Is It Just Drip, Drip, Dripping Away?…

We are talking here about U.S. competitiveness and economic might. In the 1800’s we wrestled economic power away from Britain. We begged, borrowed and stole their technology and trade secrets and this allowed us to take over the top slot.

Now we have a new competitor – China. They are trying to do the same to us as we did to the British, just with ‘Chinese Characteristics.’ They drag their feet about opening their markets and when they do open them, they demand that we transfer our highest technology to Chinese companies. It can seem like a no-win game, either we don’t transfer the technology and lose out on their large market or we do transfer knowledge, get access to their markets but then face enormous competition down the road from companies who now have our cutting edge technology.

The big boys like Qualcomm, Intel and Microsoft all hold world dominating patents. Literally every wireless device in the world is reliant either on Qualcomm’s chips or its patents. The Chinese have forced Qualcomm to share information on how they design and build their chips with Mainland companies and also to make investments in Chinese research in artificial intelligence, supercomputing, data centers and cloud computing. Other companies like Microsoft and Intel are being required to do the same.

China is sending an enormous number of students abroad and as the chart here shows, most are returning to China, some because we make immigration so difficult. We are educating the best and the brightest from China and then pushing some out the door. Doesn’t make much sense. 

Finally, China has launched a major initiative to rebuild the trade routes from China to Europe both by sea and by road. The One Belt One Road initiative already involves over $900 billion of investments in ports, railroads, etc. U.S. companies like GE, Caterpillar and Honeywell are benefitting but the price they pay is having to partner with Chinese companies who then learn the secrets of managing the logistics of big projects. The partner soon becomes the competitor.

One way to look at all this is that the world is very competitive today and we just have to live with this. The darker side however is that China is slowly but surely snipping away at America’s economic dominance. We side with the former view but we fear the latter.  

Not on Everyone’s Bucket List …But Still…

I recently returned from the South Caucasus: Georgia, Armenia and Azerbaijan.  Why the trip? I had visited Central Asia earlier and the South Caucasus is the next region to the East. 

The three states of the South Caucasus were former Soviet Republics.  They gained independence in 1991.  All three countries are blessed and cursed; blessed to be on the cultural borderline between East and West but cursed because they are on the route of so many marching Empires. First the Romans came through, then the Mongols, followed by the Persian Dynasties, the Ottomans and finally the Russians. The region has experienced its share of war and upheaval.   

The region ranges from bone dry desert in Azerbaijan to spectacular high altitude scenery in the Caucasus Mountains.  Georgia it seems has placed a church or monastery on every spectacular mountain peak (see below).

When I travel I like to practice “business tourism,” trying to figure out how people live and how economies operate. Here are some observations.

1.  Trump versus Putin. Was I asked a lot about President Trump? Not really. The focus in the region is almost exclusively on Russia. The Bear to the North is still the main trade partner and Putin is the person who everyone worries about. Russia may not want to take back the South Caucasus but it certainly wants to create uncertainty and instability. This seems to be Putin’s modus operandi worldwide.  

2.  Technology in the Third World. Emerging economies are not going to recreate our original infrastructure, like copper wire phones. They jump right to the present but with interesting characteristics. Everyone uses a cell phone and there are ATM-like machines everywhere (see below) where you punch in your personal code and pay your bills, from gas and electric to phones and parking tickets. Economies in the Caucasus are still cash based and this is what the machines accept. Very creative, very sensible and very convenient.

3.  Tourism with a regional twist.  You see the usual amount of Germans, French and Italians in the South Caucasus.  They have so much vacation time! But not many Chinese yet. The real surprise is the number of Muslim tourists. Azerbaijan is a moderate Muslim country and Georgia and Armenia are friendly enough. The region is a place where many Iranians and Gulf region tourists (including Saudis) can literally and figuratively let their veils down.

Visiting new places makes the world more complicated and this, surprisingly, is also what makes it more interesting. There are no 30-second sound bites after you have visited a country.  You understand better the complexity of history and you come away enjoying the diversity of foods and the diversity of people. The going is indeed still good.

 

What Happens When All Cars Are Electric?...

Electric cars will be taking over our roads. Not right away -- now fewer than 1% of the world’s cars are electric. But it looks like the world is getting ready for roads free of gas and diesel vehicles.

Volvo announced that it will make only electric vehicles from 2019. Norway is planning for only zero-emission cars and vans to be sold by 2025. France and the UK both recently announced they will ban sales of new gas and diesel vehicles by 2040. India has set an aspirational target of having every vehicle sold by 2030 being powered by electricity. And at least 10 other countries have set targets for sales of electric vehicles.

On the face of it, this is great for the environment. But when you go from less than 1% of cars being electric to virtually all of them, a whole other set of questions arises. Tail pipe emissions go down, but what about the other impacts?

The first thing is that electricity demand is going to surge. In the UK, electric utilities and think tanks already have warned that the country isn’t ready. Utility National Grid has said that in the worst-case scenario, if 90% of cars are electric and everyone charges up at 6 pm after work, the peak-time pressures could overwhelm the grid unless changes are made.

UK think tank Green Alliance has added that without electric infrastructure upgrades, some drivers will have to wait to charge their cars during peak hours. Already, when as few as six vehicles located in a tight cluster are charging simultaneously, there can be “brownouts” where some customers experience unplanned drops in voltage. The good news is that smart-charging, which allows cars to charge during non-peak times, would substantially decrease pressure on the system.

Another concern, though, is how “green” electricity will be when demand surges. After all, your electric car is only as green as your electricity supplier. In California, Texas and Florida, where electricity is relatively clean, electric vehicles help the environment. But in the South and Midwest, it’s been found that electric cars are simply transferring emissions from car tailpipe to utility smokestack. In fact, in these areas, hybrid vehicles have a lower CO2 footprint than electric cars.

And what about the environmental impact of mining all that lithium, cobalt and nickel needed for electric car batteries?

Most lithium is mined from brines in the South American desert. SQM in Chile, one of the largest producers of lithium from brines, says that 97% of its energy comes from the sun. But as demand for lithium has grown, more supply has been coming from crushing rock in Australia and processing it in China, which is more energy intensive. Goldman Sachs estimates that by 2020, about half of all lithium will be coming from hard rock to meet electric vehicle demand.

While lithium represents just 5% - 20% of the energy footprint in the car battery, cobalt and nickel account for 50% of it. Cobalt already has become a flashpoint because more than 60% of the world’s supply comes from the Democratic Republic of Congo where it is mined under dangerous conditions that have outraged many. Recently, regional instability has sent cobalt prices soaring.

With nickel production, the worry is that as electric cars compete for supply with traditional users like stainless steel makers, more nickel will need to come from more polluting producers in Indonesia and the Philippines.

Finally, what will happen to all those lithium-ion batteries when they’re spent? There is going to have to be a big build-out of battery recycling facilities. Now, only 5% of lithium-ion batteries get recycled as opposed to 90% of lead-acid batteries from conventional cars. The takeaway here is that while the opportunities from electric vehicle adoption are tremendous, there still is much work to be done.

Behind the Inflation Numbers...

Inflation in the U.S. today remains stubbornly subdued. Since the end of the recession, annual price gains, as measured by the Consumer Price Index (CPI), have increased in the 1%-2% range. Many consumers, however, feel like the costs of the goods and services that they buy are increasing at much faster rates.

Drilling into the composition of the CPI helps explain this apparent contradiction. Housing is the largest CPI contributor, clocking in at almost 43% of the total, followed by Transportation (15%) and Food & Beverage (15%). This weighting makes little sense to Millennials living in the suburbs and taking public transportation. Medical costs and education represent only about 10% of the total, key costs for most elderly or parents saving for a college education. Since 2000, heady gains in medical costs, education and to a lesser extent housing have been partially offset by price declines in things like cellular services and apparel.

Interestingly, prices in some of the fastest growing categories appear to be moderating somewhat today. Take a look at the chart below. Over the last year, tuition at colleges and graduate schools (after scholarships and grants are factored in) grew about in line with inflation or just 1.9%. Higher education prices are following the basic laws of supply and demand. Between 1990 and 2012, the number of two and four year colleges increased by 33% to 4,726 according to the Department of Education. But thanks to demographic trends and a strong job market, college enrollment has fallen more than 4% from a peak in 2010.

This decline in pricing power represents quite a sea-change for colleges which over the last three decades increased stated tuition rates almost 400%. Scholarships and awards reached a record this year and most schools are closely examining costs and programs. This pricing dynamic is not likely to reverse anytime soon with the population of high school graduates expected to remain flat until 2023.

While the overall cost of medical care continues to rise, the rate of increase in some segments appears to be moderating. Prices for physician services, which had advanced in the 3%-5% range annually over the last several years, is increasing lately at a more modest 1% rate. Changing federal and private sector reimbursement plans are behind this reduction. While price gains in certain components of health care, may be moderating, few economists expect the upward trend of overall costs to be radically altered anytime soon.

The course of future inflation is important. For better or worse, the CPI is used to determine annual increases in Social Security and a wide range of other fixed payouts. Inflation rates will also remain a key determinant of future Federal Reserve interest rate policy. Wage gains, a key driver of all prices, will be our best gauge as to where inflation and interest rates are headed. Up until recently, wages have been surprisingly weak given the nation’s historically low employment rate. But recent evidence seems to suggest some firming here, particularly among lower paid workers (see chart above). This population is more likely to spend than the rich so any sustained pick up in wages could be good news for overall consumption trends and the economy at large.