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Another viewpoint: the problem is capital imbalance, not the trade deficit.

Another viewpoint: the problem is capital imbalance, not the trade deficit

Just as the U.S. in the late 1800s and Germany and Japan in the mid 1900s imported capital and industry for many years, so must the U.S. do this today if it is to fuel an economic revival. Fortunately, this revival will coincide with an aging U.S. population saving more and importing less, and foreign nations wishing us to "export" their capital back to them. The biggest problems facing the new administration are not the budget and trade deficits. Rather, the biggest problems are all those people in Congress, in editorial offices, and even in some corporate boardrooms who want to drive those deficits down as fast as possible. This is absolutely not what the U.S. economy needs right now.

At the heart of our problem is a severe capital shortage. Many people moan about budget deficits, trade deficits, etc., but those are really symptoms of a much more powerful change taking place in the capital accounts across the world. The companies that squander their capital find themselves selling for one-half of their book value and being climbed all over by raiders. The ones who learn how to manage their capital properly are the companies that are generating big multiples on asset values.

In fact, I think we're in the middle of what might end up being the second industrial revolution in the U.S. Who would have thought five years ago that the hottest story in 1988 would be Bethlehem Steel? Or that the hottest performing stock categories would include cement and textiles? This is not a deflation economy anymore. We're building some strong cash-generating companies out there.

So I'm very positive about the stock market, because today the business of buying and selling stocks is focusing on understanding management, not cost of capital. Cost of capital gave us a free ride between 1982 and 1986. Now you've got to know which managements are doing it and which ones are not.

Those who do not succeed at managing today are turning to protectionism. The U.S. attitude toward Korea is a good example of this trade-bashing as a substitute for management. I hear a lot of people saying, let's beat up on Korea. Korea's got this big surplus against the U.S.

To set the story straight, Korea had its first trade surplus in history in 1987. In every other year, they've run a trade deficit, and the sum of those trade deficits is all the money they borrowed from us in the past. That's the money we loaned them to build their economy. Now they owe us a lot of money, about $35 billion. So what does a banker do when someone owes him $35 billion, someone who's got honest employment, who's making cars and selling those cars? Is the banker interested in him losing his job? That is the choice we face. We don't get the cars and the money. We get the cars or the money. Because if we keep out the Hyundais, we shut off the $35 billion. We get to choose between the capital account and the trade account, but we can't have it both ways. That's what people don't understand.

Since 1980, the largest single component of our trade deficit has been capital goods. But capital goods are not product; they're future product tied up in a box. And only an American worker can untie it. So what we have added is productivity, cost cutting, jobs, value, wealth--all of it shipped across the border, called an import, yet labeled a trade deficit, and made the subject of all sorts of nasty press. Well, that's exactly what happened here at the beginning of this century when we imported tools and machines from the U.K. and the money to build factories, and then for the next 50 years we beat their pants off. Today, history is simply repeating itself as foreign capital retools the industrial Midwest.

The second biggest piece of the U.S. trade deficit is industrial supplies. Together with capital goods they represent 60 percent of the deficit. We are attracting capital from around the world, physical capital goods that are increasing productivity in the manufacturing sector by nearly 5 percent a year since 1982--twice the post-war average, faster than Japan, faster than Germany.

What is my point? That this is what reindustrialization looks like. It will change the face of America and the pattern of trade in the future. Trade reflects the investments that were made in the past. Right now, the U.S. has the oldest factories and the fanciest hotels in the world. Japan has fancy factories and old hotels. So what would you expect our international trade would look like? That Japan would sell machine tools to the U.S. and the U.S. would sell hotels to Japan, right? And that's exactly what is going on.

But what is also happening is that, in our international bookkeeping, hotels don't count as exports. Perhaps they're too heavy. If they had wheels or weighed four pounds apiece, they'd be on a boat going back to Japan right now. And then you would see that our trade is balanced, because we're exporting securities and assets on one side and importing product on the other. There is no such thing as imbalanced trade; it's just imbalanced for one industry versus another industry. The currency markets balance every minute of every day. The same amount of dollars are being bought and sold. So the question is: do you want to sell hotels or machine tools? Right now, we're a lot better off to sell those hotels and have more plants built in Tennessee with imported machine tools.

As I said, this is a recapitalization process we're going through, just as Germany did when it had the world's largest trade deficit between 1946 and 1960. That happens when you import factories and you borrow the money to do it. And Japan, of course, did the same.

A yen for savings

Now, the so-called experts say our trade deficit is too great today because the dollar dropped so much. Well, here's a radical idea. The dollar didn't drop. It certainly dropped against the yen, against the Deutsche mark, and against the Swiss franc. But has anybody been to Mexico lately? Or to Australia, Peru, or Brazil? If you include not just the 10 countries everyone focuses on, but all of the countries we do business with, more countries' currencies fell against the dollar in the last three years than rose.

But what about the yen, you ask. Over here, we have a low savings rate, while Japan has an enormous savings rate. They've got a big pile of money and we've got a little pile of money. They've also got a lot of machines; we've got only a little pile of machines. So what would you expect to see in our respective rates of return? That they take those machines and they use up investment opportunities with them, right? While we're short, we take out a much higher rate of return. That means we're talking about rates of return here that are double or triple those of the high savings countries in the Far East.

So if you're an investor in Japan, where would you rather have your savings account? The one in the U.S. is a little more risky because of the currency situation, but if you can triple your return on retirement day, you're probably going to invest it over here.

And this is where savings relates to international trade, because of the age distributions in the U.S. and in Japan. We've got a spike here that says a lot of people are 35 years old. That's the Reebok, Perrier, BMW crowd, and after a decade of spending more money than they earn and rolling up debt, they're about to change their ways. They don't want to crash and burn, so they're going to start tearing up their credit cards, paying off their debts, and saving money. Because by the end of their lives they want some money to live off.

So while our savings rate last year was 3 percent, it's not always going to be 3 percent. It stays at 3 percent only while people are in their thirties. When they age, you'll see a phenomenal change in savings behavior. We're going to be a big savings country in the 1990s.

The car and the money

Meanwhile, what's going on in Japan? There you've got an average 47-year-old worker, at the peak of his productivity, who's worried about retiring. So he works but he doesn't spend the money. Instead, he sends the money over here, where there are higher rates of return. He gets the money to send here by building a car and shipping it here on a boat. Now what's the result of all this? We've got the car, right? So we try to pay him for the car. He says, no, no, please, keep the money and invest it for me. We've got the money, right? And we've got the car. Explain to me why this is so bad. We have a trade deficit, and we also have a higher standard of living. We've also got a factory in Tennessee and the cars to drive around in at the same time. And what does he have? Confidence that we're going to pay him back.

Now, when would you expect he's going to want that money back? Clearly, when he's ready to retire and live off his savings. But his savings are here in an office building in Los Angeles, a factory in Ohio, or whatever. So he needs to sell that investment to take the money home.

Let's analyze this. When his investment first came into the U.S. to help us recapitalize, the money contributed to our trade deficit. But that, in turn, suggests what has to happen for him to get his money back out. Indeed, it says that it is impossible for foreign investors to reclaim their money without the U.S. having a trade surplus. It is not just a bookkeeping question. They've got to take that money home as U.S.-made goods. Or, one footnote, they could come here and spend all their money as tourists.

But in some way or other, that $300 billion in Japanese investment is going to show up as a demand for U.S. products in the 1990s when our Japanese investors are going to retire. And by then what we'll see here is a retooled industry, costs going down, productivity going up, and the U.S. getting competitive again, exporting cars from Ohio back to Japan.

Meanwhile, our baby boomers will be grown up and will be starting to save, which will facilitate the cashing out of the Japanese. Of course, interest rates will come down in this savings environment. Growth will be driven by capital, not by consumer spending, while the stock market will perform well. Gradually, trade will turn around, moving from a big deficit to a big surplus.

As the world turns

What many do not understand is that trade is not supposed to balance every day. Trade is not even supposed to balance within a calendar year. Trade is supposed to balance within the economic horizons of the players. When you're talking about investing in retirement plans and pensions, your time frame is a generation. We had trade deficits, for example, three out of every four years in the 1800s. But those three out of every four deficit years represented our borrowing of money and buying of capital goods, mainly from Europe, to build our railroads and our industrial infrastructure. Which we then used to compete later on.

That is what's going on again in the 1980s and 1990s. Of course, I would like less government spending and a lower budget deficit. I'd like a lot of things that I can't have. But don't believe the sky is falling when people say that if the trade deficit continues at this rate, we're all going to die.

What's going on now with the trade deficit is happening for a reason. It's happening because there's a worldwide capital imbalance. This imbalance is being solved today by capital exports and imports. It's reflected, too, in changes in cost and productivity. And down the road, it's going to shift the flow of trade back the other way.

In this kind of a situation, I like companies that have carefully planned asset management strategies. I like to hear about Bethlehem Steel and other Rust Belt companies that are working with brick and mortar and seeking new ways to generate returns on assets.

That, indeed, is my message to financial executives. Do not worry so much about what the budget deficit is going to do. Worry instead about extra capital lying around that is not doing anything. Capital is not your friend today if you've got too much of it. Get rid of it, or it's going to kill you.
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Author:Rutledge, John
Publication:Financial Executive
Date:Jan 1, 1989
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