Squabbling Towards Autumn, the Fading Hegemon

                                In a world awash in debt, power shift to the creditors. 

                                                                                          ---Fareed Zakaria 

America is the undisputed global hegemon today. What gives us the power to be the world hegemon? Well, there are four pillars that undergird our power. The first is financial. We are the world's richest nation. We produce the most GDP per year. The next highest, China, with four times our population, produces 70% of what we do. The next pillar is scientific achievements. One look at the top universities in the world will find that a very large share of these are based in the United States. The third one is military. The U.S. spent more on our military than the next 11 countries combined. We have 11 carriers that outclass anything the world owns. China, the next biggest operator of carriers, has two. They are also not in the same league as our Nimitz and Ford class carriers. Finally, our ability to control international discourse, news and entertainment gives us the fourth pillar of our power. 

These four pillars reinforce each other. Our wealth allow us to extend our investment all over the world. Our military allows other countries to defer to our interests and wishes, even if some of these may go against their own. It also protects our investment  from being seized by other countries. Our scientific discoveries produced in the Universities allow us to keep our edge on both the military and the economy. You can see it in the many pioneering achievements such as the use of stealth aircraft in the military as well as the founding of the new economy such as micro electronics and the flourishing of the internet and its related businesses. Hollywood lowers the cost of governing the world. Many of the best minds of the world want to come to the U.S. as we are seen as the shining city on the hill. The rest of the world internalize our values and cooperates with us. This is a much lower cost model of running the world compared to the traditional empire way where brute power must be used. We still send our warships if things don't go our way, but not nearly as often as the British might have to with their empire model. 

It has not always been this way. Before the two world wars, Great Britain has the most money and military. Germany was a powerhouse in science and technology. The U.S., while up and coming, was considered backwaters in terms of military, science and tech. 

Being the world factory for WWII gave us our wealth and productivity.  Acquiring the best scientific talents from Europe after WWII kicked started our ascend in both our scientific achievements as well as advancing our military. 

Scientific achievement is definitely the most important of the four pillars. It allowed us to have the most advanced military and also to trail blaze new segment of the economy that did not exist even a decade before. Financing it all has been a strong economy. 

We are no longer alone. Yes, we have challengers before, like the Soviet Union, Germany and Japan. None of these countries have anything close to the economic parity with the U.S. that China did. In the next decade, China will have a larger economy compared to the U.S. With their new found wealth, they have started competing with us in scientific research . In fact, in the next decade, they will outspend us in R & D. Actual scientific achievements will take a few more years after they achieved parity in spending, but they will come. In the not too distant future, China will most likely surpass the U.S. in scientific achievement, just as the U.S. surpassed old Europe. China has the most number of start ups which are worth 1 $billion or more, what is also known as unicorns, though the value of their unicorns are somewhat lower compared to the U.S. Their military have also come a long ways. 

                                                picture courtesy of Raymond Dalio at

                                       https://www.principles.com/the-changing-world-order/

With this backdrop, a high national debt that may cause the dollar to lose the reserve currency status will erode all four of our pillars of power. Already, our economy is vulnerable as the financial sector is too big and suck the life out of our manufacturing. Our healthcare sector is too big which depends on generous benefits. Once we lose our reserve currency status, domestically, we will go through a stagnation period with inflation, or stagflation. While Hollywood is a commercially profitable industry, our military requires enormous amount of money, our basic research also requires a fiscally sound government. A government that is severely constrained financially will not be able to finance more scientific research and military. In turn, it would impact our businesses abroad. Suddenly, Exxon Mobil may find that their deals with Russia or the Middle East unraveled as our military is not there to enforce our interests against the interests of the countries that has the oil under their grounds. With the constant bickering of the two political spectrum, the nation may turn more violent and chaotic and outsiders may find our way of life less appealing. Top scientists in the world may go someplace else. Hollywood may loses its magic to the world as the U.S. is no longer viewed as the shining city on the hill. The unraveling of our power will continue until we become only a regional power. History is repleted with examples of former hegemons that lost their power to upstarts as each fall into the spiraling debt traps of their own making.

The four pillars of American Power had been dominant for the last few decades. However, due to our imprudence with war and spending, they are now all endangered. In the future, the probable course is for these powers to further erode as we flounder. The power of the American global hegemon is fading.

Squabbling Towards Autumn, Debt and the American Dollar

"A democracy cannot exist as a permanent form of government. It can only exist until the majority discovers it can vote itself largess out of the public treasury. After that, the majority always votes for the candidate promising the most benefit with the result the democracy collapses because of the loose fiscal policy ensuring, always to be followed by a dictatorship, then a monarchy."   

                                                                                                                       -Elmer T Peterson

The problem with all democracies is that politicians must get elected. In the case with the U.S. president, every four years. With voters, a dollar today is worth ten dollars tomorrow. This is especially true if the benefits are not evenly distributed. When the opposing party can fundamentally change the direction of who gets taxed more and who reap the benefit of this tax, you vote your guy in to get the benefits today. As a result of this dynamic, democracies always spend tomorrow's money today. 

U.S.  national debt to gdp,  courtesy of zfacts.com

The U.S. was very fortunate to have won the cold war. To do so, Reagan had to increase the national debt. We can see that in the red portion of the graph labeled Reagan/Bush I. Partly due to his luck, and partly due to his wisdom, Bill Clinton became the president to reap the benefit of winning the cold war. While gdp continue to grow at a good pace, budget deficit was getting smaller. At the end of his term, we actually had a budget surplus. W was the first president to squander this cold war dividend. During his presidency, we fought the Iraqis and the Afghanis, both of these wars cost money. What was even more significant was the housing bubble that happened under his watch. The fiscal impact lasted well beyond his presidency. Obama had to spend most of his first term dealing with the impact of this crisis. By the end of Obama's presidency, the national debt stood at 100% of GDP. When Trump took office, he accelerated this a notch by cutting taxes. As we can see from the graph, debt to gdp was approaching 120% in the short three years of his presidency. That was before Covid-19 hit. Today, in Sept. 7 2020, it stood at $26.5 Trillion. With the U.S. economy shrinking by at least 8% this year, we are now staring at 135% of gdp right now. To get some ideas what kinds of countries sport this kind of national debt, let's take a look at the highest debtor nations in the world.

Japan          - 234.18%

Greece        - 181.7%

Sudan         - 176.02%

Venezuela   - 172.08%

Lebanon      - 160.57%

Italy             - 127.51%

Eritrea          - 127.34%

As we can see, these are not the most economically dynamic countries in the world. To be sure, our economy is not anything close to as bad as that of Greece or Italy. Even at the robust growth of 2+% of the past up cycle, 135% of gdp is very hard to pay back. Going forward, we are facing headwind in two areas. The first is that growth had slowed below the 2% norm that we used to see. During the entire up cycle from 2009 to 2020 before Covid hit, our gdp had indeed gone higher than 2%, but that was done with a lot of deficit spending. This means even during good times, debt to gdp ratio will continue to climb. Indeed, this has been the case as you can see in the first chart above. The second issue is that we are about a year away from getting Covid under control. We will see not only more deficit spending, we will also have more damage to the economy. Entire layer of the economy such as restaurants, travel are going through an extinction event. After Covid, it will take many years before these people and enterprises can recover. This means more deficit spending. We are staring down 150% gdp worth of debt by 2021 and maybe 200% by 2025. 

                                   Gold prices courtesy of yahoo finance.

There are two ways out of this mess. We can either tighten our belts after the economy steadied, or print our way out. Given that we are a democracy and belt tightening involve pain, the most likely path forward is that we will print our way out. Fortunately, we have the world's reserve currency. That means as we print and spend, the world (at least those that hold U.S. dollars) is partially subsidizing our spending. However, that is not without limits. 

The reason the world uses U.S. dollars for trade happened after WWII. Before that time, the British pound was the reserve currency. As a result of fighting two world wars, the British was bankrupt, so they print money and devalued the pound. Since the U.S. was the most productive economy in the world after WWII, the U.S. dollar replaced the pound as the world reserve currency. Initially, the dollar was pegged to gold. During Nixon's time, this peg was removed. Still, up until Ronald Reagan, the status of reserve currency was carefully managed and not abused. Instead of coupling this to gold, we forced OPEC to trade their oil using only U.S. dollars. On the other side, the finished goods that the Chinese are selling are also done with U.S. dollar. This forced everyone who is not North Korea to hold U.S. dollars. 

When potential bond buyers see the U.S. with 150% debt to gdp ratio and climbing, they naturally would demand a higher interest payment to compensate for the printing that will be done. However, on the ground, the interest rates are actually quite low and declining. That is because of two factors. Developing countries are taking a big hit from Covid and many may not be able to pay their debt. At the moment, they are scrambling to get more dollars so they could service the debt. Having people lining up to sell one of their good kidneys for more dollars will certainly drive down the yield. Eventually, many of these countries will run out of rope and have to default on their debt. At that time, the demand for the dollars will be lowered. Also the Federal Reserve can step in to buy U.S. bonds to drive the interest rates down. That is because the U.S. government, with our wobbly finance, can ill afford to pay the true interest rates that are determined by the market. The Fed acts as another source of bond demand, artificially lowering the interest rate. 

In the longer run, U.S. bonds that pay little interest and a U.S. dollar that is losing its value due to currency printing will drive the other countries to find alternatives to the U.S. dollar. The Europeans are trying to do more trade with the Euro. The Chinese are cutting back their holding of the U.S. dollar. As the world (including the U.S. investors) sours on the dollar and dollar denominated assets, even if there is no substitute to the U.S. dollar as the reserve currency, there will be a flight away from U.S. bonds and U.S. dollar into other classes of assets. This will force the Fed to become increasingly the buyer of last resort for the treasuries. The last time we printed a lot of money was during WWII. Fortunately for us, in the 1950's,  the U.S. was making everything for the world. Our strong economy relative to the world helped lowered our debt over time. Today, we are a slowly declining economic power. Once the general population realize the dollar is losing its value, inflationary behavior will set in where U.S. dollars are quickly traded for something that will hold its value and we will start to have spiraling inflation. 

The generous benefits we voted ourselves with along with all the wars that we fought around the world have resulted in ever increasing national debt. Covid-19 and the inept handling of it by the Trump administration, our local governments as well as our citizens have only accelerated this debt built up. Like all other governments in this predicament, we are printing money to get out of this situation. The cost is partially born by other nations and companies holding U.S. bonds and U.S. dollars. However, we have so abused our reserve currency status that a reckoning is coming. When people lose faith on the U.S. dollar, a dumping  of the dollar and dollar based assets will take place. We will go through a phase of rapid economic decline.

Squabbling Towards Autumn, Make America Great Again

Being a Midwesterner, I know that many of the middle class manufacturing jobs that had been at the heart of our economy are either gone or going, and they are not coming back.

                                                                                                               --- Eli Broad

 
As the Spanish passed their empire to the Dutch, who in turn passed their empire to the British, there was one common theme that runs through it all. As each empire got rich, they paid the backwater place that was good at manufacturing to do their work. The people that did their work, later rose from the backwater to become a strong power of their own and eventually replaced their former masters. The Spanish never mastered manufacturing, but they got gold and silver from America and paid the Dutch to build warships. The Dutch in turn paid the British to do the same after they took over from the Spanish and got rich. 

America have made out like a bandit in our push for globalization. You just have to look a the growth and the profits made by the S & P 500 to see that. Since 1980, the SP500 index have grown 15x. During this time, the Chinese also gain quite a bit. While the American corporations earned out sized profits, the Chinese have learned a lot of know how and able to build the world's most complete supply chain. On the sweat and blood of their diligent workers, they have also grown rich. When I left China, they were making 36 yuan a month for the entry workers. Today, their per capita GDP is $10000 a year. Based on Purchase Power Parity, they are even richer at $18000. Loss of the American manufacturing sector and the stagnation and shrinking of American Middle Class is the price we paid for the high profits from our corporations. 

We were not worried when they were making Nike shoes and Christmas ornaments. We are panicking now that they can make telecom equipment, cell phones computer chips. They also are making carriers and fifth generation fighter planes. Trump wanted to see a return of manufacturing to America. Failing that, he wanted to see manufacturing at least moved out of China. 

Is it possible to rebuild the manufacturing in America? First, let me state that manufacturing have not all left America. The high end ones like Boeing, GE, GM, Caterpillar are still here. In fact, the Chinese are still trying to catch up in many of these areas like commercial aircrafts, jet engines and medical equipment. They have a firm lock on the lower and middle segment of manufacturing and are moving up the value chain. The trouble is, America has very high welfare for the low income people and a very large segment of the population with lower IQ. This is a deadly combination for in-sourcing manufacturing. Already today, newborn babies from Hispanic and Black population outnumber Whites and Asians. With Black Americans and Hispanics both have a mean IQ of 85 or so, this implies a future work force with this demographics will have 2/3 of the population at or below an IQ of 100. We have a high tech sector, a financial sector and high end manufacturing sector using up what limited smart people we have, so to bring back low to middle end manufacturing will rely mostly on the lower half of the bell curve. We have many examples where corporations have tried to bring in manufacturing to America. The picture is quite discouraging. A Chinese glass maker opened a glass manufacturing plant in Ohio. Under the pressure of a competition, the American work force achieved 80% of the target. Their Chinese counterpart achieved 120%. Obviously, the target was lowered to make American work force look better. We can imagine in normal circumstances, the American workforce is 50-60% as productive as their Chinese counterpart with this test. For the glass plant, it made sense to do this due to proximity to their customer and the cost of shipping the product to the U.S. Foxconn, with the urging of President Trump, started building a plant in the U.S. to make flat screens. Three years later, that plant lie empty with no sign  that it will be functional anytime soon. In this case, the company is very eager to make this work, but it failed. One of the reason is the difficulties of hiring the right work force. These two examples are special cases where the factory owner have a very high incentive to move to U.S. in spite of the high labor cost and the low productivity of the workers. As we see, only one of the two succeeded. This means the run of the mill factories simply don't stand a chance. We can  see how increasing welfare without a way to motivate the low income people to work harder will make this situation even worse.

Since we have a big consumer base, would taxes help force relocate these plants here? There are at least two things that stood in the way of this happening. First, the Chinese this year just past America to become the biggest end use consumer market in the world. Since the rest of the world is not doing a trade war with China, the combined market of China and the rest of the world still dwarf America's market. For a company to move to the U.S., with half the productivity of China, based on the trade policy of a president that could be on the way out, it does not work out for most manufacturers. The Trump Administration even offered to pay for the moving cost to move factories back to the U.S., but so far there do not seem to be any takers.

In addition to their big consumer market, the Chinese have another huge advantage; a complete  manufacturing eco system. This makes factories that are located inside the eco-system highly efficient and the ones outside it at a huge disadvantage. In fact, after Covid-19, the Chinese took a look at their economy and found that those industries relying on a local supply chain fared much better compared to those that rely on a more global supply chain. Since they are the first to get Covid under control, they have moved to attract manufacturing from around the world to ensure that their supply chain stays local and more robust. Knowing how well they have executed thus far, we can see that their supply chain advantages will be much more formidable coming out of Covid-19. Combining this with their push in automation and AI manufacturing, their advantages are indeed quite formidable. 

What about moving manufacturing out of China to other countries? Actually, that has been happening for quite a while now. Even there, the target countries have become an extension of the Chinese supply chain rather than to replace them. An article used the following example to illustrate how difficult it was for another developing country to displace China. Take the manufacturing of the disposable lighter. It only retails for a couple of dollars. Why isn't this done in a different (and lower labor cost) country? Well, the lighter fluid and shell are made of chemicals, it requires a sophisticated chemical industry. The developed countries have this but the labor cost is too high to make a $2.00 lighter. Most developing countries are not able to align the money, talent and planning to build up this industry. The lighter stone is a specialty steel which requires a strong and advanced steel industry. Again, most developing countries do not have the ability to create a sophisticated steel industry. Now you can ship these components to the developing countries, but the cost is prohibitive due to the lowered margins of the lighter and there is not enough profit left for someone to setup a factory there. For that reason, the most successful target country that received the outflow of Chinese manufacturing, Vietnam, have become the low end extension of the Chinese manufacturing. Their factories are entirely dependent on Chinese suppliers who performed the high value added steps. 

The success of Chinese manufacturing have other implications. Due to their booming ship building and electronic industry, the Chinese are able to to build their warships at a third of the cost compared to the U.S. and are able to do this with great speed. In 2018, the Chinese launched 203200 tons of warships, dwarfing the U.S. at 58600 tons. The lost of our ship building industry have placed our naval development on a difficult path. 

Squabbling Towards Autumn, Rednecks and Libtards

                          A house divided can not stand

                                                                  --- Abraham Lincoln

 

There was a time, when the left and the right can come together after the election, and do what is in the interest of the nation. We are all Americans after all. Lately, we are going down a different path. 

Actually, the reason that different groups of people come together in a Democracy is that they share at least some common interests. At least, they feel that coming together accomplish more then fighting each other. This requires that among the main voting blocks, there are no irreconcilable differences.

This was easier back in the day when all the voters have to be land owning white males. When women were allowed to vote, while they added a dimension to the voting blocks, they too, have to watch out for the interests of their families. When the blacks were allowed to vote, they were a smaller percentage of the population. 

Times have changed since the good old days. Economically, we are losing our middle class and going towards a nation made up of a small elite group of knowledge workers and a larger group of underclass that work at lower end service jobs. The eruption of the "99%" against Wall Street was born out of this demographic change. The factors that drove this trend for the last few decades showed no sign of slowing down. 

             1.   Automation as well as offshoring of manufacturing have taken a large number of what was middle class paying jobs. Automation also made what is left of the service jobs worth less. For example,  cashiers used to need to do addition and multiplication on the fly. Now, she just scans all the items through and bag them. As the skill requirements of the jobs gets dropped by automation, so are the wages. 

             2.  Automation also requires a more skilled and disciplined work force at a time when Americans are getting less disciplined and willing to work. We all want to blame the big bad corporations for offshoring the jobs, but a Chinese glass company opened up a factory in Ohio, and showed that the American factory worker is only about half as productive as their Chinese counterparts given the same technology and work conditions. This is on top of the higher wages that the company must pay to hire an American compared to Chinese. 

             3.  At the same time, technological advances and more interconnectedness  have allowed the high IQ workers to be much more productive compared to before. Unfortunately, only a small group of us could be high IQ workers. Unlike in Lake Wobegon, not all kids grow up to be above average.  

             4. Ironically, higher degree of meritocracy through institutions like colleges and assortative mating have significantly reduced upward mobility. America is sorting itself out with an elite upper class based on good genetic endowment and a lower class based on the lack of. 

Our relatively high wages and many who are unwilling to even work have opened opportunities to Mexicans willing to work hard. Many industries like construction in California and meat packing as well as agriculture for the entire nation will collapse today without the contribution of the Mexicans. 

Adding to this mix is a large permanent Black underclass. Most studies show that their under achievement to be mostly genetics in nature. Largely unproductive and under the care of the government, this group is bitterly angry at the world. The crimes committed by this group is vastly disproportional to their numbers. Not willing to blame the man in the mirror, they have, instead, blame racism and the police. In a world for the rest of us, when we are stopped by the police, if the police wanted to take us in, we don't resist. Among this group, many put up a big fight. When some are killed or injured by the police in the scuffle, it reinforce the idea that the police are bad and out to get them.

The Democrats, for whom Blacks and Latinos are major constituents, have pandered to this anger. The entire Black Lives Matters movement, with the abetting of the Democratic Party, have carried this pandering to new levels of absurdity. A Black person was killed during his arrest by a White cop, maybe with less than honorable intent. There is not a single person in this country that is on the side of the White cop. Instead of chalking this to a bad apple in the force, riots erupted nation wide with vandalism, theft and some people killed by the rioters. What is much more alarming is the call to defund the police. In a city with a significant black underclass, defunding the police is the fastest way for the city to commit suicide.

On the other side is the angry White lower and middle class that have been displaced by automation and offshoring. They feel the competition from the Mexicans and the anger from the Black underclass. Angry that their lives are harder compared to their parents, this group feel that Trump is the only one on their side even though he has done a horrible job with Covid and can point to no achievement during his four years in office. Indeed, Trump got into office by being one of the most divisive candidates and presidents in our time.

Mexicans and Blacks together are already near majority for the newborns. This means in a not too distant future, the Democratic Party that they will help elect will enact policy that will pander to these groups at the expense of the others, further dividing the nation. This demographics and the divisiveness of the two parties ensures that conflicts between most Whites on one side and Blacks and Latinos on the other will be a permanent feature of American Landscape. The Democrats will have control of the government in the not so distant future and will carry this control for a long time. We can expect more unconditioned largess for the poor. As I will talk about in the next post, this is the wrong thing to do. Bigger financial aid to the underclass based on the condition that they have low income will have serious implications for the manufacturing revival that is needed if our country is to be turned around.

The forces that I have outlined above are all structural and very hard to reverse. There are two things that potentially could reverse them, but the chances of these being implemented are very low indeed.

If the nation were to widely accept Human Bio-Diversity, to understand that group differences in achievement are mostly due to the difference in genetics, there would be much less anger and hate. The Black underclass will understand that there is no "the man" causing all their issues, they need to change themselves if they want to do better. Many Whites will at least be sympathetic to groups of people that under-achieve through no fault of their own. They were just dealt a bad hand at birth. Unfortunately, this goes against the victimization industry that is the left and to a less extent, the right of American politics. American politics have become a spoil system. Under this system, victimhood is jealously guarded as a means to extract a larger piece of the pie. The truth will not stand in the way when the interest of the group requires a different narrative.  

Universal Basic Income, if done right, will relieve the anxiety for the poor and bring back their initiative to work again. The key is, while we provide Universal Basic Income, we must remove all other financial aids for the poor. People have a way to survive. The government does not care if you are rich or poor. The poor must manage their financial affairs on their own. Work will not be penalized if you are taking Universal Basic Income. Further, we need to prevent the poor from given birth to more kids purely as a means to extract more financial gain through Universal Basic Income. Charles Murray had the idea that Universal Basic Income is only extended to people starting in their early twenties. Indeed, some candidates are talking about this. Jerry Yang was the most energetic proponent of this Idea. Unfortunately, the welfare industry is too strong and powerful, so if this is implemented, the most likely way is that the poor will keep their welfare and the Universal Basic Income goes on top of the other mean tested financial aid. This will move the country further in the wrong direction.  

Our nation is divided as never before. Rich against poor, left against right and Black against White.The most likely future is that this will not only continue, but will get significantly worse.