By Alan Weeks
It is well known that Costa Rica has attracted increasing numbers of pensionados, entrepreneurs and tourists over the last 10 years. However, this influx of new wealth has also attracted more unsavory individuals who wish to "help" newcomers to invest in a wide variety of enterprises and get-rich-quick schemes.
We appear to have entered a "post- bubble" world facing more uncertainty than most could even imagine only three years ago. The economic downturn that began when the NASDAQ collapsed in March 2000 still bedevils the industrial world.
Massive over-investment in Internet gear not only brought down the technology industry, destroying millions of jobs, but also devastated the previously reliable telephone industry. As long-distance charges across the Web went close to zero, jobs for engineers, accountants, telemarketers, call center personnel and other white- collar positions began migrating to Asia, a movement that has been gaining strength by the month. Why? Because, the global interconnection of telecommunications systems has allowed educated English-speakers in Asia, earning one- tenth or one-fifth what North Americans earn, to become formidable competitors for good jobs without leaving home. Cost cutting by management remains the driving force for this movement.
In earlier economic cycles it was manufacturing jobs, both high and low tech, that migrated to low-wage economies. That process is still occurring. How many can even remember the time when quality TV sets were produced in the US?
But, this is only part of a more ominous trend. Printing more money in the US and Europe does little to improve the competitive position of local workers. Ironically, it creates greater consumer demand for imported goods and services, thereby speeding up the export of Jobs. This export trend has become Americans' biggest economic problem.
THE DEFLATION MONSTER
Recently, the US Federal Reserve (the FED) announced It Is now more concerned about excessive disinflation. Disinflation is a sustained slide in prices for goods and services that promotes rising asset prices. This has occurred almost continuously since 1981. Disinflation has been a Good Thing. But, the FED said that a further fall in inflation would be unwelcome.
There has been less concern in the US about deflation recently. Deflation is a sustained collapse of prices for goods, services, stocks, an real estate. This has not occurred since the 1930s Depression, except in Japan. However, did you notice that April's US producer price index (wholesale prices) fell 1.9%, the biggest drop in 56 years? Deflation Is a Bad Thing.
Most economists say that deflation can be averted; just print enough money. There is general agreement that the excess monetary creation and mania In Japan for real estate and stocks in the 1980s created a "bubble" that the Bank of Japan finally decided to "prick" in the early 1990s. Since then, Japan has been a model in demonstrating the challenges for re-inflating a "pricked bubble" economy.
That disaster was Greenspan's (the FED) excuse for continuing to print money enthusiastically from 1997 to 2000 amid the mania in tech stocks. Since that mania was not spreading into real estate, the FED assumed this wasn't a Japanese-style "bubble" and the stock market would correct itself without economic damage. That was one terrible call!
The second terrible mistake was to assume during the dot.com and tech mania, that there would be some rationality on the part of mania chasers, and hence, no need to tighten investor margin requirements. The grossly excessive borrowing to chase the "next big thing in the New Economy" in the very late 1990s has left an enormous hangover of c9orate and personal debt after the bubble burst.
Meanwhile, deflation is also being imported. The Industrial world is "drowning" in a sustained torrent of imports from China at prices that keep falling even as the volume of imports increases. Thus, China Is gaining in global market share even though its customers' economies are treading water. Also Western manufacturers who keep their plants open must cut prices to compete, and so China promotes price deflation even for goods made in the West.
Many economists have argued that the Japanese deflation experience is unique because the long decline in birth rates has meant that the nation has not been replacing itself for decades. Thus, Japan suffers from demographic deflation.
But, Japan is actually just ahead of the curve as demographic deflation starts to spread across the industrial world. The most powerful driver of this new kind of deflation isn't tight money, or China, or technology, but birth control.
In this decade, populations will begin a continuing decline in Germany, Italy, Spain and other countries in the Eurozone. Why does this matter? Do not forget that construction of homes, schools, hospitals, office buildings, shop ping centers and roads to meet the needs of an expanding population is the one major industry that is virtually immune to offshore competition. When that industry enters permanent decline, what we knew to be appropriate fiscal and monetary policies will no longer work to create demand for domestic workers. And these nations will also start having a decline in national wealth from falling home prices.
Fortunately, the US has the strongest demography in the industrial world - just above replacement rate - thanks to the growing number of Hispanics. And, they have been one of the most powerful forces in maintaining the home building industry's status as the most vibrant sector of the US economy. Indeed, had home building not stayed strong when the tech "bubble burst", this would have become the worst economic downturn since the Depression.
Japan avoided outright depression be cause of. its permanent trade surplus - which means it imports jobs. The US, on the other hand, runs a permanent trade deficit. It now exceeds 5% of GDP, and thus the US has been exporting millions of jobs. Because America's huge current-account deficit is becoming harder to finance, there has been hope that the recent US currency devaluation against most major currencies would correct this. Indeed the US dollar has fallen by more than 14% against most other G-7 nation currencies over the last half year.
Last year, a study by FED economists of Japan's slide into deflation came to a significant conclusion from their woes. That is, as interest rates move closer to zero, central banks need to cut interest rates more forcefully than would normally be called for by growth and inflation forecasts. This has justified the FED's aggressive easing over the past two years. The weaker dollar will also help to fend off deflation. However, the distinct possibility that further FED actions could be required to get the economy growing well again, is either a testament to how much the challenges facing the US economy have changed, or a confirmation that a "post-bubble" monetary policy is careening out of control.
The European Central Bank's (ECB) recent past behavior suggests that it has not read the FED study. Indeed, it was not until Germany, Italy and the Netherlands reported negative GDP growth that the ECB finally cut interest rates. In addition, Germany looks much more susceptible to deflation than the US because it cannot loosen fiscal policy (which is constrained by the Euro area's stability pact). The Euro is appreciating in value, making exports more expensive; German banks are in much worse shape than America's are; and, German households and companies have even bigger combined debts than their US counter parts.
Under current circumstances, will the central bankers in the US and Europe avert deflation and restore strong economic growth? And, will the Japanese finally manage to re-inflate their stagnant economy? And, the ultimate question is whether the US can return to and sustain strong growth alone since the behavior of the other major governments and their central banks have not been inspiring, to date. Therefore, the FED may find it harder than it thinks to escape the deflation monster.
If the central bankers and governments succeed in restarting economic growth one should buy more equities. If you think they will fail, perhaps one should consider buying more bonds and gold stocks.
In conclusion, it is most unfortunate that, after three consecutive down years in the equity markets, there continues to be so much uncertainty. In fact, there is a real possibility that further equity markets gains will be modest for some time to come. This continuing uncertainty provides another good reason to consider investing more in hedge funds to move away from the possible lackluster performance of other asset classes.
References:
1) This article is based on and much taken from an article called GOOD, BAD AND UGLY by Donald Coxe, Chairman of Harris Investment Management of Chicago, IL, published in Maclean's, May 26, 2003.
2) The Economist article on deflation called, Hear that hissing sound? Published on p.61-62, May 17, 2003.
For more detailed information and specific recommendations on Hedge Funds, please contact the author at 256-5848.
© El Residente ARCR Administración S.A. San José, Costa Rica N.B. Like all information on the internet, this article may currently be incorrect or out of date.
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