Alan Greenspan will be leaving
as head of the Federal Reserve Board at the end of this month
to be replaced by Ben Bernanke as everyone knows by now. The
markets have had their ups and downs over the past eighteen
years which implies that the markets are much bigger than
one man. Mr. Greenspan oversaw the stock market crash in 1987,
to the technology boom of the 90s, to the stock market collapse
in the early part of the new century, to the current recovery.
So what does Alan leave his successor?
First of all a strong economy. Economic growth as measured
by Gross Domestic Product (GDP) will come in at close to 4%
for 2005. The fifty-six expert economists are predicting a
growth of 3.5% in the first half of this year and a slowing
to 3.1% in the second half (How can anyone predict GDP growth
down to decimal points?).
Secondly, a very manageable rate of inflation. Core inflation
(less food and oil) of less than 2%. We feel that China has
had more impact on our low rate of inflation than any Fed
policies. China has become the low-cost provider of manufactured
goods to the world holding inflation down. This will continue
for a while longer, but soon we will see worker revolts in
China as they demand higher wages, health care and retirement
benefits. Also, the rest of the global community will put
pressure on the Chinese to clean up the environment. All this
will raise China’s cost of manufacturing and in turn
start the wheels slowly turning to inflation.
Thirdly, a low interest rate environment. In spite of thirteen
Fed increases in the last eighteen months from 1% to 4.25%
(and at least one more at the end of this month), interest
rates remain at historic low levels. In fact, there is concern
now of an inversion of the yield curve where short-term rates
(two year) exceed long-term rates (10 years). That happened
briefly last week. Economists are worried that an inversion
of this type will lead to a recession as it often has in the
past – but not always. This has led to the conundrum
that Greenspan leaves Bernanke. Usually all interest rates
rise together. However, because of the heavy purchase of long-term
treasury bonds by foreign investors, long rates have been
kept at low levels. This conundrum is also evident in Britain,
Germany and Japan as cash circulating around the world is
also finding its way into long-term government bonds in these
countries. This is all part of the ongoing globalization.
Other large economy countries are on the watch for inflation
so their central banks are directly controlling short-term
interest rates and indirectly influencing long rates like
the US.
Who let the dogs out? It is the Chinese year of the dog.
In the West, dogs are considered loyal, faithful and man’s
best friend. In Chinese astrology the dog is a bit more unpredictable,
having trouble trusting others and being prone to telling
little white lies. So what can we expect out of China this
year? It is difficult to find information coming out of China
that is trustworthy. There is a definite bias in the media
to report glowing articles about the tremendous growth opportunities
for American corporations in China. Most of this is designed
to keep American dollars flowing in to build modern factories
and take advantage of cheap labor to produce goods for one
billion Chinese and the rest of the world. We are still cautious
about this semi, pseudo, quasi capitalism. The communist party
is still in control and is subsidizing most of their economic
growth, so you have to question the stability of their banking
system. The party’s propaganda machine is keeping a
lid on problems that are boiling beneath the surface. However,
there are now over four hundred million cell phones in China,
and if you dig deep enough, you
will find that some of these problems are getting out. Most
recently has been the pollution of a river and the anger expressed
by citizens that led to riots that had to be put down by state
police. We think American corporations should move a little
more cautiously before pouring so much money into China.
China is also planning for the 2008 Olympics, and they want
to make a strong impression of their advances to the rest
of the world. They have been building high rise structures
like crazy and most of them sit half empty. They look impressive
however.
There is no question that China is an economic force to be
reckoned with, but their economy is only 15% the size of ours
and their growth will slow. Additionally, you can’t
have your cake and eat it too. Communism and capitalism will
not work in the same mix, and this may be China’s most
insurmountable problem.
Random thought for January 2006:
Venus is the only planet that rotates clockwise.
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