Friday, October 09, 2009

David Malpas On The Weak US Dollar

Former Bear Stearns economist David Malpass wrote a great editorial in yesterday's Wall Street Journal concerning the coming effects of a continued weak US dollar policy.

In brief, Mr. Malpass notes that while a country temporarily gains trading volume from a weak or weakening, depreciating currency, those illusory profits are more than offset by a global flight from the currency.

Thus, while the US goes about its merry way flooding its trading partners and global investors with dollars and liabilities which are steadily declining in value, fewer investors will continue to want to either hold US dollars or dollar-denominated assets. In time, there will be a shortage of capital inflows to the US, and, quite possibly, a net outflow, as sophisticated investors flee the dollar for hard assets or other currencies.

Malpass gives a very good, clear account of the fall of the British pound and the accompanying hollowing out of their economy.

He writes,

"At the end of empire, the giant sucking sound was from British capital and jobs moving offshore as the pound sank."

Sound familiar?

He continues by observing,

"Some weak-dollar advocates believe that American workers will eventually get cheap enough in foreign-currency terms to win manufacturing jobs back. In practice, however, capital outflows overwhelm the trade flows, causing more job losses than cheap real wages create.

No countries have devalued their way into prosperity, while many- Hong Kong, China, Australia today- have used stable money to invite capital and jobs.

There's been a clear demonstration this decade. The S&P nearly doubled from 2003 through 2007. Those who borrowed to buy won big-time. At the same time, the dollar's value was cut nearly in half versus the euro and other stable measures. Capital fled, undercutting job growth. Rent, gasoline and food prices rose more than wages.

Equity gains provide cold comfort when currencies crash. From the euro perspective, the S&P peaked at 1700 in 2000, finally reattained 1100 in the 2007 bubble, fell below 600 in March and now stands at 700. With most of the market capitalization of U.S. stocks held by Americans, the dollar devaluation has caused a massive decline in the U.S. share of global wealth."

Malpass doesn't explicitly address the reserve currency issue, as I did in this recent post. But he really doesn't have to. Everything he writes points to an implicit move away from the dollar as a stable, globally-preferred store of value and safety.

His recommendations for how to fix this problem are fuzzy and lack the ability to actually be implemented. Just calling for "jobs and wealth" policies isn't enough.

What Malpass avoids saying is the obvious, i.e., that the U.S. must rein in deficit spending, stop monetizing its own borrowings with Fed purchases, and begin to behave like a world leader in commerce and economics again. Something not done since, oh, the Reagan administration, and perhaps the Clinton years, as well.

American politicians may fool the country's residents into believing that simply running the printing presses overtime and issuing excessive debt, too, won't affect America's global economic standing or hamstring monetary policy in years to come.

But global investors and trading partners understand reality, and won't be so fooled.

Thursday, October 08, 2009

Boeing's Problems Extend to The 747

I wouldn't have expected to be writing another post about Boeing so soon, after this one in August.

In that post, I commented on Boeing CEO Jim McNerney's apparent inability, during his 4-year tenure, to get the company running on all cylinders. Two months ago, the news was more delays in the Dreamliner project.

Yesterday's Wall Street Journal reported that the company's troubles have now spread to its 747 redesign.
Apparently, the production problems with the Dreamliner have so sapped talent at the company that engineering skills shortages are now affecting the 747-8 program.
The chief of the commercial airplane division, Scott Carson, was eased out on September 1st, replaced by a Boeing military programs executive, James Albaugh. So much for bench strength in the formerly-premier Boeing commercial side of the business.
Apparently the delays on the 747-8 jet have become severe enough that the company announced a $1B charge and, like the Dreamliner, delayed the first flight of the redesigned wide-body until next year.
Meanwhile, economic conditions will probably delay both planes' profitability, as airline customers struggle with decreased demand. Cargo versions of the 747-8 are much more in demand than the passenger versions.
As the nearby 5-year price chart continues to show, as in August, McNerney's Boeing can't seem to outperform the S&P500 Index.
In fact, the company's slide from its price peak in early 2007 has been much more rapid than the index's. For the past 18 or so months, the company's equity price has pretty much tracked the index.
That doesn't say a lot for McNerney's management prowess. As I mentioned in the August post, for the sort of risk one takes in holding an indvidiual firm's equity, shareholders expect and demand a better return than simply tracking the equity markets.
I wonder how long it will be before Boeing's board concludes that McNerney just doesn't have the horsepower to move Boeing's performance up above the index for the long term, and eases him out.

Wednesday, October 07, 2009

On The Dollar Losing Reserve Currency Status

My business partner and I were both horrified that yesterday, on a day when there was so much news about secretive, joint talks between Arab oil producers, Russia and China on establishing a non-US dollar reserve currency basket, the S&P500 Index didn't plummet, but rose 1.4%!

What about this potential calamity don't investors understand?

Like many other business people, I've read warnings about the loss of reserve currency status for the US dollar for decades. It's usually the same song- large deficits, inflation debauching the value of dollar assets held by foreign governments, etc.

In the past, though, no other nation held out such hope for economic growth with fairly stable regimes and legal frameworks. Next to the US, other potential reserve currencies paled in comparison.

Now, however, the threat takes a slightly different, and more credible form.

First, Arabian oil producers are viewing US military hesitancy over Iran, and potential withdrawals from Iraq and Afghanistan, with alarm.

Add to this an unprecedented flooding of the world with dollars and dollar liabilities. Despite what many talking heads my believe about current modest price deflation due to lower demand, there has never not been a relationship between excessive printing of money and subsequent hyper-inflation of said currency.

Finally, three other global powers or power blocs- Arab oil producers, Russia and China- each have a desire to see the US weakened. It's no secret that post-WWII US power has always implicitly rested on the dollar's reserve currency status.

When our own Treasury Secretary begins to talk up the use of SDRs to replace the dollar, and the US, as part of the G20, lends credibility to this move, the jig is nearly up.

This is, of course, idiocy on the part of the current US administration and its misguided new sense of multi-lateralism and global harmony.

With these forces as context, it becomes chillingly plausible that some major oil producers and a major consumer- Arabia, Russia and China- could indeed jointly agree on a basket of commodities and currencies with which oil may be purchased, none of which is the US dollar.

I'm quite familiar with what would be the counter-arguments to this development. In brief, it will be the repetition of what I, too, used to believe. That current holders of so many billions of US dollars and dollar-denominated liabilities won't dare precipitate the loss of value of their own substantial assets.

The question, now, is at what point these countries essentially choose to finally go cold turkey on the US dollar, reasoning that loss of wealth by a sudden switch to other stores of value is preferable to a few more decades of gradual erosion of value of the dollar.

Google the topic or relative currency values over time and choose any of the results you see. By many measures, be it purchasing power, other currencies, or gold, you'll see that the US dollar has fallen by at least a quarter in value in the past 8-9 years.

Now consider the massive issuance of dollar-denominated government debt in the past year, and the monetizing of that debt by our own Fed. And the coming huge inflationary spending on stimulus, health care and 'cap and trade' bills.

Any thinking person in the rest of the world is watching this and seeing a monetary train wreck ahead for the US dollar and its debt instruments.

On our current trajectory of government spending and legislation, it's not far-fetched to see a weakening of our economy, as we impose self-inflicted, crippling increases in energy prices and pollution costs, while spending money we don't have on living standards we will no longer be affording through economic growth.

Add to this the probably loss of global trade through over-priced products, again, thanks to increased energy prices and self-imposed faux pollution costs, and you come to a choice between two very bad options.

Either US tax rates will soar to previously inconceivable levels, depressing demand and wealth creation, or the crushing debt load and interest payments on said debt will result in the dollar's rapid decline in value.

All this near-term babbling about deflationary pressure on the CPI due to demand moderation misses the point.

When other major global resource players openly deny the secret talks that are obviously occurring, on the subject of replacing the dollar as oil's payment mechanism, it's finally very late in the reserve currency game for the US.

How this can possibly be seen by investors as a reason to bid up US equity prices is beyond me.

Tuesday, October 06, 2009

Further Thoughts On GE's Disposal Of Its Media Businesses

Over the weekend I wrote this brief post on GE's overdue admission that it needs to begin unraveling the underperforming, diversified conglomerate.

Perhaps my most succinct piece on the pointlessness of GE's current incarnation was this May, 2007 post. In it, I noted,

"Simply put, corporate diversification for cash flow smoothing has been a discredited management approach for creating consistently superior total returns for some time. My own proprietary research, which drives my equity portfolio selection of consistently superior large-cap companies, confirms this. Back some thirty or forty years ago, when trading equities was expensive and information and innovation were in shorter supply, it may have made sense for investors to hold shares of conglomerates. And, in the day, they existed- Gulf&Western, ITT, and Litton, to name just a few. But they are gone now. ITT still exists, but in nothing like the shape it had under Harold Geneen.

Today's large firms are usually focused on a particular product/market. Diversified conglomerates are pretty much a thing of the past. Mediocre analysts and fund managers might confuse large focused global firms, such as Intel, Cisco, or ExxonMobil, with yesteryear's broadly diversified giants. You should not. I don't think investors do, either. That's why GE's stock is in suspended animation. Everyone can diversify more cheaply today than they can by paying an enormous tax on operating earnings of GE's business units in order to keep them under one administrative regime.

What's ironic is how everyone seems to have forgotten GE's heritage of being subjected to wrenching change with each new CEO of the prior forty years, except for Immelt. He's the only one not to have actually made a big change in the firm, and it has stalled."

I've had a couple of conversations with business colleagues about GE's newly-disclosed decision that it's time to unload the media businesses. While I am not, of course, privy to the board's or senior managements' private discussions, it seems to me that one or more of the following may be reasons why Immelt has suddenly come clean that GE needs a "greater fool" to buy NBC/Universal, and that fool is Brian Roberts.

First, according to the Wall Street Journal articles about the GE media unit, NBC's network operations are finally, inexorably sliding in profitability terms. While the company doesn't break out results in any more detail than the major business units, somewhere down in the depths of the NBC/Universal unit is, we are told, a declining network income statement. With each passing month/year, these properties become bigger drags on GE profit growth and total return.

Next is the Universal studio property. This morning's Journal announced that the studio co-heads are being shot and tossed out. Apparently, this unit, too, has been suffering from poor performance. Taking the network and movie studio together, I find myself recalling an Immelt remark about how much fun it was sitting in meetings to decide on production slates for both units.

Guess Jeff's touch isn't so good. And other executives will pay the price.

Then we come to NBC's cable properties. The ones with which we are well-acquainted, CNBC and MSNBC, are fairly small in the larger cable world. CNBC may be a the premier business cable channel, but it's woefully small next to general cable news networks like Fox or CNN.

However, the company also owns Oxygen, SyFy and USA Network, in addition to which it recently bought The Weather Channel. However, this collection of entertainment channels isn't going to carry the underperforming assets of the remainder of the entire NBC/Universal business group.

So, just in terms of the arithmetic of assets, revenues and profits, GE's media group is finally beyond a tipping point in its effect on GE's overall performance.

Beyond financial performance, there's the issue of the media unit's growing prominence as a lapdog for the current administration. There's been much written about NBC's and related properties' leftward political tilt. It could be that Immelt and his minions are beginning to realize that it's becoming riskier, given the actions of the current administration, to be seen as apologizing and cheerleading for it.

There is also growing awareness that GE stands to benefit financially from a government-run health care system and the crackdown on CO2 emissions and greenhouse gases. This bargain with the devil in Washington may be just a touch too cozy when the company also owns a collection of media properties which trumpet those government programs.

Simply put, it borders on GE churning out propaganda for the government, in return for favored treatment in various new programs. That makes the company a target for lots of criticism.

My next point is one that, ideally, would be a subject on my companion political blog. But I feel it's necessary to mention it here, and will do so as non-partisanly as possible.

If Immelt and his board feel that current legislative difficulties are likely to increase the chances that this will be a one-term administration, then the risks of betting everything on Washington's initiatives, and broadcasting them, too, literally, becomes higher.

If GE didn't own a media business, it would avoid and evade quite a bit of criticism for conflicts of interest. And, later, could duck a lot of flak for having been tailoring news and opinion to please Washington. Being seen as the media stooge for a failed administration might add unwanted pressure to the already long-underperforming conglomerate.

Then there's the embarrassment of GE's having to have taken government funding handouts to stabilize its over-leveraged, ailing finance unit. It was a pretty bitter pill to swallow for Immelt to have to rely on federal help to avoid a serious funding crisis of his own.

How can a company with the federal life support needle in its arm appear to run an objective, credible media group? It can't.

This, too, might now be seen as a real point of vulnerability moving forward. Thus, another reason to dump the media businesses ASAP.

Finally, there's the old adage, "strike while the iron is hot."

Just when the financials and, perhaps, political winds are beginning to blow ill for GE's media business, someone came along with an interest in relieving the company of this headache.

If GE can successfully get Brian Roberts to buy out Viviendi's interest in the media group, and then take it off GE's balance sheet, leaving the Connecticut-based conglomerate with a minority interest, it will have managed to unload a problem child before the value in it really craters.

One trend that is afflicting both GE's networks, and cable properties, as well as Roberts' cable business, is the move by many consumers to direct viewing of entertainment and other video content on the internet, rather than through intermediaries such as cable channels.

Roberts thinks he can scoop up enough content to be a key player in even internet-based content, just in case his distribution pipes really do begin to empty.

Whether this makes sense would be the subject of another post focused on Comcast. For right now, it's enough to note that Robert believes in this strategy.

There's nobody else on the horizon capable of taking NBC/Universal off GE's hands like this. TimeWarner is so messed up it couldn't possibly consider it. And, anyway, even Bewkes might be wary of having so many old network properties dumped on his balance sheet. TimeWarner seems to be moving out of content, at least on the print side. It's far from clear it would suddenly try to move into video content, but not in a gigantic way.

No, Brian Roberts is probably the last, best hope for GE, short of an outright spin-off of the media group. Which, by itself, is not a bad idea. And one I've advocated for over two years.

Having now broached the notion that it should jettison its media businesses, it may be hard for GE to avoid the spin-off route, if the Comcast talks fall through.

Of course, deep in the background of all this negotiating is the unspoken but implicit judgement that Jack Welch probably messed up in buying NBC to begin with. If it was such a great, strategic move, why is it being uncoupled now?

In fact, you could argue that the media group, as a standalone unit, might have been more nimble, savvy, and successful at doing what was necessary to enhance performance long ago. But, as part of the larger GE conglomerate, it was hamstrung by a corporate parent's oversight, bureaucracy, and funding.

But, now, there are a legion of reasons for GE to do something to shed the businesses. And no time like the present. Because, frankly, the present is still way too late for this move.

Monday, October 05, 2009

An Important Detail On Unemployment Measures

Last week on CNBC there was a fascinating discussion by an economist on the mechanics of unemployment rate measurement.

I can't recall who was speaking, but his details called to mind similar comments by another economist last year on the network. The difference was, this time, the guest linked it to the allegation that rising unemployment lags an economic recovery.

The specific detail is this. When employment is surveyed, it's by telephone. The two key questions asked are:

1. Are you employed?
2. Are you looking for work?

The response to the first is pretty simple. If you answer "no," then, at that point in the survey, you are unemployed.

However, the second question is asked if the answer to the first was "no." If you answer "no" to this question, you suddenly become not unemployed, but simply not counted as either employed or unemployed. That's because if you say are not looking for work, you effectively reduce the denominator of people looking for work who are either working, or not.

From a purely arithmetic viewpoint, you can understand this logic. However, it has, as the CNBC guest noted, perverse consequences on the stated US unemployment rate.

For example, he said, during many months of no expansion whatsoever, people simply stop spending time and money looking for a job. Thus, by the survey's standards, they are not unemployed.

Then, one month, say, last month, the person hears of hiring activity somewhere in the economy, and decides to once again seek employment. The monthly phone survey now finds him "unemployed," because he's not working, but looking for work.

The guest pointed out that, in reality, nothing changed about the person's employment circumstance. What changed is the survey's treatment of this not-working person.

Because behavior like this tends to occur later in a recession, as some hiring begins to take place, the measured unemployment rate thus rises.

And that is why it appears that continued rising unemployment lags a recovery. It's an statistical measurement artifact, not a real phenomenon at the basic level of people who are, or are not employed.

Not only does this explain why unemployment appears to lag economic recoveries. It also sheds light into the probable underestimation of unemployment throughout a recession.

With the current unemployment rate standing at 9.8%, this suggests that you can bet the real rate of unemployment topped 10% a while ago. Perhaps in mid-summer. Nobody knows for sure.

Thanks to this pollution of the unemployment measure by removing those who once sought work, then did not, then did, again, what we have is consistent measure which we know is wrong.

Wouldn't it be better for the survey to be modified to track whether the respondent was looking for work, if not now, some months ago? Or ask how many months it has been since they last actively sought work?

Then several measurements of unemployment could be provided, with varying denominators, according to what one chose to measure.

As it is now, a supposedly "hard" number rests, in fact, on psychological influences upon the unemployed as to whether they will say they are actively seeking work.