| Rodrigo C.

Serrano, CFA
| SIPA | Columbia University
Master of International
Affairs 14 Candidate

| New York City, NY
| 01-305-510-0181
| rcs2164@columbia.edu

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Chart: RCS Investments Source: American Association of Railroads

RCS Investments 2014 Global Macro Outlook

December 28
th
, 2013

This report researches the major macro factors that will affect
the economic landscape over the coming year. A macro
summary of the U.S. and other major global economies is
followed by an investigation into the main trends likely to
affect the economic and investment landscape next year.

Economic Summary

The Eurozone has stabilized. Led by Germany, the region has
produced numerous positive signals indicating that the worse
has passed for the monetary union. Investors have begun to
divert funds towards the territory in a vote of confidence;
indeed recent reports of U.S. investors moving back into
Europe at the fastest pace since 2008 serves as evidence.
Leading indicators imply growth is set to continue in 2014.

Meanwhile periphery countries remain in harrowing shape
however. Unemployment rates north of 25% for Spain and
Greece have brought about despair; youth unemployment for
both surpass a dangerous 50%, which may result in a lost
generation. Furthermore, growth has been increasingly
asymmetric, comforting a German populace but generating
growing anxiety for underperformers such as France and Italy,
among others. A protracted period of low inflation, in the
words of Mario Draghi, Central Bank Chief of the European
Central Bank (ECB), has placed a fissuring ECB board
when considering the Bundesbanks headstrong opposition to
loose monetary policy on high alert.

In the U.S. a frail manufacturing sector over most of the
year has recently found renewed spark, joining a brisk pace of
growth in the service sector. This development has been
confirmed by strong readings in the American Association of
Railroad and the American Trucking Associations
transportation indicators. If core durable goods orders could
also confirm, factory activity would have a solid bill of health.




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App Level ?o? 1 MLh Avg. (8PS)
Chart: RCS Investments Source: Mortgage Bankers Association
Notwithstanding the latest downturn in demand as
suggested by the Mortgage Bankers Associations purchase
applications index, the housing market has been on the mend
throughout the year. Rising home prices, currently at their
fastest pace since the go-go times of 2006 according to Case-
Shiller, are assisting rising equity values in bolstering consumer
psyche (wealth effect), a key benefit of Bernankes
Quantitative Easing (QE) program. While the rancorous
debates over the U.S. budget and debt ceiling damaged
consumer confidence for a while, it has slowly reappeared.
This has been largely due to an improving labor market.
Regardless of joblessness remaining above the Federal
Reserves interpreted range of normal unemployment of 5.2-
6.0%, private sector job creation has remained relatively robust
and less volatile in recent months, while leading indicators
point to further gains ahead.

Despite these improving conditions, consumer spending,
the economys largest component, remains stuck in low gear.
Household spending for Q3 rose at its weakest pace since
2009; the holiday shopping period has relatively disappointed
as well. The principal reasons for this inadequacy are an ailing
pace of real wage growth, currently less than 1%, as well as the
beneficial but asymmetric impact of QE. The aforementioned
wealth effect has largely benefited households with notable
financial assets, an infrequent characteristic among lower wage
earners. In fact, according to a recent study by respected
economists Emmanuel Saez and Thomas Pikettey, the
dispersion of income from economic activity has benefited the
top 10% of households by the most since the government began
tracking the data almost a century ago. This dynamic has
translated to diverging measures of confidence within income
groups as shown by Bespoke. Meanwhile inflation has
consistently underperformed the Federal Reserves mandate of
2%. The Feds preferred measure, the price index of the
personal consumption expenditures indicator, stands at 0.9%
year over year (YoY) growth.

In general the U.S. economy has been an outperformer in
terms of growth this year, recently exemplified by the strongest
quarter of growth in Q3 since Q1 of 2012. Furthermore it is
poised to contribute more than China towards global growth
(at market exchange rates) in 2014 as per The Economist.
Improving business metrics, particularly within the labor
market, have marked the beginning of the next chapter in what
I have termed the Global Economic Restructuring.

(Source: Bespoke)




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Chart: RCS Investments Source: National Bureau of Statistics
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Bernankes announcement on December 18
th
of a $10B taper of
the Feds QE program to $75B, comprised of $40B in
Treasuries $35B in mortgage backed securities, has served as
an indication of optimism for the recovery as well as a closure
to his legacy.

In Asia, China has seen a rather pedestrian year for
factory activity; growth in industrial production downshifted.
This has been a direct consequence of a weakened global
economy. YoY growth in exports has mostly declined but
remains in positive territory, indicating that worldwide trade
flows may have stabilized. Fixed-Asset Investment, another
long-standing pillar for the economy, has remained in low
growth mode. However, retail sales have held mostly steady
throughout the year. These business sectors or barometers are
important for Chinese leaders to gauge their progress in their
role in the Global Economic Restructuring. Rearranging the
economy to one geared more towards consumption and
innovation vs. exports and fixed-asset investment is a critical
step in attaining a worldwide long-term sustainable expansion.

Business partners, such as South Korea and Australia,
verify the weak trade picture. The formers growth in exports
and industrial production has roughly flat-lined since the
beginning of 2012; at least the latter has seen a modest revival
in demand for business. In Japan, Abenomics has resulted in a
positive inflationary environment; however, real wages have
been the victim. Household confidence has faced adversity
since mid-year, translating to a growing but weakening pace of
spending growth. This has led many to wonder whether
upcoming labor market reform and a weaker yen which
raises profits and cash piles will give companies enough
confidence to increase investment in time before a planned
sales tax increase takes effect in April.

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8
Key Themes

In a vacuum, the U.S. is enjoying strengthening economic growth buttressed by a positive
feedback loop due in large part to improving household debt dynamics and job creation. Asia
seems to be adequately managing economic growth as well; investors remain sanguine on
China and the general regions long-term outlook. While Europe struggles to grow, due to
continued austerity, the situation has improved. Taken together, these 3 regions illustrate an
ongoing global recovery that remains on weak foundations, susceptible to influence by both
positive and negative factors. Below are the most important trends investors need to keep an
eye out for over the coming year.

Europe needs growth, not just stabilization.
Will political and military tensions increase in Asia? (p. 8)
Japan: Are the clouds parting, or is it the calm before the storm? (p. 9)
China: What lies in store for the global economys arcanum? (p. 13)
Wave of Uncertainty to come from the Fed (p.16)
Fracking: Revolution or Retirement party? (p. 19)
Re-shoring: Likely or not happening? (p. 22)


>) Europe needs growth, not just
stabilization.

While the Eurozone crisis has somewhat
ebbed, its repercussions will remain a key
determinant of the macro landscape over
the coming year. If economic growth
disappoints in the coming months, expect
renewed turbulence.

Few Choices Left for Citizens

The roughly 3-year-old plight has
transformed the political landscape
throughout the region, retarding the
democratic process. In Greece, the center-
right New Democracy party is allied with
the center-left Pasok party. In Italy, Silvio
Berlusconis center-right Forza Italia
withdrew its support from a coalition with
Enrico Lettas center-left Democrats party,
having since been replaced by a defecting
center-right faction (the New Centre
Right) led by Angelino Alfano. Austria,
Finland, and the Netherlands sport similar
pro-European alliances in an effort to
support the Eurozone project. These
partnerships have effectively blurred the
idiosyncratic ideologies of the participating
parties, leaving voters without an effective
political outlet. Meanwhile leaders with
absolute majorities have seen their support
dwindle as campaign promises have gone
unfulfilled, as has been the case for French
President Franois Hollande and to a
lesser extent for Spanish President
Mariano Rajoy. In fact one could say that
these leaders have served merely as
figureheads imposing dogmatic but
destructive economic policy, crafted by
technocrats in Brussels with a German
nod.

Overall voters have been repeatedly
disillusioned with the false promise of
better economic conditions as well as a lack
of control over the direction of policy. This
has led to their increased flirtation with
more extreme parties, which seem to be the
lone viable outlet left. As a result, anti-




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9
euro parties have enjoyed increased
support and are gearing up for gains in the
upcoming parliamentary elections on May
22. In France, Marine Le Pen of the
National Front party who currently sits
atop French polls for the May vote and
Geert Wilders of the Freedom Party of the
Netherlands have allied to battle This
monster called Europe. Meanwhile in
Italy, Beppe Grillos 5-Star Movement
took the largest share of home votes in last
Februarys general elections. In the UK
Nigel Farages UKIP party took the
second most votes in local elections in
May. The Finns party (formerly known as
True Finns) and Alternative for Germany
are also in an increasingly advantageous
position to augment support.

The resounding popular endorsement
for euro-skeptic parties is likely to
drastically shift the political discourse
throughout the region; by way of a shift in
national politics; a greater representation
on the European Council; and maybe, just
maybe, a significant faction in the
European parliament.

A Game of Chicken in Store?

In the Hellenic Republic, a recent poll
places Alexis Tsiprass SYRIZA which
stands for Coalition of the Radical Left in
first place ahead of the New Democracy
party led by current Prime Minister
Antonis Samaras. A triumphant result in
the parliamentary elections for SYRIZA
would increase pressure for snap elections,
likely leading to the fall of the current
government. Mr. Tsipras has stated that
SYRIZA would complicate the European
Councils operations by vetoing any
decision requiring unanimity unless a
feasible solution was crafted for the nation,
in hopes that such a move would foster
discussion on a shift towards more growth
friendly policy for periphery countries.
Rest assured that France and Spain would
welcome such debate. Furthermore Mr.
Tsipras has stated that he was prepared to
face the prospect of the troika which
comprises of the European Commission,
the IMF, and the ECB cutting off
funding to the country in response to the
government renouncing the terms of the
bailouts. Critically he believes that Greece
would unlikely be left to default, due to the
adverse consequences such a development
would have on the rest of the region and
the world for that matter. While Mr.
Tsipras has repeatedly stated that he will
work to keep Greece in the Euro. His
rhetoric and mention in calling the troikas
bluff of withholding funds will be sure to
ruffle feathers in Brussels and Germany.

Its Crunch Time for Italy.

Matteo Renzi, recently elected as the new
head of the center-left Democratic Party,
has thrown his support behind current
Prime Minister Enrico Letta by proposing
a pact lasting 12-15 months, in order to
pass structural reforms many see as pivotal
to Italys long-term growth. For starters
that will mean work on a new electoral bill
the latest proposal was rejected by the
constitutional court with the aim of
reducing political uncertainty. The hung
parliament result in February was the
result of the current law. Furthermore, a
slimming down of bureaucracy, reduced
taxes, and labor reform will be presented
over the coming month as part of the
coalitions formal pact.

With regards to the countrys
relationship with Brussels, the status quo
will not continue indefinitely. Mr Renzi
has stated that he does not support the
1992 Maastricht Treatys annual budget
deficit ceiling of 3%, calling it outdated.




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Moreover he said he would not feel
compelled to follow Europe if its in the
hands of bureaucrats. While Mr. Renzis
rhetoric would inflame tensions with
Brussels and Germany, his pact with Mr.
Letta means that this issue will unlikely be
a short-term concern.

Lettas government must move
quickly to turn the intensifying anti-euro
tide. Joining Mr. Grillos 5-Star
Movement is Forza Italia, headed by Silvio
Berlusconi. Combined, both currently
represent an anti-euro faction with wider-
reaching public support than the current
pro-European coalition. Additionally, the I
Forconi or Pitchfork movement, an anti-
euro camp initially of farmers and truckers
that began in 2011, has grown to include
students, pensioners, and struggling
business owners.

French Divergence Leading to Despair

In an effort to mold the states economy to
conform to the aforementioned 3% annual
budget deficit parameter by 2015, Mr.
Hollande has largely resorted to fiscal
adjustments instead of structural ones.
This year the deficit is estimated at 4.1%; in
2014 it is expected to fall to 3.6%. The
result has been a deepening lack of
competitiveness, stemming primarily from
5 consecutive years of draconian tax
increases next year will feature a 75% tax
on millionaires as well as an increasing
risk of a triple-dip recession.



Building Europe and subduing
German might have been principal
components of Frances foreign policy ever
since World War II. It has always seen
itself as an equal of Bundesrepublik.
However, this has now changed. French
public opinion is ever more anti-euro. The
project has weakened the nations standing
and has been primarily a result of
Germanys austerity policies. News of
Marine Le Pens National Front party
leading in the polls has led Steeve Briois,
Secretary General, to proclaim that The
French are showing a wish to take their
destiny into their hands and give back their
country its sovereignty. As stated by
Ambrose Evans-Pritchard, The split in
economic performance between France
and Germany cannot continue for much
longer without causing severe political
strains.

Recovery now the Elixir of Political Will

On December 17 Merkel signed off on a
Grand Coalition between the CSU/CDU
and the SPD. For struggling Eurozone
nations, this represents a welcome change;
for the SPD has stated it supports
solidarity in advancing the project. In
spite of this, initial indication from the new
government is that it will be business as
usual in dealing with the Eurozone, a
strategy overwhelming approved by
cautious German voters. As has been the
case over the past few years, financial
assistance will come in exchange for fiscal
rigidity. German sacrifice would come, if
the project were in danger of unraveling.
This tit-for-tat arrangement has been
feasible due to strong domestic economic
growth. How would it be politically
tenable to support other countries, if
conditions were not satisfactory at home?

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It is no secret that Germanys bread
and butter lies in exports. It will be
pivotal for this sector to operate near or at
full capacity in 2014. Yet, the current
trend remains feeble. The global recovery
must gain momentum.



A healthy export sector would mute
potential headwinds of upcoming and
existing Germany policies such as: a new
minimum wage demanded by the SPD
(likely to price out low wage workers), a
continued push to eradicate all nuclear
power by 2022 (raising electricity prices
further), and an underwhelming amount
infrastructure investment. In addition to a
fragile rate of growth in exports, job
growth has disappointed. Germany is not
as strong as many believe at this point.



In the periphery it will be crucial for
the recovery to become ensconced. While
investors have cheered at the fact that
stabilization has arrived, this will not be
enough to truly mark a turning point in the
crisis. Lack of a strong region-wide
recovery would mean record high
unemployment rates in Spain, Italy, and
Greece. In the case of France 16-year high
unemployment would persist, fueling anti-
euro sentiment. The crux of the matter is
that austerity/recession fatigue is at an
extreme. The current economic
environment must improve.

To be sure, leading indicators signal
that growth is set to arrive; it could not
come any sooner. Improving region-wide
economic activity would undermine anti-
euro sentiment, decreasing an already
dangerously high level of political risk.
The climate for reform would also improve.
Slowly but surely, falling unemployment
rates would give people hope that the
worse has passed, providing an incentive
for further sacrifice, since they would be
almost at the finish line. In Germany
fulfilled promises by the periphery would
give leaders confidence to continue
granting financial support to struggling
nations Greeces bailout money from the
IMF and European countries is set to
expire this coming July. They would also
take key steps in consummating the
monetary union, such as using the
European Stability Mechanism to close
down failing banks, initiating a region-wide
deposit insurance scheme, and ultimately
issuing Eurobonds. In effect, a positive
economic/political feedback loop would
develop.

The ultimate bullish scenario of a
consummate monetary union in its current
form remains largely wishful thinking.
Asymmetric growth, a hallmark symptom
of a non-optimal currency area, is clearly
on display in Italy, France, and Greece.
Even with recent signs of stabilization, the
current state of affairs is clearly untenable
from a social standpoint. Lack of definitive
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<
leadership from Germany Merkels fort
lies in creating consensus, not exerting
bold direction will mean anti-growth
policies will persist. Eventually Germany
will be forced to make the painful decision
of fully either embracing the European
project or not. Worsening economic
prospects would in essence make this
decision a lethal political grenade. Perhaps
understanding the gargantuan gravity of
her decision, she may ultimately offer
herself as the sacrificial lamb by solidifying
the union. Developments that would make
me reconsider this pessimistic view would
be a reaccelerating growth in the U.S. and
Chinese economies, which would provide
demand for exports thus jumpstarting the
German export machine and raising
demand for exports from the periphery.

>) Will political and military tensions
increase in Asia?

On October 20
th
Japan became alarmed
when a Chinese drone was spotted flying
over the Senkaku (Diaoyu in China)
Islands. Japan claimed them as rightfully
theirs after purchasing them from private
ownership on September 11
th
last year. In
response, new Japanese protocol was
published that declared the right to shoot
down any drone that trespassed its airspace
and ignored orders to leave. Chinas
Ministry of Defense promptly re-escalated
the incident by declaring that downing one
of their drones would constitute an act of
war.

Roughly one month later, on
November 23
rd
, China moved to assert its
claim over the archipelago by establishing
an Air Defense Identification Zone
(ADIZ). Not only does the zone cover the
islets, it also covers a large section of
Japans own ADIZ.


(Map: The Economist)

On the 25
th
, the U.S. sent 2 unarmed B-52
bombers through the zone as part of a
long-planned exercise, clearly an act of
defiance to the recent Chinese
announcement. Japanese and South
Korean aircraft have entered the zone
without notification numerous times as
well. China has remained silent on the
encroachment. This recent development
has turned into a near-term risk for the
global recovery. Military conflict would
pit the 2
nd
and 3
rd
largest economies in the
world against each other and could disrupt
major energy trade routes in the South
China Sea.

Chinas action has been seen by many
as destabilizing the status quo in the
region. It has led to Japan increasing its
defense budget by 5% over the next 5 years
and announcing that this coming Spring
recommendations would be made by a
national security panel on lifting the
countrys self-imposed pacifist policy of
self-defense. It has given the U.S. a
renewed urgency in executing its Asian
Pivot, in order to communicate its
incontrovertible security commitment to
the area; this after President Obama




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=
missed Asia-Pacific Economic Cooperation
and East Asia conferences both in early
October, as a consequence of the
government shutdown.

Despite the hoopla caused by the
circumstance, there are reasons to be
hopeful. Japan and China conduct a lot of
business and investment with one another.
Economic dependence has long been
known as an effective deterrent against
conflict. Furthermore both countries have
their plates full in terms of fostering the
domestic economic expansions, on which
their governments survival depends.

Regardless of the economic reasons to
not pursue military conflict, Japan and
Chinas nationalistic leaders will find it
hard to back down from their escalations.
Furthermore the U.S. will be hard-pressed
not to increase its military presence in the
area and show its most valuable Asian ally
that it has its back. Whats more, triple
coverage of territory in the East China Sea
South Korea expanded its ADIZ to
overlap Chinas and Japans ripens the
situation for an accidental clash.

Taken together all nations involved
will go through great pains to avoid
conflict, while attempting to save face at
home. However, an elevated probability of
an accident similar to the Hainan Island
incident in 2001, which involved a mid-air
collision between a U.S. spy plane and a
Chinese fighter aircraft, may occur, leading
to a period of financial risk aversion.
However, leaders would find a way to
defuse the situation. Beginning a war, on
the basis of claiming a few uninhabited
rocks, which would seriously disrupt the
fragile global recovery and place both
countries governments at risk, would be
utterly foolish.

>) Japan: Are the clouds parting, or is it
the calm before the storm?

Abenomics, the term used for Shinzo Abes
three-arrowed cocktail of intense monetary
easing (a doubling of the money supply),
strong doses of fiscal stimulus, and far-
reaching structural reform have resulted in
a roughly 50% rally in the Nikkei stock
market index and improved performance in
business indicators, such as industrial
production and export growth (due to a
lower yen). These policies have been put
into place to achieve a virtuous cycle of
rising wages, leading to increased
spending, investment and employment.
Whether it succeeds or not may profoundly
affect the economic and financial landscape
over the coming year. Its success remains
yet an open verdict.

Wages are rising shrinking! Aprils a coming.

Haruhiko Kurodas monetary policy
of quantitative and qualitative easing
(QQE), which has stoked national
headline inflation to a 5-year high of 1.2%
YoY, has enjoyed the most favorable
attention. A notable portion of this
increase has been due to a lower yen,
leading to increased costs of energy and
imports. Core inflation remains subdued
but at least in positive territory at 0.6%, the
highest in 15 years. Be that as it may, the
effectiveness of inflation as a spark for
consumer spending depends on the pace of
wage growth.

Earnings growth has thus far lagged
behind rising prices. This has effectively
squeezed real disposable income and
affected confidence.





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>?




Mr. Abe, cognizant of how pivotal it will
be to reverse this budding relationship, has
pleaded with companies to raise wages to
give consumers more spending power.
Early 2014 will be important as they make
their compensation plans. They will need
to feel confident that business conditions
are improving in sustainable fashion.
Slowing economic growth over the past
year wont help.




This seemingly lackluster set up comes
before a watershed moment for Abenomics.
Beginning April, an increase in the
countrys sales tax from 5 to 8% will mark
the biggest test of whether Mr. Abes
virtuous cycle has begun to settle in.
Consumption is likely to increase in the run
up to the hike, as households push forward
their purchases to avoid the tax. It will be
the months after that will yield the verdict.

Similar to the Eurozone, Japans
condition also highlights the need for a
strong global recovery to boost exports and
sustain the economy, should weakness in
consumption become protracted.

Debt dynamics: Weve Heard this Before.

Japan is saddled with the worlds largest
gross debt pile, projected to be 242% of
GDP in 2014, according to the IMF. This
figure is roughly 40% higher than the next
most indebted country (Greece); 82%
higher than currently criticized Italy, and
more than double that of the U.S. While
this worrisome state of affairs is nothing
new and many have warned of an acute
deterioration in the countrys finances in
the past, it particularly merits attention due
to recent developments. First, a recap of
the long-standing factors

First: Japanese 10-yr interest rates
currently stand at roughly 0.7%, which
translates to an interest expense of roughly
20-25% of the governments revenue.
Rising global interest rates would pressure
this cost higher quickly: 2% interest rates
would raise costs to nearly 80% of
government revenue, according to Asia
Confidentials James Gruber. This factor
has not proved a headwind in the past in
part due to Japans decades of deflationary
conditions. Interest rates have continued
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>>
to fall since the crisis began. How long will
this trend persist?



Second: Japan faces a declining
population and workforce. As a potential
offset, government could enact policies
aimed at increasing the labor force.
However, at nearly 80% for men, which
surpasses participation rates of other high-
income countries, and 61% for women,
which closely matches the U.S. metric of
62%, Abes administration will find it quite
difficult to offset the principal trend.



The government could also target
productivity enhancements to offset the
falling number of workers. According to
Martin Wolf of the Financial Times, a
needed rate of 2.5% productivity growth
would be a tall order, No high-income
economy achieved trend productivity
growth so high between 1990 and 2012.
The area in most in need of higher
efficiency lies in the countrys traditional
service sector.

Third: A declining population also
has important implications for money
flows. As workers retire, their need for
liquid financial resources rises. This means
pensions and retirement funds will need to
liquidate investment assets (partially
comprised of Japanese bonds) to provide
funds. This will be an increasing headwind
for government-sponsored, fixed income
instruments in the years to come.

Whats new?

Two factors have materialized that raise
the stakes further. On March 11, 2011, the
T!hoku Earthquake, the 4
th
most powerful
earthquake in history and the strongest to
hit Japan since records began, produced a
tsunami that ultimately triggered the
Fukushima Daiichi nuclear disaster. The
catastrophe lead to Japan halting
production of nuclear energy, which
consisted of 30-40% of the countrys power
supply, substituting it with imports.
Recent public opinion remains resolutely
opposed to using nuclear energy any time
soon. Japans current account standing
has since deteriorated to flirtation with
deficits. Imports are close to exceeding
exports. Japan is losing its status as a net
creditor nation. Investors may begin to
question how the country will continue to
service its debts since money flows are
almost outwards on net.


(In billions of yen)

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>6
To be sure, there are reasons to believe
that this will correct. A firming global
recovery would lead to higher factor
income, another component of the current
account, thus boosting the aggregate figure
back into surplus. More importantly,
passage of the Trans-Pacific Partnership
(TPP), which includes Japan and 11 other
countries, is expected sometime early next
year. This will likely serve as an additional
tailwind for Japanese exporters.

The other factor revolves around the
politicalization of monetary policy. Mr.
Abe has directly elected Mr. Kuroda to
implement loose monetary policy.
Therefore the Bank of Japan (BoJ) will be
subject to political pressure in its decision-
making, regardless of whether the economy
expands or contracts. Lack of
independence would increase investor
skepticism towards the true underlying
motives of the BoJ, particularly if they
announce more extreme measures, such as
inflation targeting. Inflation expectations
may become unanchored, if it becomes
progressively accepted that the government
is looking to diminish the real value of its
outstanding debt.

Possible Triggers Over the Coming Year

1. The April sales tax knocks the
economy back into protracted
recession or stagnation (ie.
Abenomics fails); a current account
deficit becomes increasingly
structural. Investors may become
jittery as it becomes ever more clear
that Japans debt pile will never be
repaid on the sole basis of improved
economic growth. Shinzo Abe, in
efforts to maintain his strategys
credibility, pushes for more fiscal
stimulus, backtracking on promises
to slim down the federal deficit.
2. A conflict erupts with China or
tensions lead to substantial, reduced
investment between both countries.
Although unlikely, due to self-
inflicting damage, China could
resort to economic warfare by
boycotting Japanese products,
inflaming the already delicate and
increasingly structural current
account deficit.
3. A period of higher interest rates,
due to a global pick up in inflation,
would lead to significantly higher
interest expenses on Japans debt
pile, seriously hobbling its budget.
Monetizing the debt could become
an unofficial preferred policy
choice.

In sum betterment in the economy
would improve the Japans fiscal picture
and kick start inflation. Higher
government revenues and an increasing
but controlled rate of rising prices would
work hand-in-hand in slowly bringing
down the very elevated debt to GDP ratio.
However, Japan may be biting off more
than it can chew. On top of an extremely
large debt pile (volatile interest costs are a
major risk), falling population, and a
shrinking current account surplus, Mr.
Abe is now raising the geopolitical stakes
with China, and increasing military
spending at home. Increased economic
precariousness could temper Mr. Abes
nationalistic fervor. Harbingers of what
may lie ahead are whether Sino-Japanese
relations can be ameliorated or at best kept
from spiraling out of control, and whether
Mr. Abe can convince companies to both
increase base wages and investment, which
would kick start the virtuous cycle he so
desperately seeks.





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>7
>) China: What lies in store for the
global economys arcanum?

China remains a key cog in the global
recovery. A significant slowdown in
growth, below 7%, would reduce
worldwide aggregate demand needed for
economic growth in periphery Eurozone
countries. Japans export-reliant economy
would lose steam. President Obamas
National Export Initiative, which promises
to double exports by the end of 2014,
would fall into serious jeopardy.

Two-Way Street

Inasmuch as the international
economy needs China for continued
growth, by no means is it a two-way street.
To maintain growth over the coming year,
officials in the commerce ministry have
expressed increased dependence on
rebounding demand from developed
countries, U.S. and Europe in particular.
So far the news has been positive. Firming
business activity within the worlds largest
economy and stabilization in Europe have
recently provided headway for Chinese
exports; 12.7% YoY growth in November
was the strongest result in 7 months.

A stronger global recovery will be
needed to buoy fragile, domestic economic
gauges. In addition to a reduced pace of
expansion in industrial production, growth
in fixed asset investment has also slumped.
Meanwhile consumption, which according
to the World Bank in 2012 stood at a
paltry 34.6% of GDP compared to a world
average of 60% and 68.6% in the U.S., has
not emerged as a serious candidate to
rescue these ailing sectors.





Additionally higher exports would act as
an insurance policy for development
during the multi-year implementation of
the most far-reaching reforms since 1978.

The 3
rd
Plenum of the 18
th
Central Committee

Not since Deng Xiaopings 3
rd
plenum of
the 11
th
Central Committee, which opened
the nation to foreign markets and signified
the beginning of a dizzying resurgence
onto the global stage, have Chinese leaders
emphasized the importance of the 4-day
meeting that took place on the 9
th
of
November. In a determined effort to open
the door of Chinas Bird Cage economy,
officials have established a panoply of
reforms aimed at further liberalization,
emphasizing decisive results by 2020.

Business analysts attention was most
drawn to markets playing a decisive
versus a fundamental role in the
economy, a clear nod that a model of
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>8
reduced government interference is under
design. This could entail a large-scale
metamorphosis of various state-owned
enterprises (SOE). In addition to
ordaining these firms to direct more of
their profits to the public purse, they are
also prescribing a larger divesture of
profits instead of retention. Even more
radical, deliberations in allowing private
ownership of firms in sectors not
considered to be the lifeblood of the
economy, or deemed important to national
security, have been publicly stated. Rural-
dwellers will incur more property rights.
On the real estate front, a property tax will
be introduced to temper rising home
prices. Reforms will aim to increase
competition and urbanization. Corruption
looks to be confronted. These and other
reforms will be supervised by a leading
small group, which some speculate will be
headed by the General Secretary Xi
Jinping himself. These reforms are seen
by many as pivotal for a better China and
long-term and sustainable global
development. But implementation risk
looms.

Xi Jinping: So Far an Obfuscating Leader.

Notwithstanding these reputable reforms,
which would lead investors and world
leaders to believe that Mr. Jinping
understands the importance of maintaining
a sound incubator for growth, recent
actions have left many flummoxed. The
establishment of an ADIZ over the East
China Sea and a Defense Ministry
announcement that it would establish
other air defense identification zones at an
appropriate time after completing
preparations has raised fears of a second
ADIZ being established in the South
China Sea. This would be a big deal in
energy markets. The U.S. Energy
Information Administration remarks
Almost a third of global crude oil and over
half of global liquefied natural gas (LNG)
passes through the South China Sea each
year. Why would Mr. Jinping risk
alienation of important trading partners
during a vulnerable moment in Chinas
economic development? Perhaps to divert
attention from poor economic conditions
by fomenting nationalistic sentiment? Or
maybe it is the latest example of Chinas
long-standing incongruous foreign policy,
an issue to be addressed by the plenum
announcement of a new state-security
committee.

Another example of the inconsistent
nature of Mr. Jinpings actions is the
recent bugaboo of threatening to withhold
visas for Bloomberg and New York Times
bureaus operating in the country. On the
business front, numerous prominent
enterprises have been subject to
investigations and laws curbing their
operations, all the while markets will be
playing a decisive role in the economy.
While all these actions will not deter
continued investment China is just too
big and compelling from a business
standpoint to withdraw from they serve
to show the capricious nature of Chinas
most powerful leader.

Financial Tremors

Beijings 1994 fiscal reform reduced the tax
intake of the countrys provinces. Before,
they were in charge of collection and
passed an amount over to the central
government. While the economy grew, tax
revenues did not rise in sync, the result of
provincial mandarins snatching their fair
share of the proceeds. The establishment
of a central tax ensured the federal
government of its portion of economic
activity at the expense of the cantons.




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>9
Chinas provinces have long been
salient actors in executing Beijings
directives. During the 2008 financial crisis,
under the command of then Secretary
General Hu Jintao, a $586 bln economic
stimulus plan was unveiled to battle the
adverse effects of a slumping global
economy. Local governments would
provide " of the funds. With reduced
revenues and the enormity of the funds to
be dispersed, they began to borrow from
the powerful state-owned banking, and
later on the shadow-banking sectors,
mostly via the creation of local government
financing vehicles (LGFVs). Questionable
investments in infrastructure and pet-
projects were made with the ultimate goal
of providing economic activity to counter
the export slump. Meanwhile state-owned
enterprises were pressured by the
government to keep production lines
humming, despite lack of demand, in order
to preserve and grow payrolls.
Skyrocketing unemployment would have
spelled doom for the communist party.
Have the adverse results of these policies
begun to materialize?

In mid-October Fitch Ratings
warned that the economic efficiency of
Chinas debt was plunging. Each yuan of
debt produced only 0.18 yuan of GDP
growth. Unproductive infrastructure one
of many ghost cities sports a replica of the
Eiffel Tower and Champs Elysee and
real estate speculation on the part of local
governments in search of enhanced returns
have brought increased scrutiny on
Chinese banks. While large-scale
urbanization may provide for demand in
the coming years for housing and
infrastructure, markets have gotten antsy;
two financial tremors have been felt, one in
mid-June and one currently ongoing.
Chinas 7-day repo rate, a key measure of
the cost of interbank lending, has recently
spiked on worries of overvalued bank
assets (ie loans to local governments, state-
owned enterprises, real estate developers,
and other industries). Whether the
increase in interbank lending costs is
simply due to a scramble for cash to
comply with year-end regulatory
requirements, or a sign of a nascent credit
crunch is something investors will be keen
on deciphering over the coming weeks.
Unfortunately money market rates may
remain volatile due to the Lunar New Year
occurring on the final day of January.
Demand for cash tends to rise in the days
approaching.

What lies ahead?

The plenum has produced admirable goals.
However, the delicate state of the global
economy makes their execution fraught
with danger. Cropping overcapacity, a
major focus over the coming year, will be a
headwind for development. A pick up in
global trade would be bullish to offset.
Help would likely come from some sort of
stimulus package if growth disappointed.
Meanwhile, powerful vested interests
ensure a high level of implementation risk.
Among other impediments, local
governments, fearful of job losses within
their jurisdiction and falling tax revenue,
may challenge objectives.

On the financial side, liberalization of
interest rates, a form of markets playing
the decisive role, may yield unintended
consequences. Higher deposit rates would
shave banks profit margins and draw
funds away from the real estate sector.
Furthermore, weaning the economy off of
cheap credit would result in reduced rates
of economic growth due to a falling pace of
credit expansion.





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>:
Chinas ghost cities are an example of
a gross misallocation of capital. A fair
share of these debt-financed ventures will
sour. Non-performing loans will rise.
While central government officials recently
announced that they would not bailout
provinces and local governments, they will
eventually relent. Many of these debts
were incurred due to Beijings decree on
November 2008, the nadir of the financial
crisis.

Global trade needs to rebound. The
U.S. economy is accelerating which bodes
well for Chinas exports. Attention should
be paid to money market rates for clues on
whether banking troubles are picking up
steam. Will relations with Japan improve?
The path to sustainable growth for China is
riddled with mines. A top government
think tank mentioned how growth next
year would be supported by a gradual
recovery in exports. This marks the
communist country handing off the baton
to the U.S. and Europe. Can they hold
serve? The communist party certainly
hopes so.



>) Wave of Uncertainty to come from the Fed

On December 18
th
, Chairman Ben Bernanke finally pulled the trigger. A reduction in the
Feds QE program from $85 to $75 billion in monthly purchases of Treasuries and mortgage
backed securities was the result of a potent 4.1% third quarter mark in annualized GDP
growth, a 5-year low in the unemployment rate, stabilizing consumer demand, and rising
home prices. Over the summer, the mere suggestion of a tapering was met with turbulent
sell-offs in emerging market currencies, U.S. Treasuries, and to a lesser extent equity markets.
This time around, U.S. indices rallied on execution, not suggestion, of tapering. U.S.
Treasury prices did not fall with the ferocity exhibited over the summer months. Emerging
market currencies, such as the Mexican peso and South African rand, shot up on the news.
This time investors took tapering as a sign of genuine strength in the worlds largest economy.
Furthermore, tapering has no longer been seen as tightening to many. Liquidity remains
abundant, and in fact the Fed is still easing by purchasing assets. Even better, further
tapering would be data-dependent; officials could delay a further cut back in purchases.

A Different Gadget. But Why?

Yet, the latest Fed announcement introduced a novel tool for investors to counterbalance
tapering. Stating that short-term rates would remain near zero well past the time that the
unemployment rate, now 7%, declines below 6.5%" was new and ultra-dovish. Forward
Guidance serves as an indication to investors, business, and consumers of how the Fed intends
to conduct monetary policy in the future. In this case, it has made clear that rates would
remain low for a prolonged period. This would therefore place downward pressure on longer-
term interest rates since theyd be close to zero at that point in time. Lower interest rates
would translate to lower borrowing costs for households and businesses. However, some are
skeptical of the efficiency of forward guidance. Stanley Fischer, previously the head of the
Bank of Israel and in line for the vice chair position at the Fed, voiced his opinion that the
future is inherently unknowable; therefore investors would discount the Feds own forecasts.




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>;
Furthermore this policy could raise the risk for reputational
damage, if it suddenly became probable that they would
have to backtrack on a stated promise. The tapering of QE
and introduction of forward guidance is likely to ferment
uncertainty over the coming months.

Despite optimistic sentiment, due to robust perform-
ance of risk assets in the days following these announce-
ments, its important to ask why the Fed has chosen to shift
gears, despite concern of the efficiency of this new policy.
After all, an unemployment rate of 7% and a personal consumption expenditures price index
of 0.9%, versus the Feds target of 2%, both signal a sizable failure to achieve the institutions
mandates. The most important reason is that many worry that loose monetary policy has
distorted asset prices, splitting them from economic fundamentals, a sentiment I share. This
encourages perverse risk-taking behavior on the part of investors as they embrace the
Bernanke Put. At the sign of market distress, the Fed would step in and buy more assets.
While some at the Fed have expressed these serious reservations, their points have been
repeatedly out-voted when making policy decisions.

Meanwhile, a slowly recovering economy and the
expiration of the payroll tax holiday early this year has
resulted in rising federal revenues, up 10% in the first two
months of fiscal 2014 (October and November) versus the
same two months of last year. Meanwhile the sequester has
reduced government spending, which fell 5% over the same
period versus last year. Taken together they have rendered
a 22% decline in the fiscal deficit over the same period a
year earlier. A falling deficit translates into reduced issuance of government debt. Meanwhile
the supply of mortgage-backed securities, the other asset being purchased by the Feds QE
program, has fallen due to a weakening demand for housing. As these quantities decrease, the
Fed ends up buying a larger share of the total issuance. Peter R. Fisher, Senior Director at
the Blackrock Investment Institute, estimates that if asset purchases continued at their current
rate, the Fed would soon be buying up all new Treasury and mortgage-backed security issues.












(Continued)
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Chart: RCS Investments Source: Bureau of Economic Analysis
!The Fed is running out
of stuff to buy"
--Peter R. Fisher--
Senior Director at the
Blackrock Investment Institute





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><
A Rambunctious Fed?

On February 1
st
, Janet Yellen takes the helm at the Federal Reserve. She wont be the only
new face. In addition to implementing forward guidance, potentially 75% of the FOMC
voting committee may change, further adding to the uncertainty. How will the groups
dynamic evolve? How will differences in opinion be handled?



The Road Ahead

Ms. Yellen faces an uncertain period. In addition to taming her new voting committee,
consisting of a stronger hawkish contingent, she will be faced with mixed but improving
signals on the economys health. Will longer-term rates remain low as bond market investors
embrace the Feds new communication policy of forward guidance? Price action in bond
markets will be key to start the year. Higher borrowing costs may disrupt the sluggish
domestic recovery. Leading indicators imply that the housing market may hit turbulence in
over the coming months. Moreover, how would investors worldwide prepare for continued
tapering if U.S. economic data improves markedly? The road ahead will be tricky.

Continued monetary loosening since 2008 has culminated in a sea of liquidity as Jim
Rodgers, a prominent investor, would say. These monies have been used to purchase
investments not only in the U.S. but also abroad. Emerging markets summer doldrums were
an important indication of just how important Fed policy has become, not only for the U.S.,




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>=
but also for the world. The Fed has inadvertently created a 3
rd
unofficial mandate of having to
responsibly handle global pecuniary flows or risk a weakening global recovery. The
repercussions of a receding tide are being felt, particularly in China, where credit markets
have had difficulty digesting outflows. The cost of rolling over debt for developers in the
communist country has increased as well. In Turkey, an ongoing sell-off due to political
conflict may be harsher than it would be, if the Fed did not announce tapering. The prospect
of further tapering is likely to make global investors skittish with their riskiest holdings. The
Fault Lines, a term used by Raghuram Rajan, Governor of the Reserve Bank of India, to
express the hidden weaknesses of our global economic foundation, may become re-ruptured.

Tapering is sure to be a rigmarole for officials, investors, and the global economy.
Because of its potential negative side effects, I would expect at best a pause in the tapering
process. The global economy remains on rickety foundations. The big question is whether
tapering is tightening or not; in case it is, removing liquidity will act as an increasing weight.
Will the half-renovated house hold?



>) Fracking: A Revolution or Retirement
party?

George Mitchell died 6 months ago at 94
years of age a proud man. Of Greek
descent, one of Texas A&Ms finest Aggies,
and the father of Hydraulic Fracturing and
Horizontal Drilling, he has unleashed a
revolution certain to shift the bedrock of
energy markets in the years to come.
America will likely become the worlds
largest natural gas producer and will
compete for the zenith in oil production,
currently owned by Russia. Fracking,
short for hydraulic fracturing, is the
process of extracting oil and natural gas
from difficult-to-reach rock formations by
injecting a pressurized solution of water,
sand and chemicals. This mixture creates
fissures in the stone, eventually releasing
the fuels.







(Source: Environmental Protection Agency)

This new form of oil and gas
extraction has expanded at a rapid pace.
According to McKinsey Global Institute,
shale gas production has grown by a little
over 50% per annum over the past 5 years,




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6?
with the strongest boom occurring in the
Haynesville Shale formation, covering
regions in Louisiana and Texas. Moreover
the approach accounts for 36% of all
natural gas production in the U.S. as of
2012 versus only 5% in 2007. In terms of
oil production, words cannot do justice to
the drastic turnaround since 2008.


(In Thousands of Barrels/Year)

North Dakota has become the poster child
for the boost to economic activity this
technology has provided. At 2.6%, it
boosts the lowest unemployment rate in the
U.S. Industries ranging from trucking to
rail construction to even restaurants have
benefitted.

Growing Tailwind

Given its early success, many surmise
that fracking will grow and contribute to
economic growth for the foreseeable future
with substantial multiplier effects. IHS, a
consulting company, believes that the
evolution of unconventional oil and gas
extraction will close to double the industry
workforce, via increased demand for labor
directly involved in extraction, as well as
indirectly throughout the oil and gas
supply chain. Over the near-term, building
transportation infrastructure (rail,
pipelines, and even ports) would require
substantial manpower. More jobs mean
more income, which translates to higher
spending.

The longer-term benefits come in the
form of cost savings for firms and
consumers. Energy intensive industries,
such as chemicals, steel, paper, and cement
would enjoy reduced expenses. The latest
example lies in BASF, the worlds largest
chemical maker by sales, recently
announcing escalating its investment along
the U.S. Gulf Coast, in an effort to escape
rising energy costs in Germany. Many
other firms are planning similar projects.
Foreign direct investment would increase.
On top of that, the prospect of rising
exports of natural gas and reduced energy
imports would further bolster U.S.
macroeconomic stability, by way of a
strengthening trade balance. On the
consumer front, falling energy costs free up
disposable income. Boston Consulting
Group (BCG) estimates that households
spend roughly 20% of their income on
energy, in the form of direct energy costs
(the electric or heating bill) and indirect
costs (via the purchase of goods and
services with priced-in transportation costs
and overhead expenses). Falling energy
and petrol prices this year have resulted in
savings used to offset higher payroll taxes,
which took effect at the beginning of the
year. As fracking picks up steam, costs for
consumers and producers will drop
further. Harold Sirkin, Senior Partner
with BCG, declares You have this big
windfall. We are not seeing the full impact
of this yet.

Sounds too Good to be True: Whats the Catch?

In the face of these benefits, there are
various drawbacks ranging from economic
feasibility to questions of true economic
impact and environmental concerns.

While optimists may point out
overpayment for land due to a tardy arrival
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Chart: RCS Investments
Source: EIA's Petrol supply Annual Vol 1, 2011
& Petrol supply monthly, both via Utah.gov




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6>
to the party, some prominent energy
players (Exxon, Shell, and BHP Billiton)
have become skeptical of the allure of dry
natural gas fracking. The threshold cost
for operating a well through its life cycle
stands at roughly $6 per million British
Thermal Units (BTUs) according to Rick
Grafton, CEO of his own asset
management firm and oil and gas pundit.
Tumbling natural gas prices since 2008
(down around 60% to about $4.40 per
million BTUs) have thus made economic
feasibility dependent on higher oil and
natural-gas liquids, which would make the
extraction of dry natural gas a by-product.


(Chart: Nasdaq)

According to The Economist, an oil price
of above $80/barrel makes drilling for
liquid and dry natural gas profitable. With
the price of West Texas Intermediate
trading at close to $100 per barrel, so far so
good.


According to Allen Gilmer, Chairman
and CEO of Drillinginfo, a firm that tracks
well yields, production from fracking in
tight oil formations declines by 60-70%
within the first year alone. Traditional
wells on the other hand take roughly 2
years to fall 50-55%. Unconventional oil
and gas extraction may pack an initial
oomph of energy production but lack of
staying power calls into question fracking
as a long-term tailwind for economic
growth. Those hopeful of fracking will
point out that drilling technology and
geological understanding of the terrain are
continually improving and will make it
more financially feasible to expand. A
better handle of the process will augment
yields from shale formations. This can be
seen in the Bakken Shale Formation by
reduced well spacing from initially 640-
acres to 160-acre without robbing adjacent
boreholes of their productivity, a term
known in the industry as communication
between wells.

In terms of contribution to economic
growth and opportunity costs, there are
bearish prognostications. Outside of
energy intensive industries, most industrial
sectors regard energy as a small cost in
their operations. This means that the long-
term benefits of lower energy prices may
not be all theyre fracked up to be. You
may have some industries move operations,
but not enough to make a substantial long-
term impact. Financially speaking, many
fracking firms enjoy tax benefits, but at the
expense of retained earnings. The flimsy
nature of these companies working capital
ratios thus makes them vulnerable to
mercurial investor sentiment. A period of
bearish emotion among financiers may
spell doom for many smaller firms.
Finally, you have the environmental and
social side effects of exploration:
contaminated ground water (videos have
!I l ook at shal e as more of a
retirement party than a
revol ution"
--Art Berman--
Petroleum geologist and
20-year veteran with Amoco





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66
shown tap water burst into flames), lack of
appropriate infrastructure to absorb
ballooning town and city populations,
increased crime; there have even been
reports of a higher incidence of
earthquakes due to unconventional
drilling.

Overall, Constructive.

True, the economic feasibility of fracking
makes the venture risky. However, rising
global populations, geopolitical uncertainty
(Middle East / China), and the
consequences of rampant money printing
will act as powerful tailwinds for elevated
oil prices over the longer-term, making
fracking a viable economic alternative.
Furthermore, the issue of energy
independence is important for U.S.
national security. Government will
support increased research on perfecting
fracking methods. Additionally, while
environmentalists / opposition groups may
put up a fight against enlarging fracking
activity, politicians are hungry for job
creation. While government officials will
listen to their side of the story, token action
will be taken. However, a matter of
concern does lie in the life of unorthodox
wells. This topic creates ambivalence.

Despite my earlier statement,
attention should be paid on the upcoming
assessment from the Environmental
Protection Agency on the impact of
fracking. Occasional monitoring of oil and
natural gas prices, to confirm economic
feasibility, would be prudent as well.
While a negative surprise may bring about
increased pessimism on the industrys
prospects, I would remain optimistic over
the longer-term. Finally, should fracking
prove more successful than expected, the
geopolitical consequences of a paradigm
shift in energy markets would be
interesting for further research.
Authoritarian regimes dependent on oil
revenues may begin to sweat.

>) Re-shoring: Likely or not happening?



Roughly 3 months ago, BCG published an
updated tally of manufacturing executives
at companies with sales of more than $1
billion who are planning to bring back
production to the U.S. from China or are
actively considering it. The results are
stunning and welcomed for the Obama
administration: last year the count was
37%, this year, 54%. BCG predicts that
this dynamic will create 2.5-5.0 million jobs
by 2020. Coupled with previous
investigation on lower energy costs
attracting foreign firms, the concept of re-
shoring seems to be picking steam.

Two key dynamics are at play.
According to Chinas National Bureau of
Statistics, labor costs have more than
quintupled since 2001 and more than
doubled over the past 6 years.


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Chart: RCS Investments Source: National Bureau of Statistics of China
!The resul ts of our l atest survey
make cl ear that a profound shift
in attitude is beginning"
--Harold L Sirkin--
Boston Consulting Group #BCG$
Senior Partner





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67

The loss of competitiveness doesnt end
there. The yuan has experienced an
appreciation of roughly 35% since 2000, of
which 25% occurred since 2007, largely a
result of political pressure from the United
States. Both are a lethal brew for a nation
that once prided itself as the worlds
lowest-cost producer.




There are reasons to believe that the
former trend will continue. Chinas labor
supply is dwindling. According to The
Economist, citing Chinese officials,
between 2010 and 2020, the countrys core-
working population (15-59 years of age) is
expected to fall by 30 million. Falling
supply is a harbinger of rising wages.
Another factor lies in rising minimum wage
requirements. Recent news of an increase
of 17% in the minimum wage by 27 cities
and provinces will raise demand for
household products and food, leading to
higher inflation. This inflation could lead
to further upward pressure on wages, a
vicious cycle. Finally, companies may
grow weary of dealing with constant
investigation from the National
Development and Reform Commission,
while state-owned enterprises receive
subsidies that create an uneven playing
field.

Aint Happening!

There are numerous reasons why the
re-shoring effect will be muted at best. To
begin: rising wages are not an indication of
falling competitiveness; instead they are the
result of rising productivity. As long as
productivity growth keeps in line with
wage growth, there is little loss of
competitiveness. A simple example follows:

Consider a worker who produces 1
widget per hour at a labor cost of $1
dollar per hour. Say his wage rises by
$1 to a new wage of $2 per hour, a 100%
increase. However through experience,
he is now able to produce 2 widgets per
hour, an equal increase in productivity.
The result ends the same, each widget
costs the firm $1 per hour. A wage
increase of 100%, complemented by a
100% increase in productivity makes no
difference in costs.

Second: Despite rising efficiency,
Chinas absolute measure remains very
low. Large differences in work efficiency
between the U.S. and China will
substantially mute the positive labor
market impacts of re-shoring. According
to The Conference Boards 2013
Productivity Brief, a Chinese worker
produced 17% of output produced by an
American worker. In essence, 1 American
worker yielded the same output as roughly
5.88 Chinese laborers. Therefore, a loss of
100,000 workers in the Orient would
translate to a gain of only 17,000 American
jobs. BCGs best-case scenario of 5 million
jobs created in America would mean a loss
of roughly 29.5 million in China. Granted
this is a rather blunt measure as every
industry is different, but it goes to show
that a large scale re-shoring would need to
occur for the benefits to be widely felt in
America, one that could destabilize China.

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68
Other arguments are the following:
Low-cost producers would likely move to a
country with lower manufacturing costs,
not back to the U.S. Furthermore why
would companies move away from the next
likely multi-decade source of consumer
demand? As for the argument of a
declining workforce, in addition to relaxing
the one-child policy, one of the plenums
reforms, news of increasing the retirement
age over the coming years will provide for
a slower rate of decline in labor
participation.

Verdict?

Even though it isnt evident in current
economic data, re-shoring is indeed an
ongoing phenomenon, exemplified by
BCGs drastic change of sentiment in its
latest survey. It will act as a tailwind for
economic growth in the U.S. in the years to
come. However, in view of the impactful
difference of absolute productively levels
with China, the ultimate reverberations of
this budding bullish catalyst may be less
than the hype presently suggests. Given its
long-term nature and early stage of
development, its ultimate effect will be
path dependent on policy actions in both
economic powerhouses as well as in
continued global economic growth.






(Continued)




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69
In Closing

Taken together, re-shoring and the rise of fracking provide for long-term optimism for
America, contradicting pessimistic forewarning of a prolonged period of secular stagnation.
Long-term reforms in China would strengthen the foundations for a protracted period of
expansion, which would benefit the rest of the world. However, investors must first traverse
numerous unstable bridges, to make it to the promised land of long-term sustainable growth.
The valleys are cavernous.



A political crisis looms if European stabilization fails to shift into first gear and beyond.
Meanwhile, large imbalances within China, dependence on fixed asset investment financed by
dizzying credit growth, will make global expansion pivotal as officials attempt to reverse this
long-standing trend. Could Fed tapering actually trigger a banking crisis in China? 2014 will
mark an important year for the global economy. As I stated in my prior outlook roughly one
and half years ago: If world leaders can successfully navigate the treacherous waters of
global restructuring over the coming years, eventually todays seemingly endless period of
weak economic performance will lay the foundation for a powerful secular bull market that
may last for decades. Until then, investing today will require flexibility, risk management, and
a willingness to embrace the fact that buy-and-hold investing has taken a back seat for the
time being.