Stronger US Asset Prices (and a Strong Dollar)

The guys at GaveKal (via John Mauldin) are making an interesting arguement why the emergence of new economic power in developing nations will support asset prices in the US and the US dollar.


"As mentioned [in the book], one of the first implications of the 'platform company' model is that industrial jobs (those close to the hearts of our bearish friends and left wing politicians) in the 'creative world' disappear, only to reappear in Mexico, China etc... Over time, the job market in the developed economies moves to a minority of very creative individuals who work for themselves, and a majority of fellows who work in the service industry for the creative minds and/or the tourists coming in from the industrial world....

"If we assume that a new part of the world is getting richer (China, India, Russia, Brazil, etc.), then we should probably assume that some entrepreneurs in those countries are making it big. This assumption is not a stretch; there is enough anecdotal evidence to support (if you doubt that some new entrepreneurs are making it big, go to the Louis Vuitton store in Shanghai on a weekend). If we further assume that, in the countries getting richer, we will start to witness the emergence of institutional savings (pension funds, mutual funds, family offices, etc.), then we should expect big 'savings flows' from the rapidly growing developing world into the Western world.

"In simple words, the emerging markets' newly rich will feel like investing a part of their newly created wealth in regions of the world where property rights are well protected and where there is a rule of law. The excess trade balances earned by the 'industrial world' have, in fact, little choice but to be reinvested in the assets of the 'creative world'. The pension funds of the 'industrial world' will buy the companies which give their countries work. The successful individuals in the 'industrial world' will also buy real estate in the 'creative world' (because it also happens to be the 'fun world'). This implies that the assets in the 'creative world' and especially the prestige assets will always border on the overvalued. Similarly, given the ability to change a producer if he becomes a little bit too demanding, asset prices in the industrial world will remain a little bit undervalued at all times...

"Which brings us to the following point: balance of payments consists of two parts:

1. The Capital Balance: if the above holds true, that part will always be positive for countries with well developed financial markets.
   
   
2. The Current Account: since the two parts add to zero (by construction) it means that the current account in countries with well developed financial markets (US, UK, HK etc.) should always be in deficit, and massively so...

"Taking this a step further, we can assume that, as a result of the constant capital flows, the countries with a well developed capital market will have an overvalued currency and a very low level of long rates. Which in turn leads to robust real estate markets and higher asset prices.

"We call this 'the dollar asset standard'. Basically, diversified and safe assets in the Western world replace gold as the standard of value in the eyes of new savers in Asia, Latin America, or Eastern Europe.

Timothy Burger
timothyb(at)timothyburger.com