Thursday, November 12, 2009 9 comments ++[ CLICK TO COMMENT ]++

Bruce Greenwald on global imbalances

I ran across a thought-provoking interview with Bruce Greenwald conducted by Robert Huebscher of Advisor Perspectives. Bruce Greenwald is a well-known professor who has written several books on value investing and is director of research at First Eagle Funds so I was surprised to see his strong views on global macroeconomics. I'll bet most readers would not agree with everything that is said. The author covers macro in this first part and apparently will publish a second part covering investments later on.

If you are into macro stuff, this is a must-read! I don't agree with everything Bruce Greenwald says but he has interesting theories on the financial crisis, global imbalances, future unemployment, and so forth. Bruce Greenwald touches on some important, oft ignored, issues, such as the loss of jobs from rising productivity. I wish I had time to tie this into one of Peter Drucker's macro calls from a few decades ago but I don't have time to go into it right now. But, essentially, problems have been developing in the background but we are only starting to see them now. So far people just talk about the economic implications (such as loss of wealth or unemployment) but the more grave issue are the social implications. This interview makes me gloomy :(

I thought I would tackle some of the points covered in the interview so read on...

Unemployment & The Great Depression

The interviewer asks about unemployment and Greenwald remarks:

You want to go back and think about what is going on. In a sense, you are seeing issues that are going to take a long time to fix and are similar to what happened in the Depression. Basically, in the Depression a huge sector of the economy that everyone had always regarded as central, died. And it dies for an almost virtuous reason.

That sector of course is agriculture.

Since about 1870, productivity growth had been 4% to 5% and demand growth had been 1% to 2%. Agricultural prices had been up before and during the first World War, and then they were down. But the inexorable trend had been down, with all this growth in productivity and limitations on demand, and sooner or later prices were going to collapse. Approximately 35% of the US population was either in farming or in farm towns or were supporting a farming enterprise, and they were going to be marooned.

So when you look at the countries that suffered the worst as a result of the Depression, they are the big agricultural producers: the US, Australia, Canada, Germany, France, and most of Europe, but not the UK or other countries that were less agriculturally dependent. Japan was very agriculturally dependent, and they suffered terribly and quickly in the early 1930s, but fortunately for them they started a war in China and entered the second World War right away. The country that never recovers is Argentina.

When the Depression happens, the challenge becomes how to get that portion of the population that is trapped – because their housing, jobs, and capital are in agriculture – to the manufacturing enterprises. The answer is that is very hard to do.

I don't agree with Greenwald's view of the Great Depression. Although he is correct in saying that agricultural job losses caused the most pain, I don't believe that was the key element in the unemployment picture. I believe the difference in the recovery between the various nations had more to do with monetary policy (such as getting off the gold standard) than with agriculture per se. Furthermore, farming had been shedding jobs for 50+ years, from the late 1800's, so why say that it was a cause in the 1930's? Overall, I think Greenwald is wrong with this view.

Where Greenwald is right, in my opinion, is his description of the loss of farming jobs. The Great Depression did result in an anti-climax—the final collapse of farming if you will—and the adjustment process, as Greenwald astutely points out, was painful and difficult. The presently unfolding switch from manufacturing to services, and from services to something-new is going to be tough.

The End of Manufacturing

We may be witnessing the end of manufacturing, just like someone 50 years ago was witnessing the death of farming:
The comparable thing that is going on today is that manufacturing is dying, and it is dying for exactly the same reason, which is productivity growth is 5% to 6% a year and demand growth is 2% to 3% a year.

A lot of people in USA, Canada, and other developed countries mistakenly think that manufacturing is something that needs to be developed. I generally notice this with either nationalists (both on the left and right) or hard-currency advocates (who tend to favour commodities, gold, and decaying industries.) The fact of the matter is that manufacturing is not coming back. Ever! American manufactured output is severalfold higher now than 30 years ago, yet the number of workers has shrunk considerably. America is more of a manufacturing nation now than 30 years ago. But not in terms of employment.

What is happening is a natural process. As Bruce Greenwald comparison between agriculture and manufacturing shows, when productivity outstrips demand, there is only one way for employment to go: down!

Another point that needs to be mentioned is that Americans/Canadians/others lose more manufacturing jobs to technology than to outsourced labour. American auto workers have lost jobs over the decades, not because of cheap Chinese labour or Japanese labour, but beecause of robotics and other advanced technologies (this is very evident if you look at auto employment in the 80's and 90's.) The production line in automobile factories are so advanced now that a few robots probably do the work of 20 or 30 workers—and they can work 24 hours if needed.

China Facing Similar Risks As Japan

Bruce Greenwald makes a highly controversial claim suggesting that China is going to face some serious problems. It's not just China; but Germany; and others too.
China has decided to grow, and they can’t grow based on domestic demand, so they have to do it through international demand, and that’s of course demand from manufacturing. They have exactly the same problem as Japan. They have a command economy, and they have sort of kept their workers busy, but they are heading for big trouble. Manufacturing employment hasn’t grown for three years in China, and that’s a huge problem for them, despite the fact that, like Japan, they are manipulating their currency, which is just a modern version of protectionism. And they’re generating exports.

Japan and China are in the same situation. Germany is too; they have powerful unions and powerful firms, and basically those who they are undermining – because they have fixed the Euro exchange rate – are the other European countries. Overall, the Euro should go to $2.50. But there is no way they will let that happen, because they would go from surplus to deficit, and all their manufacturing jobs would be gone.


So you’ve got these enormous trade surpluses as a result of countries trying to sustain in various ways their manufacturing bases, partly because they have people marooned there. But also, like with agriculture, they think they can’t have a successful economy if nobody makes anything.

You go into a Japanese factory, by the way, and nobody makes anything. There are more people on the loading dock, which is a service function, than there are actually in the factory. That’s why they are a hopeless enterprise.

I completely agree on his point about China. If China does not get its service economy going, it is going to face serious problems. Even if China has no competition and does not see external demand for its manufactured goods decline, it would be losing jobs due to productivity growth from technology, improved processes, and so forth. Unless you avoid technology and progress and become an official member of the Luddite club, it is a certainty that manufacturing jobs will be lost.

(Not covered here but a similar problem will be faced by agricultural countries like India. If India ever pursues a path of wealth creation (so far it has decided not to) it will result in hundreads of millions of farmers losing their jobs. Advances in fertilizers, irrigation technology, and so forth, alone will put millions out of work within a decade.)

Nature of the Financial Crisis
There is a phenomenon that helps this take place, and it’s really what generated the financial crisis. If the US buys $900 billion more than we sell overseas, the surplus countries accumulate that $900 billion. That number is growing every year. They have to get rid of that money, and the only way they can get rid of that is to go from surplus to deficit, and that would destroy their economic growth.

The US controls how surplus countries deploy dollars in the US. They are not going to be able to buy US equities – we showed them that in Chevron – and they are going to have to buy US fixed income. That drove down long Treasury rates, and Alan Greenspan had nothing to do with it. They got tired of the low yields, and they looked for other fixed income. They are poor, uninformed investors, and we sold them a lot of bad mortgage-backed investments. Interest rates got to be really low in the US, and there was a housing and consumer lending bubble, and savings rates went to zero. And that’s what sustained growth in the US, which sustained demand, which sustained all the manufacturing industries.

There’s a weird stability to this, because the Chinese can’t do anything about it. If they try to get rid of their dollars, they can buy Euros. But then the Europeans have the choice of letting the Euro go to $3.00 or buying the dollars themselves. And then they go back and buy the Yuan, and then the Chinese have the choice of letting the Yuan go up and undermining their exports.

I share the minority view, as Greenwald here, that the housing bubble was not caused solely by the Federal Reserve. Most people keep blaming the FedRes, JCB, Bank of Canada, and others, but they only played a minor role. Most central banks follow the market!

The key driver was the funnelling of huge amounts of US$ into US Treasuries, which resulted in low long term bond yields—hence lower mortgage rates, credit card rates, etc.
The problem comes with consumer demand in the US. Basically the saving rate went to zero. In the US, the top 20% of people have 40% of the income and save about 15% of their income. A lot of that is pension plans and paying off principal on mortgages, so it’s automatic savings. If you take 15% of 40% you have a savings rate of 6%. This means that the bottom 80% is earning about 60% of the income and is spending 110% of their income. That is not sustainable. So, finally when housing prices collapse and the defaults in consumer finance occur, that whole system falls apart.

Bruce Greenwald doesn't say it but a lot of it has to do with the rising discrepancy in wealth as well. USA has created trillions in wealth over the last two decades but most of it has accrued to businesses and their owners (who are generally wealthy.) Worker wages have essentially been flat for a decade or more. Essentially, the savers are upper-middle-class or the wealthy, who funnel their savings into financial intermediaries and businesses. But the lower classes were borrowing from these financial intermediaries, as well as foreigners, and living outside their means. This is why you see stats implying there is huge amounts of excess private capital sitting on the sidelines—for instance cash at money market funds or short-term government bonds—while at the same time Americans (and Canadians and others) are drowning in debt. The savings are held by the upper class while the debt is largely owed by the lower class.

A Solution

I don't know if others will agree with this but Greenwald suggests the following solution to the global imbalances:
You’ll notice that we basically fixed the banks, but the underlying imbalances are in no way fixed. Those who suffered the worst, in international terms, are the Japanese and the other big manufacturers. So what you’ve got is this fundamental economic imbalance that hasn’t gone away, which is going to mean slow growth.

We can resolve this by just directing tariffs. But Obama plays nice with others, and he’s not going to do that, which would harm the rest of the world. We can’t try to control our currency, because if we sell dollars we would drive the price of the dollar down, and Japan and China would just buy them and sell Yen or Yuan, and there’s no percentage gain in doing that.

So the actual way we could relieve the pressure is to have the IMF just print money and give it to Korea and the other countries so that they could buy Chinese and the other exporting countries’ goods without having to incur foreign debt. That is the Stiglitz plan and that’s the plan that the Chinese are talking about.

At the same time, you’d like to tax the surplus countries to force them to adjust. That’s a short-term solution. The long-term solution is you have to get people out of manufacturing – and governments have to cooperate in this effort – and get them into industries like health care. Cutting health care is not a good idea at this point. They have to work in education, housing, and financial services. But if all those industries are under attack globally, you are not going to get the jobs that you need to replace the manufacturing jobs.

There is this huge structural problem taking place. The governments can offset it to some extent. I think what you are going to see in the US is what you saw in Japan for years, which is stagnant demand. We will grow a little bit, imports will flood in, purchasing power will go out of the US economy, and we will stop growing, and then the government will do something and the dollar will fall a little. All these things will happen sequentially, but ultimately you are going to have slow growth.

I'm not sure if the Stiglitz plan is related to the idea that is floated around with the SDRs (special drawing rights.) Creating a fictional "currency" seems like a better idea if the surplus countries are ok with it. One thing that is not obvious to me is whether wealth is being created anywhere. China, for instance, has accumulated a huge stash of Treasury bonds but how useful is that?

Yikes! Horrible Unemployment Picture

I hope Greenwald is wrong because he is not painting a pretty employment picture:
The next phenomenon that people are not aware of explicitly but ought to be is that productivity growth doesn’t come from innovation. It comes from people taking tried-and-true methods and actually applying them better. The reason I say “tried-and-true methods” is because, if you look at the most productive firms in an industry, they typically have costs that are a half to a third of the industry average. It’s the same technology that everyone else has available to them. There’s a huge opportunity for productivity and cost cutting.

Imagine that you’ve got basically 1% or 0% GDP growth and productivity growth of 2% to 3% per year. Employment is going to be decreasing by 2% to 3% per year. That means unemployment is going from 10%, where it is now, to 12% to 14%. I don’t think there’s a natural stopping place for that much below 15%.


We’ve seen this in Europe, and basically what it means is that people under 30 can’t get jobs unless they are from the absolute elite universities. That’s the sort of forecast you have to think about...

I think a lot of it also depends on where the wealth is recycled into. Greenwald is assuming that GDP doesn't grow much (his 0% to 1% forecast seems extremely bearish and may turn out to be wrong*) while productivity growth is around 2% to 3%. So, someone is making money off the productivity increase (basically the corporations and their owners) and it remains to be seen where they "spend" or "save" that money.

Political Consequences

Greenwald thinks the Democrats will lose the presidency due to the gloomy economy but Republicans will be in a dilemma given their ideologies:
Question: Other that then Stiglitz plan, is there any other solution?

Greenwald: This is the problem for the Republicans, even though they are going to win because it’s going to be such a disaster for Obama. The Democrats are not going to improve things unless they get lucky. The services people have to buy are lots of health care, custodial services for old people, college education and graduate education, and housing. They are big lumpy expenditures, and the government has to help finance them. So, in the meantime, while you are making this transition out of manufacturing and you are getting these institutions and the private methods of payment in place, the government is going to have to borrow a lot of money and do a lot of support. That’s going to be the hardest, because nobody has faced up to that.

We are actually in pretty good shape, because we don’t have much of a manufacturing employment base left. To give you an example, we have more professional athletes and referees, including tennis pros and golf pros, than we have extractive workers, which include coal miners and oil platform workers. We have approximately 200,000 professional athletes and 180,000 extractive workers. It’s just unbelievable what’s happened to productivity in these areas.

That sports professional example is very good and hammers home the point that manufacturing is very small in America. This is also why I remain more bullish than many other regions (in contrast, you'll notice that the consensus is very bearish on America and bullish on other regions.) I don't know if there will be huge losses with a US$ decline but in terms of the economy, America has an easier path than other regions.

Bruce Greenwald doesn't touch on it (probably because he is more of an economist and doesn't delve into politics or sociology) but there are other serious problems that are somewhat related. These include immigration (legal as well as illegal), pollution, crime, ethnic issues, and so on. For instance, America has huge black and gray markets for employment given the large illegal immigration population. There will be some issues to be tackled if unemployment gets worse (or doesn't improve quickly).


* To see why 0% to 1% in the long run is unlikely, consider Japan after their bust. Their GDP has grown around 1% real (around 0% nominal) and that is with horrible demographics. If Japan didn't have such bad demographics, I think it would have grown closer to 2%. Japan also had far bigger stock market and real estate bubbles (but consumer and government debt was low) so I would imagine that its outcome would have been worse than in America. I disagree with Greenwald and expect USA to grow at 2% for the foreseeable future (note that US GDP grew around 3% real in the last few decades so this is 33% less.)

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9 Response to Bruce Greenwald on global imbalances

November 13, 2009 at 6:23 AM

This is the most interesting interview and blog post I've read in several weeks.  I have some thoughts to contribute when I have more time.

Sivaram Velauthapillai
November 13, 2009 at 10:50 AM

Yeah... I was really blown away by the interview too. It may not help one's investing but it impacts our lives.

Credit should go to Robert Huebscher for conducting the great interview. I was surprised to see Bruce Greenwald tackle all the controversial topics and lay out his opinions. Right or wrong--there are many issues that can be debated--he doesn't hold any punches back.

I'm curious to hear your thoughts, when you have some time... on issues that you disagree with as well as whether you agree with Greenwald's scenario (particularly on whether China will run into serious problems if it does not convert its economy from manufacturing to a service one)...

Sivaram Velauthapillai
November 13, 2009 at 10:52 AM

BTW, I don't remember if you mentioned it before but are you in Europe? Are you in Germany by any chance?

November 16, 2009 at 12:45 AM

I am not so sure about replacing manufacturing with health care. If health care is a labor intensive sector, then it is a good idea. However, if health care is capital intensive (and this includes human capital), then it is not a plausible solution for the unemployment problem.

November 18, 2009 at 11:56 AM

The second part of the interview is now available. Greenwald discusses some investmentment ideas there.

Sivaram Velauthapillai
November 18, 2009 at 5:08 PM

Saw that already but thanks for the reminder... I'll post something about it...

Sivaram Velauthapillai
November 18, 2009 at 5:11 PM

We may be awash in capital. It depends on one's view but if Bernanke is correct, we have excess capital and that won't be a problem...

I'm not sure about human capital but I suspect that isn't the issue here given how we are trying to solve unemployment, which basically deals with unused human capital...

November 21, 2009 at 5:12 PM

Both parts were quite excellent. As an investor there is a clear cut dichotomy if inflation or deflation win and how important it is to allocate one's assets.
December 8, 2009 at 3:53 AM

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