CHAPTER 9

International Cyclical Impacts on Multinationals and Small Businesses

To set the stage for understanding cyclical developments around the world, we have seen in Chapter 2 that the U.S. economy has experienced recurring business cycles since the early days of the republic. Before the Federal Reserve was created in 1913, banking panics occurred frequently. The cause of 19th-century banking panics is attributed to the fractional reserve banking system, which creates new money that businesses, farmers, and individuals eagerly borrow.¹ Some of the new money was used for speculative purposes, such as land purchases, which drives up the price of many assets including commodities creating an unsustainable boom. As the new money diffuses through the economy and holders want to redeem their banknotes for specie—gold and silver—held in the banks’ reserves, lo and behold, the bankers did not have enough “real” money in their vaults. In short, a bank run would ensue, causing some banks to collapse followed by a depression.²

This reoccurring phenomenon of money creation, speculation, boom, malinvestments, crisis, and depression did not end with the establishment of the Federal Reserve, which was created for the express purpose of “stabilizing” the economy. For more than 100 years since the Federal Reserve was given the power to create money and manage interest rates, the business cycle has not disappeared. In fact, the historical record is clear. The Federal Reserve has destabilized the economy beginning with the forgotten depression of 1920–1921, created an unsustainable boom in the 1920s, and prolonged the Great Depression of the 1930s.

After World War II, the Federal Reserve continued to create new money and the boom-bust cycles persisted. And more recently “easy money” caused the dot-com and housing bubbles. (Figure 9.1 shows the ups and downs of the U.S. gross domestic product after World War II.)

Figure 9.1 Real gross domestic product (1950–2020)

Source: U.S. Bureau of Economic Analysis, Real gross domestic product [GDPC1], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/GDPC1, February 12, 2021.

The so-called everything bubble was well underway before the pandemic of 2020 struck the United States and world economies. The sharp rebound in the U.S. economy in late 2020, including the booming stock market and robust residential real estate price inflation, has reflected the enormous amount of liquidity the Federal Reserve poured into the economy since early 2020.

Prior to the pandemic, there was compelling evidence that the U.S. economy as well as other countries in the Group of Seven (G7) (Canada, U.K., Japan, Germany, France, and Italy) were slowing down or on the cusp of a recession.³ In other words, it was becoming more evident that the major economies of the world, except China, were in “sync.” (See the performance of several of the G7 economies in the following figures: Figure 9.2–Figure 9.7.) The graphs reveal the deceleration in economic activity before the pandemic and the plunge that occurred in 2020 as governments locked down their economies to stop the spread and the subsequent rebounds as restrictions were eased.

Figure 9.2 Real gross domestic product for Germany

Source: Eurostat, Real gross domestic product for Germany [CLVMNACSCAB1GQDE], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/CLVMNACSCAB1GQDE, February 13, 2021. © European Union, 1995–2021

Figure 9.3 Real gross domestic product for Japan

Source: JP. Cabinet Office, Real gross domestic product for Japan [JPNRGDPEXP], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/JPNRGDPEXP, February 12, 2021.

Figure 9.4 Total gross domestic product for Canada

Source: Organization for Economic Co-operation and Development, Gross domestic product by expenditure in constant prices: Total gross domestic product for Canada [NAEXKP01CAQ189S], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/NAEXKP01CAQ189S, February 12, 2021.

Figure 9.5 Real gross domestic product for the United Kingdom

Source: Eurostat, Real gross domestic product for the United Kingdom [CLVMNACSCAB-1GQUK], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/CLVMNACSCAB1GQUK, February 12, 2021. Copyright, European Union, http://ec.europa.eu, 1995–2016.

Figure 9.6 Total gross domestic product for Mexico

Source: Organization for Economic Co-operation and Development, Gross domestic product by expenditure in constant prices: Total gross domestic product for Mexico [NAEXKP01MXQ189S], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/NAEXKP01MXQ189S, February 13, 2021.

At the regional level, the United States, Canada, and Mexico, which are interlinked because of geography and/or culture, have had highly correlated business cycles in recent years. (See Figure 9.6 for Mexican economic performance.) Monetary policy in all three countries tends to be synchronous, which would prevent capital from flowing into one country at the expense of other countries in the trading bloc. The three North American countries have seen their business cycles become more correlated.⁴

International capital flows created bubble conditions in Mexico, Thailand, Iceland, and other emerging markets in the 1990s; the culprit was not surprising, easy money conditions in the United States and other developed economies provided the wherewithal for banks to lend what was thought to be extraordinary profit opportunities in these countries.⁵ As Aliber and Kindleberger observed:

The authors’ summary of the first (1970s) of the four waves includes Mexico, Brazil, and Argentina and other developing countries that borrowed heavily from Western banks that increased to unsustainable levels. The second wave unfolded in the 1980s, and is highlighted by “the mother of all asset price bubbles” in Tokyo as the supply of credit soared after bank regulations were eased.⁷ Investment inflows to emerging economies in Brazil, Argentina, Thailand, Malaysia, and others set the stage for the third wave, the 1990s financial crises.⁸ In the early 2000s, the fourth wave occurred when real estate bubbles unfolded in the United States, Britain, Spain, Ireland, and Iceland, among other countries, after another episode of easy credit made it possible for residential home buyers and purchasers of commercial real estate to bid up prices to unsustainable levels.⁹

Financial crises have occurred throughout the world for the past 400 years, mostly confined to one country or region. The events of the past 100 years reveal how crises have been more synchronous since the Great Depression of the 1930s. But even more fascinating is how the major industrial economies are virtually lockstep as their economies boom and bust together. This is not surprising given the similar policies of central bankers in North America, Europe, and Japan—namely, keep interest rates low and create money to boost output and employment. However, the evidence shows that these policies are counterproductive. The economic fluctuations since the mid-1990s continue with the downturns being more severe and unsettling for businesses of all sizes and workers.

Nevertheless, corporate managers who oversee tens or hundreds of millions or possibly billions of dollars of assets and small-business owners who serve their local and/or regional markets, they can survive and thrive despite the business cycle. The next two sections will focus on how decision makers in large-scale businesses or mom-and-pop shops can be better prepared to navigate the inevitable economic fluctuations that have become more internationally synchronized.

Opportunities for Multinationals

Trade is the lifeblood of civilization. Domestically, local and interregional trade creates a network of mutually beneficial relationships between buyers and sellers to achieve their goals. In cities and towns across America, shops located on Main Street and in a multitude of neighborhoods throughout a metropolitan area, entrepreneurs provide goods and services that satisfy the wants and needs of consumers. In addition, consumers benefit from trading with merchants across the national economic landscape. Supermarkets and grocery stores, for example, sell fruits, vegetables, and meat products that are shipped from farms and cattle ranches that are located hundreds if not a couple thousand miles away for consumers in the northeast and upper Midwest. Economic specialization, therefore, increases living standards by allowing entrepreneurs to provide the marketplace with products and services that consumers want.

International trade allows specialization to occur across the globe. For the United States, this means nearly $5 trillion of goods and services were imported and exported in 2020. Both imports ($2.81 trillion) and exports ($2.13 trillion) declined in 2020 because of the global pandemic, creating a trade deficit of $678.7 billion, an increase from 2019, when the deficit was $616.8 billion.¹⁰ In addition, when all the numbers are tallied for 2020, global trade probably contracted by 8 percent, but may rebound to prepandemic levels in 2021.¹¹

Despite the challenges entrepreneurs around the world faced during 2020 because of the pandemic, there are nevertheless compelling reasons for U.S. businesses to export their goods and services to the rest of the world. The most obvious reason is that 95 percent of the world’s consumers reside outside United States and have 84 percent of global spending power.¹²

Major benefits for both small and large businesses that export include higher productivity. According to data compiled by the U.S. Census Bureau and the U.S. international trade commission, businesses with less than 250 employees had nearly two times more revenue than non-exporting firms, and generated 70 percent more revenue per employee.¹³ Additional research concluded that workers earn more in industries where exports are a major component of the local economy; exporting firms tend to have higher revenues, faster revenue growth, and higher labor productivity. Lastly, according to one academic study, “exporters file seven times MORE patents and deliver four times MORE product innovations than their non-exporting peers.”¹⁴ The overwhelming evidence is undeniable—no matter what, the size of the firm exporting is a pathway for substantial business success.

However, trade throughout the world is less “free” than it otherwise would be because of the confluence of several factors. Countries use various policies to boost and/or hinder trade such as quotas, tariffs, subsidies, foreign exchange manipulation, and taxes—among other tools—to manage imports and exports. Managed trade creates “winners and losers” such as consumers who have to pay higher prices for imports, importers who may see their supply chain disrupted, workers who may lose their jobs, and companies that may see their revenue decline because of interventionist trade policies. Apparent winners from managed trade include domestic companies whose overseas competitors may ship fewer goods to the United States because of tariffs and/or quotas—and thus would be able to raise their prices. Workers in so-called protected industries may have their wages raised as the firms they are working in expand and need to attract more workers. On the other hand, if companies that are hurt by protectionist measures have to lay off workers or shut their doors, the unemployed workers may depress wages in industries that presumably are supposed to be the beneficiaries of higher tariffs, and so forth.

Managed trade has many unintended consequences. Nevertheless, businesses have to keep their eyes on the prize, which is creating value in the marketplace, both domestically and possibly internationally.

The trade war with China that began during the Trump administration has rattled American businesses. Both importers and exporters have had to deal with another contentious factor in doing business with America’s largest trading partner. In fact, one consequence from the trade tensions with China and the pandemic is the shift in direct foreign investment from the United States to China.¹⁵ Foreign direct investment (FDI) in the United States has been declining since 2016, when it peaked at $472 billion. China, meanwhile, has attracted FDI as a strategic policy to provide employment for its massive labor force, and its ability to remain relatively open during the pandemic.¹⁶ China’s growing GDP is illustrated in Figure 9.7.

U.S. companies that have been in China or even thinking of entering the Mainland may want to follow the suggestions of David Nordstrom, the chairman of consulting firm PRI, and John Evans, managing partner of Tractus Asia. Their advice was recently reported by Robert Hess, vice chairman of Newmark Knight Frank, in his summary of Nordstrom’s and Evans’ presentation about the Chinese market.¹⁷ Needless to say, the suggestions are what you would expect—they range from sourcing the materials outside of China to making products for the Chinese market and non-U.S. markets as well as negotiating better terms from Chinese suppliers and other tactical and strategic initiatives to maintain a presence in China and overseas locations.¹⁸

Figure 9.7 Historical real GDP at constant national prices for China

Source: University of Groningen and University of California, Davis, Real GDP at Constant National Prices for China [RGDPNACNA666NRUG], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/RGDPNACNA666NRUG, February 12, 2021.

One of the most successful U.S. multinationals that has grown into an international “behemoth,” Estée Lauder, began as a New York–based cosmetic company in the 1930s whose founder was “a genius at sales,” according to 87-year-old Leonard Lauder, son of Mrs. Lauder.¹⁹ Lauder recounts how the company went from less than $1 million in sales (1958) to more than $14 billion in revenue in 2020, and is now worth more than $107 billion (February 2021), making the Lauder family one of the wealthiest in America.

Lauder took the company global and its 25 brands are now sold in 150 countries. According to Lauder, “We were one of the first companies to enter the Asian market. If you’re the first to market, you always win.”²⁰ Lauder hopes his book (published in November 2020) is an inspiration to anyone who is willing to work, persevere, and be optimistic about the future so they can achieve great success just as the company his mother founded in the midst of the Great Depression.²¹

The bottom line for multinationals could not be clearer. Knowing the economic, financial, political, and cultural landscapes of overseas markets and having a product(s) or service(s) that will be in demand plus having all of the key personnel in place makes for a successful formula to penetrate non-U.S. markets. The growth and success of Estée Lauder since the Great Depression occurred despite World War II and the numerous boom and bust cycles since the economic calamity of the 1930s. Nevertheless, companies with more economically sensitive products or services should be able to survive and thrive during the boom-bust cycle by implementing the tactics and strategies outlined in previous chapters. If business is about “survival of the fittest,” corporate managers and small-business owners who are best able to identify the coming peak of the boom and take necessary actions to limit the “damage” during the bust will continue to prosper in the years and decades ahead.

Small Business Opportunities

Just as adults once were infants and youngsters, large businesses were once small businesses that may have started in someone’s basement, on a dining room table, or in a garage. As a small business grows, over time it may become a “behemoth” like Apple, Microsoft, Netflix, Amazon, Facebook, Tesla, and scores of other businesses that operate around the world. The common thread of all these businesses is the vision of their founders and their focus on the long-term sustainability of their firm with products and services for the masses. Another entrepreneur who could be added to the above list is Warren Buffett, CEO of Berkshire Hathaway since 1965. Buffett took an $11 million declining New England textile company and turned it into a $500 billion conglomerate nearly 60 years later. Buffett’s genius was not that he had a product or service to sell to the masses, but that he was the “great allocator” of capital that allowed him to purchase companies such as GEICO, Dairy Queen, Benjamin Moore, Fruit of the Loom, Duracell, See’s Candies, and other businesses in a variety of industries.²² Berkshire owns a $275 billion portfolio of stocks including Apple, Coca-Cola, American Express, and dozens of quality companies, including foreign businesses.²³

For Warren Buffett, the secret of his success was realizing that compounding money over the long term would lead to wealth and possibly great wealth, a lesson he learned when he was 10 years old.²⁴ As Jason Zweig points out in his summary of Buffett’s investment philosophy, “Even at low to moderate rates of return, long periods of continuous growth turn small amounts into mountains of money.” Warren Buffett’s long-term perspective has paid off for him and his shareholders, whom he calls partners. Berkshire’s stock has increased by more than 2.7 million percent since 1964 or more than 20 percent compounded annually, while the S&P 500 has increased slightly—nearly 20,000 percent, or about 10 percent compounded annually. In addition, the price of Berkshire Hathaway stock has declined by about 50 percent four times during Buffett’s helm as CEO. This did not faze Buffett at all. The following chart (Figure 9.8) shows the decline of Berkshire’s stock price both during the dot-com bubble burst and the housing bubble bust. Despite these “setbacks” over the long term, the stock price of quality businesses will be much higher than the day when the stock is purchased. As of March 2021, Berkshire’s stock rose above $400,000 for the first time.

Small business owners are in many respects in the same position Warren Buffett was in when he took over Berkshire in 1964. Buffett did not have to start from scratch, but his challenge was how to use the assets of Berkshire to generate shareholder wealth. Buffett successfully utilized the investment skills he learned as graduate student of the father of value investing, Benjamin Graham at Columbia University, to become the “world’s greatest investor.” Buffett, however, does not consider himself an “investor,” but an entrepreneur who takes a very long-term view of business. The same mindset could be said for Jeff Bezos, the late Steve Jobs, Reed Hastings, and Elon Musk, who are (or were) not focused on short-term profits but on creating value for customers.

To tap into the international markets, where most of the world’s customers live, U.S. small business owners can begin by obtaining tools that are available from the federal government, such as Ten Free Tools to Help You Become an Expert in Exporting.²⁵ In addition, small business owners should take advantage of the information available in the Office of the U.S. Trade Representative, which contains the terms of free trade agreements and other international protocols to facilitate trade around the world.²⁶

Figure 9.8 Performance of Berkshire Hathaway stock (1995–2021)

Courtesy of Stockcharts.com

There are enormous opportunities for small businesses to export their goods and provide their services to scores of countries around the world despite the boom-bust cycles, which have become more synchronous. That could work to a small business’ advantage. Booms tend to last longer than busts and therefore small business owners who keep their finger on the pulse of business conditions are in a strategic position to ride the wave of the boom and take appropriate measures when the economy begins to slow down. When the bust occurs that is when small business owners can gobble up assets at depressed prices to ride the wave of the next boom.

Although the major economies of the world probably are more in “synch” than ever before, as the boom-bust cycle has linked the U.S. economy with many of our trading partners, small businesses should have an advantage over large corporations to deal with deteriorating economic conditions. Small business owners should be able to adjust their plans quickly when the bust is on the horizon, especially if they have a set of “what if” scenarios they could choose from to implement a “survival” strategy. Of course, if corporate managers also employ the tactics and strategies outlined here, they too would survive—and thrive—as the boom-bust cycle unfolds.

Over the long term, small business owners will be able to take their one-million-dollar-or-more business to a level of great success as long as they have a niche in the marketplace and, as Buffett would like to say, a large “moat” to keep their competitors at bay.