The Headline You Never Expected: Foreign Growth Could Bail Out the U.S. Economy

[Editor's Note: Money Morning's Martin Hutchinson, a noted commentator, author and longtime international merchant banker, understands the intricacies of the global economy as well as anyone. So while you'll be surprised by the conclusion he reaches in today's essay, be sure to take his recommendations very seriously.]

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During a period of increasingly worrisome headlines about the U.S. economy, there is one bright spot.

The rest of the world appears to be doing much better than we are.

In the long run, that's good news for the United States. Rapid world growth will eventually rekindle the economic fires here, producing a growth that is more balanced than the bubbles of 1995-2008.

Still, getting to that point will be a challenge, since – economically speaking – the home fires don't appear to be burning all that brightly.


Trouble on the Home Front?

The U.S. recovery appears to have slowed to a crawl – or perhaps even ground to a halt. The "advance" estimate of U.S. second-quarter growth was reported at 2.4%, indicating a long road to recovery – during which unemployment is likely to remain far too high.

Almost half of the quarter's gross-domestic-product (GDP) growth projected for the second quarter was inventory buildup. Government spending and a temporary housing blip – caused by the homebuyer tax rebate, which expired April 30 – accounted for the rest.

June durable goods orders, reported July 28, were unexpectedly down 1%, suggesting that even manufacturing is currently slowing. Add to that weak consumer confidence numbers for July and house sales well below expectations for both May and June, and it becomes clear that there's cause for concern on the domestic front.

While inflation does not seem to be an immediate problem, unemployment remains appallingly high. That's especially true of long-term unemployment, which – at 4.6% of the working population – is at a post-World War II record. The federal budget deficit is hovering at roughly 10% of GDP and interest rates remain close to zero, thanks to polices that are looking increasingly eccentric when compared to the routes that other countries have chosen to pursue.

It looks as if the U.S. economy will be dealing with the "Great Recession" for a long time to come. But most of the world's other major economies are experiencing fairly rapid recoveries, meaning that they are putting the "Great Recession" firmly in the rearview mirror.

Searching For Growth

Cast your eyes away from the United States, however, and the picture becomes much brighter. Canada posted first-quarter growth of no less than 6.1%, and its budget is almost in balance. Even sluggish Britain expanded at 4.5% in the second quarter, and its heroic effort to balance its budget will undoubtedly help growth going forward. German industrial production was up 12.4% in the 12 months through May.

In fact, the overall Eurozone is safely into a growth mode – although its overall budget deficit is still dangerously high. The Economist estimates that shortfall it will reach 7% of GDP this year.

Turning to Latin America, we see that Mexico is something of a basket case. But Brazil is expected to grow at 7.8% this year, with Chile not far behind at 5%. Meanwhile, China is projected to grow at 9.9% in 2010, India at 7.9%, and wealthy South Korea at 5.9%. Even sluggish Japan will manage 3.1% growth.

The bottom line: The wise investor will allocate most of his money internationally.

Modest quantities should go into Europe – particularly Germany and Britain, where valuations are reasonable and growth prospects good. Some should go into Canada, China, Brazil and Chile – each of which have natural-resource-based economies. Canada and Chile also will benefit from having thoroughly reliable governments.

A large proportion should go into Asia: A little into Japan, where prospects appear somewhat brighter than they did a few months ago, and a substantial amount into China. Somewhat less should go into India, where valuations are too high and there are signs of inflation. Finally, a substantial chunk should head for South Korea, which boasts good growth, stability and a capable government.

America: The Global Growth Beneficiary

It's important to remember that prospects for the U.S. economy are not universally gloomy.

The bad news is that the Obama administration and the U.S. Federal Reserve are together following the policies that Japan has followed for the most of its last 20 years, prolonging recession and producing dangerous bouts of deflation. (While I don't agree with Federal Reserve Chairman Ben S. Bernanke's excessive fear of deflation, there is no doubt that prolonged or steep bouts of deflation can be damaging, because they discourage investors from holding anything other than cash.)

There are, however, two bits of good news. The first is that U.S. policies may change. Bernanke will man his post until January 2014, so rapid change in ultra-low interest rates can't be expected. However, the movement towards budget balancing is gathering strength in both political parties, and it seems likely that fiscal discipline will be restored once the new Congress takes office in January – following the midterm elections. If the budget is brought towards balance, as is happening in Britain, resources are freed up for the private sector and economic growth becomes easier.

The second, bigger piece of good news – not noticed by those who fear a Japanese "Lost Decade" type of future – is that the U.S. position differs from Japan's in one important respect: Whereas Japan has always had a large balance-of-payments surplus, the United States currently has an enormous balance-of-payments deficit.

The United States has a huge advantage when world economic growth is strong, as is currently the case. With export markets growing faster than domestic consumption, exports will tend naturally to increase faster than imports, producing the most pleasant of all economic states – export-led growth.

Japan couldn't grow its way out of its malaise, because its huge international reserves made the yen too strong, intensifying deflation. Furthermore, foreign countries became disquieted by Japan's surpluses and erected hidden trade barriers against Japanese imports.

Of course, in the U.S. case, rapid growth in exports would reduce global imbalances, not increase them. The U.S. balance-of-payments deficit would decline, reducing its need for foreign funding. That would make the world economy more stable and increase its intrinsic growth rate. But it wouldn't push up the dollar, because the balance of payments would still be in a deficit.

Provided that stern action was taken to rein in the budget deficit, U.S. economic growth would accelerate and unemployment would decline. If the budget deficit remained huge, there wouldn't be so much money coming in from abroad, meaning domestic savers would be forced to buy U.S. Treasuries. That would force up interest rates and restrict the flow of funds to private-sector borrowers.

On balance, U.S. investors should be optimistic for 2011 and beyond. Rapid global growth should rectify the U.S. balance-of-payments problem, so that even modest fiscal discipline will produce a quickening of U.S. growth rates, and a full economic recovery.

Thus, we don't need to emigrate in search of a better economy. But until the U.S. economy actually does turn around, our money should take an overseas vacation.

Actions to Take: Until the U.S. economy starts to show some real signs of life, U.S. investors need to up the ante on their overseas holdings – especially in such countries as China, Korea, Germany, Chile, Brazil, Canada and Britain.

[Editor's Note: As you reflect upon today's recommendations, keep one fact in mind: Money Morning's Martin Hutchinson has been on a global hot streak.

Here's what we mean. Just a week after Hutchinson recommended Germany, the European keystone reported much stronger-than-expected GDP. He recommended Chile back in December, and three of the stocks he highlighted have posted strong, double-digit returns - and one is up nearly 25%. He again recommended Korea - which analysts were downgrading - only to have the traditionally conservative International Monetary Fund (IMF) come out with an upgraded forecast that projects solid growth for that Asian Tiger for this year and next.

A longtime international merchant banker, Hutchinson has a nose for profits instincts - as evidenced by his unerring ability to paint a picture of what's to come. He's able to show investors the big profit opportunities that are still over the horizon - while also warning us about the potentially ruinous pitfalls hidden just around the corner.

With his "Alpha Bulldog" investing strategy - the crux of his Permanent Wealth Investor advisory service - Hutchinson puts those global-investing instincts to good use. He's managed to combine dividends, gold and growth into a winning, but low-risk formula that has developed eye-popping returns for subscribers.

Take a moment to find out more about "Alpha-Bulldog" stocks and The Permanent Wealth Investor by just clicking here. You'll the time well spent.]

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  1. Sandra Stuber | August 13, 2010

    Martin: Thank you for this very important article. I hope people take your advice. It's refreshing to see that finally – someone, somewhere, has their focus on the real issues.

    The one thing that separates U.S. growth with other established and emerging markets is our competitiors are focused on exporting – and bringing in foreign exchange. There is very little evidence that the U.S. manufacturing sectors are doing the same. As a sector, we give lip – service to becoming globally competitive, but without a clear cut plan of action, we will see very little progress.

    Without abrupt changes to our export policy, we will experience continual losses to our domestic market share – some sectors are expected to lose up to 49% within the next five years. If that doesn't give us an incentive to become more competitive in global markets, I don't know what will.

    Once again, thank you for this informative article.

  2. Michael Hullevad | August 13, 2010

    As my uncle Pete said to me in 1971 when the dollar became a paper standard (fiat): americans does not want to balance the budget and they wont pay taxes, so they are going to pay the public debt with the printing press.
    It took 40 years before the prophesy came true!
    I am a dane and keep asking myself: what has happend to the nation I have admired for 50 years?

  3. Tib Csabai | August 13, 2010

    I am amazed that Hutchinson doesn't grasp that a $200 billion per year outlay to US war policy compounded by a $700 billiion per year defense outlay on top of that are "dragging" the US economy down.

    There is no way the US economy can revive until these worthless spending projects are reigned in.

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