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8/14/2019 Basic Points June 2009 BMO CM
1/43
Basic PointsSummer Issue
Who Will ReallyLead the Global Rescue?
June 8, 2009
Published by Coxe Advisors LLC
Distributed by BMO Capital Markets
8/14/2019 Basic Points June 2009 BMO CM
2/43
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Company Name Stock Ticker Disclosures Company Name Stock Ticker Disclosures
Alcoa AA 3,4 Goldman Sachs GS 3,4
Aluminum Corporation of China ACH Google GOOG 2
American International Group AIG 3,4 Imperial Oil IMO
Anadarko Petroleum APC 4 Intel Corp. INTC 2Apple Computer AAPL 2 Magna International MGA 1
Bank of America BAC 4 Microsoft MSFT 2
BHP Billiton BHP 2 Morgan Stanley MS 3,4
Canadian Oil Sands COS.UN 1,4 Potash POT 1,3,4
Citigroup C 3,4 Research In Motion RIMM 1,2
Companhia Vale do Rio Doce RIO Rio Tinto RIO 2,4
ConocoPhillips COP Suncor SU 1,3,4
ExxonMobil XOM Teck Resources Ltd. TCK.B 1,4
Fannie Mae FNM Wells Fargo WFC 4
Freddie Mac FRE
8/14/2019 Basic Points June 2009 BMO CM
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Don Coxe
THE COXE STRATEGY JOURNAL
Summer Issue
Who Will ReallyLead the Global Rescue?
June 8, 2009
published by
Coxe Advisors LLC
Chicago, IL
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THE COXE STRATEGY JOURNAL
Summer IssueWho Will ReallyLead the Global Rescue?
June 8, 2009
Author: Don Coxe [email protected]
Editor: Angela Trudeau [email protected]
Coxe Advisors LLC. www.CoxeAdvisors.com
190 South LaSalle Street, 4th FloorChicago, Illinois USA 60603
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OVERVIEW
Who Will ReallyLead the Global Rescue?
Judging by the stock market performance since March, the green shootsshould be as high as an elephants eye by the time this text reaches you. The
longest-sustained rally in decades caught bears unaware. We hear from clients
that the rally is driven by professional investors fear that the Pelosi-Obama
stimulus might work almost instantly and theyd miss out on the move that
would put their clients back on side after the 50% meltdown.
Paradoxically, as fund managers fly from fear into stocks, insiders fly from
fear to cash. The insider trading reports suggest that corporate bigwigs
stockholdings are being managed by acolytes of Nouriel Roubini, Nassim
Taleb, and David Rosenbergwho were so right for so long about the extent
of the housing disaster. Bulls who saw green shoots at a time insiders weregreen around the gills said, We have nothing to fear but fear itself. Problem
for bulls: which fear should they fear more: fund managers fear of missing
The Recession-Ending Mega-Rally or the insiders fear that their companies
miseries are far from ended? The fear that is winning proclaims, Happy Days
Are Here Again! The opposed fear growls, That song came out in 1929.
And whatever happened to Greed? Has it been repealed?
This has been one of the few times in most institutional clients lives when
theirbusiness is the first order of business for media and governments and
social conversationsday-after-day, week-after-week, month-after-month.Everybody wants to know what professional investors think. And nearly
everybody wants to hear that the Obama optimism which spread across the
land and across the sea is fully justified.
As hard as it may be for clients to tear their attention away from screens and
screaming front-page stories, we believe this is a time to step back and reflect.
This lengthy summer issue is meant to be used along with suntan lotion and
gin-and-tonics.
Our theme this month is that this one of those rare moments when history is
being made without most of its leading participants recognizing that they arecollectively reading from the wrong script.
With the industrial world in its first serious deflationary downturn since the
Depression, the acknowledged leader of the rescue brigade is Barack Obama.
That title goes with the lease to the White House. Had John McCain managed
to hold his pre-Lehman lead in the polls, then he would now be the Hope
of the World.
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THE COXE STRATEGY JOURNAL2 June
But Mr. Obamas personal claim to leadership is one that would not have
been accorded to McCain. He is the most popular American Presidentabroad
since Roosevelt. On his European tour, he showed he could draw crowds that
were both larger and more enthusiastic than local leaders could pull. (Indeed,
even the Germansthe Germans!have been gripped by Obamamania: the
new hot toy there is a stuffed animal that looks like the White House dog.)
His domestic poll ratings remain highand are as high at this stage as G.W.
Bushs, which, thanks to the crisis that followed 9/11, stayed so lofty that
Congress backed not only the invasion of Afghanistan but of Iraq. Obamas
the man, and the image he projected of cool centrist as crisis manager was
exactly right.
But what if Americas economic problems are so seriousand the Pelosi-
Obaman remedies are so seriously wrongthat he will not be able to pull
his nationlet alone the rest of the industrial worldout of the bog and
back into sustained non-inflationary growth?
Ourfear is that the Presidents past enthusiasm for reshaping America from
the top down by summoning statist changes from the ground up will push
himand Americainto a new adventurism that will ultimately lead to the
shift of global economic leadership abroad.
We are continuing to reduce the share of US assets in our Recommended Asset
Mix. The next stage of the dollar bear market has begun. Have a rewarding
summer. Our next issue comes out in 3 months.
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Who Will ReallyLead the Global Rescue?
Since 1943, the US has been the dominant military and economic power in
the world. Although the barefoot Krushchev told the UN he would bury the
capitalist world, his successors were unable to keep pace with the dynamism
of America and resurgent Europe, and Reagan and Thatcher were able to bury
Communism alive.
In each postwar recession, it was the US that pulled the rest of the industrial
world out of its downturns. Not only was the US economy so much larger
than any others, including what would become the Eurozoneit remained
the centre of innovation, risk-taking and productivity gains. Meanwhile,
powerful trade unions were able to retain their stranglehold on most
Continental economies even after Thatcher had broken their power in Britain.
Trade union veto power on US economic progress waned during the 1970s
and shrank dramatically thereafter, as capitalist vitamin content flourished
in Americas bloodstream.
The technology boom of the 1990s was, in retrospect, the high-water mark for
American capitalism. As new billionaires were being anointed each month,
and outsized productivity gains became accepted as inevitable, US equities
value soared to more than 60% of total global equities.
But what was glittering wasnt, as Greenspan believed, a new Golden Age. As
Nasdaq soared through 5,000 and Baby Boomers were planning luxurious
retirements for their forties or fifties, investors who had feared that the
Millennium would bring Y2K shock, found that it brought something much
scarier: reality. They learned that Tech company earnings were vastly inflated,
due to failure to account for stock options (which were the main form of
compensation for top execs), and that Asian-based companies were rapidly
gaining global market share in terms of employees, profits, and patents. What
would become the stars of this decadeGoogle, Apple and RIMwere either
not public during the boom, or had proprietary products based onbrand-based
profit margins that were no longer available to the established manufacturers
of the defining commodities of the 1990schips and bandwidth.
America retained its stock market leadership until 2007 because of the
new centre of high-margin innovationWall Street. At the peak, financial
companies were reporting 41% of US corporate earnings.
Except that their overstatement of earnings turned out to be on a scale that
made the Nasdaq cheaters look like pusillanimous Puritans. Those new tech-
spawned financial products that created trillions in reported profits after
paying hundreds of billions in unearned bonuses turned out to be frauds
designed to fool investors, US ratings agencies and financial institutions at
home and abroad.
At the peak, financial
companies were
reporting 41% of US
corporate earnings.
Except that their
overstatement of
earnings turned outto be on a scale that
made the Nasdaq
cheaters look like
pusillanimous
Puritans.
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Who Will ReallyLead the Global Rescue?
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Those who do not learn from history
The sudden implosions of Long-Term Capital and Enron came from marketvolatility that the Myron Scholes model said was of a rarity that could occur
only once since mammals replaced dinosaurs as the masters of the universe.
How did Wall Streets biggest, boldest and brightest respond to those late
1990s debacles? By imitating LTCM and Enron! They levered up LTCM style,
using hidden off-balance-sheet entities Enron-style, with risk probabilities
calculated on models used by both LTCM and Enron.
Should anyone have been surprised that Wall Street got the same results?
The bosses expected sustainably black earnings statements from following
those models. Instead, they created Black Swans on a scale that devoured theavailable supplies of junk financial foodwith predictable results for the
consumers financial health.
There is talk of criminal prosecutions against the big names that got the big
payouts and spawned the big disasters. However, apart from insider selling
prosecutions such as have finally been launched against Countrywides
Angelo Mozilo, we predict few prosecutions and even fewer convictions. Wall
Streets accused could win acquittal on the grounds of insanity. A well-known
proof of insanity is trying the same experiment over and over, expecting to
eventually achieve a different result. What they did in creating trillions in
AAA-rated illiquid products out of financial sewage should be enough to
trigger insanity diagnoses from Park Avenue psychiatrists with sterling records
in testifying on behalf of the tarnished rich. The accused would surely be let
off on pledges to continue their treatment programs with their psychiatrists,
and at their golf and bridge clubs.
Last month, we asked, Where Will America Go to Grow?
Were America, once again, relied on to pull the global economy out of
recession, what would be its Comparative Advantagesin terms of trade in
goods and services?
A new book by Robert C. Allen (The British Industrial Revolution in a Global
Perspective) seeks to explain why Britain was the first home of the Industrial
Revolution. It argues that cheap, abundant energy was the key factor. Britain
had a huge comparative advantage in terms of carbon-based energy. Its coal
reserves were Europes largest, and its early emphasis on converting coal
and iron into steel gave it a lead that was crucial in the formation of the
British Empire, which was based on the Navys power to sustain free trade
in commodities, food, and industrial goods. Britain prospered by importing
commodities from its colonies and selling them its manufactured goods.
How did Wall Streets
biggest, boldest and
brightest respond
to those late 1990s
debacles?
By imitating LTCM
and Enron!
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The first century of American industrial prowess was also energy-based.
After Spindletop launched the US oil industry, America powered ahead to
global leadership based on oil for transportation and coal for electricity and
steeland by benefiting from global free trade enforced by the British Navy.
America replaced Britain as world leader, in part because the British had
dwindling supplies of cheap coal, negligible supplies of oil and gas, and world
leadership in entrenching the power of industrial and transportation unions
that could bring the economy to its knees, thereby reducing its international
competitiveness in each new cycle.
Chris Patten observed that, for the first eighteen centuries of the Christian
(or Common) Era, the two largest economies were China and India. They
didnt experience the Industrial Revolution and therefore ceded leadership to
America and Europe. In the first half of this century, he predicted, the world
would revert to normalcy.
Although few forecasters publicly dispute this long-term prediction, even
fewer suggest that this global recession would put the world into fast-forward
into the future.
Consider a few developmentsat home and abroadsince Obama and his
party swept to dominance:
1. The recessions in the US and Europe have been far more severe than
consensus forecasts predicted.
2. After two decades in which economic growth was positively correlated to
nations reliance on capitalist principles, the industrial world has suddenly
accorded to governments and central banks the entire responsibility for
saving the global economy. Capitalism is widely blamed for the Crash,
and government is now the savior. (A recentNew Yorkercartoon sums up
the new consensus: it shows a king with his head on the chopping block,
with the headsman holding high the axe; a man is rushing in, shouting,
Stop! Wait! Governments no longer the problemits the solution!
3. As Chryslers bailout was proceeding, President Obama appeared on TV
to denounce the speculators who were insisting that their ownership of
secured bonds gave them priority in the bankruptcy. This was not the calm,
cool, compromise seeker who had reassured the business community that
he would respect its claims to full participation in the economic rescue
program. He shouted, (like the Marxist Labourites who kept the party
out of power until Tony Blair cowed them), I stand with the workers!
In the outcome, the UAW, whose benefit programs were unsecured
creditors, was awarded a 55% ownership share in the company, and the
[Obama] shouted,
(like the Marxist
Labourites who kept
the party out of power
until Tony Blair cowed
them), I stand with
the workers!
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Who Will ReallyLead the Global Rescue?
THE COXE STRATEGY JOURNAL
secured bondholders were given only pennies on their holdingsand
threats of the kind of personal retaliation suffered by AIG officers.
Only later did we learn (on Page 16) that the speculators included public
pension funds in Indiana. The state funds had, (despite the investment
rules in ERISA), invested heavily in the secured debt of Chrysler, which
was, directly and indirectly, a major economic power in Northern Indiana.
In GMs bankruptcy, a large percentage of the secured debt was held by
yield-seeking individual investors, and leading law firms announced their
willingness to protect their rights from White House assaults. Result: this
bankruptcy is now, thankfully, proceeding according to the law, and GM
executives need not fear being harassed in their homes by ACORN radicals
paid, (at least in part), by Washington.
4. The Pelosi-Obama budget that swept through Congress with Indy speed
will, according to the non-partisan Congressional Budget Office, double
the national debt within five years and treble it in teneven assuming that
the President is right that US economic growth in the coming decade will be
far above its average level of recentcapitalist-drivendecades. The growth
will come from millions of jobs in clean energy, new techniques in health
care management, and public (read unionized) education. Offshore
drilling bans will ensure that none of the nations vast untapped oil and
gas reserves will compete with switch grass bio-fuel and other expensive
new forms of energy. (Mr. Allen would presumably be astonished.)
5. The Fed has been transformed into a Fast-Feeding operation. Its balance
sheet has doubled, and it keeps finding new classes of assets to buy. Apart
from its newfound willingness to lend against some of Wall Streets pet
products, it is buying longer-dated Treasurys to try to ensure that interest
ratesparticularly mortgage ratesstay low. Like other aspects of the
stimulus programs, results of this unprecedented initiative are somewhat
disappointing: yields on the Ten-Year Note (the basis for first mortgage
rates) have climbed 85% since year-end. Among those holders of Treasurys
who have expressed public alarm at quantitative easing and other novel
programs are the Chinesethe biggest gluttons in what Bernanke oncecalled The global saving glut. (When Tim Geithner spoke to a Beijing
audience last week, student laughter greeted his claim that the dollar would
remain strong and the Administrations policies would protect the value
of Treasurys. Those students are already learning how to act like tough,
arrogant creditors to yesterdays #1 economy.)
6. Indian voters went to the polls at a time of a global economic crisis, and
civil wars in two of its neighboring statesPakistan and Sri Lanka. Defying
predictions that the next Parliament would be even more hamstrung
The Fed has been
transformed into a
Fast-Feeding operation.
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by excessive leverage from Communist and other intransigent minority
parties, voters gave Manmohan Singhs Congress resounding support.
Nor were these gladsome results due to an unexpectedly high percentage
of stay-at-homes: 58.5% of eligible voters cast their ballots. So much for
the theory that only the Chinese can make modified capitalist principles
work. Then, India rather suddenly became a beneficiary of the defeat of
the terrorist Tamil Tigers, and Sri Lanka was no longer one of the two
neighboring threats to regional stability.
7. China chose not to emulate the strategy of Obamas rescue package: Sino-
Stimulus was aimed at immediate results, not in entrenching vast new
government programs designed to lock in a far bigger share for the state
in the economy of the future. Yes, Chinas growth has slowedto 7%at
a time the US and European economies have been decliningby almost
equal percentages.
8. Commodity prices, which suffered their greatest two-month decline since
records began, have been rebounding. No thanks to the US and Europe:
large-scale Chinese purchases of oil, soybeans and metals have been major
contributors to the rebound.
RJ-CRB Futures Index
June 1, 2008 to June 4, 2009
150
200
250
300
350
400
450
500
Jun-08 Aug-08 Oct-08 Dec-08 Feb-09 Apr-09 Jun-09
259.79
Baltic Dry Index
June 1, 2008 to June 4, 2009
0
2,000
4,000
6,000
8,000
10,000
12,000
Jun-08 Aug-08 Oct-08 Dec-08 Feb-09 Apr-09 Jun-09
4,093
Sino-Stimulus was aimed
at immediate results,
not in entrenching
vast new government
programs designed
to lock in a far bigger
share for the state in the
economy of the future.
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Who Will ReallyLead the Global Rescue?
THE COXE STRATEGY JOURNAL
Crude Oil
June 1, 2008 to June 4, 2009
30
50
70
90
110
130
150
Jun-08 Aug-08 Oct-08 Dec-08 Feb-09 Apr-09 Jun-09
69.50
Soybeans
June 1, 2008 to June 4, 2009
7.00
9.00
11.00
13.00
15.00
17.00
Jun-08 Aug-08 Oct-08 Dec-08 Feb-09 Apr-09 Jun-09
12.30
Copper
June 1, 2008 to June 4, 2009
1.00
1.50
2.002.50
3.00
3.50
4.00
4.50
Jun-08 Aug-08 Oct-08 Dec-08 Feb-09 Apr-09 Jun-09
2.33
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9. Commodity stock prices have responded:
Coxe Commodity Strategy Fund (COX.UN) relative to S&P 500
June 1, 2008 to June 4, 2009
60
7080
90
100
110
120
130
Jun-08 Aug-08 Oct-08 Dec-08 Feb-09 Apr-09 Jun-09
106.33
MS Commodity Related Equity Index (CRX) relative to S&P 500
June 1, 2008 to June 4, 2009
60
70
80
90
100
110
Jun-08 Aug-08 Oct-08 Dec-08 Feb-09 Apr-09 Jun-09
98.36
Gold Stocks (TTGD) relative to S&P 500
June 1, 2008 to June 4, 2009
60
80
100
120
140
160
Jun-08 Aug-08 Oct-08 Dec-08 Feb-09 Apr-09 Jun-09
142.90
(Readers please note: we cite as the example of commodity stock performance
the fund in which we are Advisors, because it includes all four main
commodity sectors, with weightings approximating those that have been
Commodity stock prices
have responded.
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Who Will ReallyLead the Global Rescue?
THE COXE STRATEGY JOURNAL
recommended from time-to-time in this publication. We are not aware of any
other exchange-traded company that has investment policies that reflect those
discussed each month in Basic Points. If any readers are aware of comparable
products, wed be pleased to be informedand will include them in a future
issue. Citing the Fund herein does not constitute a recommendation to buy its units
or warrants.)
The US Claim to the Title The Global Economic Rescuer
It is widely taken for granted that the US has been the driver of the world
economy since World War Iwhich so devastated the economies of Britain,
France and Germany that the US succeeded The Old World as industrial
and military leadersand has stayed in that role ever since.
We suggest that, as is so often the case, investors with inadequate knowledge
of history are nonetheless among the most dogmatic in citing it to justify
their conclusions.
It is an oft-cited fact that the US has pulled The Old World out of each
recession since 1921; that record, we are told, means it is the worlds only
hope for exit from this deep recession.
Since World War I, there have been three great recessions, two of which were
deflationary and one inflationary. The Great Depression and this one have
been the deflationary downturns; the first of the 1970s recessions was the
sole inflationary recession. (No less an analyst than Niall Ferguson says (New
York Times Magazine, May 17th) the 197375 recession was every bit as severe
and protracted as the one were in now.)
Yes, the US pulled the world out of all the recessions since World War II, but
it was the Old World that pulled the US out of the Great Depressionby
engaging in World War II.
Yes, yes, we know that its an American article of faith that Roosevelt and
the Democratic Congress saved America and the world from the Depression
caused by Herbert Hoover and the Republicans.
Roosevelt did a splendid job of restoring American faith in itself, and he was
a great leader during World War II. Perhaps, without Roosevelt, there would
still be Prohibition, Hollywood wouldnt have experienced its Golden Age,
Fred Astaire would have continued to avoid movies in favor of Broadway and
vaudeville, and Victor Fleming wouldnt have had the unique opportunity to
directGone With the Wind while he was completingThe Wizard of Oz.
...as is so often the case,
investors with inadequate
knowledge of history
are nonetheless among
the most dogmatic in
citing it to justify their
conclusions.
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Give Roosevelt credit for any or all of the above, but be cautious about
crediting him with ending the Depression. In actuality, Hitler, Hirohito
and Stalin did more than Roosevelt to slash US unemployment rates by
80%. Despite the Rooseveltian alphabet soup of government programs,
including NRA, WPA, and Social Security, and the brief mid-decade recovery,
US unemployment was still 17% by 1938. Then, as Continental European
leaders at last realized that Hitler was a greater threat to peace than Winston
Churchilland launched large-scale rearmament. As many scholars have
noted, the net benefit to the economy of Roosevelts job-creation programs
such as WPA sidewalk painting was largely offset by the unforeseen effects
of the Wagner Act and other Rooseveltian programs to magnify trade union
power. As Charlie ChaplinsModern Times (1936) showed, staging strikes as
soon as the workers finally had jobs after years of large-scale unemploymentmay have been good for union power, but what workers needed most was
jobs. The powers granted to union leaders under these programs ensured that
the minority of private sector workers with unionized jobs ultimately made
major gains in real income, but they actually prevented overall employment
growth for Americans because the products they made were too expensive
for much of the population. Worse, major industries became even less
competitive with factories abroad, forcing intensification of Smoot-Hawley
protectionism that had the inevitable effect of overseas backlash that shut
America out of major overseas market. That process was exacerbated by the
strength of the dollar as the worlds gold flowed into Fort Knox and currencydevaluations became routine across the world.
Ironically, the federal nature of the US would turn out to be its ace in the hole in
post war era, compared with European economies in which employment rules
were mostly set at the national level. Flexible employment arrangements
became (apart from seemingly endless supplies of low-cost coal, oil and gas)
Americas greatest competitive offset to the new industrial challenges from
Europe and Japan. Right to Work laws, which banned compulsory union
membership, undergirded the Souths strong recovery and powerful job
growth since 1960, as the former, seemingly-all-powerful big businesses in
the North succumbed to competition from abroad and the South, and theindustrial states became Rust Belt states.
Roosevelts panoply of programs and preferences might actually have worked
to end the Americanbut not the globalrecession, had he and the Fed
understood monetarism and the futility of beggar-thy-neighbor trade policies.
(Of course, there wouldnt have been anything worse than a recession had
Hoover and the Fed understood monetarismand the futility of beggar-thy-
neighbor trade policies.)
In actuality, Hitler,
Hirohito and Stalin
did more than
Roosevelt to slash
US unemployment
rates by 80%.
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Who Will ReallyLead the Global Rescue?
THE COXE STRATEGY JOURNAL
By the time FDR took office, US M2 was down one-third from its 1929 peak.
Needed: rapid growth of Fed credit. However, existing laws limited monetary
expansion that was not backed by growth in gold holdings. Roosevelt did
in fact address this challenge by (1) raising the price the Fed would pay for
gold from $20.67 an ounce to $35, and (2) making private holdings of gold
bullion and coins illegal. However, monetary policies during the rest of the
decade were hopelessly inadequate to the challengeand no amount of
increase in the supply of WPA sidewalk painters would be able to offset the
Feds failure.
The reality is that the Old World, (with help from Japan) in its final
collective act of madness, pulled the US out of the Depression by 1941.
Marx had said that capitalism needed war to survive. A large body of leftist
economic thinking drew that lesson from Roosevelts failed efforts to end
the Depression, and how waging war set US factories hummingand put
millions of unemployed Americans into military uniforms. The economists
concluded that Big Government would be needed in the postwar era to
ensure sustained growth in jobs once Rosie the Riveter and her colleagues
switched from producing weaponry to producing babies.
The rebuilding of shattered economies and expectations in Europe and Japan
took decades, and the US trade balance gradually turned from permanent
surplus into permanent deficit, as European and Japanese manufacturers
began to take advantage of the demise of Smoot-Hawley and the complacencyof US manufacturers, in an era of large-scale featherbedding, and annual
growth in union wages and benefits regardless of productivity. The European
and Japanese factories built after the bombing ended used the best-available
technologies, and, (apart from Britain, where 19th Century labor attitudes
on the shop floor and among Labour politicians in Parliament prevented a
sustained postwar industrial renaissance), the fast-reviving economies relied
on welfare state programs, and Value-Added Tax regimes to redistribute actual
production costs away from factories to taxpayers at large.
The post-Depression US consumer, who hadnt experienced the horrors of
bombings, came to believe that prosperity was his/her birthright. Because USfactories had to price not only outsized wages, but health care and pension
costs into their output, their competitive position against European and
Japanese competitors weakened by the year, and Americans began finding
more and more bargains that werent Made in the USA. Until the dollar bear
market that began in 1971 with Nixons closure of the gold window, the
dollar was still so overvalued relative to European currencies that the best-
selling book for American tourists was Frommers Europe on $5 a Day.
in 1971...the dollar
was still so overvalued
relative to European
currencies that the
best-selling book for
American tourists was
Frommers Europe on
$5 a Day.
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Result: the US consumer of goods, services and holidays became the industrial
worlds buyer of first and last resortand thesine qua non rescue force for
minimizing and ending postwar recessions across the industrial world.
Until American mortgage and credit card lenders finally realized that they
had run out of credit-worthy first-time home buyers and qualified borrowers
a few trillion dollars back on the roadand until a meaningful percentage of
the credit-worthy borrowers finally discovered there was a peril heading their
way that was much more immediate than global warming.
That shock was a long time coming.
Although some US economic analysts began to predict a peak in American
households willingness to increase their acquisition of goods and services
decades ago, for nearly all the time we have been managing money, the word
to the wise was Wall Street is littered with the bones of analysts who said the
US consumer was tapped out.
Which means that America and the rest of the world are finally going to have
to find a new set of buyers for their output.
Were Roosevelt to return to the USA from his eternal home, hed
recognizeand presumably applaudone-third of the Washington response
to this recession, but would be amazed byand presumably applaudthe
other two-thirds.
By now, if hes been in Heaven, hell have learned from Milton Friedman of
the importance of stimulating money supply growthand will be mentally
fitting out Ben Bernanke for angel wings.
When he considers the Pelosi-Obama programs, hell recognize that theyve
been reading from his script. Their priorities are (1) expanding union
power, because an economy based on strong unions should be a prosperous
economy, and (2) making government(s) the consumer of first and last resort
until the household sector has rebuilt its finances and saved something for
its retirement costs.
Under Goal (1), the Democrats are pledged to legislate Card Check, the
AFL-CIOs top legislative priority. This law would take away workers rights to
secret ballots when a union is trying to organize an employer. The decision
to join a union would hereafter be made at the employees kitchen table,
with eager assistance, one assumes, from hearty, husky union organizers, and
from those in the employees work unit who have already joined the union.
Until American
mortgage and credit
card lenders finally
realized that they had
run out of credit-worthy
first-time home buyers
and qualified borrowers
a few trillion dollarsback on the road...
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Who Will ReallyLead the Global Rescue?
THE COXE STRATEGY JOURNAL
Included in this bill is a brand-new provision that, once a company is
organized on the basis of signed cards, if the employer is unwilling to meet
the unions demands, it cant just shut down and go where it believes it can
produce competitively. Those big, brotherly people in Washington will send
in an arbitrator, who will declare what future wages, work rules and benefits
must be. The great advantage of this new system is its simplicity: instead of
competing arguments about the economic value of an employees work, it
will be decided by one of the well-trained people in a great new make-work
program for well-trained people who may not otherwise have great jobs with
great paychecks. The President has promised to create millions of new jobs,
and, since programs like carbon tax and banning offshore oil drilling will kill
vast numbers of private sector jobs, why not hire people in the Department
of Labor to say what American workers should be paid and how many hoursthey should work?
So, a returned Roosevelt would be delighted. Yes, a returned Ford, Rockefeller,
Edison, Kroc, or Carnegie would be appalled, but they believed in creating
jobs and wealth in the private sector by competitively producing products
people at home and abroad wanted and bought. That is so passthese days.
As the scope of Washington bailouts proceeds, our sympathy for the pressures
on the President grows. Somehow, he will have to take out time from
deciding which models of cars Chrysler and GM must produce, to dealing
with Ahmadinejad, Kim Jong Il, the Taliban and other tiresome people. Dontthey understand that all thats needed is for us to talk together? Dont they
know that Bushthe biggest global threat to peaceis gone?
Even if the Pelosi-Obama stimulus program succeeds in generating modestly
positive US economic growth, it wont do much for the rest of the world.
The Buy-America provisions that bespangle the stimulus bill have already
kicked off mini-trade wars with Canada and Mexico, and Europe is mulling
over potential retaliation. No, they wouldnt strike a returned Roosevelt as
a worthy substitute for Smoot-Hawley, but at least they have what might be
called by sophisticates asoupon of Smoot-Hawleyism.
That said, American politicians might try to justify these Smoot-Smart
evasions of WTO rules by pointing out that Americas allies have mostly
confined their involvement in the globalstrategic crisis to criticizing the US.
Apart from Canada, Britain and Australia, Americas allies have not only
done almost nothing to help crush the jihadists in Iraq and Afghanistan, but
theyve done squat in Swat and virtually everywhere to its South and West.
Nor, after Obama wowed crowds in their homelands by announcing closure
of Guantanamo, are they stepping up to take those victims into their own
...since programs
like carbon tax and
banning offshore oil
drilling will kill vast
numbers of private
sector jobs, why not
hire people in the
Department of Laborto say what American
workers should be paid
and how many hours
they should work?
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prisons. (How many prisoners were subjected to aggressive interrogationthe
euphemism Bushies used for water-boarding? According to a Page 16 story we read
recently, three Gitmo inmates were water-boardedSheik Khalid, who organized
the 9/11 massacres, the self-confessed beheader of Wall Street Journal reporter
Daniel Pearl, and one other.) As Obama is learning, a global policemans lot
is not a happy one.
Obama spent weeks abroad apologizing for Americas past sins dating back
to the A-Bomb. Until he attended the D-Day anniversary, he never once
mentioned the hundreds of thousands of US military corpses in European
cemeteries or the sacrifices America made to prevent a Soviet takeover of
Germany and France. Mr. Obama must be wondering, with allies like these,
who needs enemies?
Among the few prominent academic economists to challenge Obamas long-
term stimulus programs is Stanfords John Taylor, the renowned thinker
who devised Taylors Law for setting economically-successful fed funds rates.
Writing in the Financial Times last week, he observed:
The federal debt was equivalent to 41 per cent of GDP at the end of 2008;
the Congressional Budget Office projects it will increase to 82 per cent of
GDP in ten years; with no change in policy it could hit 100 per cent of GDP
in another five years.
He cites Obamas defense: We have an unprecedented financial crisis and wemust run unprecedented deficits, and he replies, While there is debate about
whether a large deficit today provides economic stimulus, there is no
economic theory or evidence that deficits in five or 10 years will help to get
us out of this recession. Such thinking is irresponsible. If you believe deficits
are good in bad times, then the responsible policy is to try to balance the
budget in good times.
He rejects Obamas pledge to cut the deficit in half, citing the CBOs projection
that the deficit in 2019 is the same percentage of GDP as the Administrations
estimate for the deficit in 2010a zero per cent cut.
Finally, he dismisses Obamas justification, We inherited this mess. The deficit
was 41 per cent of GDP at the end of 1988, President Reagans last year in
office, the same as in 2008, President Bushs last year in office. If one thinks
policies from Reagan to Bush were mistakes does it make sense to double-
down on those mistakes?
We have quoted so extensively from Mr. Taylor, because he is both eminent
and wiseand we believe that, if his view of the future is even close to being
accurate, America will not be #1 for long.
As Obama is learning,
a global policemans
lot is not a happy one.
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Who Will ReallyLead the Global Rescue?
THE COXE STRATEGY JOURNAL
So, unless Mr. Obama reverts to being the cool, charismatic leader whose
public policies synthesize the dynamic aspects of American economic process
with the expansion of governments new roles, the global rescuers torch will
be passed at some point soon. As clients are aware, we were enthusiasts for
him when he was elected and in the early months of his work thereafter.
We are not yet willing to assume that he cannot yet be the great unifier and
sensible visionary who swept the nation at the polls. But we do believe
investors should have a new caution that the recent Obama will strive to
carry out his statist programs in ways that will be deleterious both to the
economy and to investment returns. Watchful cautionnot Panglossian
enthusiasmis in order. There is a world of opportunity outside the USA.
Capital that survives and prospers is a coward, not a lover.
When will the new global leadership emerge?
Maybe as soon as the early years of the next decade, if the US economy has
become so solipsistically engaged in snaring itself in Laoconesque coils that
it has neither the resources nor the prestige to sustain its position of global
economic leadership.
If not us, who?
The New Best Hopes for the World
Shanghai Stock ExchangeJanuary 1, 2008 to June 4, 2009
1,500
2,000
2,500
3,000
3,500
4,000
4,500
5,000
5,500
6,000
Jan-08 Mar-08 May-08 Jul-08 Sep-08 Nov-08 Jan-09 Mar-09 May-09
2,764.83
Capital that survives
and prospers is a
coward, not a lover.
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Bombay Sensex
January 1, 2008 to June 4, 2009
7,500
9,500
11,500
13,500
15,500
17,500
19,500
21,500
Jan-08 Mar-08 May-08 Jul-08 Sep-08 Nov-08 Jan-09 Mar-09 May-09
15,116.27
Morgan-Stanley Emerging Markets
January 1, 2008 to June 4, 2009
400
500
600
700800
900
1,000
1,100
1,200
1,300
Jan-08 Mar-08 May-08 Jul-08 Sep-08 Nov-08 Jan-09 Mar-09 May-09
781.76
Brazil Bovespa
January 1, 2008 to June 4, 2009
25,000
30,000
35,000
40,000
45,000
50,000
55,000
60,000
65,000
70,000
75,000
Jan-08 Mar-08 May-08 Jul-08 Sep-08 Nov-08 Jan-09 Mar-09 May-09
53,764.98
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Who Will ReallyLead the Global Rescue?
THE COXE STRATEGY JOURNAL
Positions Open: Rescuers for The Global Economy
Applications requested to fill slots for two or more large economies which each meet
allor most ofthe following criteria, and show likelihood of being able to continue
to meet these tests over the next five years.
Qualifications
1. Capitalist-oriented economies that are continuing to be driven primarily
by risk-taking in the private sector and are not reliant on sustained new
forms of large-sale government intervention.
2. Respect for the rule of law in commercial transactions, particularly
bankruptcy, where the commercial rules in the Anglo-Saxon economies
have evolved slowly over three centuries.
3. High household savings rates.
4. Demonstrated competitiveness in international trade.
5. A record of fair trade cooperation with neighbors where regional trade
agreements are in force.
6. A banking system that has passed the open market stress test of survival
and growth in recent months, (not a backdoor analysis) and has not
been subject to bailouts amounting to more than 1% of GDP.
7. A public educational system in which students at Grade Eight level andhigher grades rank in the top 25 in the world in mathematics, science
and literacy.
8. If not a net creditor globally, then not a net debtor to foreign investors
of more than 2% of GDP.
9. 9.Average per capita real GDP growth rates in the previous five years of
at least 3%.
10. Positive demography, such that each new generation of first-time
homebuyers is larger than its predecessor.
Likely claimants: China, India and Brazil.
(Canada and Australia meet most of the tests, but their populations are too
small to give them the global clout as Rescuers. Their economies and stock
markets are the most obvious winners among the industrialized nations
from the sustained growth in commodities demand that will occur if those
three heavyweight emerging economies continue to grow strongly.)
Canada and Australia
meet most of the tests,
but their populations
are too small to give
them the global clout
as Rescuers.
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There are obvious caveats:
1. China is only non-democratic nation in the select circle, and proclaimsitself as being ruled by the inheritors of Maos branch of Communist
theories. It remains to be seen how long it can achieve its astonishing rate
of progress to the status of advanced industrial nation if it continues as
the oxymoronic Communist free economy.
2. Indias southeast is more secure now that the Tamil rebellion in Sri Lanka
has been quashed. However, its problems from Pakistans vulnerability
to the Taliban and other Islamic extremists remain. There has been some
good news in recent days, with the governments new commitment to
challenging the Taliban with the full power of its well-regarded army.
Jihadist terrorism cannot be eradicated in open military combat, but thecitizenry will justly conclude that democracy is doomed and defect to
the cutthroats if they are able to defy the national army successfully. This
is one military campaign that absolutely must be won. Even those who
ritualistically oppose all American military involvement abroad might have
second thoughts if the Taliban and Al Qaeda gain control of Pakistans
nuclear arsenal.
3. Brazils wise, benign ruler, Lula, is nearing retirement, and the nation has
a record of more than a century of disappointmentsbeing the most-
often cited candidate for title of Tomorrows Great Global Success Story.
As Margaret Thatcher observed, when asked whether Thatcherism would
survive, It will continue if the next Labour government is elected on, and
continues, the elements of what you call Thatcherism. Tony Blairand
even Gordon Browndemonstrated that Labour had learned from the Iron
Lady, and the party wasnt going to revert to the sterile socialist policies
that had been the Tory partys greatest electoral assets.
4. Now that Kim Jong Il has proved that one of the poorest nations on earth
can develop workable atomic weapons and inter-continental ballistic
missiles, Asia faces frightening new challenges to its plans to continue
its drive to prosperity. North Korea cooperates openly with Iran, and the
mullochracy is probably only months away from having both nuclear
bombs and long-range missiles. Dick Morris, former Clinton advisor, says
that an unchecked Iran will attempt to carry out its threat to wipe Israel
off the map. It will not be done with missiles, but by giving suitcase
bombs to terrorists. Although Hezbollah failed to win at the ballot box
in Lebanon last weekend, it still has a large brigade of jihadists on its
staff, eager for action. But since Ayatollah Khomeini took power (while
Jimmy Carter stood aside and waxed eloquent about democratic progress
Even those who
ritualistically oppose
all American military
involvement abroad
might have second
thoughts if the Taliban
and Al Qaeda gain
control of Pakistansnuclear arsenal.
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Who Will ReallyLead the Global Rescue?
THE COXE STRATEGY JOURNAL
as Americas allythe Shahwent down), Iran has never failed to
make clear that it regards America as The Great Satan, which, in its
interpretation of Shia prophecies, means America must be dislodged
from its global throne. So any American city could, in theory at least, be
the first victim of a suitcase bomberand destruction of any major city
would, if only because of insurance and rebuilding costs, wipe out the
American economy.
We only mention these geopolitical challenges because Planet Earth is
probably the riskiest it has been since the day before the meteor landed
in the Yucatan and wiped out most life. No investment thesis can protect
private wealth from a cataclysm of those proportions. We can only hope that
Obama and his military advisors are seriously pondering the implications of
the suddenly-changed situation. Unfortunately, were the CIA to learn that a
catastrophe looms, it could lack the credibility to convince the Administration
that desperate measures must be planned, because Ms. Pelosi, major architect
of the stimulus program, has repeatedly charged the agency with misleading
Congress and serial lying.
So What Should Investors Do Now?
After having made passing reference to the (thankfully) still-remote possibility
of The End of the World As We Know It, we resume consideration of what a
peaceful transformation of global economic leadership means to investment
policymakers.
If, in fact, over the next year or so, global investors gradually come to conclude
that the Third World, as led by China and India, is the key to global economic
recovery, then this is one of those Hinges of History that dictate changes to
investment policies.
We sum it up as The Old, Old World Has Come To Redress the Balance
of the New.
Among the basic investment axioms that have underlain concepts of portfolio
construction in our lifetimes are:
1. US Equities will always be the global standard, and the US stock market
will always have the greatest liquidity and highest capitalization.
2. The US bond market will always be the global standard, and will always
have the greatest liquidity and highest capitalization.
3. The dollar will remain the global store of valueperhaps not for always,
but certainly for the foreseeable future.
...this is one of those
Hinges of History that
dictate changes to
investment policies.
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4. Global equity markets will continue to follow the lead from Wall Street
and the US economy.
5. Commodities share of global wealth and GDP will, across most economic
cycles, continue their two centuries of decline, because industrialized
societies commodity content declines as the values of manufactured goods
and services increase. Commodity stocks investment outperformance will
occur during periods of rapid inflation (such as the stagflationary 1970s),
but otherwise will be seen as mere aberrations and will be short-lived.
If, however, the Obama rescue programs do not produce the gaudy results he
has predictedand which voters have come to believethen the probability
exists that investors will reduce their exposures to US equity and debt products
relative to those from the economies that are demonstrating global leadership.If a parade is proceeding along a street, one can choose to watch it or join it:
standing in front of it yelling Stop! is not, for most of us, an option.
As the Chinese, Indian and Brazilian economies were booming, and stock
markets in those countries were solidly outperforming the S&P, and as the
dollar was underperforming most major currencies, and as commodities and
commodity stocks outperformed, many respected investment commentators
said, knowingly, Dont join this parade. Its about to come to an end.
After The Midnight Massacre of July 13th, those experts wereat last
vindicated. Emerging Markets equities were savaged more severely than thenon-financial sectors of the US stock markets, Emerging Markets bonds were
savaged as severely as US junk bonds, and commodities had their quickest and
most brutal collapse since 1930. The parade ended quickly and ingloriously
and the spectators dispersed.
But then, the pattern began to shift back toward what had been normal for
most of this decade:
US Dollar Index (DXY)
July 1, 2008 to June 4, 2009
70
75
80
85
90
95
Jul-08 Sep-08 Nov-08 Jan-09 Mar-09 May-09
79.41
...yelling Stop!
is not, for most of us,
an option...
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Who Will ReallyLead the Global Rescue?
THE COXE STRATEGY JOURNAL
Morgan Stanley Emerging Markets Index
July 1, 2008 to June 4, 2009
400
500
600
700
800
900
1,000
1,100
Jul-08 Sep-08 Nov-08 Jan-09 Mar-09 May-09
781.76
Shanghai Stock Exchange
July 1, 2008 to June 4, 2009
1,500
1,700
1,900
2,100
2,300
2,500
2,700
2,900
3,100
Jul-08 Sep-08 Nov-08 Jan-09 Mar-09 May-09
2,764.83
Bombay Sensex
July 1, 2008 to June 4, 2009
8,000
9,000
10,000
11,000
12,000
13,000
14,000
15,000
16,000
Jul-08 Sep-08 Nov-08 Jan-09 Mar-09 May-09
15,116.27
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We see this shift as more than a blip. We think it heralds an emerging reappraisal
among globally-oriented investors to go back to the future. From 2002 until
The Midnight Massacre, the S&P significantly underperformed most of the
stock markets of two kinds of economies: those (such as Australia or Brazil)
in which commodity exports are large or major components of GDP, and
those (such as China) in which commodity imports are large components
of GDP. In the first category can be some industrial or newly industrializing
economies; in the second are newly industrializing countries.
It was these nations stock markets sustained outperformance from 2002
through June 2008 that, in retrospect defined the real growth of the global
economy. The S&Ps performance from March 2002 to July 2007 was, we now
know, heavily based on heavily-overstated earnings of the financial stocks,
which reported 41% of total S&P profits. If one adjusts the US stock markets
performance for all the financial frauds and folly, the outperformance of
economies linked by growth in commodity trade becomes even clearer.
We believe that relationship is about to return, and will be the leitmotifof
the music of the markets over the next five years.
We also believe that it will have especial impact on the prospects of the
important commodity-oriented companies
Which prospered so mightily as soaring commodity prices made these
producers the scarcity stories on stock exchanges this decade
And which could soon be acquiring a rather different kind of scarcity value.
RJ-CRB Futures Index
July 1, 2008 to June 4, 2009
150
200
250
300
350
400
450
500
Jul-08 Sep-08 Nov-08 Jan-09 Mar-09 May-09
259.79
We believe that
relationship is about
to return, and will be
the leitmotifof the
music of the markets
over the next
five years.
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Who Will ReallyLead the Global Rescue?
THE COXE STRATEGY JOURNAL
Are Private Sector Commodity Companies CapitalismsNext Endangered Species?
Since last summer, we have been reporting (with growing concern) on the
tragic fall of free market capitalism from prestige and leadership in the global
intellectual and economic pantheons. Romes fall was due, in great measure, to
the failure of Augustuss successors to live up to his ethical standards. Roman
soldiers and citizens lost faith in the system. (We know just how decadent
many of them were because of Suetoniuss classicLives of the Twelve Caesars,
which, with its enthusiastic reporting on the emperors sexual proclivities,
has been delighting prurient history students for nearly two millennia.)
Similarly, many of our modern Masters of the US Financial Empire have
betrayed their capitalist heritage, collectively undermining not just their owncompanies and the global financial system, butmost tragically of allthe
strategic and moral justification for letting large capitalist companies function
in privileged positions at the core of the financial system.
Taxpayers across major Western countries are being hit for trillions of dollars
in bailout funds for companies whose leaders had previously been as rich and
haughty as Tiberius (although not, as far as we know, as personally appalling
as Caligula). Each week, one reads new commentaries arguing that the
neo-capitalist models most countries adopted after the collapse of Bolshevik
Communism are being rejected in favor of statism in various modes.
What text can capitalists use to defend themselves?
Oddly enough, the Chinese government is publicly suggesting that the
OECD nations should go back to Adam Smith. Chinese premier, Wen Jiabao,
spoke at Davos of Smiths bookTheory of Moral Sentiments, saying it was a
guidebook for the rulers in Beijing.
Who would have thought 20 years ago that China would be the third biggest
economy in the world by 2010?
And who would have thought that a red-hot favorite book in of Asias
communist leaders would be written by the father of the Westerncapitalism.
We live in wondrous times.
...trillions of dollars
in bailout funds for
companies whose
leaders had previously
been as rich and
haughty as Tiberius
(although not,
as far as we know,as personally appalling
as Caligula).
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The best-known modern American book praising the glories of unrestricted
capitalism and denouncing socialism is probably a novel published fifty
years agoAyn RandsAtlas Shrugged. It describes an American dystopia of
the future run by politicians, pundits, union bosses, and leftist foundations.
Ms. Rand was a better pamphleteer than novelist, and the book was panned
by critics for its Castro-length speeches by capitalists, and the simplicity of
its characterizations of public and private figures who were either glorious
heroes or despicable villains. Belletristic merit, and subtlety it lacks, but it
was an enormous hit and has never gone out of print.
We havent re-read it in decades, but we thought of it as we watched President
Obama declare war on Chryslers secured bondholders.
Mr. Obama, whose only paid job other than being a community organizer(whatever that may be) was as a law professor, overturned bankruptcy
preference rules which have been on the books here since the Constitution,
part of English Common Law for a century before that, and a strictly-
enforced part of European lawsfrom the Hanseatic League to Renaissance
Switzerland and Italyfor centuries before that. But such an uncontested
legacy of business practice could not be allowed to get in the way of satisfying
the demands of the UAW.
In the same week, he announced that he would withhold Californias $14
billion in federal emergency funds unless the tarnished Golden State restored
the full wages, benefits and work rules of state employee locals of the Service
Employees International Union. The Governator had imposed some work
hour cutbacks and unpaid holidays on many state employee groups as part
of crisis measures to deal with a $20 billion deficit.
In his Chrysler speech, Obama seemed to have stepped right out of the pages of
Atlas Shruggedan America ruled by leftist demagogues (called looters) who
were strongly influenced by enlightened socialists and strongmen abroad.
Her tale begins with a story of the looting of a commodity-producing company
by a Latin American Marxist dictator. The scion of a family (loosely modeled on
the story of the Patinos) arranges to have the familys great copper-producingoperation blown up rather than handing it over to a Latinstalinist.
What dates Atlas Shrugged most is its view of the major strengths of the
American economy of her era, which was dominated by heavily unionized
basic industriescommodity-producing companies, auto companies, and
railways. The economic progress that has defined America since the Reagan
Revolution made capitalism respectable has been led by newer, non-unionized
industries.
In his Chrysler speech,
Obama seemed to have
stepped right out of
the pages of
Atlas Shrugged
an America ruled by
leftist demagogues
(called looters)...
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Who Will ReallyLead the Global Rescue?
THE COXE STRATEGY JOURNAL
(We exempt the construction industry from this comparison, because that
industry has long been led by companies which have pension and benefit
funds jointly managed with the construction trades unions. From long
personal experience working with clients in those fundsin Canada and
the USand from speaking at the jointly-managed conventions of the
International Foundation for Employee Benefits, we can attest that this is
a model that works for the industry, its employees and the economy. The
old-style adversarial labor relations of the auto companies and airlines
operate in an outdated, Randian mode.)
Were Rand alive today, she would be shocked at what had happened to the
oil industry, which was then the biggest and most profitable of the goods-
producing industries. Back then, The Seven Sistersthe transnational
Supermajorsdominated the global oil industry, and, from the fruits of
their worldwide exploration, owned most of the worlds proven oil reserves.
Although reviled by fashionable politicians, pundits and moviemakers, they
kept finding new oil and gasand the postwar economic boom was based
on cheap, reliable energy.
Today, analysts estimate that the surviving supermajorsExxon-Mobil,
Shell, Chevron, ConocoPhillips, BP and Totalown only 3% of total known
conventional reserves. State-owned or controlled enterprises are collectively
the owners of most of the known oil and gas deposits.
What about the other commodity industries?
Despite such Randian robberies as the looting of Freeport-McMoRans nickel
mines in Cuba, the mining industry still remains largely in private hands,
subject to royalties and other income-sharing contracts with nations and
states. Notable exceptions: (1) Codelco, the Chilean government company,
is the worlds foremost copper producer and a respected industry leader; (2)
after Yeltsin-era privatization and a decade of stockholder control, Norilsk,
the Stalin Gulag nickel giant, has reverted to Kremlin controlbut remains
a public company.
However, the mining industrys era of private ownership is now threatenedby the emergence of a new trend in the commodity world: the desire of
commodity-short new industrializing economies to gain controland
ownershipof important commodity production facilities.
The miners first experience with this brave new world in which the biggest
commodity buyers would try to use their financial muscle to control
their access to resources came with Chinalcos (China Aluminum Co.)
dramatic intervention into the takeover battle of Rio Tinto by BHP Billiton.
Despite such Randian
robberies as the looting
of Freeport-McMoRans
nickel mines in Cuba,
the mining industry
still remains largely in
private hands...
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With the notably insipid Alcoa as front man and junior partner, and with
the approval of the Chinese government, Chinalco bought 12% of Rio Tinto
in a matter of hours. That effectively blocked BHPs bid. Chinalco thereafter
entered into negotiation to acquire outright some of RTPs major mineral
properties in Australia.
As we were preparing for publication, RTP stunned the financial markets
with the announcement that its deal with Chinalco was off, and that it was
entering into a partnership with its former foeBHP Billitonto develop
major iron ore properties in Western Australia. Chinalcos consolation prize
is a $195 million breakup fee. Heavily-indebted RTP will rebuild its finances
with a $15.2 billion rights offering, and a $5.8 billion payment from BHP for
its share of the joint venture.
This multi-billion-dollar deal has two strategic elements that suggest that
other attempts to buy major commodity producers are inevitable: (1) to buy
enough of a commodity-producing company to have real influenceor even
a vetoon its major decisions and investments, and (2) to buy particularly
desirable properties owned by the company, develop and manage them,
and ship their production to the investing country. Had this deal succeeded
China would have become a large-scale producer of metals and minerals
abroad, and acquired major influence on global pricing of those metals and
minerals. (China has, in fact, been trying to open mines in some of the parts
of the globe with the most noxious rulers, and, to its disappointment, hasenjoyed only modest success. The rebels in the Congo, for example, didnt
show any more respect for the Chinese than they had for capitalist investors.
That may be another reason why it decided to switch its strategy to investing
in proven superstars with global reach.)
Why didnt China just buy Rio outright?
We believe that the American response to the CNOOCs bid to buy Unocal
showed the Chinese that domestic politics could bedevil the best-laid plans of
mice and Maoist men. Chevron was able to win the bidding war without having
to pay an excessive price because of threats by some Congresspersons against
a Chinese takeover of a national treasure. (Unocal was hardly a national
treasure, and its biggest appeal for CNOOC was its hydrocarbon reserves in the
South China Sea, which should hardly have concerned politicians whose energy
policies have been mostly directed toward banning offshore drilling. But the
Chinese Peril publicity worked. This wasnt as disgraceful a Congressional
intervention as its cover-up and connivance in the corruption at Fannie Mae,
and it wasnt even low comedy: it was just low.)
...the American
response to the
CNOOCs bid to buy
Unocal showed the
Chinese that domestic
politics could bedevil
the best-laid plans of
mice and Maoist men.
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What was supposed to distinguish the Rio Tinto-Chinalco deal from
CNOOCs setback was that it was merely a business venture between two
mining companies. Beijing spokesmen denied that the government was
behind the bid.
However, the outraged response from RTP shareholders and Australian
politicians showed that the market believed Beijing was deeply involved.
Chinalcos chances of having its offer judged solely on financial merits
evaporated quickly when its Chairman and CEO, Xiao Yaqing, was named to
the State Council, Chinas cabinet, shortly after the deal was announced.
The Chinese doubtless also learned of the political perils in outright takeovers
from what happened to Inco when it negotiated a merger with Falconbridge.
Because the two companies together had such a sizable share of world nickelproduction, anti-trust bureaucracies in Washington and the EU had to sign
off. Swiss-controlled XStrata also wanted to buy Falconbridge. Washington
granted approval fairly quickly, but the Brussels snouts kept rooting around
trying to find a threat to the competitiveness of European steel manufacturers.
A tie-up period of stock control expired as Inco frantically tried to complete
the deal. XStrata leapt in, bought Falconbridge, and, hey presto! No problems
with Eurocrats! Control shifted from Sudbury to Zugthen the home of that
fine, principled capitalist, Marc Rich.
(We cannot help but suspect that some Eurocrats may have had personal reasons
for gloating about the victory of a Continental company (even if it isnt in the
EU). Brussels is, after all, an expensive city to live in. What can we do next? Hey,
those guys at Intel have been displaying the kind of arrogance you expect from
Yanks. Lets see whether theres something we can nail them with.)
China Inc. is now zero-for-two in takeovers of Western mineral giants. Does
that mean that commodity companies should breathe easier?
We strongly believe that the Chinese will lick their wounds, learn from what
went wrongand will be even more forceful the next time. Beijing will not
be content to continue its policy of reducing its acquisition of Treasurys
through purchase of commodities. It has powerful reasons to become anowner of major resource properties.
It showed it could move with lightning speed in blocking BHPs takeover and
becoming the largest holder of RTP shares. Next time, it will doubtless be more
selective in its choice of partners, and will be more willing to pay up. Better
to own a significant share in production of what you need to buy to grow,
rather than holding an extra quarter-trillion-or-so of bonds denominated in
the currency issued by the most profligate big nation on earth.
China Inc. is now zero-
for-two in takeovers of
Western mineral giants.
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If the worlds economic power has shifted, then managements of none of
the major diversified companies except Teck can feel secure about their
futures. (Tecks multi-vote share structure precludes a takeover unless the
controlling stockholders approve.) These companies are worth more to the
Chinese (and, for that matter, the Indians) than they are to open market
investors. Why? Because ownership of strong minority interests allows China
to intervene in pricing decisions on products subject to long-term contracts,
such as iron ore and metallurgical coal. As the worlds biggest buyer of both
those bulk products, China has powerful reasons for wanting to break open
the producers group that sets global prices.
If effective control of major mining companies is going to be acquired
by government-controlled companies for purposes other than profit
maximization, then we could well be seeing a dramatic shrinkage in supply
of commodity equities as the next cycle unfolds.
Apart from coal and iron ore, what other mined mineral of great concern to
China and India is subject to such contractual pricing formulas?
Non-nitrogen fertilizerparticularly potashmight be the most obvious.
Rumors that BHP would make a bid for Potash Corp. have been titillating
underemployed investment bankers for years. They resurfaced after BHP
floated a large bond issue for general corporate purposes. At its annual
analyst day, CEO Bill Doyle was asked outright about the possibilities of atakeover, and he was suitably dismissive. [Full disclosure: We were there to
give the luncheon speech, not as analysts or as stockholders.] Now we know
that BHP had enough cash on hand to be able to leap back into bidding for
RTP propertiesto the tune of $5.8 billionon what seemed to be a few
days notice. Potash management and its shareholders can relaxfor now.
Remarkably, there is one major agricultural stock subject to 90% control
that just might become controlled by open-market investorsthereby going
against the trend we think will come in the next cycle. That is CNH Global,
the worlds second-largest manufacturer and distributor of farm equipment.
FIAT owns 90% of the stock and there had been rumors it might make adivestiture to concentrate managements full energy on the manufacture of
cars if its grandiose plans to merge its operations with Chrysler and GMs
Opel divisions were approved. Canadas Frank Stronach (of Magna fame),
seems to have won the Opel auction, so at the moment it looks as if CNH
will continue in its role as the most reliable cash flow producer in the FIAT
organization.
As the worlds biggest
buyer of [iron ore and
metallurgical coal]
China has powerful
reasons for wanting
to break open the
producers group that
sets global prices.
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However, the trend is already rapidly becoming global in agricultural land.
As we often noted, one factor which made this global food crisis different
from past occasions of soaring grain prices was the appearance of widespread
state intervention among grain-producing countries to control grain exports.
For decades, governments of grain-producing countries across the world had
competed with each other to promote grain exports.
What had changed?
First, almost unnoticed by consumers, politicians and policymakers alike, the
grain surpluses which had been at the core of farm policies quietly shrank
until observable supplies of corn, wheat and rice were down to levels that
would mean that almost any crop failure anywhere could raise prices above
government support levels.
Second came the first serious outbreak of global food inflation since the
stagflationary 1970s, and prices of all grains skyrocketed.
Result: governments began to taxcontrolor even ban exports of grains
and oilseeds. Two motivations appeared: (1) the rebirth of autarky among
nations , which hadnt been seen since World War II; it reappeared in a few
countries where food scarcity among urban residents suddenly became a
hot political issue; (2) keeping food at home to suppress domestic inflation,
even if it meant that local farmers were forced to sell their output at prices
far below world levels.
The major food-importing nations that had the money to buy food werent
initially frightened as grain prices climbed. What got their attention was the
threat that food might not be available at almost any price because of export
controls abroad.
Their response has been astonishing. Saudi Arabia, South Korea, China,
Egypt, Kuwait, Qatar and Bahrain have been making deals to buy or lease
farmland to grow grains that must be sent to the investing nation. According
to The Economist, at least 5.4 million hectares have already been acquired
by foreign government agencies in such countries as Sudan, Cambodia,
Ethiopia, Mozambique and Turkeyand the process is still proceeding
rapidly. The International Food Policy Research Institute told The Economist
that between 15 and 20 million hectares have been subject to transactions or
talks involving foreigners since 2006That is the size of Frances agricultural
land.
What got their
attention was
the threat that
food might not be
available at almost
any price because
of export controls
abroad.
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Some of these deals (such as Saudi Arabias with Ethiopia) involve production
of grain for delivery to the foreign investors from poor countries that are
receiving emergency food aid from the UN. (When Joseph agreed to supply
Egyptian grain for delivery to Jacobs family in modern-day Israel, he wasnt
taking it out of the mouths of poor residents of Egypt: they were already
well-looked after, thanks to excellent long-range crop forecasting, and major
expansions of grain storage facilities.)
If deep-pocketed food-importing nations are going to pour billions into
irrigating and farming in grain-producing nations abroad, how will this
affect the share prices of the great input stocks, such as Monsanto, Deere,
Syngenta, Potash and Mosaic?
We suspect that investors who spend time pondering this question willconclude that, over the long run, it should help to prevent sudden grain price
spikes such as corns runup from $2.50 to $7. We believe it will significantly
increase sales of fertilizers, seeds and high-end farm equipment, because the
new owners (or lessors) are spending heavily to produce gobs of grain. To
the extent that this massive inflow of capital does make vast stretches of
under-utilized land rich and productive, this could do more to prevent a
truly disastrous global food crisis than all the food aid one could imagine.
So we are, in principle, in favor of this trend.
We conclude this discussion by raising the following overall question about
growing government ownership in commodities.
In the last cycle, once commodity prices began to climb, the producers stocks
soared, and were the pre-eminent sector of many global stock markets until
The Midnight Massacre. Will they be even more valued this time because
sovereign wealth funds and other emanations of governments will, from time
to time, choose a more appetizing investment alternative than Treasurys?
And will the whooping crane-sized population of high-quality publicly-
traded non-oil-producing commodity companies become an endangered
species?
To us, the likely answers to these questions suggest strongly that the great
commodity companies should be at or near the top of most investors short
list of Buy And Hold stocks.
...will the
whooping crane-sized
population of
high-quality
publicly-traded
non-oil-producing
commodity companies
become anendangered species?
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INVESTMENT ENVIRONMENT
Back in the Sixties, there was a saying in some intellectual circles. Learn aforeign language! If youre an optimist, learn Russian! If youre a pessimist,
learn Chinese!
That reflected the fashionable feeling that capitalisms best days were behind
it. And a very good thing, too, because most of the history of capitalism was
of robber barons, exploited workers, raped environments, and wars.
Even a few months before the Wall fell, liberal elitists thought that the USSR
was an economically successful society, albeit undemocratic, and with a
regrettable tendency toward building dreary housing developments in dreary
cities.
We cite those perceptions from the past as evidence one must be wary
about assuming that the economic system that has, for two centuries, been
the source of most of the worlds progress, is about to cede leadership to
the self-proclaimed heirs to a Communist fanatic responsible for more
deaths among his own people than either Hitler or Stalin. We are, of course,
delighted that the current Beijing politburo reads Adam Smith. That gives
China an automatic advantage, because we doubt that Smith is standard
bedtime reading in the White Houseor in leading economics departments
other than the University of Chicagos.
The remarkable paradox of our time is that China since Deng Xiaoping has
achieved its longest continuous politico-economic program in at least two
centurieswith dazzling successwhile the new US leadership is in the
process of dismantling the model developed by Reagan, and continued
mostlyby his successors. During that time US GDP climbed far faster
than Continental Europes, which managed its economic torpor brilliantly:
it offset that underperformance by convincing most of the most powerful
American liberals thatits model was better than Americas.
Now that it is President Obamas job to get the economy performing the
way it did between Reagans First Term and the Recession of 1999, the multi-
trillion-dollar smorgasbord of policies on offer seems to be a mixture of
Depression-Era Roosevelt and Modern-Era France and Belgium.
With one conspicuous exception: the only Rooseveltian initiative that
not only created jobs and economic gains almost from Day One was the
Tennessee Valley Authority (TVA). This became, over the years, one of the
worlds most successful energy development programs and was a big factor
in fulfilling the classic defiant cheer from Dixie: The South will rise again!
...the multi-trillion-dollar
smorgasbord of
policies on offer
seems to be a mixture of
Depression-Era Roosevelt
and Modern-Era France
and Belgium.
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But, apart from a few windmills and a lot of research into converting hay
into electricity, there is nothing in the Obama program that creates jobs
nowand continuously into the futureand finances them TVA-stylein
public debt markets based on cash flow generated from electric power plants
and other contributions to economic renaissance. TVA became a big producer
of nuclear power, which somewhat tainted it in the eyes of the True Left.
What about the hundreds of thousands of real jobs fixing the worn-out
highways and bridges across America that would be at the core of the Obama
recovery program?
We lost the roads and bridges somewhere along the way.
The numberand dollar valueof new US highway and bridge contracts
has actually plunged since the stimulus was announced. So much for all
those shovel-ready projects that were going to create jobs and improve
transportation.
Obamas vision of creating economic progress through millions of jobs in
governments, universities and NGOs is doubtless a hit in Brussels. Following
those policies has meant that the unemployment rate in Continental
European countries in this decade has for many years been roughly at the
levels America is experiencingnowand twice the rate it experienced under
the horrors of the Bush Administration.
We think the likeliest outcome of our current discontent is a recovery that will
disappoint both bulls and bearsby making neither much richer. Obama
could have stimulated large-scale immediate job creation in the private sector
in California and other coastal states by authorizing and promoting offshore
drilling. Instead,