Would You Buy This Stock?
(MONEY Magazine) – You can't actually buy the U.S.A. like a stock, of course. But there are similarities between the U.S. and publicly traded firms. The U.S.A. produces goods and services and competes in the global marketplace. It has the equivalent of a CEO (President Bush), a CFO (Alan Greenspan), a board of directors (Congress) and shareholders (we citizens). You could even say it has multiple operating divisions--consumer, corporate and government.
On these pages, we examine the U.S.A.--let's make that USA Inc.--much the way a securities analyst would analyze a publicly traded firm. Our aim: to give you a better sense of the economic health and future prospects of our nation at a time when the self-serving claims and counterclaims of the election season tend to, shall we say, obscure rather than illuminate the situation. We don't mind saying up front that our overall assessment is optimistic, although many daunting challenges await USA Inc.'s CEO, whoever that may be after the November election.
USA Inc. vs. the World
GROWTH ENGINE OF THE WORLD With just half the area of Russia and a population not even a quarter as large as China's, USA Inc. doesn't have an edge over its competitors in size. But in terms of the most comprehensive measure of economic might--gross domestic product (GDP), or the value of goods and services produced in a given year--USA Inc. far outstrips the competition. (See figure 1.)
That sheer economic power, combined with USA Inc.'s ability to grow its economy faster than its industrialized rivals do (though not, of course, as fast as emerging markets like India and China), accounts in large part for USA Inc.'s attractiveness to investors and the superior performance of its equity markets (figure 2). USA Inc. still faces hurdles, however, the biggest of which in the international arena is the ballooning trade deficit and weak dollar.
HOW LOW WILL THE DOLLAR GO? USA Inc.'s current-account deficit--essentially, the amount by which imports outstrip exports plus the amount by which the investment income that USA Inc. pays to foreigners exceeds what it gets from foreign investments--more than quintupled to $542 billion between 1995 and 2003, hitting a record near-5% of GDP. This rising trade imbalance has contributed to a major slide in the value of USA Inc.'s currency (figure 3) and even led some investors, notably Berkshire Hathaway's Warren Buffett, to bet against the dollar by investing in foreign currencies. The major concern: If the current-account deficit continues to expand, it could trigger a dollar crisis in which foreign investors flee from the dollar, driving its value even lower. That would increase the price of imports, boost inflation and eventually raise interest rates as foreign investors demand higher yields for U.S. Treasury bonds.
We're aware that chronic large current-account deficits could mean less vibrant growth in future living standards for USA Inc.'s citizen-shareholders. But we see no reason for panic. Trade deficits have a self-regulating element. When the economies of USA Inc. trading partners like Europe and Japan begin to perk up, so too should their demand for USA Inc.'s products, especially since the weak dollar makes those goods relatively cheap. We also believe China will eventually have to revalue its currency vs. the U.S. dollar, which should also help narrow the trade deficit. And while we don't totally dismiss the possibility of a dollar crisis, we think it's unlikely. There's really no other currency that can effectively serve as a universally accepted means of international exchange. So while we'll certainly keep an eye on the current-account deficit, we believe it would be foolish to forgo investing opportunities in USA Inc. because of it. We take the fact that Mr. Buffett's foreign-currency investments at the end of March represented just 8.5% of Berkshire Hathaway's total assets to mean that, like us, he still sees USA Inc. as the best place to put his money.
ON THE MEND BUT JOBS ARE THE KEY USA Inc.'s Consumer Division--which consists of some 293 million people, including a work force of 147 million--has improved both its income statement and its balance sheet after suffering through massive layoffs and huge stock losses in recent years. Personal disposable income after taxes has been growing at a respectable pace since the end of the recession, and a recovering stock market combined with a boom in house prices has raised the net worth of USA Inc.'s citizen-shareholders beyond 1999 levels (figure 4). Granted, this division is carrying a record level of debt, which makes it vulnerable to rising interest rates. That's a legitimate concern, since inflation and interest rates have been moving up lately. We have little doubt that we've seen the bottom in rates and inflation for some time. But where do they go from here? That depends in large part on how skillfully CFO Greenspan handles monetary policy. If he pushes up rates too much too soon, the recovery could flag. If he waits too long, inflation could be a problem down the road. In their May statement on monetary policy, CFO Greenspan and his advisers all but guaranteed that they would begin boosting short-term rates soon, though at a "measured" pace. Given the CFO's past record on managing the economy, we're fairly confident he'll be able to do so without undermining this recovery. That said, rising rates could create some rocky times in the financial markets over the next year or so, but we doubt the damage will be severe enough to trigger a bear market in stocks or bonds. We'll keep a finger on the pulse of the consumer price index and interest rates, however, to ensure that our confidence in the CFO is warranted.
IS THE JOB RECOVERY FOR REAL? We say yes. The April employment report showing that a total of 625,000 new jobs had been created in March and April was especially welcome news. In our view, much of the disconnect between an overall healthy economy and a weak job market resulted from sharply higher productivity. The tech revolution of the '90s has allowed businesses to boost production without fattening payrolls. But productivity gains of the magnitude we saw in the late '90s can't last. And when they begin to slow--as they have--companies that want to increase output and boost profits will start hiring again. While we may not see a reprise of the 251,000 jobs a month created during the 1993-99 boom years, we should see strong job gains in 2004 and even more in 2005 (figure 5).
OUTSOURCING: SHORT-TERM PAIN, LONG-TERM GAIN A recent study by Forrester Research predicted that some 3.3 million USA Inc. service-industry jobs representing $136 billion in wages will move to India and other low-wage Third World countries between 2000 and 2015. With stats like that, it's no surprise that offshore outsourcing has become a major economic and political issue. Is outsourcing in and of itself economically harmful and should it be stopped? We say no on both counts. The evidence suggests that, if anything, outsourcing is more beneficial than harmful for USA Inc. Last year alone, for example, foreign countries paid $54 billion more to USA Inc. workers to perform a variety of business and professional services than USA Inc. paid foreigners.
By focusing on only one side of the ledger--jobs lost--critics miss the fact that outsourcing will create new jobs in the long run by lowering companies' operating expenses, increasing profits and allowing expansion. Outsourcing can be devastating for workers who lose their jobs. But the answer is to provide training for new skills rather than try (in vain, we believe) to subvert a natural economic process that ultimately boosts the living standards of USA Inc.'s citizen-shareholders.
TAKING CARE OF BUSINESS Despite the litany of negative headlines--Martha Stewart, Tyco, the incredible expanding mutual fund scandal--USA Inc.'s Corporate Division is in its best shape in years. Even the beleaguered manufacturing sector has improved dramatically. Consider:
PROFITS HAVE REBOUNDED TO AN ALL-TIME HIGH After taking a major hit in the recession, this division's earnings have come roaring back. And we don't mean those funny-money earnings (EBITDA and the like). We're talking about real profits calculated by the Bureau of Economic Analysis, excluding one-time capital gains and other distortions. These figures show that after declining 11% from their high in 1997, the corporate division's profits regained all their lost ground by 2002, then climbed another 18% to an all-time high in 2003 (figure 6). Economists surveyed by Blue Chip Indicators expect earnings to increase another 18.7% this year before reverting to a more modest 10.7% in 2005, estimates we consider reasonable considering expected economic growth, productivity gains and improved profit margins.
BUSINESSES ARE INVESTING AGAIN One final bit of good news from this division is that it's been revving up its spending on everything from software to new facilities and equipment (figure 7). Indeed, the area that everyone assumed would languish for years--tech--has bounced back fastest and is projected to surpass its 2000 peak this year. This increase isn't quite as strong as we'd like, given this division's increased profits and cash flow. But this uptick is still very encouraging because it shows that the division has truly bought into the economic recovery, which augurs well for future growth and will help take some of the burden off the Consumer Division for keeping this economic expansion going. Finally, investing in new technologies and state-of-the-art plant and equipment will help USA Inc. maintain its productivity edge over economic rivals.
HEY, BIG SPENDERS USA Inc.'s Government Division has been caught in a classic cash-flow squeeze. Just as the division's tax revenue was declining because of the recession and CEO Bush's successful lobbying of USA Inc.'s board (Congress) for tax cuts, spending began to rise as a result of hostile takeovers in Afghanistan and Iraq and the need to bolster homeland security in the wake of Sept. 11. Result: huge deficits plus continued strains on this division's budget caused by soaring medical and retirement expenses for USA Inc. retirees.
ANY END IN SIGHT TO THESE DEFICITS? In a few short years, this division has gone from running a large surplus to an even larger deficit--an estimated $477 billion, or 4.2% of GDP, in fiscal 2004. The big question is where does this deficit go from here? The Congressional Budget Office forecasts that the deficit will decline to $15 billion, or a negligible one-tenth of 1% of GDP, by 2014. (CEO Bush's projections to 2009 trace a similar trajectory.) Critics, including economists at the Brookings Institution, call those projections wildly optimistic. They say that if, among other things, CEO Bush's tax cuts are extended and this division's discretionary spending rises with inflation and population growth (hardly an aggressive assumption), then USA Inc.'s deficit will balloon to $651 billion by 2014, representing 3.6% of GDP--a slight improvement from this year but not real progress (figure 8).
CEO candidate Kerry proposes to narrow the deficit by rolling back CEO Bush's tax cuts on dividends and capital gains as well as the lower rates on taxpayers with incomes over $200,000. CEO Bush says he intends to retain those breaks and rely largely on economic growth to close the budget gap. While that certainly makes for a stark choice for USA Inc.'s voter-shareholders, it's important to remember that for a variety of reasons--inability to get the board to go along with a plan, shifting economic or political conditions and so on--what CEOs say they will do while campaigning and what happens once they're in office are not always the same. Our position is that unless we see some progress toward reducing the deficit as a percentage of GDP within the next few years, we'll have to re-evaluate our take on the future growth prospects of USA Inc.
TIME TO RETHINK ENTITLEMENTS? As daunting as the current budget issues are, USA Inc. faces an even more daunting long-term challenge--namely, funding the retirement and medical benefits that it has promised through its Social Security and Medicare programs. There's no shortage of statistics detailing the financial problems that both of these programs face. (You can peruse them by downloading the Social Security and Medicare 2004 trustee reports at ssa.gov.) But we'll focus on this central fact: Much the way the pension obligations of some older manufacturing firms like Bethlehem Steel expanded beyond their ability to meet them, so too are Social Security and Medicare benefits far outstripping the programs' resources, resulting in what amounts to a huge contingent liability for USA Inc. Indeed, if you total the present value of the cost of these programs for current beneficiaries and generations to come and subtract the value of premiums and payroll taxes earmarked for those benefits, you end up with a shortfall of some $72 trillion.
Considering the strain this liability will begin putting on the budget in the next decade or so (a burden that will only increase with time), we believe that USA Inc.'s management--both the CEO and the board of directors--will have to make some serious adjustments. We don't think a tax hike alone can do the job; it would have to be too big. Which brings us to the conclusion that, one way or another, the growth rate of spending on benefits must also be reined in. We know this will be a tough sell. But unless USA Inc. comes to grips with this issue, the rising costs of these programs and the demands they'll place on future budgets could adversely affect USA Inc.'s competitiveness in the global economic arena.
Of course, economies and markets constantly change, so we stand ready to revise our outlook as the various factors we've outlined play out and new information becomes available to us. But this much seems clear: Unlike four years ago, when the incoming CEO inherited a decimated stock market and weakening economy, whoever wins USA Inc.'s CEO slot in this year's election will inherit a stock market and an economy that, despite the prospect of rising rates, appear poised for more growth. Thus the challenge for shareholder-voters will be to choose the CEO they believe can manage USA Inc.'s economy to leverage this favorable position in the short run, while simultaneously making progress on the long-term challenges that lie ahead.