U. S. Corporate Profits are being earned "off shore"

Recently I have written about how the Fed’s injection of funds into the banking system has gone over seas because that is where the profits are.  See “Federal Reserve Money Continues to Go Offshore,” http://seekingalpha.com/article/276909-federal-reserve-money-continues-to-go-offshore. 

Now we are getting more and more information that non-financial resources are also going offshore because that is where manufacturing profits are as well.  See the Wall Street Journal article “Business Abroad Drives U. S. Profits,” http://professional.wsj.com/article/SB10001424053111904772304576466003840674770.html?mod=ITP_marketplace_0&mg=reno-wsj.

“A third of the way through the second-quarter reporting season, earnings at companies in the Standard & Poor’s 500–stock index are the highest in four years…”

“Corporate profits—one of the few areas of strength in the limp U. S recovery—appear to be weathering the economy’s soft patch.  But the gains in many cases have come from international operations, particularly in emerging markets.”

Companies conforming to this pattern include Air Products & Chemicals, United Technologies Corp., Hasbro Inc., McDonald’s Corp. and General Electric Co. among others.

While American consumers and small- to medium-sized businesses fight through a period of debt deflation trying desperately to get their balance sheets under control (http://seekingalpha.com/article/279283-credit-inflation-or-debt-deflation) larger American corporations seem to be doing just fine, thank you, in international markets. 

It seems as if about half of the monies these corporations are spending on capital investment is going into other countries.  That is where the sales are so that is where the funds are going.

Also, the investment that is being done in the United States is going more to increase productivity and lower costs than it is to expand employment and generate further economic activity. 

In terms of aggregate figures, the article reports that “U. S. multinational corporations cut their work forces at home by 2.9 million during the 2000s while increasing them overseas by 2.4 million, according to data from the U. S. Commerce Department.” 

In contrast to the slow-growing United States economy, companies found substantial purchasing strength elsewhere.  General Electric, for example, said it experienced double-digit revenue growth in each of its international divisions in the second quarter.  The largest growth came in India, registering a 91 percent gain; in China, revenues rose by 35 percent and orders increased by 80 percent. 

This is what happens when capital can flow freely around the globe. 

Money will follow opportunity.

The United States prospered through the last fifty years of credit inflation because it had the reserve currency of the world.  Others were willing to take on United States debt because the world still traded in U. S. dollars. 

But, this credit inflation did two things.  First, it eroded the productive ability of the United States. See my post “Why This Economic Expansion is Going Nowhere,” http://seekingalpha.com/article/279928-why-this-economic-expansion-is-going-nowhere.

Second, it resulted in a build up of consumer debt and business debt that was unsustainable and had to be reduced.  The reduction of this is the debt deflation the United States is now experiencing. 

The government’s attempts to push further credit inflation on the economy is just pushing money out into the rest-of-the- world, as reported in some of my posts mentioned above, and has created economic growth…and profits…elsewhere.

In a world of freely flowing capital, a nation cannot just conduct its economic policy independently of the rest of the world.  As stated above, the United States got away with it for a long period of time because it had the reserve currency of the world.  But, this lack of discipline has caught up with us and more and more the statistics are supporting this conclusion.

The other thing the credit inflation policies of the United States government has done is to skew the income/wealth distribution in America toward the wealthy.  Small- and medium-sized business are not profiting from the current efforts to stimulate the economy.  However, as reported, the larger, wealthier companies are doing very, very well. 

Federal Reserve QE2 Watch: Part 3.3

The Federal Reserve injected $73 billion more reserve balances into the banking system in the banking week ending February 23, 2011.

The Federal Reserve has injected $272 billion into the banking system since the end of last year, since December 29, 2010.

Reserve balances at Federal Reserve Banks totaled $1.290 billion at the close of business on February 23, 2011.

Excess reserves for the banking system averaged almost $1.220 billion for the two weeks ending February 23, 2011.

QE2 rolls on!

And commercial banks still seem to prefer holding onto the cash rather than lending the money out. And, it seems as if a large percentage of the funds being pumped into the banking system are now going to foreign-related financial institutions. (http://seekingalpha.com/article/254004-why-is-most-of-the-fed-s-qe2-cash-going-to-foreign-related-banking-institutions)

The major mover of bank reserves is still the Fed’s purchase of US Treasury securities. The Fed added $23 billion more Treasury securities to its portfolio last week. Holdings of Treasury securities are up almost $200 billion since December 29, 2010.

The Treasury still continues to move money around. In the past week it reduced balances it holds in it’s General Account at the Fed by almost $32 billion. (This action puts reserves into the banking system.)

Since December 29, 2010, the Treasury has reduced it’s balances in the General Account by about $66 billion.

Last week the Treasury also reduced the amount of funds it holds in it’s Supplementary Financing Account by another $25 billion. The Treasury reduced these balances by $75 billion since December 29. As the Treasury spends out of these accounts it puts reserves into the banking system. (For more on the Treasury’s Supplementary Financing Account see my post: http://seekingalpha.com/article/199444-the-fed-s-new-exit-strategy.)

As the Treasury has moved funds around since the end of last year it has put more than $140 billion into the banking system that has ended up as reserve balances.

There are three conclusions I have drawn from the financial statistics I have seen:

First, the Fed is scared silly that the smaller banks in the United States (all banks other than the largest 25) will experience a massive series of failures before the FDIC can close a sufficient number of them in an orderly fashion;

Second, the largest 25 banks in the country are having a feast on the low borrowing costs that the Fed is maintaining (the FDIC reported that 95% of all bank profits in the fourth quarter of 2010 went to the largest banks in the United States, http://seekingalpha.com/article/254700-u-s-banking-system-is-still-in-trouble);

Third, given the mobility of capital in the world today, the Federal Reserve has become the central bank of the world and is supplying funds for potential bubbles in commodities and natural resources globally.

My question: Is conclusion one above sufficient justification for the resulting consequences of the Fed’s policy as observed in conclusions two and three?

Is the United States Making the Emerging Nations Stronger?

Why is the rate of inflation so low in the United States when the government has pumped huge amounts of debt into the country and the Federal Reserve has loaded the financial system with large amounts of liquidity?

The same question was asked in the 1990s. Where was the United States inflation?

The answer for the 1990s…and for the present time period…is that the United States has exported inflation to the rest of the world…more specifically…Asia. As the accompanying chart shows, inflation seems to be heading up in Asia…as it is also heading up in many other emerging nations.

As reported in the LEX column of the Financial Times yesterday, global inflation has seemingly bifurcated. In the developed countries the current inflation rate is below 2 percent (Australia and the UK are exceptions). Morgan Stanley expects a 1.5 percent rate of growth for the wealthier countries in 2010. “By contrast, the emerging market inflation rate is about three times higher—expected at 5.4 percent in 2010…” (http://www.ft.com/cms/s/3/0c01f5a4-fb0d-11df-b576-00144feab49a.html#axzz16h9jdCiK)

The post-financial crisis stimulus is now feeding the inflation in the emerging countries. “A significant portion of the river of cheap money flowed into commodity markets. The initial price recovery caused no problems, but the trend now threatens to create a vicious circle.”

There is also the “carry trade” which takes United States dollars throughout the world seeking higher interest rates. This flow is certainly not insignificant.

In these days, it seems like it is very difficult to contain the international flows of capital. Maybe policy makers need to give this a little more weight in their policy discussions.

There is an argument that central banks, in some Asian countries, kept their interest rates “appropriately low” over the past year or so because of “concerns about the strength in their developed-market trading partners” especially the United States. Now, with inflation threatening to get out-of-hand in the emerging nations, these same central banks are faced with the need to raise their domestic interest rates higher and higher. (See “Emerging Wild Card: Inflation”: http://www.ft.com/cms/s/3/0c01f5a4-fb0d-11df-b576-00144feab49a.html#axzz16h9jdCiK.)

The article continues: “One conundrum for investors is how more aggressive tightening would play out in the currency markets. Most investors have been operating on the assumption that with the Fed keeping interest rates at zero for the foreseeable future, any moves by emerging-market countries to raise interest rates would attract even more money from yield-hungry investors.”

This seems to reflect a cumulative problem. By keeping interest rates low in the United States, dollars are flowing out into the rest of the world. This out-flow is threatening to bring about greater amounts of inflation in the emerging nations of the world. In order to combat this rising level of inflation, the central banks in emerging nations are raising interest rates. But, in raising interest rates, more United States dollars flow to these emerging nations.

And the flow of money into dollars from Europe as a “safe haven” has kept the value of the dollar stronger than it otherwise would be in such a situation which just enhances the return to investors from moving into the interest rates in the emerging countries.

So, the Federal Reserve continues to inject large amounts of reserves into the banking system, hoping to get the United States economy going again. But, individuals, families, and small businesses do not seem to want to be borrowing. Only large, healthy companies seem to be borrowing and piling up cash reserves. The money the Fed is printing seems to be going off-shore.

Therefore, instead of stimulating the United States economy, the Federal Reserve seems to be stimulating the emerging countries of the world. The two results of this seem to be that the United States is not getting stronger, but it is helping the rest of the world to get relatively stronger. The rest of the world needs to keep inflation under control, but the emerging nations feel the relative shift in power within the world and are taking more and more advantage of this increased power. See reports on the recent G-20 meeting. (http://seekingalpha.com/article/236430-release-from-the-g20-what-more-needs-to-be-said)
Only strong, self-disciplined countries come out on top. Right now, the United States is anything but self-disciplined and it is finding that its relative strength is slipping away. The unfortunate thing is that in its lack of self-discipline, the United States is feeding the rising relative strength of the emerging nations in the world. This is our fault, not the fault of other nations within the world.

The Currency Wars and the Free Flow of Capital

The foundation for the economic health of the world for the last fifty years has been the relatively free flow of capital begun in the 1960s. That consensus is being threatened now.

The extent of the problem is captured in the New York Times article by Landon Thomas, “Countries See Hazards in Free Flow of Capital.” (http://www.nytimes.com/2010/11/11/business/global/11capital.html?_r=1&ref=business)

“In China and Taiwan, regulators are imposing fresh restrictions on stock market investments by foreigners. In Brazil, officials have twice raised taxes on foreign investors. Even South Korea…pressure is building on the government to take similar steps.

As the leaders of the 20 major economic powers gather in Seoul, an increasing number of them have either imposed curbs or are in the process of doing so to slow the torrent of hot money into their markets…

Once a core policy commandment of the so-called Washing consensus and held dear by the United States Treasury, the International Monetary Fund, and global investment banks, the belief that unfettered capital flows are a boon for everyone—including the country on the receiving end—has been dealt a major blow.”

The culprit that has brought us to this situation is another one of the legs of what is called the “Trilemma” of international monetary relations. The “Trilemma” basically states that only two of the following three conditions can hold: free capital mobility; fixed exchange rates; and a country’s independent economic policy. The leg that is now causing all the trouble is the leg that allows a country to pursue an independent economic policy.

More specifically, in terms of the situation that the world is now facing, is the ability of the United States to “go-it-alone” and follow an economic policy that is independent of the rest of the world.

Whereas most other countries in the world, especially in western Europe, that have tried to conduct economic policies independent of the rest of the world, ultimately paid a price for this independence. The United States, because of its size and the fact that the United States dollar is the world's reserve currency, has never had to face the reality created by its independent economic policies.

The bill is now coming due.

The United States government, since 1946, has had one major economic goal and one minor economic goal. The major goal: to achieve low levels of unemployment within the United States economy. The minor goal: to achieve homeownership for most Americans.

For more on this assertion see the Financial Times award winning book by Rajan Raghuram, titled “Fault Lines.” (http://seekingalpha.com/article/224630-book-review-fault-lines-how-hidden-fractures-still-threaten-the-world-economy-by-raghuram-g-rajan)

Given these goals, the United States, in the past fifty years, has persistently followed an economic policy of credit inflation. This policy has resulted in a decline in the value of the dollar by more than 40 percent during this time even though there were two periods when the value of the dollar actually rose. The decline in the value of the United States dollar since January 20, 2001 has again been dramatic.

The value of the United States dollar has been able to decline as it has because in August 1971 President Nixon floated the value of the dollar due to increasing capital mobility internationally and due to the fact that he wanted to retain the independence of United States policy making.

It is very interesting that Thomas, in his article, brings up one of the conditions of the Post- World War II monetary system agreed upon in Bretton Woods, New Hampshire in 1945. A crucial part of this agreement was the presence of controls on the international flow of capital. As quoted in the article by Thomas, “Just as John Maynard Keynes said in 1945—capital controls are now orthodox.” In the 1930s and 1940s, Keynes was a major proponent of restricted capital flows. Nixon “broke” the Bretton Woods system.

Running an independent economic policy based upon credit inflation does have consequences. The value of the currency of the country running such a policy may decline. And, as we have seen, the credit inflation created by this country, especially if it is the largest economy of the world, can export its inflation to all of the rest of the world!

And, this is precisely what the United States has been doing, regardless of what is going on any place else in the world. And, this is precisely what the rest of the world is rising up against.

There have been other consequences of the United States economic policies, regardless of whether the party in power has been the Republicans or the Democrats. I have presented these consequences in many other blog posts and will just state them here. First, the credit inflation policies of the government have tended to keep unemployment lower…in the short run…but, in the long run these policies have resulted in about one in four workers of employment age being under-employed. Second, capacity utilization in the industrial sector has continuously declined since the middle of the 1960s. It is now around 75 percent. Third, the inflationary policies of the federal government have resulted in a substantial skewing of the income distribution, with the wealthier, who can hedge and protect themselves against inflation, receiving more and more of the income generated within the United States.

Still, the leaders in the United States government use an economic model that prescribes more of the same: more spending and more monetary expansion to further stimulate the United States economy. Whereas the Congress will not provide further stimulus from the fiscal side, Bubble Ben at the Federal Reserve has entered into a desperation commitment, a “hail-Mary” pass if you will, in order to try and save the game.

The problem is that a “hail-Mary” pass at this time in the game cannot do much if your team is down by 35 points!

However, this “hail-Mary” pass can do a lot of damage to the rest of the world because the international flow of capital is so open and fluid. But, the rest of the world does not seem like it will bend over and just accept what the United States has to give it.

Two final points: First, I do not believe that we will go back to an age in which world capital flows are highly restricted. For one thing, I believe very strongly in the advancement of information technology and the increased flow of information throughout the world. Regulations and controls are going to have less and less impact over restricting international capital flows in this world. Restrictions of any kind will be “gone around” if there is an incentive to do so. This is why I believe the Frank-Dodd financial reform legislation is relatively useless. Fluid international capital flows, to me, are a given for investment analysis in the future.

Second, the United States is not going to prevail in its efforts to keep inflating the world. There are three reasons for this. One, other countries will band together and more aggressively confront the United States and work against it. And, I don’t believe the United States really wants a world of controls and protectionism. Two, by following this inflationary policy the United States is handing over its assets to the rest of the world. (See my “China Buys the World”: http://seekingalpha.com/article/236060-china-buys-the-world.) Finally, the United States must ultimately stop hurting its own people through its macroeconomic policies.