The New Economy
Mark Zuckerberg got to be a super billionaire for all of 12 days.
On May 18, when his company went public, the Facebook CEO was instantly No. 29 on Bloomberg's Top 40 richest list. By May 30, as Facebook's value continued to plummet, he'd fallen off the list altogether.
To most people, the loss of $5 billion in less than two weeks might matter a lot. Understandably.
But if you were 28 years old, and in those two weeks you had launched one of the most closely watched initial public offerings in years, gotten married, sold off $1.1 billion in stock mostly just to pay taxes, and seen your life's work stumble embarrassingly on Wall Street, it's probably fair to say you'd have more important things on your mind.
For all the criticism that's been heaped on him in the past several days, Zuckerberg appears to be the real deal as a visionary entrepreneur. He has not tried to cash out from Facebook. He still has major skin in the game, owning more Facebook shares than anyone else. He seems committed to building it into a great tech company the way that Steve Jobs, Bill Gates, and the founders of Google built iconic tech companies did before him.
If anything, Facebook is losing value not because it has become too commercialized but because it has refrained from trying to make a killing on advertising (or has not yet figured out how to do it).
Either way, don't count Zuckerberg out. A fortnight of Wall Street Sturm und Drang is hardly a reliable bellwether for the long-term prospects of young, committed innovators.
None of this means that Facebook is necessarily worth $38 a share (its opening price) or $28 a share (its current price). Ultimately, its value will turn on how much Facebook influences social media and whether it can monetize that influence.
Those questions, I suspect, loom far larger for one particular 28-year-old than the paper loss of $5 billion or whether he figures on someone's Top 40 richest list.
For visionary entrepreneurs, it's not about the money. It's about the future.
So the Facebook IPO finally took place and Facebook shares are now available for all and sundry – worth at the end of their first day of trading almost exactly what they were worth at the beginning: about $38 apiece.
Now the next difficult question: Is Facebook the next Apple, Google, or Microsoft – that triumvirate of companies that we tend to come across one way or another in our daily dealings, or which have in some way or other driven how we experience the Web today? (You might not own an Apple device, but if you've used a smartphone recently then it probably had a touch-screen-driven system, and apps, and you might have thought about buying music from an online store.)
So is Facebook going to drive our Web experience forward in the way that those three have? In researching and writing my book "Digital Wars," on how those three companies have interacted down the years, a few points became clear to me.
First, if you get it right, then controlling the software platform can make you very rich. Microsoft owns Windows and Office, and together they actually contribute about 105 percent of its profits every quarter (other divisions, notably search, then make a loss, bringing us back to 100 percent).
Equally, you have to have the right way of making money from that software. Apple owns iOS and Mac OSX, its mobile and desktop operating systems, and because it also controls the hardware, it can rake in colossal amounts of money. But when it briefly tried licensing the Mac OS back in the 1990s, it nearly killed the company, because the ecosystem was too small. So you need breadth – in effect, a broad monopoly – for a software platform to be viable.
The next lesson is that Web companies are very vulnerable to disruption. Google in 1998 (when my book opens) was just an upstart, a company that thought it had a better way to search. But many people thought then that search was solved; Yahoo turned down Google's search algorithm because it was too good, which would mean too few people would look at the pages where it sold ads. Google zoomed past Yahoo within a few years.
What also helps: getting embedded into the public consciousness. The first use of "Google" as a verb that I could find in a newspaper was in January 2001; by February 2003 it was being mentioned in passing in an episode of ER, then the biggest show on TV. Nobody has ever, ever used any of the various names for Microsoft's search engine as a verb. Everyone knows what you mean by "Googling" something. That's pretty hard to dislodge.
Finally: It really helps to have a strong, driven leader who feels deeply involved in the company's fate. Apple benefited hugely from Steve Jobs returning in 1996/7; he felt that what happened to Apple reflected deeply on him, and to some extent he couldn't separate himself from it. Bill Gates was Microsoft, for quite a lot of its life: a hard-driving, detail-crunching, incredibly smart businessman. Google's founders, Larry Page and Sergey Brin, have made many of the key decisions (such as buying the mobile company Android in 2005, without even referring to their then-chief executive Eric Schmidt).
So if we roll all that together, what can we forecast for Facebook?
Working backwards: Facebook chief executive Mark Zuckerberg is deeply committed to it. He is not doing Facebook as a side project; he's not in it to cash out, because he could have done that years ago. This is his life's work, and he is clearly going to try to make it the biggest company it can possibly be.
Next, the site's name has entered the language. Pretty much everyone in the West knows what Facebook is, and essentially what it's for, even if they don't use it. There is a vast group of people who have never heard of it, mostly in Asia and Africa, and many countries where it is not the biggest social network – particularly China. But having become embedded in our language, it won't go away quickly.
Third, how vulnerable is it to disruption? We can cite Friends Reunited in the United Kingdom (which got old school friends together), Bebo, and of course MySpace as once-giant social networks that are now rotting hulks moored off the shores of the Web, just waiting to be broken up. But a key difference about them: They were bought by bigger corporations. Quite possibly Facebook would be facing the same fate if it had acceded to one of those takeover offers, because corporations struggle badly with the idea of acquiring a company that becomes bigger than the parent; they naturally try to rein it in, or absorb it, and that kills the spark.
Even so, the question everyone has is whether "some other social network" will come along and take away Facebook's unique selling proposition. Google is certainly trying its best with its Google+ network, but there's little sign that people are engaged with it. Facebook has the heft to push aside many others.
The toughest challenge in terms of disruption is the shift to mobile. Born in 2004, Facebook effectively predates the mobile Internet, which only began to take off in 2007. That means its DNA isn't adapted – yet? – to being viewed on a four-inch screen. That's a tough challenge, and one that all the older Web companies – notably Google and Yahoo – are struggling with. This will either be the growth limit for Facebook, or its rocket booster. But recall what I said above about Mr. Zuckerberg. Mr. Jobs was able to pilot Apple into the world of mobility (iPod sales quickly outstripped Mac sales, and iPhone quarterly revenues alone now exceed Microsoft's total). Facebook knows it has a huge shift to make.
And lastly, controlling the platform. Once more, Zuckerberg has seen that it's better to own the playing field and hire it out to all comers than to wall it off and charge an entrance fee. He's turned Facebook into a platform that is spreading all across the Web (through Like buttons, apps, commenting systems, and more). And we all know its name.
So for all those reasons, I think Facebook's best days still lie ahead of it. Note that I'm not making any recommendation about whether the shares are worth buying or good value; that's entirely up to you to decide. (I don't own or directly control any shares in any company, and have no intention of changing that.) This is just the bridge to the next stage.
– Charles Arthur is the author of "Digital Wars: Apple, Google, Microsoft and the Battle for the Internet," published by Kogan Page and available in bookshops, and from Amazon in paperback and Kindle formats, and from Apple's iBooks store. He is also the technology editor of the Guardian newspaper in the UK. He is on Twitter as @charlesarthur.
The number of foreclosures in April fell to their lowest level since 2007 – and one reason is that lenders are getting smart.
Instead of foreclosing on people, a costly and lengthy process, they're increasingly using short sales to move people out of homes they can no longer afford. Short sales are not only faster than foreclosures, they often turn out to be cheaper. By forgiving part of the loan up front (a loss they would take anyway during foreclosure, lenders can get possession of a house faster and sell it before it has had time to deteriorate. Homeowners get to shed their mortgage debt faster – and with less damage to their credit rating.
Short sales began outpacing foreclosures in some states late last year. Six states saw more preforeclosure sales – typically, short sales – than foreclosures in the fourth quarter, according to RealtyTrac, an online marketplace for foreclosure properties based in Irvine, Calif. In preliminary first quarter data for 2012, that total jumped to 12 states, including traditionally big foreclosure states like California and Arizona, RealtyTrac reported Thursday.
"I think we will see more states with short sales outnumbering foreclosure sales in the coming months," says Daren Blomquist, RealtyTrac vice president, in an e-mail. " In addition to the government incentives they can get for a short sale through the HAFA [Home Affordable Foreclosure Alternatives] program, lenders are realizing they can often recover more of their losses through a short sale than through foreclosure, and also that they can avoid any accusations of improper foreclosure procedures."
Bank of America, for example, announced this week that it will offer its short-sale incentive program, piloted in Florida, nationwide. Under the program, delinquent homeowners can get up to $30,000 in relocation expenses once they complete a short sale.
One challenge with short sales is that they're complicated. They involve negotiations among three parties (the bank, the seller, and the buyer) over what price the house will sell for and what loss the homeowner and the bank will take. These talks can drag on for months, with the buyer eventually walking away for lack of a clear decision.
Accepting an offer is no trifling matter, because homeowners in a short sale typically owe more on the home than the home will sell for. Banks are likely to lose that difference whether they agree to a short sale or foreclose.
"Short sales are a more efficient way for the market to absorb the distressed properties and that should help pave a quicker path to market recovery," Mr. Blomquist says.
Still, they're a drag on the market, he points out. On average, short sale homes sell for 21 percent less than nondistressed properties. They're just not as much of a drag as foreclosure homes, which typically sell at a 34 percent discount.
A & E Custom Manufacturing hums with the sound of robotic presses and welders, automated laser cutters, and other state-of the-art equipment that bend and cut metal into precise shapes. More than 900 sheet-metal components for the New York City subway come from this shop, as do aluminum parts for an electric sports car in Finland.
The Kansas City, Kan., metal fabricator also made parts for a popular commercial cooking appliance until several years ago, when its customer moved production to China in order to save money. When quality and delivery problems in China couldn’t be resolved, the customer brought the work back and A & E is once again making the parts.
“We’re doing the work we used to do,” says A & E owner Steve Hasty. “We’re become more competitive in what we’re doing and the type of equipment that we’re using.”
Call it reshoring, backshoring, or onshoring: Twenty years after a flood of American manufacturers began moving to China to cut costs, a growing number of them are trickling back to the United States to improve quality and reduce delays. Many of the high labor-content products, like shoes, textiles and most clothing are probably gone forever. But in an unexpected and beneficial twist for the US economy, manufacturing, much of it high-skilled, is returning from abroad, primarily China. Some analysts go so far as to call it a renaissance in US manufacturing that will create high-paying jobs and provide crucial economic support for local communities across the country.
“A combination of economic forces is fast eroding China’s cost advantage as an export platform for the North American market,” says Boston Consulting Group in a report issued last summer, which forecast that by sometime around 2015 it will be as economical to manufacture many goods for US consumption in the US as in China. BCG points to seven industries that are nearing that break-even point: electronics, appliances, machinery, transportation goods, fabricated metals, furniture, and plastics and rubber – all products with relatively low labor content and high transportation costs.
Some US companies have already made the move:
- Two years ago, General Electric relocated the production of some water heaters from China to Louisville, Ky.
- NCR has moved production of its automated teller machines from China to a plant in Columbus, Ga., that's expected to employ 870 people by 2014.
- Ford Motor Co. is bringing up to 2,000 jobs back to the US from Mexico, China, and Japan.
- Even toy company Wham-O now manufactures half of its popular Frisbees in California and Michigan, where it previously sourced its goods from China and Mexico.
How many jobs reshoring is creating is hard to determine. When a large, well-known company like Master Lock brings 100 jobs from China to its factory in Milwaukee – and earns a visit from President Obama and a mention in his State of the Union address – it’s big news. When a small contract manufacturer gets an order for components previously made offshore, it's barely noticed.
“It’s definitely happening,” says Harry Moser, founder of the Reshoring Initiative, a nonprofit organization based in greater Chicago whose goal is to bring manufacturing jobs back to the US. “It’s still small relative to its potential, but it’s growing.” He estimates reshoring has created at least 10,000 American jobs in the past two years.
One big factor behind the move is the rising cost of labor in China. When it joined the World Trade Organization in 2001, China's average manufacturing wage was 58 cents an hour, says Harold Sirkin, senior partner at the Chicago office of BCG and one of the coauthors of its report. Since then, Chinese wages have risen 15 to 20 percent per year.
“The decisions you made when wages were 58 cents an hour are potentially going to look very different than when wages are around $6 per hour, as they will be in China in 2015,” Mr. Sirkin says. When the cost savings of manufacturing offshore is less than 10 percent of manufacturing domestically, companies start to reassess their decisions, he adds.
US manufacturers have also made strides through “lean” manufacturing techniques and automation, which have made factories far less labor-intensive than in the past, says Chris Kuehl, an independent economist in Kansas City, Mo., and an analyst for the Fabricators & Manufacturers Association, a trade group in Rockford, Ill. BCG estimates that the average US worker is now some 3.4 times more productive than the average Chinese worker. "That takes us out of having to compete with China for low-wage jobs, because we’re producing things that require more sophisticated robotics,” Mr. Kuehl adds.
Other considerations also factor into reshoring decisions: transportation costs, proximity to customers, currency fluctuations, the benefits to innovation when design and production are under the same roof, and intellectual property risk, among others.
For many companies, low wages overseas don’t outweigh the advantage of making goods closer to the customer. Outdoor GreatRoom Co., maker of outdoor products, brought production of fire pits and pergolas back to Minnesota in 2010 to reduce the several-month lag time in getting shipments from China . Now, the company can fill its orders in three months or less, which reduces the risk that the company is locked in to an older inventory that no longer corresponds with consumer tastes.
In the case of Big W Industries, which brought back the work to A & E for its commercial cooking appliance, the issue was quality.
“We went overseas to try to cut costs,” says Chuck Nickloy, president of the Kansas City, Kan., firm. “We brought things back because of quality. We tried a couple of times to get the job done right, but the thousands of units we brought in were all substandard. Before it was over, we scrapped them all. It was a nightmare.”
Not all the manufacturing moving from China is coming back to the US. Some of it is going to lower-cost countries in Asia, like Vietnam and Singapore. Many US companies are likely to keep some production in China because they want to sell into its fast-growing domestic market. Other US firms are opting for “near-shoring,” moving manufacturing from Asia to Mexico or Central America, where they can take advantage of low wages but reduce transportation costs and other problems that go with having a supply chain that stretches halfway around the world.
Reshoring or even near-shoring may not work for everyone, cautions Mr. Sirkin, who consults with many manufacturing firms. “That may not be the right answer for you in the same way that rushing to China or Vietnam may not be the right answer.”
But if today's reshoring trickle turns into something much bigger, the benefits to the US economy look promising – and not just for manufacturers. By one estimate, each new domestic manufacturing job creates three additional jobs in the US, in logistics, transportation, construction, finance, and other areas. With a renewed focus on technical education, far from becoming a nation of hamburger flippers, the US could be poised to reclaim at least some of the 7.7 million manufacturing jobs it has lost since 1979.
America's poor jobs report has rattled world markets. Germany's DAX index fell 2 percent Friday. Wall Street saw its worst week of the year, as slowing job growth stoked fears that recovery in the United States is faltering. Last month, the economy added only 115,000 jobs.
But the more telling number is 169,000. That's the number of jobs lost in the euro zone in March. For all its sluggishness, the US economy is still growing and its unemployment rate is down to 8.1 percent. The euro zone appears to be contracting and its unemployment rate has risen to 10.9 percent, a 15-year high.
There are myriad structural reasons for this dichotomy. But the distinction getting the most attention these days is a policy difference: America has chosen growth. Europe has chosen austerity. And it looks like the Europeans are losing the argument.
Everyone recognizes that austerity is hard. But what if it's wrong, too? This is boosting calls for more growth-oriented policies – on both sides of the Atlantic – which is having important political repercussions.
On Sunday, millions of voters in France and Greece go to the polls and are likely to throw out the leaders who have backed austerity and spending cuts. In France, Socialist Francois Hollande is expected to win the presidency and has pledged to renegotiate the austere European Union treaty that would cap national deficit and debt levels. In Greece, both major parties are so discredited by the cuts that they have begun to initiate that it's not clear that they can win a majority of parliament even in coalition.
In the Netherlands, which is in far better economic shape than Greece, the government collapsed over the debate about austerity. Even German Chancellor Angela Merkel, who has been the face of German insistence on budget cutting and spending reform, is beginning to talk about the need for growth as part of those reforms.
That growth-vs.-austerity debate is also moving to the forefront in the US. It was behind the brinksmanship over raising the federal debt ceiling last year. It is a prime mover in the various congressional attempts at tax reform. It could crystallize this fall in the election, depending on how closely presumed GOP presidential nominee Mitt Romney ties himself to GOP budget-cutters in the US House.
So far, austerity has not fallen into disrepute in the US the way it has in Europe (perhaps because Americans have not felt its bite). An ABC News/Washington Post poll last month found that support for the tea party movement has slipped somewhat since last September but remains at a still-high 41 percent. The fate of tea party candidates in the US House in this fall's elections will be an important bellwether. After the election, a lame duck Congress must decide what to do about several tax and budget cuts that expire at the end of the year, which represent some $500 billion in federal stimulus.
If they decide to withdraw that stimulus, US growth will slow.
No one denies that the US and other indebted nations will have to embrace austerity at some point to reduce their rising pool of red ink. The big debate has always been about timing. Here's the problem with starting austerity too early when the economy is still too weak, according to Lawrence Summers, a former economic adviser to President Obama, writing Monday in The Washington Post. When official interest rates are near zero, every 1 percent cut in government spending reduces the size of its economic output by 1 percent to 1.5 percent. So trying to reduce your debt-to-asset ratio through spending cuts just reduces your assets, so the ratio never goes down.
Take Greece's austerity plan: In exchange for a bailout, it has agreed to cut spending so that it will average a budget surplus of 4.5 percent of gross domestic product (GDP) per year between 2014 and 2020 (before debt payments). Under official projections, Greece will be able to reduce its debt-to-GDP ratio from 160 percent to 120 percent by the end of the period. Private forecasters are skeptical. For example, Greece's GDP will fall 5 percent this year, according to Standard & Poor's, not 4.3 percent as the official forecast calls for. Realistically, according to the Royal Bank of Scotland, Greece's actual debt-to-GDP ratio will be no better off in 2020 than it is today.
Of course, embracing growth doesn't mean that a nation can keep up piling on debt. At some point private investors lose confidence and quit financing its operations at reasonable interest rates, as happened with Greece. So how can a nation cut its debt without shrinking its economy?
By backloading the cuts for a period when the economy is growing more robustly, argues Christina Romer, another former Obama economic adviser who now teaches economics at the University of California, Berkeley.
"The core of a more sensible approach is to pass the needed budget measures now, but to phase in the actual tax increases and spending cuts only gradually – as economies recover," she wrote in an op-ed for The New York Times last Sunday. "What's to stop policy makers from promising the moon and not delivering? History shows that countries have done such gradual consolidations before. In 1983, for example, the United States passed a Social Security reform plan that was backloaded in the extreme: it specified tough changes, including higher taxes and increases in the retirement age, to be phased in over almost three decades."
Of course, history also shows that lawmakers often don't follow through on making the tough cuts that they've agreed to. If the US fails to reduce its unsustainable deficits, then the holders of its debt eventually will lose confidence, forcing far harsher taxes and spending cuts than US politicians are contemplating.
Congress mush also overcome the sharp partisan divide over how to rein in spending: through spending cuts or tax increases or both, which will play out in the upcoming debate over tax reform. Optimists on the left and the right think Republicans and Democrats can strike a grand bargain on tax reform, perhaps as early as the lame duck session of Congress right after the election.
That's not only achievable, it would be a signal accomplishment, Forbes magazine publisher Steve Forbes told an audience in Boston earlier this week. If the US can get the tax and spending balance right, it will be an example for Europe and the world to follow.
The unemployment rate ticked down to 8.1 percent in the United States in April, which is the lowest it's been since President Obama took office in January 2009. One might expect cheering on Wall Street and predictions of an easy reelection for Mr. Obama. Instead, the Dow Jones stock index fell nearly 150 points in morning trading Friday and Obama looks vulnerable this fall.
Why? Because the unemployment rate is dropping for all the wrong reasons.
While the economy added 115,000 net jobs in April, some 350,000 Americans gave up looking for work. That has the effect of reducing the unemployment rate because, by the federal government's calculation, those people no longer count as part of the labor force. As a result, the share of Americans who are part of the labor force – either working or actively looking for work – has reached a 30-year low.
"The 8 percent that we see for unemployment is not a full and fair picture of unemployment," says Scot Melland, president and CEO of Dice Holdings, which runs specialized career websites in the technology, financial services, and health-care industries. If the participation rate were at normal levels, the unemployment would be above 11 percent, by one estimate.
So what's the real picture? It looks as though the economy is slowing. In January and February, the US added 275,000 and 259,000 jobs, respectively; in March and April, it added only 154,000 and 115,000. But economists suggest the outlook may not be so bleak.
For one thing, the official figures keep getting revised. When the US Labor Department announced Friday that the economy added 115,000 net new jobs in April, it also revised the February and March job numbers upward by a combined 53,000. For another thing, the abnormally mild winter weather throughout much of the country may have encouraged more-than-expected hiring in January and February, causing less-than-expected hiring in March and April.
"March and April’s results clearly raise questions, and given the numerous negatives confronting the economy, they cannot be simply dismissed as a hiccup in the data," writes Joshua Shapiro, an economist at MFR Inc., a New York research firm. "Rather, they play into the notion that an unusually mild winter combined with more aggressive seasonal adjustment than in past years probably boosted economic data in general during the winter months."
The real growth in jobs probably lies somewhere in-between. "We look for a better but still subdued pace of [monthly] job creation in the 150,000-200,000 region over the rest of the year," writes Nigel Gault, an economist with IHS Global Insight, an economic research firm in Lexington, Mass.
That's solid but uninspiring growth. Moreover, it's occurring at different speeds in different parts of the economy.
In the first four months, the private sector added 827,000 jobs; government lost 24,000. In the private sector itself, industries are moving at different speeds. Professional and business services have added 267,000 jobs; construction, only 12,000.
"This is not a balanced labor recovery: There are winning sectors and not-winning sectors," says Mr. Melland. "The skilled sectors are doing better than the not-skilled sectors." His own job search websites show no slowdown in advertising for skilled technical positions.
Even the 30-year low in labor participation may not be as bad as it looks.
"Normally we would characterise the contraction in the labour force as a big negative, presumably a result of job seekers becoming so disillusioned they give up," writes Paul Ashworth, an economist for Toronto-based Capital Economics, in a research note. "But it is worth remembering that this is a volatile series and the labour force increased by almost 1,000,000 in the first two months of the year, so some drop back was to be expected."
The headline that caught my eye – "Nutella settles lawsuit" – took me back instantly to memories of slathering the product on real French bread. It was convenient. You spread it on like peanut butter, but it tasted so much better: chocolate with just the right essence of hazelnut.
Back then, it was touted as an after-school treat for European kids and hard to find in the United States. Now, it's marketed increasingly for breakfast for American children. That's what got its maker, Italy's Ferrero Group (which also makes Ferrero Chocolates and Tic Tacs), into trouble with US courts.
Advertised as a way to get children to eat a healthy breakfast, Ferrero was insinuating that Nutella was healthy when, in fact, it has about as much nutritional value as a candy bar. Or so claimed several consumers, who sued the company's US unit.
As part of its settlement of two class-action suits, Ferrero U.S.A. Inc. is offering to reimburse consumers for up to five jars (at $4 a jar). Since it doesn't appear you need any receipts, it's one of the easiest $20 you can make. You can apply here.
Your actual reward could amount to less than $20, because so many people may apply for the $3.05 million available. But I'm not sure I'll be one of those people.
Our family is certainly entitled to the money. My daughter has become a big fan, so we bought far more than five jars of Nutella between the court-specified period of Jan. 1, 2008, to Feb. 3, 2012 (Aug. 1, 2009, to Jan. 23, 2012. for those in California, where one of the suits was filed).
And while we were never duped into thinking Nutella was health food, some food companies are so cavalier about enhancing the appeal of their products with words like "natural" that maybe Ferrero deserves to be made to pay. Call it social justice. Or punitive damages.
But here's the thing: Ferrero doesn't appear to be a rapacious megacorporation. It looks to be run like a conscientious family-run business.
The company issued its first social responsibility report two years before the first lawsuits were filed. This year it stopped advertising to audiences where more than half of the viewers or readers are under 12; next year, no more than 35 percent of the audience can be under 12. It has started a training program with USAID for hazelnut growers in the country of Georgia. Last year, one of its two managing directors (and a grandson of the founder) died during a humanitarian mission to South Africa. By 2020, the company aims to supply all its cocoa, palm oil, and coffee from sustainable farms.
These are not the moves of a company with a single-minded focus on the bottom line.
And the ads that helped convince several judges there was a case against Ferrero? Here's the transcript of one TV ad from court documents:
"[MOM]: As a mom, I’m a great believer in Nutella, a delicious hazelnut spread that I use to get mykids to eat healthy foods. I spread a little on all kinds of healthy things, like multigrain toast. Everyjar has wholesome, quality ingredients, like hazelnuts, skim milk, and a hint of delicious cocoa. AndNutella has no artificial colors or preservatives. It’s quick, it’s easy, and at breakfast I can use all thehelp I can get.
[VOICEOVER]: Nutella—breakfast never tasted this good."
Does that qualify as deception? You be the judge. I'm not applying for the money.
Is the United States on the brink of a recession? To judge by the Federal Reserve, which boosted its economic growth forecast Wednesday, the answer is no. Pointing to the 25 percent rise in the S&P 500 index from its October 2011 low, bullish investors cry, “No!”
But consumers, not investors, set the tone for the economy. On the consumer side, the risks are tilted toward the downside.
The US economy has been fueled in recent months by strong consumer spending, which increased in February by 0.8 percent, its best showing in seven months, and 0.4 percent in January. Retail sales rose 1.1 percent in February – the fastest pace in five months – while same-store sales advanced 4.7 percent. These numbers correlate with recent gains in consumer confidence and sentiment.
Unfortunately, that pace doesn't look sustainable. Personal income growth continues to be weak – up just 0.2 percent in February – meaning this recent exuberant consumer spending is being fueled largely by increased debt and further dipping into savings. Real household after-tax incomes declined in February for a second straight month and have gained a mere 0.3 percent year over year. Consumers still face high personal debt levels.
Housing activity remains depressed, with the only life coming from the multifamily component, which is being driven by the zeal for rental apartments as homeownership falls. Homeowners are losing their abodes to foreclosures; many can’t meet stringent mortgage lending standards; some worry about homeownership responsibilities in the face of job uncertainty; and many people have no desire to buy an asset that continues to fall in price. I am looking for a further 20 percent slide in housing prices.
Employment has gained in recent months because American business has, at least temporarily, run out of productivity enhancement, which earlier allowed it to cover output gains with reduced staff. Payroll employment growth has risen in recent months, although the unseasonably warm winter may have temporarily boosted jobs. Furthermore, employment growth has been from an extremely low recessionary base and the unemployment, while down from 9.1 percent last August, is still high at 8.2 percent.
A very disappointing jobs report showed that just 120,000 nonfarm jobs were created in March versus an expected gain of about 205,000. Sure, the unemployment rate ticked down to 8.2 percent, but only because the number of unemployed fell as people dropped out of the labor force. In response, stocks plunged here and abroad as worries were revived about the true strength of an already-feeble economic recovery from the Great Recession.
Are there any positive signs of growth? Gross domestic product has been accelerating in recent quarters, but not after inventory investment is removed to yield final sales. In the fourth quarter of 2011, inventory growth accounted for 60 percent of the rise in GDP, and that accumulation may not have been desired, suggesting future production cutbacks. Industrial production growth is already sliding. The liquidation of excess inventories accounts for a major share of the decline in economic activity in recessions. Recall that late last year, retailers, worried about being stuck with unsold Christmas goods as in 2010, held early sales, even opening on Thanksgiving Day.
Consumer spending is the only major source of strength in the American economy this year. On the other side of the scale several weaknesses are piled up: State and local government spending remains depressed by deficit woes and underfunded pension plans; excess capacity restrains capital spending; and recent inventory-building appears involuntary.
So it should not come as a surprise if a consumer retrenchment tips the balance toward a moderate – and overdue – recession.
– A. Gary Shilling heads an economic consulting firm in Springfield, N.J. His latest book is "The Age of Deleveraging."
China is responsible for about 20 percent of total global manufacturing and the ubiquitous “Made in China” label can be found on an astonishing array of products. But its days as the world’s discount manufacturer may be coming to an end. This weekend's loosening of controls on China's currency is the latest sign of the transformation under way.
China is moving inexorably up the value chain. It boasts some of the most advanced manufacturing firms in the world. As the level of factory and worker sophistication has grown, so have salary expectations. And the pool of workers once thought inexhaustible is, in fact, proving to be limited. Throw in higher fuel prices to ship its good overseas and it's clear that the factors that tilted in China's favor during its dramatic first phase of development are now tilting away from it in its second phase.
While this might help North America’s beleaguered manufacturing sector eventually, at this point it appears other emerging nations are reaping the main benefits from the change in China. Over the past few years, for example, several US toy companies have turned to Vietnam and Indonesia to produce more of their products. Auto parts manufacturers have likewise increased their presence in India where a thriving auto industry continues to build momentum. Even Foxconn, the manufacturing giant that makes products for Dell and Apple, is in the process of expanding its operations in India and Vietnam. These moves will come at the expense of plants the Taiwan-based firm has contracted in China.
The shift is understandable. Chinese wages are going up – and will continue to go up by 19 percent a year, according to a report from Credit Suisse Group AG. That's explosive growth that's almost double the expected rate of growth in the economy. As a result, Credit Suisse forecasts, wages – which stood at 50.5 percent of China's gross domestic product in 2010 should rise to 62 percent of GDP by 2015.
That's not necessarily bad for China. Richer Chinese will buy more Chinese goods. Credit Suisse expects private consumption, which accounted for 35.6 percent of GDP last year, to reach nearly 42 percent by 2015.
Another reason wages are rising is that the pool of workers is shrinking and companies are having to compete for skilled workers. The old model of factory owners having the upper hand over migrant workers fleeing rural poverty and willing to take on any task at any wage is disappearing. The advantage is slowly turning to the worker.
That, too, is good for China. Employers are being forced to address some of the horrendous working conditions much of the workforce has been forced to endure. Not all abuses have been eliminated by any means, but progress is coming bit by bit.
Chinese manufacturers are also dealing with considerably higher fuel prices, which makes it more expensive to ship goods. Boston Consulting Group predicted a year ago that at the current rate of appreciation for labor and shipping, within the next five years it will be just as cost-effective to manufacture in North America as in China.
China may have no choice but to concede the production of low-margin goods to other countries in order to concentrate on products with sufficient capacity to absorb higher production costs. The transition must be carefully managed, however, as it is paramount for China to maintain growth as the country continues to evolve.
For guidance, China can look to Japan, which faced a similar dilemma.
In the years following World War II, it was Japan that specialized in the mass production of cheap goods as a means to rebuild its economy after the war. By the 1980s, however, Japan had mostly shed its status as a peddler of poor-quality trinkets to become a leader in electronics and automobiles. This ushered in a period of rapid growth that made Japan a global exporting powerhouse.
Alas, heading into the 1990s, the collapse of a wildly out-of-control domestic asset bubble triggered a serious bout of deflation. This period is still referred to in Japan as the “lost decade” and the hangover from this period continues to affect the economy today. China will have to avoid such pitfalls if it is to manage successfully its next period of growth.
Chief among the needed reforms is to allow the yuan to fluctuate freely against other currencies. This is a move China has long resisted as keeping the yuan devalued has helped maintain an export advantage, but Chinese authorities have signaled a new willingness to ease currency controls. The latest action came this past weekend when the People’s Bank of China doubled the yuan intraday trading band from +/- 0.5 percent to a full percentage point.
Despite the greater currency fluctuation authorities are now willing to tolerate before intervening, the yuan’s value is still tightly controlled. The chronic undervaluing of the currency, while helping export sales, is fueling higher price inflation within China’s borders. This has some observers warning that China could be heading for its own lost decade.
Investing is about making good choices. It's also about avoiding bad ones.
Last month, we looked at nine investment themes for 2012. Here is my list of the 10 areas investors should avoid. In my view, we're in an age of deleveraging, which began in 2007 and probably has another five to seven years to run. Despite rising economic optimism, I foresee a moderate US recession, a hard landing in China, and a severe recession in Europe – in sum, a global recession in 2012.
1. Developed country stocks: This theme reflects my forecast of a downturn in global economic activity accompanied by financial crises of unknown depth. The United States and other developed economies are in a secular downswing that includes a secular bear market in equities.
2. Your house, second home, or residential investment property: If you plan on selling soon, do so yesterday. If I'm right and house prices have another 20 percent to fall in the next several years – after already declining 33 percent – this approach is obvious.
3. Home builders and related companies: Conditions now are far different from when home building was a growth industry characterized by lax underwriting standards, laissez-faire regulation, and, most of all, conviction that house prices would never fall. All those conditions have now been reversed.
4. Selected big-ticket consumer discretionary equities: With real incomes falling amid a continuing need to repay debt, I expect consumers to retrench this year – to the detriment of cruise lines, automakers, high-end consumer electronics, recreational vehicles, and resorts.
5. Consumer lenders: The consumer retrenchment and global recession I foresee will be bad for credit-card is-suers, who are still dealing with all the bad debt piled up in the borrowing-and-spending years.
6. Banks: Deleveraging and the carryover from past financial woes still plague major US banks and financial service institutions. I expect more weakness as deleveraging and write-downs persist in a recessionary climate. The downturn will affect banks here and abroad, big and small.
7. Junk securities: The slow-growth, deflationary scenario I foresee will be lethal for many junk bonds – both those issued as high-yield instruments by companies with shaky balance sheets and fallen angels that have been downgraded to junk status. Slow revenue and cash-flow growth will make it difficult for financially weak and weakening firms to service their debts.
8. Developing country stocks and bonds: The effects from the hard landing in China will spread widely from the world's second-largest economy and major commodity importer. Along with the likely major recession in Europe and economic downturn in the US, a severe slowdown in China will spawn global economic retreat, battering commodity- and export-dependent economies.
9. Selected commodities: I doubt that the commodity price declines in 2011 fully anticipated the global recession I foresee this year, so further significant declines are probably in store, especially for industrial commodities.
10. Many old-tech capital-equipment producers: Besides the depressing effects of excess capacity, low-tech and old-tech firms suffer from foreign competition that grows as their technology is transferred abroad. Challenges include: high-cost labor, lack of productivity gains, and saturated, slow-growth markets.
– A. Gary Shilling heads an economic consulting firm in Springfield, N.J. His latest book is "The Age of Deleveraging."