I think America will be transformed by the Great Recession, but not in such a dispirited direction.
Let's start with Warren's energy bet. The bet seems plausible, given fears of Peak Oil and Obama's intent to regulate and tax energy under Cap & Trade or similar schemes. The bet reminds me, however, of the bad policy and misleading extrapolation of the '70s:
- Then, as now, we had a weak Dollar policy which led to rising commodity prices, especially oil.
- Then, as we intend now, we regulated oil prices, which led to shortages.
- Much doom & gloom was extrapolated from those bad policies, including the demise of the American Dream.
Seems to me investors are once again are in grave danger of being driven down the wrong path. Policy changes create high prices and (potentially) shortages, and drive extrapolation of transformation from high energy costs; but those policies can and likely will be reversed if we have another decade like the '70s. Anyone investing in high energy in 1980 found their plans were busted by the continued drop in energy prices, and the gradual loss of government subsidies. Governments are always the last to react to a change in underlying conditions, and relying on them to hold dis-economical policies for long enough to get out is fraught with risk for investors.
Yet it is likely that America will be radically transformed by current economic conditions. The Great Recession is of a kind and scale seen three prior times in American history: 1929, 1873 and 1837. Each of those had a serious depression following a credit bubble, and led to rapid transformation of American business and power centers. You could see glimmers of the future change extant already, but the entrenched power centers were able to withstand the tide and hang on. The crash and subsequent depressions seemed to break open the constrained forces. Here are the prior three transformations:
1837: Andrew Jackson broke the Bank of the United States (the Fed of the day) and in doing so broke the power of Philadelphia bankers. The financial center shifted to NY, which has held it ever since; and the food processing center shifted from St. Louis to Chicago, where it has remained.
1873: German reunification led to a global bubble and crash, and also came with a global shift from silver to gold, bringing about a grinding "long depression" of over 20 years. The mill towns of New England, which were the foundry to the Civil War, gave way rapidly to the new manufacturing powerhouses in the Midwest. Cities like Pittsburgh, Detroit and Cleveland became the foundry for the world.
1929: A poorly-designed return to gold in 1925 by England led the Fed to loosen credit to bolster the Pound, and the Roaring '20s were off. Hoover's meddling after the crash exacerbated the problem, and a global banking crisis in 1931 led to the Great Depression. The US was dramatically transformed from agriculture (40% of employment before the crash) to manufacturing. After the recovery, power shifted from the Midwest, soon called the Rustbelt, to the suburban splendor of the Sunbelt.
The impact and duration of these three depressions was charted back in 1943 and can be seen in this download in comparison to other downturns.
If the pattern continues, I would expect a step function down in manufacturing, much like the vast shrinkage of agricultural jobs last time; and a shift away from the Sunbelt to a new power center. If we shrink in manufacturing jobs, what will the basis of production shift to? It won't be services, nor construction, nor 'green jobs' which tend to be temporary construction projects, not permanent new factors of production. (Spain provides a good case study in green jobs being a mirage for a new basis of production.)
Instead, the US will drive for value in encapsulated intellectual property (IP), embodied in drugs, software, chips, web services (like Yahoo), data (like Google) and products (like the iPhone). We already see this happening in technology products, and now that the floodgates have opened will become the new factor of production across all industries. One of my favorite thinkers, Will McDonough, is the leading proponent of a "cradle to cradle" ecological architecture for technology. Among other achievements, he rebuilt the famed River Rouge plant of Ford, the very model of a modern major assembly line, into a sustainable model with pavers instead of asphalt, natural lighting, and grass on the roof. He is urging a technology cycle similar to a biological cycle, where manufactured products can reduce back into the ecosystem. An example is to redo plastics based on organic carbon, not petrochemicals. These plastics look and feel like petro-plastics, and yet dissolve when thrown away.The whole plastics industry can transform itself into a new range of products. With a little extension of thinking, this approach can go into architecture, autos, food processing and across many other industries. Rather than the lame green jobs of Obama, to build wind farms and similar, this is the real green revolution.
And this is but one example. Similar revolutions are occurring in pharma, biotech, entertainment, telecomm, lighting, marketing-media and other industries.
What therefore changes is a drop in blue-collar manufacturing jobs and a rise in high-value-add knowledge jobs. While manufacturing flies overseas to China and India, we retain the marketing, design, control systems and materials science that goes into those products. It is no accident that the center of smartphones is now rising in Silicon Valley (Apple, Android, Palm), and the web world is also centered there (Google, Yahoo, Facebook, Twitter). This is but a sampler of what is likely to happen across the whole US.
How will this change the power centers in the US? One of the most interesting thinkers of this potential transformation is Richard Florida. His view of the coming transformation is set forth in his books, and is most accessible in a recent Atlantic Magazine article. He is a proponent of the 'agglomeration effect' first popularized by a brilliant economist, Jane Jacobs. She is best known for saving Greenwich Village from a debilitating freeway through its heart, ending Robert Moses's remaking of NYC and starting the NIMBY movement to preserve the charming and inviting city centers of major US cities. I discovered her work in an Atlantic article that reprised her book, Cities and the Wealth of Nations.
Simply put, "agglomeration" means a city-region becomes the center of a technology and holds it for a long time. Detroit for cars, Pittsburgh for steel, Chicago for food, NY for finance, LA for entertainment - these were the prime US examples. Today, we would say Silicon Valley for technology, Shenzen for contract manufacturing, Tokyo for cars, Milan for design, and London for finance. Birds of a feather flock to the center to be part of it. The efficiency and networking of being in the center lead it to get stronger. With globalization, the centers are no longer within protected boundaries. Where we had three car centers - in Stuttgart, Detroit and Tokyo - it appears the center is accreting to Tokyo. This also happens within a country, as the venerable Route 128 around Boston has given way to Silicon Valley.
The implication of agglomeration is a shift from the Sunbelt to Knowledge Centers, denser areas in semi-urbanized settings such as Ann Arbor, Austin, Palo Alto and Cambridge. This is not the RR dream of Buffett, back to the urban core; but neither is it the continuation of suburban sprawl and transplant factories in far away cities.
This change has already started. The great migration to the sunbelt seems to have ended. This chart from the WSJ (which is interactive if you click here) shows census data on how migration has begun shifting. A video discussion of this is below.
This transformation-by-innovation will not happen quickly. In another inestimable article, Houses of the Future, The Atlantic provides a model of how this will come about. The article looks the burgeoning housing innovation in New Orleans, post Katrina. First, the government had to get out of the way. After a failed stimulus and political squabbling between FEMA and local authorities, grandiose schemes with no follow-through gave way to bottoms-up innovation. A number of competing visions are emerging throughout the city, from Will McDonough's zero-energy green homes to much simpler "Caribbean" homes linked to the lifestyle of the locals. The key message seems to be for the government to back off gold-plated regulations and attempts to "help" and let innovation thrive.
Similarly, after yet another Stimulus bill and continued attempts to impose costly regulations across our economy (healthcare, energy, autos, etc.), we should see these efforts peter out due to their own failure, to political squabbling and to lack of follow-through. At this point (2014? 2017?) the ground will have been prepared for innovation from the private economy to emerge.
For investors, the key is to invest in the leaders of the new knowledge industries. For society, the key is to promote the rise of knowledge industries. Until then, we will have to suffer through a self-destructive decade of high taxes, hostility to small business and venture capital, false promotion of ebbing unions, and malinvestment in the wrong priorities. Caveat investor.