Recent protestations to "Buy American" are more evidence that we are entering the "Beggar-Thy-Neighbor" phase of "The Cycle of Deflation" (see attachment).
On January 15th we posted a comment titled "Market's Readjustments Now Taking Place is Normal" with the subtitle "Competitive Devaluations and Beggar-Thy- Neighbor Policies". Beggar-Thy-Neighbor essentially means using whatever means available to enhance a nations' exports at the expense of their trading partners. It also includes limiting foreign workers and restricting capital movements. We quote from that report in which we were discussing China-- "Now, the subject is rarely discussed. Even as our government expected China to raise interest rates and decouple their currency in order to have their currency drift higher and be more equitable, their currency has drifted LOWER NOT HIGHER. Also, the export subsidies in China are very punitive to the U.S. When it comes to "push vs. shove" you will find that every country will do what they consider to be in their own best interest.
This trend, in our opinion, will be pervasive. Virtually all of our trading partners have economic problems that they hope will be helped by being able to sell more of their goods and services abroad. But exports are falling off a cliff everywhere and the only temporary solution will be to do whatever possible to export goods and services. This starts with lowering their currency--competitive devaluations, and next in line will be resorting to "beggar-thy-neighbor" policies.
Some of these actions have already been initiated, and it is only beginning. Great Britain Prime Minister Brown has urged banks to give preference to domestic borrowers. In a world where governments are gaining more control over their banks, taxpayers will revolt against lending their funds overseas. British labor has raised vigorous protests against Italian workers employed in England as taking jobs from citizens. As global economies slide, resentment against immigrant labor is sure to rise throughout the world. French President Sarkozy has stated that French auto companies should confine layoffs to overseas plants. Globally, increased tariffs,imposition of quotas, and restrictions on movement of labor and capital are highly likely in the period ahead.
Even we were surprised to see how close these predictions would coincide with the new U.S. stimulus package being replete with "BUY AMERICAN" all over it. If the stimulus package includes these "protective" measures, just watch to see how fast retaliation takes place and we become immersed in "beggar-thy-neighbor" policies. 60 Minutes had a special recently showing the CEO of Nucor explaining why we must include "Buy American" in the stimulus package. An example of the "Buy American" clause mandates the use of American made steel by U.S. companies benefiting from the stimulus package unless it violates trade agreements. This means steel from Canada and European companies can be purchased while steel from China, Russia, and other countries would be locked out.
Dan Damico, the CEO of Nucor, stated, "There is no such thing as free trade if you want to save steel workers jobs". He said the steel industry turned to Washington a decade ago for help against foreign competition and was turned down. This drove 33 steel companies into bankruptcy. He could not have felt more strongly that the "Buy American" is the only solution. Just like the automobile industry feels that they need government help, you will see this attitude permeate world markets even without the "Buy American" clause. With it, the U.S. will be begging our trading partners to retaliate. After all, after many years of successful trade negotiations (Tokyo Round, Uruguay Round, and WTO successes) just recently the Doha Round talks failed due to the financial crisis last year.
We recall that President Obama, in his election campaign, promised to toughen provisions of previously negotiated bi-lateral trade agreements and to revise parts of NAFTA, which was negotiated with Canada and Mexico during the Clinton administration. On his recent trip to Canada, the president promised that no actions would be taken that conflicts with our WTO obligations and that NAFTA would remain in force unless revised by all of the parties to the treaty. However, the "buy America" provision remains in the stimulus bill.
There also have been numerous recent examples of protectionist moves from our trading partners, especially involving currencies and interest rates. Today the ECB and the Bank of England both reduced their short-term rates by 50 basis points. Can trade wars be far behind?
The latest numbers released by Case-Shiller brought their median price of homes back towards the normal ratio of median family income, but they still have another 20% to go to reach the norm-and 35% to reach past lows (see attached chart). When this happens we will see more defaults and foreclosures as well as negative feedback into the rest of the economy. Furthermore, we believe that the commercial side of real estate is now emerging as yet another major problem that will have highly negative repercussions this year and next. The commercial side dropped by 16% since the end of 2007, but that is just the start. Employment is the main driver of commercial real estate and we all know what is taking place along that front. Apartment complexes are affected by layoffs and the fact that consumers have "hit the wall" as the assets that were providing a positive "wealth effect" are now in a downward spiral. This will prove onerous for retail outlets -especially since we have many more stores than are required to fulfill normal consumption. They will continue shrinking, and naturally, that is not good for the owners of shopping malls.
The factors discussed in this comment are among the many problems that keep popping up as the global economy plummets in a classic negative feedback loop brought on by a severe credit crisis. At this point we still don't know what is going to hit us next. That is why we continue to believe that the stock market has not yet bottomed.