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The Rebirth of Middle America


(This article was originally published in the Huffington Post)

By Jay Pelosky 

For much of the past 30 years, Middle America has been fly-over country, both economically and physically. The Coasts, the East with its financial boom and the West with the tech revolution, dominated investor thinking and attracted the flow of capital. Along the way, emerging economies in the developing world boomed, further eroding the heartland's mind, market, and wallet share.

Well, change has come to these three segments of the U.S. For the first time in decades, Middle America is beginning to generate private sector interest and attract investor dollars. While the East Coast works off the financial bubble and the West Coast encounters a defense spending down cycle, the heartland beckons as America's new area of economic opportunity. This is not to say the U.S. economy is off to the races; rather that Middle America may generate enough self-sustaining demand to keep the U.S. economy afloat while the Coasts recover.

I believe the period ahead, from 2010-2025, will mark the rebirth of Middle America. As one contemplates America's 21st century economy (See "Bi-Sectoralism: It's the Economy Stupid II,") Middle America looms large. From an investment perspective, one always likes to invest in themes that have multiple legs. The more legs, the greater the prospects, and the bigger the pay out. The Rebirth of Middle America will be one of the decade's big investment themes in large part because it has three main legs.

These three legs are: competitive manufacturing, cheap domestic energy, and global demand for agriculture. The synergies between competitive manufacturing and cheap energy are enormous. Add in agriculture and one has a mutually reinforcing regional economy firing on all cylinders. Scaffolding support includes access to cheap domestic capital and the beneficial trade off between $125 global oil and $2.30 domestic natural gas.

Let's examine each leg in turn. America is a world-class manufacturer today–this is not just rhetoric but reality. America's manufacturing prowess never went away; it just went up in market. Shop floor productivity kept high-value added work onshore while low-value added production moved offshore, just as one would hope. Following China and Germany, the U.S. remains one of the world's leading exporters of manufactured goods, .What did change was that the number of workers required to manufacture the same amount of products fell sharply. Today, manufacturing employment is growing at its fastest pace in thirty years, which is good news given the job multiplier effect: Estimates suggest every 100 manufacturing jobs support an additional 291 jobs.

America's manufacturing competitiveness is its best in decades. U.S. unit labor costs (ULC) a principal way to measure competitiveness, have fallen over the past three decades while those in Germany have risen by close to 90 percent. At the high end, German manufacturing ULC today are 30% more expensive than in the US. At the low end, wages in China have increased 600 percent in the past decade and are rising 15 to 20 percent per annum. Class A office space in Beijing is more expensive than in Manhattan while trucking costs in China's main export areas are over 50 percent more than U.S. levels on a per mile basis.

Transportation costs ($125 oil) and logistics issues (Japan's tsunami and Thailand's floods) are fueling a desire to produce closer to the end customer and a rethink of the global supply chain. Record low U.S. corporate borrowing costs coupled with record deposit-to-loan ratios at U.S. banks suggest access to capital is a competitive advantage. Watch for a surge in foreign direct investment (FDI) flows into the U.S. from China and elsewhere as these factors come to the fore, replicating that of the late 1980s when it was Japan's turn to move production here. "Insourcing" will replace  "outsourcing" as the new buzzword.

The second leg to the thesis is cheap domestic energy. The recent surge in shale oil and natural gas extraction, while not without its environmental concerns, has led to a startling shift in the domestic energy and power sectors. The speed of this change offers investors an opportunity. The linkage between cheap energy and manufacturing prowess could be the sweet spot.

Over the past five years, domestic production of natural gas has risen by 30 percent while its price has collapsed from $13 PMBTU in 2008 to $2.30 currently. This price collapse represents a massive turbo charging of America's competitive advantage given that natural gas in Asia or Europe costs roughly five to six times more or $14-15 PMBTU. Furthermore, it has led to a 50 percent decline in U.S. electricity costs. Rising global oil prices and falling domestic natural gas prices are twin engines for the Made in USA case. This is especially true in the chemical sector.

The third leg of Middle America's rebirth is the global demand for agriculture. U.S. farmland prices have skyrocketed as investors consider what the rise of the emerging economies' middle class is going to mean for food demand. America's heartland is becoming the world's breadbasket. One often hears that China is our banker given its vast holdings of US Treasuries. But we are China's farmer.

A couple of data points help make the case. First, China's corn imports are expected to surge by 75 percent over the next year or so, from 4 million to 7 million tons. Second, global corn reserves are down to 52 days of consumption, the lowest level since 1974; leading U.S. farmers to plant the most corn acreage in any year since the 1940s. China has only recently become a corn importer and its demand is likely to remain robust as it moves to a domestic demand and consumption led economy; a shift many emerging economies will make in the next few decades.

If having a three-legged thesis is good, having multiple ways to invest is even better. This is particularly important given the very sharp equity market rally (close to 25 percent) since last fall. This theme does not suggest buying stock today with eyes shut but rather offers the chance to consider specific investments that offer more than a liquidity bubble for support. The Rebirth theme provides several diverse ways to express a positive view on Middle America's future prospects.

Three legs, five ways to invest, thirty years in the making, the Rebirth of Middle America and the rise of America's 21st Century economy is something both investors and workers can benefit from for years to come.



Jay Pelosky is the founder of J2Z Advisory LLC, an investment strategy consultancy, and a board member of the World Policy Institute

Photo: Jeff Whyte


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