Economy
High Economic Growth Does Not Guarantee Strong Investment Returns
Is there a strong correlation between high economic growth and strong investment returns?. A recent study of economic growth in 14 industrialized countries by Orbis, the global asset management partner of investment management firm Allan Gray of South Africa, proves that there is very little correlation between growth in real dividends per share over the 20th century and economic growth.
Chart - Real Dividend Growth Per Share and Economic Growth
Via Equinox.co.za
Many investors mistakenly believe that high-growth countries will deliver high investment returns. The study used real dividend growth per share instead of earnings since earnings are impacted by accounting changes over the years. Dividend growth is a good indicator of returns delivered to shareholders.
From the chart above, we can infer that Japan had an annual real GDP growth of 4.2% in the 20th century. But it had a negative dividend growth rate of 3.3% per year during the period. Italy, Belgium, France, Germany, Spain, the Netherlands, Switzerland and Ireland also had positive GDP growth but negative real dividend growth.
Even when the real GDP and dividend growth rates were going in the same direction, the differences between the two rates were too high.Canada, USA, the UK and Australia had this scenario.
Overall it is not the high-level economic or industry conditions that affect a company’s performance. Rather it is the competition and individual performance that determines a company’s financial success.
The above theory holds true when we look at the high growth economies of India, Brazil and China. Very people invest in the companies domiciled in these countries for their dividend growth. Similarly in the US, during the dot com era people invested for the overall GDP growth and a company’s earning growth rather the real dividend growth.
Household Savings in China, India and South Korea
The household saving rate in Asian countries like India and China continue to be much higher than the U.S. personal saving rate. In the U.S., the personal saving rate as a percentage of disposable income was just 4.4% in October this year. This rate is actually higher than where it stood in 2008. In the first quarter of last year it was just over 1%. From 2008, the rate has been increasing and reached 5% in the second quarter this year as consumers saved more of their disposable income and reduced consumption.
Source: BEA
The latest edition of Finance and Development magazine from the IMF, has an interesting article titled “Rebalancing Growth in Asia”.
National and Household Savings
The following is a summary of main points about household savings in China, India and South Korea:
- In India, since the 2000s household savings have remained the major source of national savings, amounting to about 20 percent of GDP
- In South Korea, household savings has fallen as a percentage of GDP since the 1990s
- China’s household saving rate reached 28% in 2008 after rising consistently from 1991
- The household saving rate as a percentage of disposable income in India has increased to an incredible 32% in 2008 from about 20% in 1998
- South Korea’s saving rate has fallen from about 30% in the 90s to just 7% in 2007
It is interesting to note than during periods of tremendous economics growth in India and China, the household saving rate has increased nicely.This is in sharp contrast to the US where the personal saving rate actually decreased to almost negative levels during the high growth period of the 1990s.
USA Ranks 114th in the Happy Planet Index
The GDP is the most commonly used standard to measure the growth and development of countries. It has many flaws such as the exclusion of variables like the quality of life. Another factor that is also widely recognized is the Human Development Index (HDI). It measures the average of income measured by GDP, health measured by life expectancy and education measured by literacy/enrollment. Similar to GDP, the HDI is also not a complete representation of all aspects of growth and development of any economy since it ignores variables such as the quality of life, the relationship between current income and growth, etc.
The London-based independent think-and-do tank New Economics Foundation(NEF) developed a new measure called the Happy Planet Index (HPI) back in 2006. It measures “the ecological efficiency with which human well-being is created around the world. The HPI reflects the average years of happy life produced by a given society, nation or group of nations, per unit of planetary resources consumed. Put another way, it represents the efficiency with which countries convert the earth’s finite resources into well-being experienced by their citizens. The Global HPI incorporates three separate indicators: ecological footprint, life-satisfaction and life expectancy.”
HPI = (Life Expectancy x Life Satisfaction)/Ecological Footprint
where Life Satisfaction is calculated based on surveys and others are hard variables.
According to this index, Costa Rica is the happiest country in the world. The USA stands at 114 just one step above Nigeria and one rank below Madagascar.
The 2009 Happy Planet Index Rankings are shown in the graphic below:
Click to Enlarge
Rich countries fall in the middle of the rankings. The Netherlands is the highest ranked among Western countries and comes in at 43. Similar to Costa Rica, many of the countries that top the list are small islands including Jamaica, Dominican Republic, etc.
A few important take-aways from the THE ^UN HAPPY PLANET INDEX 2.0 report are:
- No country successfully achieves the three goals of high life satisfaction, high life expectancy and one-planet living.
- Whilst most of the countries studied have increased their HPI scores marginally between 1990 and 2005, the three largest countries in the world (China, India and the USA) have all seen their HPI scores drop in that time.
- It is possible to live long, happy lives with a much smaller ecological footprint than found in the highest-consuming nations.
- More dramatic is the difference between Costa Rica and the USA. Costa Ricans also live slightly longer than Americans, and report much higher levels of life satisfaction, and yet have a footprint which is less than a quarter the size
In the executive summary the authors of the report write “In 2008, Americans voted for ‘change’ and ‘hope’ above else.” With one year in office, is our President Obama fulfilling their expectations?
Credit Card Usage in India and China
Unlike in the Western countries, people in Asian countries still use cash for most transactions. However credit card usage is slowly increasing. With about 50% of the global population Asia holds plenty of potential for credit card growth. MasterCard(MA) and Visa (V) account for 90% of volume at the end of 2007.
Credit Card Usage by Country:
Japan ranks the highest in terms of card transactions followed by South Korea and Australia. India has the lowest card volume at just US $2.0 billion. Chinese spent nearly $24.0 billion using credit cards - 12 times that of India. With two of the world’s largest population, China and India offer substantial growth in the next few years.
Credit Card Growth in China:
Due to strong competition most banks waive annual fees for cardholders. Chinese banks have to deal with low rates of revolving credit on cards since most Chinese do not carry balances on their cards. This is a huge difference from other countries where credit card issuers earn most of their profits via interest on revolving balances. Hence Chinese banks cannot easily earn high profits on credit cards. Credit and Debit card growth rate has increased from 18% in 2004 to about 58% last year.
Source: Card payments in Asia Pacific The state of the nations, KPMG
China Remains the Largest Foreign Holder of US Treasuries
According to the latest data released by the US Department of Treasury, China remains the largest foreign investor in US treasury securities. As of September, 2009 China holds $798.90B of US treasuries. Japan is the second largest investor at $751.50B followed by UK at $249.3B.
The Top 10 Foreign Holders of US Treasury Securities with Year to Change are shown below:
(Amount in Billions of US $)
| S.No. | Country | Jan,2009 | Sept,2009 | YTD Change % |
|---|---|---|---|---|
| 1 | China | 739.6 | 798.9 | 8.02% |
| 2 | Japan | 634.8 | 751.5 | 14.61% |
| 3 | UK | 123.9 | 249.3 | 50.30% |
| 4 | Oil Exporters | 186.6 | 185.3 | -0.70% |
| 5 | Caribbean Banking Centers | 176.6 | 171.7 | -2.85% |
| 6 | Brazil | 133.5 | 144.9 | 7.87% |
| 7 | Hong Kong | 71.7 | 132.2 | 45.76% |
| 8 | Russia | 119.6 | 121.8 | 1.81% |
| 9 | Luxembourg | 87 | 98.7 | 11.85% |
| 10 | Taiwan | 73.3 | 78.1 | 6.15% |
Note:
Oil exporters include Ecuador, Venezuela, Indonesia, Bahrain, Iran, Iraq, Kuwait, Oman, Qatar, Saudi Arabia, the United Arab Emirates, Algeria, Gabon, Libya, and Nigeria.
Caribbean Banking Centers include Bahamas, Bermuda, Cayman Islands, Netherlands Antilles,British Virgin Islands and Panama.
Source: US Department of Treasury
China has increased its investment in US treasuries by about 8% since the beginning of the year. It is interesting to see that the UK and Hong Kong have increased their investments significantly this year. UK increased its holdings by 50.30% and Hong Kong raised it by nearly 46%. Russian investment in US treasuries is mostly flat this year.
Among the BRIC countries, India has the lowest US treasury holdings at $35.9B. The foreign exchange reserves for BRIC countries as of September this year are:
Brazil = $224 Billion
Russia=$413.45 Billion
China=$2,272 Billion
India = $280.34 Billion
So the Ratio of US Treasuries to Foreign Exchange Reserves for each country is as follows:
Brazil = 64.63%
Russia = 29.46%
China = 35.15%
India = 12.81%
From the above, we can infer that Brazil has the highest exposure to US treasuries and India has the lowest exposure at just 12.81%. The vulnerability ratio is high for China also since the ratio stands at 35.15%. With the US dollar on a downward spiral everyday Brazil, China and Russia will be adversely affected more than India. While in one way Russia, Brazil and China’s holdings show their confidence in the US, it may me wise for them to reduce their US treasury holdings now and diversify into other investments.
For the complete listing of Major Foreign Holders of US Treasury Securities as of September, go here.
Should the U.S. Drastically Cut its Bloated Defense Budget?
The outstanding US public debt is over $11 Trillion and the interest payments alone total over $22B per month. The unemployment rate reached 10.2% in October. The number of unemployed persons now stands at 15.7 million. The true unofficial unemployment rate U6 is over 17%. While the federal government and the states have taken various cost cutting initiatives in the past few months, one question that the mainstream media, think tanks and other outlets failed to ask the politicians is this: Should we drastically cut the bloated military budget to help solve some of the economic problems facing this country?. There should no sacred cows when it comes to finding ways to reduce the ballooning deficit.
US defense expenditures have been soaring since the 2001 9/11 terrorist attacks. In 2008, the US spent $711B accounting for 48% of the world’s defense expenditures as the chart shows below. Russia, the former superpower spent just $70B. Europe accounted for 20% of global defense spending. The US defense spending was more than the combined total of the next 45 countries.
Last month, President Obama approved a $636B defense budget for 2010. This includes $128B for the wars in Afghanistan and Iraq. By one estimate the 2010 budget is a 0.20% increase from the 2009 budget.
The chart below shows select U.S. defense-related expenditures since 1960 from the Balance of Payments data published by the BEA.
Click to Enlarge
Source: U.S. Bureau of Economic Analysis (BEA)
Note: The 1991 figure includes $42.5B received from coalition partners for the Persian Gulf war.
The three defense-related items shown in the chart are: Transfers under U.S. military agency sales contracts, Direct defense expenditure and U.S. government grants. These three expenses appear in the current account section of Balance of Payments data and represent the amount the US spends to police the world. From under $20B prior to 1980 this amount increased to $95B in 2008.
For spending this amount of money, the overall U.S. economy benefits much less. A recent study by Global Insight, the respected economics research firm, shows that increased defense spending leads to job losses.
From the article titled “Massive Defense Spending Leads to Job Loss” by Dean Baker of the Center for Economic and Policy Research:
“For example, defense spending means that the government is pulling away resources from the uses determined by the market and instead using them to buy weapons and supplies and to pay for soldiers and other military personnel. In standard economic models, defense spending is a direct drain on the economy, reducing efficiency, slowing growth and costing jobs.
A few years ago, the Center for Economic and Policy Research commissioned Global Insight, one of the leading economic modeling firms, to project the impact of a sustained increase in defense spending equal to 1.0 percentage point of GDP. This was roughly equal to the cost of the Iraq War.
Global Insight’s model projected that after 20 years the economy would be about 0.6 percentage points smaller as a result of the additional defense spending. Slower growth would imply a loss of almost 700,000 jobs compared to a situation in which defense spending had not been increased. Construction and manufacturing were especially big job losers in the projections, losing 210,000 and 90,000 jobs, respectively.
The scenario we asked Global Insight to model turned out to have vastly underestimated the increase in defense spending associated with current policy. In the most recent quarter, defense spending was equal to 5.6 percent of GDP. By comparison, before the September 11th attacks, the Congressional Budget Office projected that defense spending in 2009 would be equal to just 2.4 percent of GDP. Our post-September 11th build-up was equal to 3.2 percentage points of GDP compared to the pre-attack baseline. This means that the Global Insight projections of job loss are far too low.
The impact of higher spending will not be directly proportionate in these economic models. In fact, it should be somewhat more than proportionate, but if we just multiple the Global Insight projections by 3, we would see that the long-term impact of our increased defense spending will be a reduction in GDP of 1.8 percentage points. This would correspond to roughly $250 billion in the current economy, or about $800 in lost output for every person in the country.
The projected job loss from this increase in defense spending would be close to 2 million. In other words, the standard economic models that project job loss from efforts to stem global warming also project that the increase in defense spending since 2000 will cost the economy close to 2 million jobs in the long run.”
For a given amount of spending, the number of jobs created by the defense sector is actually less than the number of jobs created by other sectors of the economy. An article in Naked Capitalism references a study titled “The U.S. Employment Effects of Military and Domestic Spending Priorities” by the economist Robert Pollin at The Political Economy Research Institute at the University of Massachusetts, Amherst. The following chart and table are from the updated version of this study:
Employment Effects of Spending $1B on various sectors:
Spending $1 billion on the military creates just 7,100 jobs whereas spending the same on educational services creates 16,900 jobs and on health care creates 10,400 jobs.
Clearly military spending does not help the economy like other sectors do. Sure some might argue that many cool technological advancements have come out of military research such as the Internet, GPS, etc. But those are just by-products of military research that benefited the growth of civilian economy. Civilian sectors can produce much more inventions and help provide jobs stimulating the economy if the same amount of funds are invested in civilian projects. Even Nobel Laureate Paul Krugman recently agreed that defense spending creates a short-term boost to the economy. In the long-run military spending is wasteful. Most of the defense funding is allocated to pork belly projects of politicians to keep their constituents employed and the defense industry reap huge profits. Another example of wasteful spending by the Pentagon came to light today with this news item: $400 per gallon gas to drive debate over cost of war in Afghanistan.
“The Pentagon pays an average of $400 to put a gallon of fuel into a combat vehicle or aircraft in Afghanistan.
Pentagon officials have told the House Appropriations Defense Subcommittee a gallon of fuel costs the military about $400 by the time it arrives in the remote locations in Afghanistan where U.S. troops operate.”
Last month there was another case of wasteful spending when the Senate was set to fund $2.5 B for C-17 cargo plane production which were unwanted by the Pentagon.
This $400 a gallon, $2.5B for unwanted planes are just the tip of the iceberg. Billions of tax-payer dollars are skimmed off from the military by others such as the private military contractors, consultants that have enjoyed tremendous growth in recent years.
Why does it take $600+ billion to run the military?
According to the latest figures available, as of 2007 “Pentagon is today one of the biggest land owners in the world. The 737 military bases it possesses worldwide (in addition to the bases located in US territory) occupy a total area of 2.2 million hectares. They include 32,327 buildings and employ nearly 500,000 people, including 400,000 American military and civilian personnel. In Germany only, there are 25 American bases, employing 75,600 military people. In Italy, the most important American bases
(Aviano, Camp Ederle in Vicenza, Ghedi, Camp Darby at Pisa, Napoli, Verona, Sigonella in Sicily, La Maddalena in Sardinia) occupy an area of more than one million square kms and employ 15,500 military people and 4,500 civilians.
The historian Chalmer Johnson (*The Last Days of the American Republic*, 2007), who was a CIA consultant between 1967 and 1973, has recently stressed that these figures do not include the 106 American garrisons installed since May 2005 in Iraq and Afghanistan, nor the ones built in Israel, in Qatar, in Central Asia, in Kyrgyzstan and in
Uzbekistan, nor the enormous base of Camp Bondsteel, built in 1999 in Kosovo by a subsidiary of Halliburton company, nor of course the multiple NSA installations (like the Echelon net) devoted to the illegal espionage and ‘hearing’ of personal communications throughout the world (including yours and mine).”
In addition to the two unpopular wars, the Pentagon needs billions of dollars each year just to maintain the facilities mentioned above. Some 1.4 million military personnel serving the country also cost a significant amount of funds in terms of benefits, payroll, etc. In the current economy, military is one industry that is actively recruiting people and in some ways is helping to keep the unemployment numbers low.
In summary, though defense spending is beneficial to the economy in the short-term, in the long-term it is not. In most countries military spending is much lower than US defense expenditures and those countries are able to allocate those funds for other productive investments. Since the Cold War is long over and the Berlin Wall no longer exists, isn’t it time for the US to wind down its global empire and concentrate on domestic issues?
