Thursday, June 29, 2006


The US economy is facing a wonderful problem; how high do interest rates need to go to prevent huge wage increases? The American worker is in the "cat bird" seat because of another wonderful problem; very high profit growth by American companies.

If there were two businesses, one with very high sales growth and the other with very high sales and very high profits, which would you rather own? Politicians have to find a straw man to beat up. One easy target is the Chinese. Therefore the argument is made ad infanitum that the Chinese are stealing from Americans. If it is not the Chinese it is the Mexican immigrants. Politicians constantly ask, how long can we continue to have a negative trade balance with the Chinese? They then attack the Chinese for manipulating their currency to make their goods too cheap. I say, "Thank you very much"!

Yesterday, Marilyn purchased a shirt for me to try out. It is a very nice shirt and she paid less than $7.00. Thirty years ago, a shirt like this would have cost $30 or more. China is the equivalent of that first business; the country has very high sales growth on very thin profit margins. The US is the equivalent of the second business, very high sales and very high profit margins. The reason the average American is wealthier today than ever before is because he benefits directly and indirectly from those high sales and high margins.

It is true that China and other developing countries tend to steal a lot of stuff. They do this primarily by ignoring intellectual property rights. For example, until recently, Chinese companies were making tons of "Viagra". It looked like Viagra, had the Viagra name on it and worked like Viagra. The work of administration "trade" negotiators has been and will continue to be reaching agreement for the Chinese government to enforce copyright laws. Those folks who visit China are always amazed that bootleg copies of American movies are on sale at very low prices by the time the shows hit American movie theaters.

Back to the big picture: American companies are making big profits off of international trade. So much profit that we can afford to run trade deficits for centuries as we have for the past century. It is ludicrous for folks to get all uptight about the current account deficit now when it has been negative for all but two or three years in my life. Indeed, when it moves to positive (in the early 70's and late 90's) a very tough world wide recession is not far behind.

The practical information for most folks to take away is that the FOMC is raising short term interest rates in an attempt to slow the HOT labor markets. Just this week, in the Piedmont Triad there have been announcements of new plants that will hire high skilled people at higher than average wages. Yesterday, it was announced that Honda will build a new plant in Indiana. To recruit good employees, companies have been raiding other companies. In the past few days, Google, MSFT and Yahoo have all run full page ads seeking top tech. talent.

The wage battles are spreading from industry to industry. Politicans do not like to talk about interest rate hikes in terms of fighting to keep wages from going too high. Instead, you hear about fighting inflation. Well, inflation is about as low right now as it has been in my 56 years. Inflation is quickly becoming old news. The price of oil hit $70.50 about a year ago and it is $72 this morning, soon it will be $55. Even if you do not believe that the price will soon be $55, the move from $70.50 to $72 in one year is a 2% increase. Also, inflation is a lagging indicator, which means the problem is last years problem.

The problem the FOMC has is to slow wage increases to a moderate pace without "killing" certain industries that are interest rate sensitive. US mortgage applications dropped by 6.3% last month. The combination of high oil prices and high interest rates are causing consumers to cut back on other spending. The FOMC is not in this fight alone. The central bankers of the world have joined the fight. The huge gains in auto sales and oil usage in China last month were a result of announced increases in regulated prices this month. The Germans are doing double duty, they are raising taxes and interest rates at the same time.

Very soon, about six months time, the talk will be when will the FOMC cut rates and how far will rates need to decline to prevent deflation. About 65% of gold demand is for jewelry. Just a couple of months ago, billions of citizens in developing nations were enjoying "boom times". Knowing how fickle these economies can be, billions of citzens were buying gold chains to wear around their necks. What a diference a few months can make? The stock markets of developing nations have been ravaged. The demand for gold chains is on life support. Another quarter point in the states, another 2% hike in Turkey a few more quarter points in Europe and, yes, even a hike or two in Japan may kill the demand for gold chains for many months to come.

In the meantime, the capital spending boom projected for the next few years can move forward with force. Billions and billons for new refineries in numerous locations, billions and billions for interstate high ways all across China and billions and billions for new communications equipment all around the globe.

A world wide economic boom after only a modest slowdown in housing, what a wonderful problem to have? Investors who take advantage will make fortunes.