Tuesday, July 21, 2009

Rich Bernstein on the U. S. as Japan Theme

In one of EBR's early posts, the theme was propounded that we were becoming Japan (Land of the Setting Sun, Jan. 6, 2009). An update of that theme is elegantly written by Rich Bernstein, who along with David Rosenberg were a dynamic and skeptical duo at Merrill Lynch, but were apparently persona non grata with Merrill's new masters in North Carolina/Washington after BofA took it over; each found other employ. Here is the link to Mr. Bernstein's Financial Times piece America is for now still blowing bubbles (subscription required), along with the first part and then the final paragraph:

Although many market and economic observers quarrel over whether the Obama administration’s involvement in the private sector upholds the American principals of contract law, private investment and capitalism, this discussion misses the most important point for investors. The question is not whether there is a battle between socialism and capitalism, but whether the US economy is on a path to mimic Japan’s.

Financial history shows that bubbles create capacity, which is no longer needed once they deflate. An inevitable and intense period of consolidation follows. For example, the internet bubble gave rise to hundreds of publicly traded dot-com companies, many of which either merged with other technology companies or went out of business once the bubble deflated. Similarly, the gold rush of the 1800s led to construction of outposts that subsequently became ghost towns after that bubble subsided.

The global economy has experienced during this decade the biggest credit bubble in our lifetimes, and virtually every industry in every country benefited. In fact, all the growth stories of the past decade (such as China, emerging market infrastructure, residential housing, hedge funds, private equity and commodities) are capital intensive investments that benefited from easy access to cheap capital. The global credit bubble seems to have created a global economic bubble.

History would suggest, therefore, that there should now be massive overcapacity in the global economy. That is indeed the case. Global capacity utilisation was recently at generational lows.

Ignoring this history, the goal of Washington’s policies has been to stymie the inevitable consolidation, keeping companies operating – and employing voters – rather than managing the consolidation to maximise the economic benefit. History says that Washington’s is an unwise and ultimately fruitless strategy. Certainly, there may be short-term gains in an economy by keeping a bubble’s unnecessary capacity alive (this may explain the recent improvement in economic statistics), but the continued misallocation of capital significantly hinders longer-term growth. . .

Mr Bernstein concludes:

A California roll is an American version of a maki, a type of sushi. It is based on Japanese tradition, but has a decided American flavour. Similarly, the actions of the US’s public and private sectors seem to mimic Japan’s. Although the markets’ short-term reactions might correctly be positive, investors should be wary that the US will be an American version of Japan’s moribund economy.

America was very good at lecturing Japan in the 1990s but not up to the task of taking its own advice when the crisis hit here beginning in 2007.

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