Wall Street Prep Net Working Capital

[Saraid Madnick]

Welcometo Talks of the Trade. I'm your host, James Fraser. In a rapidly evolving global landscape, changes in manufacturing, security priorities, and emerging technologies are reshaping international trade. From our previous episode, my conversation with geopolitical strategist Peter Zeihan continues.

Well, let's start with the obstacles to technology in general. Having a robust tech sector, no matter what you're doing, requires a lot of very, very smart, well-educated young people to imagine the future and then to figure out the process from the idea, to operationalization, to mass manufacture.

And that's been the environment that we've been in demographically in the United States for the last 25 years. I mean, basically, that is the millennial cadre. But then you also need a huge amount of capital because none of that makes any money until you're at the tail end of it. We've been in that environment for the last 20 years because of the baby boomers having approaching retirement but not yet retired.

Well, in the last five years, that both flipped. The older millennials are now mid-forties. They're no longer the young bucks. The next generation down, Gen Z, is very small. And the baby boomers are liquidating their savings. So the capital supply isn't there. So even if nothing else breaks, for a technology to be on the verge of mass application, it has to already be through prototyping. And maybe AI is proving right now with things like large language models that it is on that threshold. So maybe it can happen.

And if it does, the applications are nearly endless. I'd say that the big four, automation for manufacturing, which could help us in any number of ways. Digitization of agriculture, which could potentially double yields. The defense applications are massive. And then in the financial space, it's all going to be about efficiency. So those are the big four. That could work.

Problem. AI requires the most advanced semiconductor chips that we as a species are capable of making. And 90% of those chips come from one town in Taiwan. And that makes it sound better than it is. Because it takes thousands of companies to keep those fabrication facilities running, those companies are scattered around the world, and half of them only produce one product for one end user, and they have no international competition.

So you peel off any country from the globalized order, and we just can't make the chips at all. So we're going to have to do something that we really hate doing. We're going to have to choose. Do we use AI for finance, or defense, or manufacturing, or ag? Because we're going to have to basically choose one, and we're only going to have enough chips for one big application. And everything else, we're going have to find another way.

In the era of globalization, we saw a steady shift in manufacturing capacity. Within global supply chains, we saw specific countries, particularly in the last 20 years, begin to emerge with specialized manufacturing capacity. The likes of South Korea, Taiwan, China come to mind.

Everyone's going to have a little bit of reshuffling they need to do. So demographics, of course, are core to this because when you have a traditional pre-industrial demographic, you've got lots of children, very few retirees, and kind built into a pyramid as you go up in age. But as you develop, it opens up into a chimney. And if you keep aging, it turns into an inverted pyramid.

Now during that process, you can have a lot of really interesting things going on. Because when you turn into a chimney, you've got a lot of people who are generating capital in their 40s and 50s. You've got a lot of young workers in their 20s and 30s. It's a dynamite combination for growth, especially industrial growth. And when it opens up more, you get workers, 40 to 60, who have decades of experience in highly productive. And that's where the Koreans are, for example.

And during these demographic moments in time, you can get incredibly productive workers with a lot of capital wired into a security environment that's pretty safe, but it's not sustainable over the long run because those advanced workers turn into retirees. And so you get a system that has basically rebuilt the culture around an industrial process that they can't sustain.

Then you add the national security component. It's like the big advantage that the Chinese have had when they belly up to the bar with their workforce is scale. We have to find a way to do that because their workforce is no longer cost competitive. It's going to look different. And if national security issues push this forward, that means we need to figure out a way to do it at scale with a workforce that's a completely different price point and completely different labor structure.

Technology can help with that. But all of this costs money. And we need to do it relatively quickly because we don't have 30 years like it took to build the industrial plant in East Asia. So we have to figure out how to do specialization at scale in dozens of subsectors within five years in an environment of shrinking capital and labor supplies. It's going to be a wild ride.

So we recognize that investment needs to be made in new markets, which may in fact be old markets. So we've seen foreign direct investment in Mexico and in the United States really have a parabolic move in the last two years, which I think links exactly to your point. What is the capacity of the United States and Mexico to absorb that shift in production?

We need to double the size of the industrial plant within North America by the end of the decade, and not everyone can play at the same scale. Mexico probably needs to triple, if not quadruple, its industrial base, and there's no way you do that on the model of NAFTA, because the NAFTA relationship, to be perfectly honest, it's the northern Mexican states and Texas. That's the reality of NAFTA.

We need to diversify that into Central Mexico and then going up into California in the Midwest. That requires a multi-trillion dollar infrastructure build out before we can start the industrial buildout. The scale of that is something we have never attempted as a country, much less a continent.

Core to your thesis, looking forward for the next 10 years, is demographics. What do the demographics look like in the United States, in Mexico, and how do we think about that on a relative basis compared to the rest of the world?

The United States is one of those open chimney economies right now, where we're aging but much more gently. We have this transition period that's going to be tight. But the millennials have made sure by their existence that we will get through it. You don't have that in most of East Asia. You certainly don't have that in most of Western Europe. And so we're looking at the end of those systems and that industrial plant. The parts that we feel that we need, we're going to have to rebuild here.

Mexico very late to the game. They really only began industrializing in 1990. And so their population structure is the youngest of the major countries in the world. If they keep aging at their current rate, they're not going to face a crisis of German proportions until at least 2080. That's a lot of time to figure out a new model. It's a lot of time to figure out how to increase your birth rate. And they will have plenty of examples of what to do and what not to do over the next 50 years. So I'm pretty bullish there.

It also means that because they fixed their educational system before they industrialized, on a productivity basis, they're arguably the most efficient workforce in the world. Their workers now are about twice as skilled as China's, and they work for one third the cost. So the potential here for expansion is immense. The challenge is infrastructure. Linking in Central Mexico into the NAFTA network. If we can do that, the rest of it will happen organically. But we have to do that first.

As we enter this new era where there's a trend of deglobalization, we've seen, particularly in the last two years, these tectonic shifts in cross-border trade, where increasingly, it looks like the East will trade with the East, and the West is trading with the West. However, there are countries which have emerged with a far more neutral stance, which seem to be positioning themselves to take advantage of that shift. India comes to mind. Saudi Arabia comes to mind. Where do you see those two countries--

Two radically different examples there. OK. Let's start with India because from my point of view, that's actually pretty straight forward. India has to do the same thing that we need to do in North America. They need to expand their industrial plant if they still want manufactured goods because the Chinese aren't going to be there all that much longer.

The difference between India and the United States is that the United States has partners in that process. We have NAFTA already. Mexico is already our number one trading partner, a position they're not going to give up in our lifetimes. And that allows us a differentiated system that we can hit the value add at multiple points of the process.

India is arguably among the most trade protectionist countries out there. So any participation in broader supply chains is going to be starkly limited and unstable. They're going to have to do it themselves, for themselves. Now this is a country with a billion and a half people. It has a differentiated labor market. Linking those parts and the subregions together is going to be an immense task.

But just like it will be here, it's a growth story. Inflationary, of course, but a growth story. And I have no doubt that 20 years from now, India will have succeeded because the alternative is just not to have finished goods. So the market is going to push this. The question is whether governments can assist it in some way. And since that's largely an infrastructure problem, I'm pretty bullish on that.

Saudi Arabia. You take all of the countries of the Persian Gulf combined, they have less of an industrial plant than the country of the Philippines. There was nothing there to work with. They've got great infrastructure. Most of the skilled labor force is imported from other continents. And the Saudis of late have decided that they don't want immigrants from certain countries. And so they've done a purge.

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