Is America in decline?

Why talk about US decline when it’s still a political and economic powerhouse?

You’ve been listening to Warren Buffett’s business partner, Charlie Munger, haven’t you? When asked a similar question at the 2009 Wesco annual general meeting, his answer was unequivocal.

The US had the best universities, he said, and a great capitalist culture. It attracted the world’s brightest minds—people who wanted to succeed and build businesses. And in California at least, the weather was perfect. Why shouldn’t US prosperity continue?

That argument looks less sustainable now. Growing Asian prosperity means that in relative terms, US decline is inevitable. In the past 12 years alone, US GDP as a percentage of world GDP has fallen from a third to a quarter.

Yes, but in absolute terms, is it becoming weaker?

That’s a big question. Ed Luce, Washington correspondent of The Financial Times and author of Time to Start Thinking: America in the Age of Descent, certainly thinks so.

We all know the stories about Detroit’s falling population and the death of manufacturing at the expense of growth in the finance and service sectors, but Luce cites a raft of salient facts to support his proposition.

A baby born in Chicago or New York is now less likely to reach the age of five than one born in Shanghai; In the last 20 years the increase in spending on US prisons has outstripped that on higher education by a factor of six; The US incarcerates more than five times as many people per head of population as Australia; And there are more African American men in jail than there are in college. Interestingly, he notes that the costs of incarceration (about $48,000 per person per year) are the same as a year’s tuition at Princeton.

Between 1980 and 2003, personal bankruptcies rose by a factor of five, the main cause of which was healthcare costs. Since 2003, they’ve doubled again.

US healthcare costs accounted for 17.4% of total GDP in 2009, almost twice that of other advanced nations. And while the world’s top 15 military spenders allocated on average 2.6% of GDP, Americans devoted 4.7%.

Then there’s the US public debt, which, in percentage terms, is in the same league as basket cases like Ireland and Portugal. Less acknowledged is the fact that the country has run a trade deficit for well over 40 years. Facebook and Silicon Valley won’t fix that problem very quickly.

The case may not be conclusive but it’s mounting, especially when one looks at the traditional engine of prosperity—the American middle class. They’ve been shell-shocked by the Global Financial Crisis. One in seven Americans now live on food stamps and one in four suffer from depression. Meanwhile, the wealthy have been travelling along quite nicely, as Chart 1 shows.

No wonder a typical American parent now believes their children will be worse off than they are. Whilst the income of the average American has flatlined over the past 30 years, for the top 1% it’s almost tripled.

The increase in prosperity over the past few decades has accrued almost entirely to the extremely rich and ordinary Americans have missed out. That’s hardly a recipe for recovery, let alone prosperity.

Oh, I get it. Let’s soak the rich, right?

It’s a little more complex than that. First, the very rich hold most of their wealth in assets, which tend to be taxed at much lower rates than ordinary income, and can be quickly moved to places like Switzerland.

Presidential hopeful Mitt Romney, with a personal net worth estimated at US$250m, paid an effective tax rate of 15.3% on earnings of over $20m. And Warren Buffett has long lamented the fact that his tax rate is lower than that of his secretary. The super-rich tend to enjoy tax rates far lower than the people they employ.

Second, economies tend not to prosper when a large portion of a country’s wealth is stuck in the vault of a Caribbean bank. Prosperous economies need ordinary people to buy ordinary things. A country doesn’t get rich from selling diamond-studded mobile phones and nose jobs.

One only need look at Africa, the Middle East and Central America to see where great concentration of wealth leads.

Third, inequitable income distribution might be justifiable (we’ll get to that) if people have the opportunity to improve their economic circumstances. But on measures of income mobility, the US is behind France, Germany, Canada, the Scandinavian countries and Australia. In the US, if you’re poor, you tend to stay that way.

The moral arguments against the fruits of a nation’s wealth accruing to the very few are obvious enough. The economic arguments are equally powerful.

Economist James Galbraith argues that inequality is actually a deep source of economic instability and that economic growth and productivity benefits accrue more strongly to those nations that work to reduce it.

Flatter wage structures, Galbraith posits, lead to lower unemployment. A policy of systematically reducing the differentials between the better and the worst paid employees puts pressure on the least efficient businesses, causing them either to upgrade or leave the market altogether.

Over time, the end result is that high productivity businesses migrate to places with more egalitarian wage structures. Galbraith claims the Scandinavian countries and Northern Europe in general, which have become some of the richest countries in the world, did so at least in part by adopting this approach. The US is taking the opposite course.

If that’s correct, why don’t more people advocate this approach?

What, you think hedge fund managers want to pay more tax?

Stephen King, whilst arguing for higher taxes himself, rather graphically said 'The majority [of rich people] would rather douse their dicks with lighter fluid, strike a match, and dance around singing Disco Inferno than pay one more cent in taxes to Uncle Sugar'. Surely he should know.

What’s behind the failure to adapt?

The US capacity for pragmatism—to do what is sensible as well as what is right—made the country successful in the first place. Its absence now seems symptomatic of a decline.

In the aftermath of the Second World War, the Marshall Plan allowed European nations to rebuild their economies with US expertise and money. The ensuing recovery created a huge market for American manufactured goods and endless goodwill on which America’s golden age was built.

Such progressive, thoughtful thinking now seems beyond the reach of today’s crop of politicians. They haven’t even managed to pass even a budget in almost four years. The gulf between what needs to be done and what appears politically possible has never seemed wider.

In Democracy in America, Alexis De Tocqueville wrote, ‘The greatness of America lies not in being more enlightened than any other nation, but rather in her ability to repair her faults.’ That quality has never seemed more out of reach.

What does this mean for Australian investors?

Well, it doesn’t mean that there aren’t any good opportunities among US stocks. In fact, our research director Nathan Bell is researching a handful of attractive stocks for members as we speak, to be published in late June.

It does however imply that Australia’s economic fortunes are dependent on China to an extremely high and worrying degree. You’ll know from our special report, The coming China crash, why that’s a matter that should concern you.

Watch out for Director’s Cut next Wednesday when we’ll go into this, and strategies to deal with it, in more detail.

Note: A rebuttal to the many contentious points contained in this column will be published in coming weeks. Let the ding-dong begin.