by Bruce Fenton

An interview with Peter S. Cohan on the state of the US Economy and Globalization. Mr. Cohan has written seven books, produced one audio program, been featured in eight compendiums of modern management thinking, writes two online management and investment columns, and contributes to two blogs. Mr. Cohan also edits a monthly investment-oriented newsletter entitled The Cohan Letter.

Bruce Fenton: How do you feel the US deficit situation will impact the economy in the future?

Peter Cohan: The US deficit situation will need to be fixed through a combination of raising taxes and cutting government spending. This will probably happen in 2009 and 2010 at the beginning of the next presidential administration. The impact of this in the short-term will be an economic slowdown. However, in the longer-term, the reduction in the deficit will lower long term interest rates and lead to a stronger dollar.

Bruce Fenton: What about the trade deficit?

Peter Cohan: The US trade deficit is likely to reverse if the deficit declines and the dollar strengthens. A weak dollar is beneficial to US exporters who can charge less for their products in overseas markets. Conversely, a strong dollar creates incentives for US companies to operate more efficiently.

Bruce Fenton: What about China’s ownership of US debt? How significant is the current foreign (particularly Chinese) ownership of US debt? Is it benign passive ownership or potentially detrimental? What is your prediction about this?

Peter Cohan: China is America’s second largest lender — it owns $350 billion worth of US government securities. This ownership is not a problem as long as China continues to hold onto the securities. However, with the dollar declining in value, the return that China earns on those securities is declining. Meanwhile other currencies like the Euro and the Pound are strengthening. This creates an incentive for China to sell more US securities and buy those backed by the strengthening currencies.

The result of China selling US securities is a further weakening of the dollar. In order to attract foreign investors back into its securities, the US government will need to raise interest rates which will slow down the US economy,

Bruce Fenton: Many other nations and economic groups have a trade surplus how does this affect the US economy long term?

Peter Cohan: The trade surplus with the US will encourage income inequality. Workers in the firms which are losing ground to foreign competitors will experience wage stagnation and consumer price inflation. Workers in the private equity and hedge fund industries whose work is not being outsourced will use their access to debt to further enrich themselves.

But the long-term success of the US economy is at risk unless US firms are able to become globally competitive and reverse the trade surplus with these other nations. In the absence of global market share gains, increased borrowing is the only way to keep up in the short term.

Bruce Fenton: Rapid growth of India, China, Russia, Brazil and other areas is significant relative to US growth. Is this a problem for the US – are we losing our competitive advantage?

Peter Cohan: The US is losing its competitive advantage in many business activities. And the activities in which the US is losing its advantage are moving up the income ladder. While in the 1970s and 1980s the US lost its manufacturing advantage, it is increasingly losing its advantage in fields such as systems consulting, legal, pharmaceutical, and investment research. When the US starts to lose its advantage in private equity, hedge funds, and investment management the loss of competitive advantage government officials will pay more attention.

Bruce Fenton: 70 million baby boomers are reaching retirement in the coming 15 or so years – how significant of an economic impact will this have?

Peter Cohan: I am not sure these projections will prove correct. I suspect that many baby boomers will not retire — they’ll keep working until they drop. I think those boomers who do retire will have more money so they will keep spending at high levels. And when they sell stock — both their own shares to finance their retirement and by cashing in the trillions they’ll receive from their parents — they will generate huge capital gains which will benefit the government.

Bruce Fenton: Is the dollar weakening? If so how much and how significant and what is the long term effect of this?

Peter Cohan: As noted above the dollar is weakening. It’s likely to decline at least another 10% by the end of 2008. That’s significant because it creates a cycle of weakening that feeds on itself. We finance our economy through borrowing money from Japan, China and others. But they are not willing to keep doing this if our currency depreciates in value. So they sell the debt which puts further downward pressure on the dollar — leading to further selling.

Bruce Fenton: How do you see increased government spending of recent years affecting the economy?

Peter Cohan: Increased US government spending has been great for defense contractors and oil companies. An endless global war is great for workers and shareholders in these companies. It’s not good for oil consumers or soldiers. This increased government spending will continue stimulating those industries until the next president cuts back on these expenditure categories. Then those parts of the economy will suffer.

Bruce Fenton: One of the US’s major exports is copyrighted material such as software and other intellectual property. Do you see copyright theft as an important factor in our economic future? What about the flipside of this that argues that overzealous copyright enforcement stifles competition and free exchange of ideas?

Peter Cohan: We will not be able to get other countries to change their intellectual property enforcement practices. This will force content providers to change how they make money. They may end up needing to give away the content and make up some of the lost revenue through advertising. I don’t think overzealous patent enforcement stifles competition. I think patents encourage innovation by protecting its profit.

Bruce Fenton: Do you feel the US is isolationist? Why or why not? Do you see our isolation or lack of it being a problem? Why?

Peter Cohan: The U.S. is involved in some way with most of the countries in the world. So it’s not isolationist. But it does have an image problem with other countries. Fixing that problem will fall to the next presidential administration.

Bruce Fenton: Do you feel Americans generally have a lack of knowledge of Islam / Asia / other areas & cultures of the world? Will this harm us in the new global economy?

Peter Cohan: I think that American’s lack of knowledge of other cultures is only a problem if the Americans lacking that knowledge are attempting to live in those other cultures or operate a business there. This is not a problem for the rest of the Americans who are ignorant of other cultures.

Bruce Fenton: How significant is Iraq War spending to our long term economy?

Peter Cohan: It is not significant to our long term economy because Iraq War spending will taper off in 2009.

Bruce Fenton: Do you feel commodity prices will increase? Specifically oil prices? How will this affect us and why?

Peter Cohan: Oil prices will increase which will create stronger incentives to come up with renewable energy sources and for consumers to drive less.

Bruce Fenton: The world public opinion of the US is not at its best. What are your thoughts on this from an economic standpoint with respect to trade agreements, tourism revenue etc.

Peter Cohan: I think most people around the world realize that the current administration is an aberration. Over the longer term, world opinion of the US will improve because Americans will elect an administration that raises the world’s opinion of the US back to the high level it enjoyed in the 1990s.

Bruce Fenton: Any comments on US worker productivity?

Peter Cohan: US worker productivity is declining as a result of business’ failure to invest in productivity enhancing technology.

Bruce Fenton: We feel that Sarbanes Oxley et al and the rise of US compliance legal and productivity costs are extremely significant. Do you agree with this? Do you feel that the increase in these areas is harmful to business?

Peter Cohan: No. I think that business is just whining because it believes it now has a sympathetic ear in the current administration. What is damaging to business is the lack of incentive for productivity enhancing technology investment. By reducing the tax rate on dividends, business is using its cash flow to pay coupon clippers and to buy back shares. This creates greater income inequality.

Bruce Fenton: Thank you for your thoughts.

Bruce Fenton is a financial consultant, a writer, and the Managing Director of Atlantic Financial Inc. Bruce welcomes inquiries, comments, and questions. He can be reached by contacting The Fenton Report.