New Phase Of Globalization Will Benefit The U.S.

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New Phase Of Globalization Will Benefit The U.S. Our focus today: With COVID-19’s impact front-of-mind today, we’re trying to look aheadto the post-outbreak reality. For starters, as the title says, we believe there will be a NewPhase Of Globalization benefiting the U.S., and potentially other DM economies.Globalization isn’t dead, but its first phase – the epic shift of supply chains from DMs toEMs -- is over.

We see 3 broad reasons for the New Phase of Globalization:

1. China’s cost advantage has evaporated, and questions concerning its reliability can’t beignored. Those will accelerate the trade-war induced shift of production away fromChina to other EMs, and increasingly, DMs (particularly for essentials, such as pharma).

2. Tech innovation’s efficiencies, significantly lower corporate tax rates, and the biggestmarkets in the world, make the U.S. an increasingly cost-effective place to invest.

3. Two body blows to the old Globalization order: 1) trade war/tariffs; and 2) COVID-19supply chain disruptions.

Putting this all together, it will pay to focus on the U.S. Indeed, Middle America RemainsOur Favorite “Emerging” Market.

Property of Cornerstone Macro -- Please do not forward

Conventional wisdom holds that the U.S. economy was a big beneficiary ofGlobalization, from the 1990s to today. Cheaper imports, as production shifted toemerging markets (particularly China), helped hold down prices. Indeed, initially,this did happen.

The downside was less visible. As production moved offshore, so didinvestment. U.S. capital stock growth slowed here from 2001-2011, crushingproductivity growth, narrowing the breadth of job growth, and leading to anunprecedented decline in the prime age labor force participation rate. As a result,during the 2000s expansion, Potential GDP growth slowed, creating aninflationary backdrop, as reflected in the sharp acceleration in AHE from 2004-2006 (2% to 4%), and core CPI. And at the same time, productivity growthslowed, accelerating unit labor costs -- a major driver of core inflation.

That decade’s China’s investment boom is long over, and Beijing is still trying tounwind its excesses. With capex having increasingly returned to the U.S. duringthe post-Financial Crisis expansion, the U.S. saw 1) a decline in U.S. imports % GDP(imports ex fuel), 2) an increase in the breadth of capital spending, 3) a pick-up incapital stock growth, 4) an impressive increase in the employment diffusion index,and 5) the well-known increase in the prime age labor force participation rate. Allhelp explain why Potential GDP growth has accelerated, helping keep inflationlower longer. In contrast, during the Globalization boom, U.S. potential GDPgrowth slowed, creating a higher inflation backdrop.

So no, the end of Globalization will not in and of itself boost inflation – justthe opposite. A healthier investment cycle will lead to stronger productivitygrowth, stronger labor supply growth, and in turn stronger potential GDPgrowth.

A New Globalization Phase Will Benefit The U.S.


Globalization: “Is the integration of national economies through trade, investment,

capital flow, labor migration, and technology.” Merriam Webster

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U.S. Imports ex Oil & Gas*% Nominal GDP 2019:4Q: 13.3%

*Crude oil, petro products, fuel oil,

and nat gas liquids

Onshoring Isn’t Necessarily Inflationary.

Remapping Global supply chains is feared to be highly disruptive and inflationary. Notnecessarily … look at the U.S, where imports (ex fuel) % GDP plateaued in 2011-2014, andhave been in a declining trend since 2015. Inflation here has been calm. Why? 1) Capexhas improved, 2) Productivity has improved, 3) Labor supply has improved, and 4) PotentialGDP Growth has accelerated. Those forces combined to dampen U.S. inflation. Today, theCOVID-19 shock will likely intensify efforts to boost domestic production, with implicationsfor capex, the labor force, etc. Again, lessened demand for imports need not beinflationary.

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China Total Investment % Nominal GDP

2018: 44.8%

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U.S. Imports ex Oil & Gas*% Nominal GDP 2019:4Q: 13.3%

*Crude oil, petro products, fuel oil,

and nat gas liquids

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Globalization intensifiedwhen China joined WTO in2001. U.S. imports* % U.S.GDP rose sharply, as moreand more U.S. consumergoods were imported,particularly from China,which enjoyed an investmentboom.

Then, during the post-financial crisis expansion,China worked to unwind theprior cycle’s excessiveinvestment. That helpsexplain why U.S. imports %GDP plateaued in 2012-2014,and are now in a decliningtrend. The U.S. became lessimport dependent. Why?Onshoring? We think so, aswe lay out in this report.

The U.S. Has Become Less Import Dependent.


http://www.free-country-flags.com/countries/United_States_of_America/1/large/United_States_of_America.png

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U.S. (SPX) div. World ex U.S. (MXWDU)Mar 19: 11.78

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2018: 44.8%

Look at these graphs.China’s WTO-ascensioninvestment boom coincidedwith U.S. equity under-performance from 2001-2008.

Since then, Chineseinvestment has shifteddown, U.S. investment hasshifted up, and U.S. equitieshave outperformed. In thislatter era, U.S. capex shiftedup, etc. etc., acceleratingU.S. Potential GDP growth.

And even during today’sCOVID-19 crisis, U.S.equities are outperforming,highlighting the health ofthe U.S. economy relativeto the rest of the world.

U.S. Stock Relative Performance Is InverselyCorrelated With Chinese Investment.


China’s Boom Boosted U.S. Inflation.Quite Different Than Consensus Beliefs.

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WTI2020 1Q: 51.9 4 Qtr Avg.

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China Nominal GDPY/Y% 2019:4Q: 7.3%

The China boom wasparticularly clear in theirNominal GDP growth, whichdid help boost commodityprices (e.g., oil), and in turn,U.S. headline inflation. Butalso core inflation accelerated,in 2004-2006, reflecting theslowing trend in U.S. potentialGDP growth, which was relatedto the deterioration in thecapex cycle, as we outlinedearlier in this report.

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U.S. CPIY/Y % Feb: 2.3%

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U.S. Core CPIY/Y% Feb: 2.4%


China’s WTO-Related Investment BoomDestroyed U.S. Capital Stock Growth.

Many companieslowered costs by shiftingproduction to China, andthen exporting theirproducts to the U.S. ButU.S. capital stock growthfaltered, when investmentmoved to China.

That’s now old news.With China’s investment %GDP declining, U.S. capitalstock growth hasimproved -- we had a solidcapex cycle from 2010-2019. We’ve writtenextensively about this. Ifyou would like more info,please let us know.


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U.S. Real Capex Diffusion Index10 Yr. Avg. 2019:4Q: 63.3%

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2018: 44.8%

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Another Support For “Middle” America: China’s Cost Advantage Is Gone.

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Global Mfg Cost Competitiveness Index: China % U.S.

Source: The Boston Consulting Group

U.S.=100

1% Cost Gap

14% Cost Gap

China’s cost competitivenessdrove its investment boomafter joining WTO; U.S.investment suffered. Now,China’s edge has evaporated,due in large part to its risinglabor costs, and the big U.S.energy advantage.

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The U.S. Has Experienced A Secular Shift Up In Capex Growth, Helping Boost “Middle” America.

Our U.S. capex diffusion index has been in a rising trend, highlighting that companies areincreasingly willing to invest here. Given COVID-19, obviously that cyclical improvement isnow over. That said, the rising trend since 2012 highlights that:

1. China is no longer competitive. China’s 14 pct. point “cost” production advantageover the U.S. from 2004 is gone (BCG data). That covers wages, productivity, energycosts, and the exchange rate (but not shipping costs or corporate tax rates).

2. Tech capex has been an important driver of the U.S. capex pickup. Indeed, the U.S.leads tech development.

3. The U.S. is the largest consumer in the world. Investing near one’s customers looksincreasingly attractive, given virus-driven disruptions.

4. Corporate tax rate cuts and reforms finally made the U.S. a competitive place toinvest. Even before the Tax Cuts And Jobs Act became law, capex was returning tothe U.S. Now, lower taxes and expensing will further support capex, both cyclicallyand secularly.

5. U.S. electricity costs are among the lowest in the world.

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Corporate Statutory Tax Rate (OECD)

U.S.2018: 25.8%

China2018: 25.0%

Eurozone2018: 29.8%

Japan2018: 29.7%

Attractive U.S. Corporate Tax Rate.

The U.S.’ former egregiouslyhigh corporate tax rate alsoincentivized companies toshift business outside thecountry. Well, thatdisincentive is gone,reinforcing the shift ofinvestment back to the U.S.


U.S. consumer spending is largerthan the next 4 largest countries(China, Japan, U.K., Germany)combined.

Nominal Consumer Spending

2017 $ Trillion (WB)

U.S. $13.4

China $4.7

Japan $2.8

Germany $1.9

U.K. $1.8

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U.S. Real Consumer Spending 4 Qtr. Avg. Y/Y% 2020:1Q: 2.6%

The U.S. Consumer Is Still The Largest In The World; An Important Reason To Make Products In The U.S.

The world’s biggestconsumer – the U.S. – hasshown solid growth. To besure, that spending will behit hard here in 2020. Butpost-crisis, that growth willresume, so if you sell it inthe U.S., you willincreasingly want to make itin the U.S.


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U.S. Real CapexTech vs. Total Y/Y%

Total2019:4Q: -0.1%

Tech2019:4Q: 6.0%

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U.S. Real Capex (2011=100)

Total2019:4Q: 144.6

Tech Capex2019:4Q: 186.2

Technology Will Be An Important Support For “Middle” America Jobs.

➢ BMW is ramping up training

programs for new technicians

and engineers to keep the robots

functional. Last year, the plant

added 1,000 workers, for a total of

10,000.

➢ As demographic trends point to a

shortage of workers, consultants

expect companies to work harder

at innovating around labor. If

humans and robots collaborate,

Bain and fellow consultancy

McKinsey agree, productivity

gains could help offset the

demographic drag.

Barron’s, Mar 10

Tech capex has beengrowing faster than overallcapex, and is creatingopportunities for mfgemployment, e.g., BMW.And the U.S. still producessemis, a source of quality“Middle” America jobs.


The U.S. Energy Renaissance Is A Secular Support For “Middle” America.

The U.S. has the lowest industrial electricity prices of any majoreconomy, and the 2nd lowest in the world, thanks to the EnergyRenaissance. They’re 13% lower than China ($6.9 vs. $8.0), 57%lower than Japan, and 52% lower than Germany – an importantcost advantage.

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Industrial Electricity Price* (IEA)2018

*¢/kWh

Note, in China we are using Beijing prices.


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China’s WTO-Related Investment BoomDestroyed U.S. Capital Stock Growth.

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U.S. Employment Diffusion Index10 Year Avg. Feb: 60.3%

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U.S. Labor Force Participation Rate: Prime Age Workers (25-54 Years)

Feb: 83.0%

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U.S. Average Hourly EarningsY/Y% Feb: 3.0%

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The healthy U.S. capex cycle from2010-2019 increased the breadth ofinvestment. This healthy capex cycleled to a broader choice of jobs, whichthen led to an increase in the primeage labor force participation rate,helping hold wage inflation down (asthe labor supply increased).

In sharp contrast, from 2002-2011,the shift of investment from the U.S. toChina weighed on all of the above.And with labor supply in a decliningtrend, wage inflation accelerated verysharply during that expansion.Globalization did not lower U.S.inflation.


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China Real GDP Y/Y% 2019:4Q: 6.0%

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U.S. Real GDP Y/Y% 2019:4Q: 2.3%

U.S. Potential GDP Y/Y% 2019:4Q: 2.8%

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Global Real GDP (CSM)Using PPP

Y/Y% 2019:4Q: 2.9%

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TOChina And Global Growth Boomed In 2002-2007; The U.S. Was In A Slowing Trend.

China’s WTO-relatedinvestment boom was a majorcontributor to their rapid GDPacceleration, supportingGlobal growth during thatcycle.

But, during that Chinaboom, U.S. real and potentialGDP growth were both inslowing trends. Why? Thelack of investment in the U.S.From that perspective, Chinawas not a major supporter ofU.S. growth, on the demandside or supply side.

But the point of this report,is that phase of Globalization,where investment “just” goesto China and other EMs, isover. That’s a net positive forU.S. Potential GDP, increasingthe odds U.S. inflationcontinues to stay lower longer.


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Fastenal (FAST) relative to Catepillar (CAT)Mar 20: 0.301

Check marks indicate “Middle America” states.Darker states have a higher share of goods producing employment.

Middle America states include: Alabama, Indiana, Iowa, Kentucky, Michigan, North Carolina,

Ohio, South Carolina, Tennessee, Wisconsin, Arkansas, Mississippi, Minnesota, Colorado, Kansas,

Louisiana, New Mexico, North Dakota, Oklahoma, Texas, Utah, and Wyoming

Our Favorite ‘Emerging Market’: Middle America.

With investment shifting back to theU.S., states with higher goods producingemployment should at the margin be bigbeneficiaries. As we’ve said for manyyears, “Middle America Is Our FavoriteEmerging Market.” And companies thatare located in this part of the countrycould do relatively well, particularlycompared to those that are still toofocused on EM growth, e.g., Fastenal Vs.Caterpillar.

Goods Producing Employment % Total Jan


Of the top 20 states with the highest share of goodsproducing employment, 17 are in “Middle” America. So, ascapex growth (post-virus) cyclically and secularly shifts up,these states stand to benefit the most.

FYI: “Middle” Americastates are goods producingstates (mfg and oil).

85% of these are in “Middle” America.

Goods Producing Jobs Are In Middle America.

State

Goods Producing

Employment % Total

1. Indiana 21.8

2. Wisconsin 20.5

3. Iowa 19.3

4. Michigan 18.3

5. Wyoming 18.3

6. Alabama 17.9

7. Kentucky 17.5

8. North Dakota 17.3

9. Arkansas 17.2

10. Mississippi 17.1

11. South Carolina 16.8

12. Ohio 16.8

13. Kansas 16.7

14. Utah 16.4

15. Idaho 16.3

16. Oregon 15.9

17. South Dakota 15.6

18. Louisiana 15.5

19. North Carolina 15.5

20. Tennessee 15.5

Jan 2020


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DR Horton Relative to Toll BrothersMar 20: 1.98

Midwest/Southern Focus Pays Off.

Indeed, some companieswith a higher exposure toMiddle America haveoutperformed their peers,as shown here.


Darker states have a higher share of goods producing employment.

*Middle America states include: Alabama, Indiana, Iowa, Kentucky,

Michigan, North Carolina, Ohio, South Carolina, Tennessee, Wisconsin,

Arkansas, Mississippi, Minnesota, Colorado, Kansas, Louisiana, New

Mexico, North Dakota, Oklahoma, Texas, Utah, and Wyoming

Goods producing jobs (i.e.,mfg, construction, andmining) are concentrated inthe center of the country,which is why Middle AmericaIs Our Favorite EmergingMarket.

Mfg activity in particularhas a big multiplier, bringingin other mfg companies (i.e.,suppliers), PLUS servicecompanies (e.g., restaurants,hotels, etc.).

Retailers In The Middle AmericaMay Continue To Outperform Others.

Goods Producing Employment % Total Jan


Companies, i.e. multiplier

1 plant supports 50other companies …That’s a multiplier.

Note

A Good Example Of The Mfg Multiplier.

In 1992, BMW announced it would build a plant in South Carolina.Soon, suppliers, etc., also built facilities there. This is a greatexample of the mfg multiplier. It has unfolded over 20 years, andthe multiplier is still on solid ground. Odds are this phenomenonunfolds elsewhere in the country, now that the U.S. has experienceda sustained shift up in capex.


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U.S. Nominal Goods ImportsY/Y% Jan

Pac Rim*8.5%

China-21.4%

U.S. Imports From Pac Rim Are Not Offsetting The Decline In Imports From China … For Now.

Net, other Pac Rimcountries have notpicked up the slackfrom the decline inU.S. imports fromChina.

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U.S. Goods Imports % GDP

*In, Kor, Twn, Indo, Mal, Ph, Sing, Tha, Vt

from China & HK2020:1Q: 1.8% e

from Pac Rim*2020:1Q: 1.9% e


Post-Virus, U.S. And EM Nominal GDP Growth Rates Could Be Similar Again.

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Nominal GDP Y/Y% (IMF)

EMs (PPP Wts.)2019:4Q 5.6%

U.S.2019:4Q 4.2%

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Real GDP Y/Y% (IMF)

EMs (PPP Wts.)2019:4Q 3.9%

U.S.2019:4Q 2.4%

During most of the1990s, U.S. and EMnominal and real GDPgrowth rates wereroughly the same.That changedsignificantly from2001-2013. But, wemay now be revertingback to the oldpattern.


New Phase Of Globalization Will Benefit The U.S.

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