagazine

October 28, 2014, 10:53 AM EST

Four years after the end of the Great Recession, it looks as if the U.S. economy might finally be poised for breakout growth.

Monthly job growth in 2014 is, on average, faster than at any point since the financial crisis. Overall economic growth appears to picking up too, with real GDP growing by more than 4% in the second quarter of this year, and many economists predicting higher overall growth compared to
last year.

But news outside the U.S. isn’t so bright. European economies are still battling depression-era levels of unemployment and the threat of deflation. And emerging economies, like China, are having trouble maintaining the kind of growth they have become accustomed to in recent years. The most recent readings out of China have the world’s second-largest economy growing at roughly 7.5% per year, down from the 10% growth it averaged for two decades before its economy began to slow in 2012. And this pattern holds for other emerging economies like Brazil and Russia.

Optimists hope that an accelerating U.S. economy will have what it takes to drag the rest of the world out of the doldrums, as it has done during so many past recoveries. But David Levy, economist and chairman of the Jerome Levy Forecasting Center, argues that the problems of the rest of the world will end up taking the U.S. down, rather than the other way around.

Levy is calling for a 65% chance that there will be a global recession by the end of 2015, based on the simple fact that emerging markets have continued to invest in an export infrastructure to sell goods to the West that it no longer has the wherewithal to buy.

Levy is an intellectual descendant of the economist Hyman Minsky, a heterodox thinker who spent many years working at the Jerome Levy Economic Institute and whose theories were largely ignored by economists up until the latest financial crisis. Once the crisis struck, however, Minsky’s ideas seemed to make a lot more sense. He argued that capitalist economies slowly and naturally become unstable over time, as banks and private businesses take on more and more debt, until the system finally snaps under the weight of these obligations. After surveying the wreckage caused by an over-leveraged banking system, which had gorged itself on debt backed by overvalued real estate, the economics world has begun to pay much closer to attention to Minsky and his views on financial instability.

Indeed, Minsky and his ideas have captured the attention of big-name figures like hedge fund titan Ray Dalio and economist and Financial Times columnist Martin Wolf, who began his latest book with a quote from Minsky arguing that economists ought to formulate theories in which depressions are a naturally occurring state for capitalist economies. These thinkers have been drawn to the Minksian notion that, over the long run, capitalist economies will inevitably suffer from the kind of trouble we’ve been in recently because capitalist systems encourage the growth of debt.

We hear a lot of people warning about the dangers of debt, specifically the government variety. But for Minksy and his followers, it’s private sector debt that is the problem. Here’s how economist Paul Krugman has described the Minskian concept of debt:

He argued that conventional views of financial crisis were too narrowly focused on the specific issue of bank runs. In Minsky’s vision, excessive leverage—too much reliance on borrowed money—creates a risk of crisis whoever the borrower. Banks, which in effect borrow money short-term from their depositors but invest in assets that can’t easily be converted to cash, may be especially vulnerable. But business and household debt also expose the economy to the possibility of a self-reinforcing downward spiral.

The following chart, provided by Levy, shows the accumulation of private debt in the U.S. and in China:

As you can see, debt in the U.S grew and grew until the trend was finally snapped in 2008. This process of “deleveraging” is beginning to end in America, but in places like China, the debt buildup hardly paused, and now the ratio of debt to GDP held by non-financial businesses in China is higher than it ever was in the U.S. So, what is this debt financing? Investment in businesses and real estate, to fund the great Chinese export machine. The problem is that exports haven’t grown in China to justify that demand, as the following chart shows:

You can see the same general trend for other emerging markets. They’ve continued to invest, hoping that the export growth catches up to pre-crisis levels. Eventually, the consequences of this overinvestment will be clear, just like the U.S. economy had to deal with its own over-investment in real estate.

So what happens when emerging markets are finally forced to face the music? It’s tough to say what a financial crisis in China would look like, Levy argues. The government in Beijing has the ability to take a much more activist role in protecting the financial system than even the U.S. did. But either way, the world’s second largest economy, and others like it, are headed toward much slower economic growth.

Twenty years ago, a recession across the emerging world might not have been a huge deal for the U.S., but the American economy is more reliant on global trade today than it has been in a long while. Thirty percent of the jobs added since the financial crisis has been the result of rising exports, according to the Treasury Department, and there are now more firms exporting goods and services in America than ever before.

The U.S. economy is even more closely connected to the European economy, which Levy also shows has done a poor job of deleveraging:

The European banking system never really recovered from the financial crisis. A stress test released on Sunday showed that 25 out of 130 institutions are unsound while critics argue that the failure rate should be far higher. Levy has little confidence that Europe will be able to withstand an economic shock stemming from the emerging economic world. And once Europe is dragged under, he says, there isn’t enough economic strength at home to keep the U.S. economy from avoiding another recession.

8 ways an independent Scotland could spell U.K. economic disaster

by
Chris Matthews

@FortuneMagazine

September 17, 2014, 2:48 PM EST

Will an independent Scotland suffer a total and irreparable economic meltdown if voters choose to break from the United Kingdom on Thursday?

U.K. loyalists, the City of London, and the most of the British media seem to think so. They believe that an independent Scotland would struggle to turn itself into a viable economy and it would be saddled under enormous amount of debt if it were to go it alone.

While leaving the United Kingdom might hurt Scotland economically at the outset, it will probably end up just fine on its own, thanks in large part to its educated population and vast energy reserves. In fact, it isn’t the Scots who should be worried here—it’s the U.K.

The following are a few of the major economic concerns that have been keeping investors and U.K. loyalists up at night if Scotland chooses independence.

1. The U.K.’s net import dependency for fossil fuels would shoot up from 47% to 95% as an independent Scotland gains control over the vast majority of the U.K.’s oil and natural gas reserves in the North Sea. This could cause energy prices across the U.K. to shoot up overnight as energy traders turn bullish and bid up future prices. While there may not be any material impact on supply, the market reaction could have a long-lasting and devastating effect on prices for some time as forward prices remain elevated. Higher energy prices would result in a decrease in disposable income, especially for the U.K.’s struggling middle class. This would hurt Britain’s service sector, possibly plunging the country back into recession.

2. Scotland could refuse to take on its share of the U.K. national debt. This scenario would raise the ratio of the U.K.’s national debt to GDP from 88% to 99%. U.K. sovereign debt rates would almost certainly shoot up as investors would require higher yields to compensate for the increase in credit risk. The extra debt servicing costs would further eat into the U.K.’s ravaged income statement, forcing it to either take on more debt or make painful cuts in services.

3. The loss of North Sea crude oil would cut significantly into the U.K.’s total exports. Crude and refined petroleum makes up 12.5% of the U.K.’s exports. Scotland stands to gain 98% of the U.K.’s crude oil, reducing the U.K.’s overall exports from $813.2 billion to $713 billion. These figures don’t include Scottish imports of U.K. goods, which could help to balance the numbers.

4. Chances are, U.K. exports to Scotland won’t be enough to make up for the loss of all that Scottish oil. The resultant expansion in the U.K. trade deficit, along with the increase in Britain’s credit risk profile, could cause the pound to lose significant value. The pound’s exchange rate to the U.S. dollar fell from $1.72 to $1.61 last week on fears of a Scottish exit. If Scotland gains independence, Nomura analysts estimate the pound could fall an additional 15%, putting the dollar exchange rate at its lowest level in 10 years, at around at $1.37.

5. The weaker pound would hurt the U.K.’s international purchasing power, forcing it to slash imports, lowering the standard of living for those left in Britain. The U.K. imported $783 billion in 2013, equal to around 28% of its GDP. A further 15% fall in the value of the pound would force the U.K. to spend $921 billion to import the same quantity of goods, making total imports equal to 33% of GDP.

6. The balance of trade could spiral out of control, sending shock waves through many parts of Britain’s economy. With exports reduced to $713 billion and imports increased to $875 billion, taking into account higher oil imports, the U.K. trade deficit would expand to $155 billion, further debasing the pound. The weakened pound would put additional strain on the (half) island nation’s ability to import goods, further lowering the U.K.’s standard of living. The one positive here is that the weakened pound would make the U.K.’s exports more attractive to foreign buyers. But there is no guarantee that U.K. exports could expand enough to fill the hole left by the loss of its considerable energy exports.

7. Depreciation of the pound combined with a growing trade deficit from greater dependency on foreign oil would lead to significant inflation, raising the cost of living and eroding real British wealth. Savings would take a hit, which could cause Britons to take their money out of sterling and convert it into a more “stable” currency, such as the dollar or the euro. This would further debase the pound and cause a major flight of capital that could destabilize British banks. Financial system instability might require government intervention to shore up depleted capital reserves. Currency controls would need to be implemented to keep the pound from falling, further eroding confidence in the currency.

8. All of this economic instability isn’t good for the City of London. Investors pulled 16.6 billion pounds ($24 billion) out of the U.K. last week, the largest such decrease in assets since the start of the 2008 financial crisis. Any additional decrease would be devastating to the city as it could set off a panic in the markets and a widespread withdrawal of capital across many asset classes. If investors kept their money out of the City for long enough, the financial industry would be forced to shrink, meaning mass layoffs. This would deliver a major blow to London’s economy, as it counts on the salaries of financial service professionals to keep it going.

Russia-Iran trade pact: Great for fear-mongering, not much else

by
Chris Matthews

@FortuneMagazine

August 7, 2014, 4:06 PM EST

Washington shouldn’t be overly concerned with Russia and Iran forming some sort of sanctions-busting economic trade pact. While a pact between the two countries may make sense politically as they both face economic sanctions from the West, the two sides truly have little in economic benefit to offer each other.

The Russian government surprised the markets on Tuesday when it announced what appeared to be a landmark economic trade pact with Iran. The multi-billion dollar deal was described as an “oil-for-goods” program in which millions of barrels of Iranian crude would be swapped for a variety of Russian goods and services. Russian Energy Minister Alexander Novak told reporters that the country would “participate in arranging shipments of [Iranian] crude oil, including to the Russian market.”

The news confirmed fears in Washington of the formation of an axis between Tehran and Moscow specifically designed to sidestep the Western sanctions targeting both countries. The fears subsided later in the day when the Russian government pulled the statement, giving no explanation. So, was there ever a deal?

Such is the folly that is Russian diplomacy these days. The Russians did reissue a statement on the pact, but it was lacking in any concrete detail regarding the oil swap. The three-paragraph statement said that the two sides had agreed to a “memorandum of understanding” in which the two “envisages the expansion of trade in several areas.” The oil and gas industry was mentioned alongside others such as construction, the development of grid infrastructure, as well as the supply of machinery, equipment, consumer goods, and agricultural products. That’s it. There was no mention of timing or possible volumes of oil to be traded.

Earlier in the year, Russian and Iranian state-owned media announced that the two sides were negotiating a pact that could see as much as 500,000 barrels a day of Iranian crude swapped to Russia. This concerned the White House as it would help Iran increase its export power significantly. Iran has the ability to export around 2.5 million to 3 million barrels of crude a day but, due to sanctions imposed by the West two years ago, the country is only able to export around 1 million to 1.5 million barrels a day.

Such an agreement would devastate the West’s efforts to curtail Iran’s nuclear ambitions through economic sanctions. At the same time, with the oil money cycling through the Russian economy, it would also undermine sanctions recently levied against Russia over its illegal incursions into Ukraine.

But while such a political agreement makes sense on paper, the reality is a bit more nuanced. Russian and Iranian trade is low at around $5 billion a year because neither country exports anything that the other wants. For starters, the last thing Russia needs is more oil. After all, it is the world’s second largest exporter of the stuff—pushing out around 5 million barrels a day or so. Since it is such a prolific exporter, Russia lacks the basic infrastructure to import foreign oil. There are no oil pipelines that link Iran and Russia, meaning that everything would need to go by ship. But since Russia lacks coastal refineries, it would not be able to receive or process any of the crude. Furthermore, its pipeline network is designed to pump oil out of the country, not back into it. This lack of takeaway capacity would make it difficult to move the oil around Russia.

It is difficult for Russia to import Iranian crude, but what about reselling it? That seems difficult as well. Even though Russia might buy oil from Iran, it would still be considered Iranian crude. That means Russia would face the same export restrictions Iran does in a sale. This would prevent it from marketing the oil to the European Union, Russia’s largest energy customer. Meanwhile, countries like China and Korea, which import large amounts of Iranian crude, have put a cap on imports. If Russia sells the oil to them, then Iran is stuck with more crude, evaporating the whole point of the swap.

What can Russia offer Iran? Well, around 70% to 80% of Russian exports is, you guessed it, energy, which, Iran doesn’t need. Reports mention that Russia could assist in upgrading Iran’s power grid and electrifying its rail network. That’s ironic, given the sorry state of Russia’s power grid and rail network, where blackouts and power surges are common. This past April, thousands of people in Russia’s far east went without power for days due to a “breakdown” at a local power plant. Meanwhile, a power surge is thought to have caused a derailment of a Moscow subway train last month that killed 23 people and injured scores of others.

Russia also mentioned beefing up agricultural exports to Iran, but that might be hard following Putin’s decree yesterday banning the importation of all agricultural products from the West. Russia will now have to make up for that shortfall in food by both increasing imports from neutral countries, like Brazil and Turkey, and by increasing its own domestic production, which isn’t an easy job given that winter is coming. In any case, that means Russia is more likely to import food from Iran, not export it.

The Russians also mentioned it could export consumer and manufacturing goods as payment for the oil. Unfortunately, though, Russia doesn’t really make a lot of consumer goods worthy of exportation. Russians themselves prefer goods from abroad and typically shun domestic goods due to their notoriously poor quality. It is doubtful that Iranians would line up to test drive the latest model Lada automobile or rip into a bag of shashlyk-flavored potato chips. The one consumer good Russia can make well is vodka but, alas, alcohol is banned in Iran.

Russia does produce one thing that may be of interest to Iran: weapons. Russia is the world’s second-largest weapons exporter, behind the U.S., so it actually has a lot to offer the Islamic Republic. Unfortunately, Russia is an unreliable supplier. Iran is still waiting for delivery of five S-300 advanced missile defense systems it says it purchased from Russia in 2007. Russia says it can’t deliver the weapons because it is banned from doing so due to, get this, UN sanctions. Iran has filed a $4 billion complaint with the International Court of Arbitration in Geneva to get its missiles. Until that case is resolved, it seems highly unlikely that Iran would want to engage in another multi-billion dollar arms deal with Russia in the near future.

A potential alliance between Iran and Russia has worried the West for centuries. But cultural, political, and economic ties have kept these two great powers at a distance. While the two do have a common enemy in the West, it isn’t enough to make them bosom buddies. Trade may indeed pick up between the two, but it won’t be much of a replacement for the markets these nations will leave behind.

The coming cocoa correction

by
Chris Matthews

@FortuneMagazine

November 19, 2010, 8:16 PM EST

An improving political climate in the Ivory Coast could result in a cocoa production boom. Combine this with slowing economic growth in the U.S. and Europe and the commodity looks downright expensive.

Cocoa futures aren’t looking so sweet these days.

We’re short cocoa, mainly because of the potential for an improving political situation in the Ivory Coast – the world’s largest producer of cocoa – and the potential for slowing demand as global growth slows sequentially.

From a consumption perspective, the U.S. and Europe are the largest consumers of cocoa. In fact, 16 of the 20 world’s top consumers (on a per capital basis) are European countries; by some estimates Europe consumes more than 40% of the world’s cocoa. In aggregate, developed countries consume more than 65% of the world’s cocoa, with North America being the second-largest consuming region after Europe. In total, the world will consume somewhere on the order of 3.6 million tons in 2010. (more…)

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