CONSUELO MACK: This week on WealthTrack, renowned financial historian Niall Ferguson examines the fault lines of 500 years of Western dominance to see where it is failing and where it needs shoring up. Professor, columnist and best selling author Niall Ferguson on the earthshaking shift of economic power from west to east is next on Consuelo Mack WealthTrack.
Full video and transcript below:
Hello and welcome to this edition of WealthTrack. I’m Consuelo Mack. We believe in having a long term perspective on WealthTrack and keeping our eye on the ultimate financial goal, which is to build financial security to last our viewers and ourselves a lifetime. But sometimes it is necessary to step back even further and think beyond a lifetime in terms of centuries, to really grasp the era we are living in. And that is what this week’s WealthTrack guest does. He is British historian Niall Ferguson and according to him, we are living through one of those seismic epochal shifts that require rethinking the old rules, including our investment ones.
Ferguson is one of those rare individuals who has the intellectual and educational fire power to tackle such a broad sweep of history. And as you will see in a moment, he also has the gift of gab to bring it alive. A professor of history at Harvard, a professor at the Harvard Business School, senior research fellow at Oxford and a senior fellow at the Hoover Institution at Stanford University, Ferguson is the author of numerous articles and columns, a recent one became the cover story of Newsweek. He has also authored several books, including The Ascent of Money, which was turned into a PBS special, and his soon to be published Civilization: The West and the Rest.
Over the past 500 plus years the west- Europe and later the United States- have come to dominate the world stage, economically, politically and militarily. As these charts illustrate, as of 1500, the so called motherlands of Europe- Austria, Belgium, France, Germany, Italy, Netherlands, Portugal, Spain, Russia and the United Kingdom- had a mere 10% of the world’s territory, only 16% of the world’s population, but even then contributed 43% of world GDP. By 1913, the dominance of the west was overwhelming. The motherlands, which now included the United States, had expanded their economic and political might to 58% of the globe’s territory, 57% of its population and a stunning 79% of the world’s economic output, or GDP.
Fast forward to today and you will see how much this is changing. According to the IMF, the contribution of the U.S. and the Eurozone as a share of world GDP has been declining; remember it was nearly 80% in 1913, to less than 45% currently and falling, while the contribution of China is soaring- China recently passed Japan as the world’s second largest economy- and India’s share is slowly rising.
Is this shift inevitable and unstoppable? And what does it mean for us as investors? I asked Ferguson to start from the beginning- how the West achieved its position of dominance in the first place.
NIALL FERGUSON: Well, it is an amazing story, actually, because if you’d gone on a world tour, say, back in 1411- you know, let’s turn the clock back 600 years- you would not have predicted that tiny, nasty little warring kingdoms in Western Europe would take over the world. I mean, you’d have been much more impressed by Ming China, or by the rising Ottoman Empire. And if you’d gone to London, you’d have thought, ugh- a sort of small, smelly, plague-ridden, and constantly fighting with one another. I mean, the West Europeans did not look like the future world leaders.
And the story of pretty much 500 years, from the mid-15th century until our time was the story of Western ascendance. The great Oriental empires languished. Per capita GDP in China basically didn’t grow throughout the entire Ming period, essentially flat lined. And then it actually declined in the Ching era. Whereas, Europe had a series of extraordinary revolutions that propelled it into a position of world dominance, and then its most successful colony in North America, which became the United States, then became the biggest economy in the world. Why? That is a really interesting question.
CONSUELO MACK: That is a very interesting question. And you have some really interesting answers, and you have this neat little device, you call them the killer apps. But talk about the killer apps that the West developed, and then we’ll find out why we are now losing those killer apps.
NIALL FERGUSON: Well, I wanted to try and explain this great divergence that means, just to give you an illustration, by the 1970s, the average American is roughly 30 times richer than the average Chinese was, whereas, you know, in 1600, there was no real difference. And the answer is that there were these killer applications, these institutional innovations that only the West had. Let me rattle them off, just because six is a lot. Number one: competition. The idea that, in the political and economic sphere, there shouldn’t be monopolies on power. There shouldn’t be just one emperor who controls the whole of Europe, economically and politically. Europe’s very fragmented, and not only is it fragmented between multiple states, within these states, there are lots of competing institutions. The very first modern corporation is the corporation of the City of London. And the king of England really doesn’t control it. So that’s number one. Competition. And out of that, you get capitalism, and ultimately, democracy.
Number two is the scientific revolution. Everything that we associate with the great breakthroughs of the 17th century, Newton’s laws of motion, is a Western discovery. There is absolutely no contribution to the scientific revolution from outside the Western world. So that’s the second pretty crucial killer application.
CONSUELO MACK: Why, Niall? Why? I mean, why was that the case?
NIALL FERGUSON: Well, the printing press is banned in the Ottoman Empire. You can’t actually ask questions in a Muslim empire about the will of God, because that’s inscrutable, and it’s sacrilegious to try to work out the laws of motion that govern the movements of the planets. In Europe, the church tried to restrain Galileo when he observed, for example, that the planets are not ordered as the church had taught, and the world is not at the center of the universe, but the church wasn’t powerful enough; where it actually was possible for the clergy to silence those who wanted to explore optics and the laws of astronomy in the Eastern world. So, the scientific revolution’s a really crucial killer application. It’s a killer application literally, because once you understand the laws of motion, your artillery becomes accurate. Simple as that. Benjamin Robbins writes a book about gunnery. From then on, Western guns basically hit the target. And, if you don’t know the laws of motion, it’s just luck if you hit the target. So that’s number two.
Number three is private property rights as the basis for the rule of law. Now, we usually think democracy is the killer application of the West. I think democracy’s a luxury good that you can have once you have the rule of law, and secure private property rights, and once representative government, on the basis of that system, is well-established. So, I would say the killer app, which is very successful in the United States, is the idea that the citizen who’s free is free partly because he or she- or mainly he, actually- is a property owner. That’s John Locke’s killer app. And it’s hugely successful. And by the way, they don’t have that in South America. Settled by Europeans, but completely different in its social and economic structure. I’ll rattle off the other three quickly, because they’re simpler. Four is just modern medicine.
CONSUELO MACK: Modern medicine.
NIALL FERGUSON: You know, if you can double human life expectancy and make people healthy, not surprisingly, you’re going to do better than everybody else. And that’s really the story of the late 19th century. The consumer society. Why have an industrial revolution, which is all about making loads of clothes really cheaply, if people don’t want to have loads of clothes? Now, the fact that the wardrobe of our teenage children are bulging with clothes tells you practically all you need to know about why the Industrial Revolution happened. It happened because a consumer society had already arisen in the 18th century, which the Industrial Revolution satisfied, and continues to satisfy. It looks like the human appetite for clothes is almost infinitely elastic. And, you know, you …
CONSUELO MACK: No question about that.
NIALL FERGUSON: It’s interesting that that’s true, because the human appetite for a lot of other things isn’t. The Dutch East India Company was in the spice trade, and the British East India Company was in the textile trade. And guess which did better? Because there’s only so many cloves that you can really get through. But clothes, that’s a different matter.
Finally, the work ethic. Western people work longer hours. They worked harder. And that really is one of the key reasons that the West forged ahead. Max Weber claimed, I think wrongly, that this was to do with Protestantism. But, you know, on close inspection, many people in the West who weren’t Protestants had the work ethic. Jews, for example. But the work ethic definitely was a part of the story. These are the six killer applications, and I can’t think of a better explanation for Western predominance than those six things.
CONSUELO MACK: All right. So, 500 years in. We have basically applied those killer apps, we’ve gotten to where we’ve gotten, which was dominating the rest of the world. The rest, as you say. And largely, when you’re talking about the rest, you’re also focusing on Asia and China, right? In particular?
NIALL FERGUSON: But not just Asia and China. I mean, South America is, you know, essentially–
CONSUELO MACK: Africa, certainly, the Middle East. All right.
NIALL FERGUSON: –subordinate. Africa’s colonized. I mean, if you’d just look at the world 100 years ago, you know, 1911, something like 80% of global GDP goes to about 11 empires. And those empires are Western-run empires. And most of the spoils, most of the income, goes to the imperial metropol. Not to the periphery. Not to the colonial periphery. So the world of 100 years ago, is incredibly unfair. It’s amazingly skewed in favor of the West.
CONSUELO MACK: So, what’s changed? And does it mean the West decline and, you know, the East ascendancy? Or does it mean that we just slow down, and the East is just growing faster?
NIALL FERGUSON: Well, we are living through extraordinary change. After 500 years of pretty steady Western ascendancy, in the space of just three decades, in our lifetimes, the gap has started to close, and has closed very, very rapidly. In the late 1970s, as I think I said, the average American, 30 times richer than the average Chinese. Today, it’s more like a factor of five. So that’s an amazing …
CONSUELO MACK: Rapidly. Right.
NIALL FERGUSON: –compression. And it’s continuing, because China’s economy is growing at about 10 percent per annum, and it has been doing so since the late ‘70s when Deng Xiaoping’s reforms began. And, the West has slowed down. And the financial crisis has really accelerated this process, by I think fundamentally shifting the growth path down of the United States, and indeed, of Europe, because much of the growth that we saw in the run-up to 2007 was based on leverage. And that game is over. The American household just can not propel itself to the shopping mall with plastic and refinancing deals. So, I think we are witnessing a profound change in the global balance of power. If you add up the GDP of the People’s Republic of China, Taiwan and Hong Kong- let’s call it Greater China …
CONSUELO MACK: So, Greater China, you call it. Right.
NIALL FERGUSON: Which, by the way, the Chinese do already. It’s 90% of U.S. GDP already.
CONSUELO MACK: Already.
NIALL FERGUSON: China is very close to being the world’s biggest manufacturer, probably will be in the next couple of years. China’s gross domestic product will probably overtake that of the United States within the next decade. So, this is an amazing transformation. The U.S. has been the biggest economy in the world since 1872. At no point in the Cold War did the Soviet Union get even close to closing the gap. China’s about to do it, on our watch, after 500 years, when the West dominated the rest. And the reason is really simple. Those six killer applications that I described to you, well, they downloaded them. It was open access.
CONSUELO MACK: Private property?
NIALL FERUGSON: The private property is the exception to the rule in China, but if you look at the rest of the rest, if you look at India or Brazil, it’s very straightforward. It’s a story in which private property rights are getting more and more important. I recently asked a bunch of Indian CEOs, “Is the rule of law a reality in India? And, you know, if we got into a legal dispute after I’ve invested in your company and we went to law, would I have a reasonable chance of redress?” And the answer was yes. So China’s un …
CONSUELO MACK: So, that’s the British rule of law, which was transferred to India, right?
NIALL FERGUSON: Yeah. I mean, one reason that India is in a different place from China is that it was directly ruled by the British for nearly two centuries, and that meant that many of the institutions of the West were imposed on India. But in many ways, I’m more impressed by what’s happened more recently, since India embarked on economic reform in 1991, where, essentially, the killer apps, including the consumer society, including modern science and modern medicine, these things have been downloaded voluntarily, because Asians realized that the only way that they could compete with the West was ultimately to adopt Western institutions.
By the way, this process began a long time ago. Japan started to do this in the Meiji era, in the late 19th century. But it’s taken until our lifetimes for the really big Asian economies to get it, and to download these killer apps. You mentioned the big exception, and that is that China clearly does not want killer app number three. Private property rights, rule of law. And ultimately, representative government. Their view is, it’s an Asian fusion world, where you can order some things on the Western menu, but other things you want to have from the Asian menu. That is, I think, the Chinese model. And the big question for the next 10 or 20 years is, can they get away with it? Can they have a sustainable growth model in which they don’t move in the direction of representative government, and in which private property rights are not as secure as they are in the Western world?
CONSUELO MACK: And your answer to that question?
NIALL FERGUSON: Well, my answer to the question is a two-fold one. Number one, it could go wrong for China, depending on how big a role the state continues to play in economic life. If they carry on with the very aggressive privatization that we’ve seen, and I think they probably will, China is going to become economically a freer society. And I think ultimately, that means it will become politically a freer society. I don’t think the monopoly of power of the Communist Party is really compatible with a truly free market economy. I think ultimately, that just won’t be sustainable. But the second part of the answer is, what do we do? Do we remain true to the killer applications? Do we really believe in the achievements of Western civilization?
CONSUELO MACK: Right, do we, the West.
NIALL FERGUSON: Or do we cop out? And we, the West, I think, have a dilemma here. Because many of the things that made the West great, we no longer really believe in them. Or at least, we don’t take seriously those achievements of the past 500 years. We don’t even teach them.
CONSUELO MACK: We’re taking them for granted.
NIALL FERGUSON: Yeah. Of course. Because it’s all around us. People are used to it. We take economic and political freedom completely for granted. Now, take the work ethic. See, one of the most interesting things that I try to show in the work that I’ve done that’s going to be published as a book called Civilization later this year, is that we don’t actually work as hard or as long as we used to.
CONSUELO MACK: Well actually, the numbers of hours worked in this country are down to 1995 levels- that was one statistic I saw- with a larger population. So, what does that tell you?
NIALL FERGUSON: Right. And that is following a European path. In Europe, what you saw, really from the 1970s, was that the rest of Europe converged on the Italian standard of really quite a short working year, in terms of numbers of hours worked per year. Whereas Asia is now significantly above. I mean, South Koreans work way more than people in the West. That’s just part of it. Then you look at education attainment. They work harder in school. I mean, they work way harder. You can see that in their attainment in mathematics, at age 14. They’re far ahead of most English-speaking countries.
CONSUELO MACK: In math skills. I mean, it was …
NIALL FERGUSON: Absolutely.
CONSUELO MACK: That was, I think, one of the most distressing statistics that we’ve all seen in a long time, is how far the U.S. has fallen in educational attainment. And that, to you, is alarming, and also basically a very bad omen for the future, right?
NIALL FERGUSON: Well, if the scientific revolution is one of the killer apps, then how are we going to be the leading force in science if we consistently fail to educate people at high school to a level comparable with Japan, South Korea and parts of China? I mean, that’s a simple no-brainer question. We have a problem. Now, it’s easy at this point to be dismissive, say, of Chinese research and development, or of all the patents that the Chinese apply for, many of which are granted.
CONSUELO MACK: We call them patents. Right.
NIALL FERGUSON: Patents. I’m sorry. I’m speaking British English. Correction. For viewers watching this in the United States, patents. But the Chinese patents are increasing in quality. The research and development is getting better. Just look at the way in which Chinese scientific papers get referenced. More and more than previously, they are premiere players in the global science game. And the way that they’re investing in scientific education means that that can only grow. They are going to overtake Germany, in terms of patents granted, really soon. Now, the Germans can’t believe that when you tell them, but it’s true.
So, I think we’re seeing a very, very fundamental shift, not just in terms of quantity, because of course, with a huge population of more than a billion, yeah, China’s a big economy, just in terms of raw numbers. But this is a quality story. The quality of education, the quality of science, and the quality, actually, of innovation. That’s really going to be the key. And I think once you give those six killer applications, or in the case of China, five of them, to these huge Asian societies, with their hunger, I mean, it’s a real hunger to work, then it seems to me almost unstoppable that the world is going to tilt back to where it was 600 years ago when it was the East that really dominated the rest.
CONSUELO MACK: From an investment point of view, do we invest in the growth of the rest? I mean, is that basically our best way, at least, you know, to get some momentum going in portfolios, or–
NIALL FERGUSON: Well, you know, beware. There’s been a great run for emerging markets, right through this financial crisis.
CONSUELO MACK: There has been.
NIALL FERGUSON: You did a lot better– if you’d bought Brazil in early 2007, or really almost any South American economy, you did a lot better than if you sat tight in the United States or in Europe. But there’s a danger there. There’s an old joke, which I’m fond of, which is that they’re called emerging markets because they’re where emergencies happen. And we’ve just seen, right across North Africa and the Middle East, what emergencies are like. And these emergencies commonly happen when, for example, food prices double. One of the unintended consequences, not only of the emerging markets boom, but also of massive monetary stimulus by the Fed, has been a huge increase in commodity prices, right across the board. Hardly any commodities have not gone up in price, by significant amounts, since early 2009.
CONSUELO MACK: Now, Ben Bernanke would look at you and say, “QE2 had nothing to do with this, and fiscal stimulus had nothing to do with this.” That in fact, what it is is that you’ve got a drought in China. You know, or you have, you know, tremendous demand from China, and that the rising consumer class needs more commodities, and therefore it’s a matter of just supply and demand. It has nothing to do with what the U.S. has done. You disagree.
NIALL FERGUSON: I do disagree, profoundly. Because, of course weather has played a part, and so has soaring demand in Asia. But those two things are not a sufficient explanation for the doubling of the price of wheat in the last year. You have to ask yourself what is happening on the monetary side. And the answer is that the Fed is acting, and has been throughout the crisis, as the central bank of the world. I mean, that is a proven fact. The Fed itself injected liquidity not just into the United States, but into the European system. And banks were lining up from all over the world to be bailed by the Fed, and they were.
CONSUELO MACK: And the dollar is the reserve currency, and there are a lot of dollars out there.
NIALL FERGUSON: Right. If China is intervening on a scale that gives is reserves close to $3 trillion, there’s no way that you can sterilize all of that intervention. In other words, there’s no way you can prevent that accumulation of reserves from having some impact on your domestic money supply. And credit growth in China is crazy. It’s off the charts. And that, of course, is a very substantial cause of inflation in China. So it’s not just about the failure of a wheat crop, which, by the way, is really an anticipated problem. It hasn’t really struck home yet. So, I think we need to recognize the extent to which liquidity has been injected by the Fed into the global monetary system.
And let me just give you an example. When a major financial institution- I won’t name any names- any of the big Wall Street players, is getting money from the Fed, what is it doing with that money? Is it, A, parking it in nice, safe Treasuries, or B, is it putting it into commodity funds? The answer is B. The commodity funds have been the major source of action in financial markets for the last six to 12 months. There’s been a huge expansion in the number of financial instruments related to commodity indices. So the notion that there’s no connection from the monetary policy of the Fed to commodity price spikes is a fairy story that we should not believe.
CONSUELO MACK: So there, Fed Chairman Bernanke. So the fact that we do have these rising commodity prices, number one, from an investment point of view, is the opportunity over in commodities? I mean, what’s your take on …
NIALL FERGUSON: Well, I think– yeah.
CONSUELO MACK: Is it a bubble in commodity markets?
NIALL FERGUSON: It’s close to being a bubble. I think there’s a real risk there. I mean, I was recently at a big conference of mining companies, and the mood in the room was like the dotcom boom of the late ‘90s. It was really euphoric.
CONSUELO MACK: Just euphoria.
NIALL FERGUSON: Not to say irrationally exuberant. And I think there’s a reason why this could be close to the peak for these markets, and it goes back to this problem of inflation in China. The Chinese are very nervous when they see enormous crowds in the streets of major cities, because they remember Tiananmen Square in 1989, and they know that one of the reasons things blew up in 1989 was in fact that inflation got out of control. Now, they do not want a repeat of that. That is their number one priority. No disorder. So I think we’re going to see more monetary tightening in China, as we go forward this year, than most people currently expect. There’s been, of course, interest rate hikes, tightening and reserve requirements, but it’s actually been too little. Relative to the inflation rate, China’s basically offering a negative real rate. Now, they have got to do something about that, if they want to avoid the nightmare of Cairo-like developments in major Chinese cities. So I think they hit the brakes, and that’s the point at which the commodity markets really start to cool down.
CONSUELO MACK: And it can happen.
NIALL FERGUSON: Yeah. It wouldn’t take much. I mean, given that China’s such an engine of growth, such a huge engine of demand, whether you’re an Australian iron ore exporter, or whether you’re a Brazilian agricultural exporter, China has been a huge source of demand for almost all commodity markets, right the way through the crisis. And I would say we might be quite close to an inflection point there.
CONSUELO MACK: So, one investment for a long-term diversified portfolio. The last one that you made on WealthTrack, which was in early 2008, was a company called Baidu, the Chinese equivalent of Google, which has quadrupled since then. So, congratulations, Niall. Only historians have recommendations that quadruple. So, what will you have us all own some of in a long-term diversified portfolio today?
NIALL FERGUSON: I think my trade right now is short commodities. And I wouldn’t say that was a trade for a four-year time horizon. But in the short run, I would not want to be in the wrong side of a real shift in the commodity market. So that is the trade that I would put on today, this year.
CONSUELO MACK: Niall Ferguson, with your new book, Civilization: The West and the Rest. I look forward to reading it.
NIALL FERGUSON: Thanks very much.
CONSUELO MACK: Shorting commodities turned out to be a brilliant trade. I taped the interview with Ferguson in February. Since then commodity prices, from copper to oil have plummeted.
Next week we will be talking about the outlook for oil and investing in it with the acknowledged dean of energy analysts, Weeden & Company’s, Charley Maxwell. Also in two weeks, we’ll have a rare interview with Morningstar’s Fund Manager of the Decade, Fairholme Fund’s Bruce Berkowitz about his controversial investments in battered financial stocks.
In the meantime, we have a favor to ask of you our viewers. Could you fill out a brief and completely confidential survey for us on our website wealthtrack.com? We would really appreciate it. Thank you for watching. Have a great Labor Day weekend and make the week ahead a profitable and a productive one.CONSUELO MACK: This week on WealthTrack, renowned financial historian Niall Ferguson examines the fault lines of 500 years of Western dominance to see where it is failing and where it needs shoring up. Professor, columnist and best selling author Niall Ferguson on the earthshaking shift of economic power from west to east is next on Consuelo Mack WealthTrack.
