NORTH AMERICAN MUSINGS.

I returned from a very enjoyable week in North America this morning.  I had been in New York since last weekend, primarily to host our Goldman Sachs Asset Management (GSAM) Growth Market Summit.  It was a highly enjoyable event with a great deal of high-level client participation. Thank you to all of you that spoke at or attended the event and made it so worthwhile.  The following day, I went up to Toronto for another GS client conference, as well as to meet with some large investors.

My trip took place against the background of a dramatically shifting mood about US fiscal policy. In this context, I found myself reflecting back on Canada’s economic fortunes since I joined the firm in the Autumn of 1995. Further, I wondered whether there are any lessons in Canada’s experiences for the US or other troubled developed sovereign states. 

These days, Canada seems to be quite a remarkably vibrant place. Even my return flight to London on Air Canada was a positive surprise.  We had nice comfortable seats that turned into flat beds, a perfectly cooled cabin, and pleasant service, none of which I remember having experienced before. Moreover, as other frequent travelers amongst you will know, this experience is not common on many airlines from North America and Europe. 

When I joined GS in 1995, I was based in New York for the first 12 months. In those days, I spent a lot of time with the FX guys, especially the traders. I lost count of the endless discussions about how Canada would soon break up and be bankrupt. Fifteen and a half years later, with the benefit of hindsight, anyone who would have invested in Canada as a long term investor would have been rather happy.

Today, Canada is arguably the role model for all troubled major nations that need to do something about their fiscal affairs and healthcare and pension systems.

Talking to lots of Canadian investors over the past 2 days, it is clear to me that there are a number of “developed countries” that are benefiting from the “Growth Market” theme rather directly.  For example, Australia and Canada have both benefited for the obvious commodity reasons.  And, together with Germany, which I often suggest is a “developed BRIC”, you can see why some might just want to invest in a portfolio of these three countries as a more advanced BRIC play. In these three countries, you gain exposure to some of the benefits of the forces driving global growth, good economic policies and, in most cases, highly credible governance.  In addition, Canada seems to be especially well placed. If it weren’t for its rather bleak winters, one could quite easily get carried away. Even Becks was in town Wednesday night!

 US FISCAL POLICY DEVELOPMENTS.

 The last couple of weeks have seen a number of major developments with respect to US fiscal policy issues. Against the background of the remarkably strong Ryan proposals to cut US spending (nicely summarized in a Martin Wolf FT column this week), I was struck by a more blunt assessment than usual from the IMF this week. While this could be a reflection of the stronger, more empowered Fund that many of us wish to see, I suspect it was also a sign that some current policymakers might be welcoming a harsher tone to help prepare the public for a shift in US fiscal policy. As I remarked to some of our fixed income portfolio managers before I left the US, it struck me that the US was getting a bit of the UK “deficit cutting” religion.

Even though our Growth Markets Summit was about the bright new world of the BRIC countries and the other four we have bracketed in our definition, there was inevitably quite a lot of discussion about the US fiscal challenge. In fact, a key leading policymaker of the past and a leading hedge fund manager both offered their perspectives on it. Having interviewed them both in front of our guests, and then having listened to two US political analyst experts at our Toronto event, I have confirmed a hunch I developed last November. More specifically, the combination of a right-of-centre Congress and current President, while problematic for negotiations, might in fact be good news for US economic policies, including deficit reduction. President Obama’s new proposals are a sign of just that, even if there are enormous paths to cross. While there are clearly huge differences on the spending and revenue-raising priorities from both sides, the fact that Obama has suggested some kind of automatic deficit reduction ceilings reminds me of something else from way back too:  Gramm Rudman Hollings and their bill that, in some ways, laid the foundation for serious deficit reduction in the 1990’s.

So, for all the Dollar haters out there, this is an important strategic moment to ponder. Yes, a tighter fiscal policy combined with a super easy monetary policy is usually a recipe for a weak currency. However, the Dollar is very cheap against other major currencies – some of which have major troubles themselves.  And, if the private sector survives the prospect and actuality of fiscal tightening, I am not sure what the bears have to focus on from 40,000 feet. Indeed, looking at the US and the world from this level, it adds to my judgment that, despite the pain it has caused, maybe the global credit crisis was not all bad.

The household savings rate in the US has risen sharply, the current account deficit is half what it was, and now we appear to be moving towards a framework for fiscal deficit reduction. Against that, in China, we now have a country focused on domestic consumption as its main growth driver, a cleaner more energy efficient economy and, most importantly, one where the current account surplus is declining. Although not given a lot of attention, China just reported a small trade deficit for the first quarter of 2011. It might indeed overstate the degree of improvement, but I suspect surpluses between 0 and 3 pct of GDP are the most you are going to see from China in coming years. And it might be less; something closer to balance might be do-able.

THE GROWTH MARKET THEME.

The main purpose of the conference in New York was to unveil why we at GSAM believe investors need to stop calling the BRIC countries and 4 of the so-called N11 countries (Korea, Indonesia, Mexico and Turkey) “Emerging Markets”.  Instead, we refer to them as “Growth Markets”.

Each of these countries accounts for at least 1 pct of global GDP. They are increasingly contributing to the world’s economic health. They are large enough to treat as “normal” from a business perspective, and over the remainder of this decade, each of their incremental GDP is predicted to be in the top 10 global economic contributors. Collectively, their incremental GDP might be close to $16 trillion or 4-5 times that of the US.

It was rather nice to hear a number of people referring to “Growth Markets” for the rest of the day! I suspect some of it was out of courtesy. But, it is going to be your interests to think about it this way, dear investor.  If you don’t, you might still struggle to get to the appropriate level of exposure in your portfolios.  Much of the rest of the day involved repeated discussion about how fixed income and equity investors can position their portfolios for this new world.  I showed a glimpse of how we are thinking about that from a benchmarking perspective. Plenty more to come from us on this exciting topic.

I returned this morning to see a remarkable rebound in the monthly Chinese numbers, showing less of a slowdown than some of the leading indicators I like to follow. At the core of the Growth Markets concept is China.  And, if you combine these numbers with the recent trade data, you can begin to see the remarkable transformation taking place.   What are the China bears talking about?

 A CERTAIN SPORT.

Luckily, I managed to creep out of our event for a certain footy match for a brief while. It is all getting most exciting. Let’s see what we do this weekend. I am not going to tempt fate on the outcome or the other possibilities that seem to be opening up…

 Jim O’Neill
Chairman, Goldman Sachs Asset Management