Deja Vu – Part 2, Lessons from the US economy,1973-1993

16 Dec

In my last blog entry I outlined the period of 1950 to 1973 as one of uneven business development between the US and its trading partners Japan and Germany (https://ravendragon.wordpress.com/2010/12/13/deja-vu-part-1-lesson-from-the-us-economy1950-1973/). It was this uneven development, I argued, that precipitated an oversupply of productivity that led to a general decline in returns over 1965-1973. I would like to contend that over the ensuing 20 years (1973-1993), oversupply was in fact exacerbated by both governments and businesses alike.

Theoretically, the market lives under an evolutionary arms race – survival of the fittest. In other words, when profits shrink, it should present a barrier to new market entrants, and ‘kill’ those companies with a cost of capital higher than their returns. However, in reality such spontaneous mechanisms do not always exist. Higher cost incumbents resist leaving the market, as their assets (both tangible and intangible) cannot switch lines. Instead, high cost producers tend to invest further capital in improving their productivity. This in turn creates an impetus for higher return companies to follow suit, which creates a cycle of lower profits/returns. Put simply, there’s no spontaneous mechanism for companies to exit the market!

On the other side, a fall in profitability precipitates the search for lower production costs. Countries and regions with lower labor costs are thereby incentivized to join the production band wagon. Over the past 2 decades Asian economies (especially China) made rapid inroads into the manufactured goods market. Yet such new entrants simply push down the profitability and returns of the industry even further. Put simply, as returns fall, there’s no spontaneous mechanism to prevent new market participants!

Over the years 1973 to 1993 world governments continued to deal with the issue of reduced returns with currency revaluations, much as we saw in my last blog entry. In 1979-80 the world witnessed the Reagan-Thatcher Monetarist response, which reversed the devaluation of the USD made during the 70’s. The 1985 Plaza accord resumed a policy of devaluing the dollar. In 1995, the US government once again reversed its policy of devaluation.

But before we get into the details, remember that the purpose of this series of blog entries is not a history lesson or political polemic, but to try and see parallels with today’s global economic, and assess the likely response of our governments over the coming years.

Without yet delving into details, I can already see that despite a serious structural issue leading to reduced returns, world governments did not contend with the core issues. Instead, they perused short-term policies aimed at plugging the hole, mainly in the guise of currency games.

This does not bode well as a precedent for dealing with today’s issues: the US “balance sheet” and the trade imbalance between China and the US.

Let’s not get ahead of ourselves though. In my next entry I will discuss what led to those three currency policies over 1973 to 1993, and the impact of each of those policies. Armed with that information we will be much better armed to try and shed some light on the coming few years.

 

Note – It’s been a while since I wrote in my series on building a core China portfolio (https://ravendragon.wordpress.com/category/building-a-core-china-portfolio/), but I hope to return to it sometime in the new-year.

Zai Jian

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