Scientists who work on cancer research have long struggled with a painful choice: If they make the treatment powerful enough to have a fighting chance at destroying cancer cells, it is likely to destroy the surrounding tissue. But if the treatment isn’t strong enough, the cancer cells will survive and possibly spread.

Now, nanotechnology is offering hope for new treatments that overcome this dilemma. Nanotech is the science of working at an incredibly small scale; a nanometer is less than one-ten-millionth of an inch. Evidence is mounting that cancer treatments based on nanoparticles can target cancer cells with a degree of precision that was unthinkable just a few years ago.

Researchers are making progress along several paths simultaneously. Let’s take a look at some of the most promising new developments.

At Yale University, researchers led by Professor W. Mark Saltzman have developed an innovative way to deliver cancer-fighting drugs to brain tumors by injecting therapeutic nanoparticles into the brain with a catheter, and then using pressure to guide them to the tumor.¹

As reported in the journal Nature Materials,² the nonviral nanoparticle developed at Yale is able to act like a virus to introduce a specific gene into diseased cells in order to kill or repair them.

This is a big improvement over conventional nonviral gene therapy agents, which often carry a positive electric charge that can kill healthy cells. It is also safer than viral gene therapy treatments, which can cause significant immune reactions.

Saltzman’s team overcame the problem of excessive charge by making the new nanoparticle more hydrophobic (water-repellant) and thus less likely to form chemical bonds with water molecules. Specifically, the team incorporated safe, water-insoluble units into the polymer that generates the nanoparticles. This reduces the positive charge and increases stability. The result is an efficient mechanism for gene delivery that is also extremely safe.

Meanwhile, at the University of Southampton, scientists have developed smart nanomaterials that can disrupt the blood supply to cancerous tumors.

The team of researchers, led by Physics Professor Antonios Kanaras, showed that a small dose of gold nanoparticles can activate or inhibit genes that are involved in angiogenesis — a complex process necessary for the supply of oxygen and nutrients to most types of cancer.

The team focused on endothelial cells, the cells that make up the interior of blood vessels and play a pivotal role in angiogenesis. As the researchers explained in the journal Nano Letters,³ they use a technique called laser irradiation. The team shines light on the gold nanoparticles with a laser beam, which is able to destroy the endothelial cells and cut the blood supply to the tumor.

Researchers at Cornell University are using a similar approach.⁴ Led by Professor Carl Batt, the researchers synthesized nanoparticles made of gold sandwiched between two pieces of iron oxide. They then attached antibodies, which target a molecule found only in colorectal cancer cells, to the particles. Once bound, the nanoparticles were engulfed by the cancer cells.

To kill the cells, the researchers pointed a laser at the nanoparticles. The gold in the nanoparticles absorbed the radiation from the laser, which caused the cancer cells to heat up and die. As described in the journal Nanotechnology,⁵ the surrounding healthy tissue was not harmed.

The researchers are now working on a similar experiment targeting prostate cancer cells.

Of course, there’s one shortcoming to techniques using lasers: If the cancer occurs in a place where a laser can’t reach, it won’t work. To remedy that problem, scientists at the Georgia Institute of Technology have coated gold nanoparticles with a chemical that brings them inside the nucleus of the cancer cell and stops it from dividing.

In the Journal of the American Chemical Society,⁶ Professor Mostafa El-Sayed, director of the Laser Dynamics Laboratory at Georgia Tech, explains that once a cancer cell stops dividing, apoptosis sets in and kills the cell. According to El-Sayed, “In cancer, the nucleus divides much faster than that of a normal cell, so if we can stop it from dividing, we can stop the cancer.”

The researchers tested the hypothesis on cells harvested from cancer of the ear, nose, and throat. They decorated the cells with a peptide called RGD to bring the gold nanoparticles into the cytoplasm of a cancer cell. They also used a peptide called NLS to bring the gold into the nucleus.

Previous studies had shown that just delivering gold into the cytoplasm has no effect on the cancerous cell. The new study revealed that implanting the gold into the nucleus effectively kills the cell.

The gold works by interfering with the cells’ DNA, although the researchers aren’t sure exactly why it works. That will be the subject of another study.

What matters is that it works — and it works even on cancer cells that can’t be reached with the laser.

Another ingenious method involves heating gold nanoparticles with alternating magnetic fields rather than with a laser. At the University of Georgia, scientists have found that head and neck cancerous tumor cells in mice can be killed in half an hour without harming healthy cells.

The findings, published recently in the journal Theranostics,⁷ mark the first time to the researchers’ knowledge that this cancer type has been treated using magnetic iron oxide nanoparticle-induced hyperthermia, or above-normal body temperatures, in laboratory mice.

The team, led by Assistant Physics Professor Qun Zhao, found that the treatment easily destroyed the cells of cancerous tumors that were composed entirely of a type of tissue that covers the surface of a body, which is also known as epithelium.

For the experiment, Zhao injected a tiny amount of nanoparticle solution directly into the tumor site. Next, he placed the mouse in a plastic tube wrapped with a wire coil that generated magnetic fields that alternated directions 100,000 times each second. The magnetic fields produced by the wire coil heated only the concentrated nanoparticles within the cancerous tumor, and left the surrounding healthy cells and tissue unharmed.

Similarly, Virginia Tech researchers are investigating the use of magnetic fluid hyperthermia to heat and destroy cancerous cells.⁸ The procedure has been used successfully in prostate, liver, and breast tumors.

According to the researchers, who presented their findings at a recent meeting of the American Physical Society Division of Fluid Dynamics, they injected magnetic nanoparticles into the body intravenously. The nanoparticles then attached to the cancerous tissues. When the researchers added a high-frequency magnetic field for 30 minutes, the particles heated up, raising the temperature of the tumor cells.

Just as in the other studies, the heated cancer cells died, with no adverse effects to the surrounding healthy tissue.

To further perfect the technique, graduate student Monrudee Liangruksa and her colleagues tested the effects of different types of magnetic nanoparticles. The most promising varieties were iron-platinum, magnetite, and maghemite. But because iron-platinum is toxic to humans, the most biocompatible agents are magnetite and maghemite.

Based on this compelling research, we offer the following forecasts:

First, nanotechnology will deliver cancer therapies with unprecedented power and fewer side-effects than chemotherapy.

The success of the experiments we’ve considered, as well as several others that are similar, points to what promises to be a highly effective, precisely targeted approach to destroying cancer cells, and only cancer cells. If the results of clinical trials on human subjects, which are still years away, prove to be just as successful, we will finally have a therapy that can completely eradicate the cancer from a patient’s body — and without the painful, debilitating side effects of current treatments such as chemotherapy. Combined with advances in gene therapy, nanotech could make the treatment for cancer as routine and effective as LASIK eye surgery.

Second, nanotech will also revolutionize medical diagnostics, with faster, more precise, and less invasive tools.

The image above shows cancer cells with gold nano-particles inside them. When the cells try to divide, the nanoparticles prevent them from reproducing.

As always, a patient’s outcome will depend in part on how early the cancer is detected. With nanotech-based diagnostics, rather than waiting for weeks for a test result, doctors and patients will be able to get a diagnosis in minutes, during a single office visit. Magnetic nanoparticles will enhance today’s x-rays and MRIs, allowing technicians to find smaller tumors that would otherwise go undetected. Advances in sensors, such as a nanotech artificial nose, will enable doctors to quickly identify lung cancer in a patient’s breath in much the same way a traffic cop uses a breathalyzer to detect alcohol on the breath of an impaired driver. Doctors will be able to determine whether a tumor is benign or malignant without the pain and expense of surgery or an invasive test.

Third, nanotech-based treatments for cancer will not be available until 2018 or later.

It can take several years for the FDA to approve a new treatment to be tested on humans, and additional years before it is approved for mainstream use. One important consideration will be determining the long-term effect of gold nanoparticles on the human body.

Fourth, nanotech-based cancer treatment will have an enormous impact on healthcare costs.

According to the National Cancer Institute, almost 50 percent of Americans born today will be diagnosed with cancer at some point during their lifetimes. In addition to all of the suffering that cancer causes, it creates a financial burden on families and the overall economy. A survey by USA Today, the Kaiser Family Foundation, and the Harvard School of Public Health found that 25 percent of cancer patients use up all or most of their savings in paying for cancer treatments.⁹ At a national level, according to The Atlantic,¹⁰ government actuaries at the federal Centers for Medicare and Medicaid Services predict that healthcare costs — of which cancer care is one of the largest expenses — will reach $4.7 trillion and 19.6 percent of GDP by 2019. The New England Journal of Medicine¹¹ reports that annual direct costs for cancer care are expected to go up from $104 billion in 2006 to more than $173 billion in 2020, due to major increases in the costs of therapy and the extent of treatment. Fortunately, those are likely too pessimistic: Once the new nanotech-based technologies are approved, earlier, faster diagnoses of cancer, followed by faster, cheaper, less harmful and more effective cancer treatments, will dramatically cut healthcare costs for individuals and eliminate much of healthcare’s drag on the economy.

Although there has been talk of it for years, many Americans are not fully aware of what the Smart Grid is. Most are aware of “smart meters” and “green energy,” which can be components of this grid, but that’s not the complete picture.

The key differentiators between the Smart Grid and our current electrical grid are those features that provide two-way interaction between a utility company and its customers. Some experts define it as a bi-directional supply chain that uses information technology to connect power generation to transmission, distribution, and consumers.¹

Another way to think of it is as the “cloud computing” for the utility industry, where “Web 2.0 technologies” will operate sophisticated switching systems to better route electricity through the system. It will also provide productive ways to use and deploy monitoring technology.

In practice, the Smart Grid will use consumer interfaces such as in-home displays, as well as programmable communicating appliances and smart meters to monitor power usage and gather other data at a house or office building.

The smart grid network will route the data it collects to the utility where analytical software and customer information systems will be used to control various functions, such as consumption patterns, demand response, pricing, and load balancing. The feedback loop will be completed when actionable information is sent back to the customer.

It is this two-way connection that offers both benefits and drawbacks. First, we’ll examine the benefits being promised by advocates of the Smart Grid. Then, we’ll consider some of the negatives.

This two-way “power conversation” between electrical devices and energy providers is being promoted as a democratization of electricity decisionmaking. A key benefit being cited is that the data unleashed will allow consumers to adjust energy consumption to their own individual preferences. They will be able to control their electricity consumption to a degree that satisfies their gadget obsessions, reduces their emissions profile, and manages their energy bills.

The Smart Grid is also expected to deliver more accurate price signals, appropriate information feedback, and technology to help manage energy use. Many experts believe these factors, when combined, will enable residential consumers to cut their peak demand by 30 percent as well as reduce power consumption overall.

The key to making this happen are the interoperability standards that will allow smart appliances and other electrical devices to automatically react to changing electricity prices.

For consumers, the major benefit would be a more efficient use of energy. In addition, this will make local generation systems more practical — and this could make individuals less dependent on utilities for electricity. In fact, the potential for selling your excess electricity from solar panels or fuel cells back to the utilities is a selling point for the Smart Grid.

A Conceptual View of the Smart Grid

For utilities, the Smart Grid would provide efficiencies for both measuring losses in the system and targeting repair efforts. Efficiency improvements would also allow power companies to generate less capacity compared to the power that is actually delivered and consumed.

Better failure prediction models enabled by the Smart Grid would allow problems to be averted before they cause outages.² This would greatly reduce the potential of so-called “cascading failures.”

For power companies, another appeal of the Smart Grid will be its ability to amass useable data which will let them use a more distributed and “local” business model. This will permit them to move away from very large central generation and core transmission networks, with their very high fixed costs and transmission losses.

In short, utilities, counties, municipalities, and cities see the Smart Grid as a path to greater energy efficiency, reliability, and scale. For consumers, it could offer the ability to respond to dynamic retail electric rates as a way to manage their energy costs.

Paul Centolella, a commissioner on the Public Utilities Commission of Ohio, offers the following summary. “A smart grid that enables dynamic pricing could reduce investment requirements, facilitate cost-effective electric vehicle charging, lower carbon emissions, elicit demand changes that improve system reliability, give consumers greater control over their electric bills, provide incentives for innovation, and allow a high penetration of wind and solar energy.”³

The push for the creation of the Smart Grid is also being fueled by the state of our current grid, which is 50 to 100 years old.

Blackouts and brownouts have become common, and many experts point to three contributing factors:

1. The slow response times of mechanical switches
2. A lack of automated analytics
3. “Poor visibility,” that is, grid operators lacking situational awareness

The impact of power losses can be profound, with such consequences as the halting of plant production, the spoiling of perishable food, the darkening of traffic lights, and the interruption of credit card transactions.

A Smart Grid, so the experts say, would alleviate the shortcomings of the current antiquated grid.

But this new grid would come with its own drawbacks.

The major roadblock is that the Smart Grid will be expensive. Telemetry, data storage, and new software, as well as monitoring and management systems, would all come at a cost. The companies that provide these systems and the utilities that use them will be adding their costs to the system.

There will also be additional costs for the consumer who wants to realize any savings from the Smart Grid. Smart appliances, which people don’t own today, will be needed, and initially these will be more expensive.

As a general rule, it won’t make economic sense to replace existing, working appliances, and there’s no guarantee that when the time comes to replace a broken appliance that a smart one will pay for its added cost in a timely manner. In addition, there’s concern that the Smart Grid is a recipe for much higher bills in peak months.

The bottom line is that, while the Smart Grid will be more reliable, it will probably not be cheaper over the short- or medium-term, and this will be a major roadblock to it being implemented.

Another serious concern will be security.⁴ Any time that data begins to flow, there is the risk of that data being compromised. In the electrical grid, it could mean more than the misuse of that data; it could mean the crippling of the power grid by bringing down the network and reducing service quality.

The recent deployment of the “Stuxnet” worm revealed that utility companies are already vulnerable. As the grid becomes more dependent on the flow of data, clever hackers will have even more opportunities to exploit critical infrastructure vulnerabilities.

A corollary to the security threat is a concern that customers have about privacy. Individuals are compelled to guard their personal information.

Many experts have already been surprised at how patients are balking at the use of electronic medical records and ePrescription technologies in the healthcare industry due to privacy concerns. The same is likely to be true in the power industry.

Will people accept the fact that their power company knows when they are using a hair dryer or a computer? Or the fact that this type of information can be compromised? These types of concerns will be a significant hurdle in the realization of the Smart Grid.

It’s conceivable there will be resistance at the utility level as well, since one of the key promises of the Smart Grid is that it will enable customers to use less electricity, something most energy providers would question as a positive step forward.

Considering this trend, we offer the following forecasts for your consideration:

First, incentives will need to be offered to get consumers on board with the Smart Grid.⁵

Certainly, marketing campaigns will make new smart devices attractive, and early adopters will jump in. However, the vast majority of potential consumers will need incentives to purchase new products that will be priced higher than existing appliances. Undoubtedly, the government will attempt to step in and pass legislation requiring households to obtain certain devices. As history has shown, it will also insert itself into the free market and pick winners and losers.

Second, the implementation of the Smart Grid will be a slow process.

Between now and 2030, this grid will slowly emerge. It will be part of the broader distributed power paradigm that will mix fuel cells with other distributed generating capacity, such as photovoltaic and traveling-wave nuclear energy. Rather than a sweeping, overnight retro-fit conversion, it will be a drawn-out process where the issues of privacy and security will be weighed against any positive economic ROI. In countries such as India or China, where dramatic increases in demand make it necessary to put in whole new infrastructures, a Smart Grid makes sense. But for the U.S. and much of the EU, it will be a hard sell.

In the April 2012 issue of Trends,¹ we highlighted the breakthroughs in agriculture and food processing that are emerging to supply the world’s growing demand for food. This month, we’re focusing on the factors driving the dramatic change in the quantity and quality of that demand, and their implications.

To get an appreciation of what’s ahead, consider this: By 2060, it is estimated that the world’s 9.1 billion people will demand at least 70 percent more food than today’s 7 billion.² Between now and then, it’s estimated that the world will consume more food than has been consumed since the beginning of agriculture 10,000 years ago.

This demand won’t only be due to an expanding global population. If trends hold, increased demand will also come from an increase in food consumption per person, per day. Figures from 1966 show this global per-capita consumption at 2,358 calories per day. For industrialized nations, the number was 2,947 calories. By 1999, the global number had risen to 2,803 calories per day, and the industrial number had risen to 3,380. Projections put the global average at 3,050 calories per day by the year 2030, with the industrialized average climbing to 3,500 calories.

Two countries that will particularly influence demand for food will be China and India, due mainly to the sheer size of their populations.³ Combined, they represent one-third of the world’s population. Though lagging behind industrial nations in per-capita calorie intake, both are on the rise. In East Asia in 1966, daily intake was 1,957 calories. By 1999, it had grown to 2,921 calories. Predicted intake by 2030 is 3,190 calories. Multiplying these increases over billions of people will have a substantial effect.

Experts predict that the Chinese population will grow and reach its maximum by 2030, after which it will decline. During this time, as China becomes more industrialized, its nutritional demands will likely shift to foods that require more water to produce, such as beef.⁴ This will stress China’s already scarce water resources, which in turn will undoubtedly force China to become a net importer of certain foods.

Evolving food consumption in India is also expected to place new demands on global food supplies. From 1994 to 2000, per-capita consumption of cereals dropped slightly, while meat, egg, and fish consumption saw an increase of about 20 percent. During this same time period, milk and milk products showed a substantial increase of around 44 percent.

Other global population trends that will affect the nature of food demand in the future include the growth of mega-cities with populations of 30 million to 40 million people. By 2060, urbanization will mean that the world’s cities will cumulatively cover an area the size of China. It is estimated that half of the world’s available fresh water will be used by these urban dwellers, and the food and nutrients they discard will be enough to feed 5 billion people.

The Challenge to Produce Enough Food Will be Greater Over the Next 50 Years Than in All Human History

The nutritional demands of the growing and changing populations will create shifts in the types of foods that are consumed. As a result, some experts believe that by 2060 as many as 10 billion people will desire a better diet. It that case, it is likely that total demand for food will have doubled from present levels.

But it won’t be just the population growth and changing tastes that will alter our diets. There will be additional factors. One of the biggest will be the scarcity of the resources needed for food production, including:

• Water
• Arable land
• Petroleum
• Petrochemicals
• Fertilizers

Rising Affluence Drives Shift to Meat

This scarcity of resources is likely to make conventional methods of growing food more difficult, costly, and unsustainable. Therefore, alternative foods and methods will be developed.

Some analysts also expect to see a shift in our diets in reaction to a growing realization that our highly refined, highly processed food is causing deadly diseases, such as diabetes, coronary disease, and stroke. Today, those maladies account for nearly half of all deaths across the world.

If we could see the food the world will consume in 2112, it would be as unfamiliar to us as our current cosmopolitan diet of fast food and ethnic fare would be to people from 1912. The food in 50 and 100 years will be much more diverse, interesting, healthy, resource-efficient, and creative.

Our current diet consists of a narrow band of the options available. While we generally only eat food derived from a few dozen different plants, agricultural scientists have compiled a database of 25,000 different edible plant species. We have also limited consumption of animals to about a dozen types.

Because many vegetables use far less soil, water, energy, carbon, and fertilizer to produce than grains or meats, it is inevitable that they will become a greater portion of our future diet. Additionally, much of our future food may be factory grown, with novel, barely imagined foods being the result.

In light of this trend, please consider the following forecasts:

First, the growing and shifting demand for food, coupled with limited traditional production capacity, means that new, creative approaches to meeting demand will be needed.⁵

Take fish, for example. It is already becoming clear that most of the fish the world’s population will consume will need to be raised in farms rather than caught in the wild. This trend became apparent when the ocean fish catch peaked in 2004. Rising food demands will merely accelerate this need. The fact that fish are nutritional and convert feed into meat at double the rate of large land animals means fish farming will grow quickly to meet rising demands for protein. This will lead to an explosion of choices in fish, as well as crustaceans, shellfish, urchins, jellyfish, seaweeds, and many other unfamiliar aquatic foods. Also, what may seem hard to imagine to Westerners will be the increased use of insects, both land and aquatic, as an easy, reliable new food source. Already, about 1,400 species of insects make up parts of the human diet worldwide. Their advantages include being low in fat and high in calcium and iron.

Second, the growing global demand for food and diminishing resources will cause a shift in thinking about how farming needs to be done.

The foods that are produced, and how they are produced, will both evolve. By the end of the century, it is likely most food production will be evenly divided between modern eco-farms, both organic and high-tech, and new industrial and urban systems. The scarcity of the resources needed to produce food on farms as we know them today, along with the very high skills required to do so sustainably, will result in farmed food being much more expensive. Robotics will be leveraged to produce the next phase of the precision agriculture revolution.

Third, algae farms will become another major source of food for both people and animals.

World Fish Production and Food Use Consumption 1976-2030

A clever input for these farms would be CO₂ from fossil fuel power stations. Algae also have the ability to be grown in tanks, vessels, or ponds constructed on waste land as well as on rooftops. Large floating containers can also be stationed in the oceans so algae farms don’t compete with land agriculture or wilderness. Because algae are just microscopic water plants, delicious and healthy foods can be derived from them, just as we get food products from wheat, rice, or any other crop. As a side benefit, algae farms will also have the ability to produce bio-fuels for transport, pharmaceuticals, plastics, and fine chemicals.

Fourth, one not-so-futuristic source of food will be “in vitro” or “cultured” meat.

European and Japanese scientists have been working toward developing it, having successfully produced the world’s first synthetic sausage last year. Artificial or cultured meat begins as animal stem cells that are grown in a glass dish. The right nutrients cause them to become muscle cells. The primary advantage of cultured meat is that it requires much less soil, water, fertilizer, and carbon to produce than does conventional meat — and it produces dramatically less environmental contamination. It’s also easier to keep cultured meat free from germs, antibiotics, and hormones that are almost impossible to eliminate in traditional ranching and meat processing.

Fifth, so-called “bio-cultures” will be yet another source of food that will help meet the rising food demand.

By 2020s Algae Could Produce Food & Fuel Economically

Currently, cell culture methods are being used in medical research, but they will soon find their way out of the lab to create major sources of healthy food. Delectable and very nutritious foods will be cultured in large steel vessels using cells from plants, animals, fungi, and microbes.

Sixth, the specific dietary needs of individual consumers will be designed into novel foods.

These foods will protect against heart disease, diabetes, or cancer based on a genetic analysis of each person’s individual risk. When people who are critical of engineered or “factory foods” learn that eating them will add 10 to 20 years to their lives, they will reconsider their position. These new foods will include more nutritious grains and vegetables, faster-growing animals and fish, and climate-adapted strains of crops. Agribusiness companies will be judged on their abilities to develop novel foods that provide real disease prevention.

Seventh, new industries and jobs will emerge to meet the growing and diverse food demand.

The untapped diversity of edible plants alone has the potential to create whole new industries and related jobs. These jobs will be welcome for the billion or so workers who will be displaced from traditional agriculture in the years ahead as the supply chain becomes more concentrated with giant supermarkets and food firms.

Eighth, the rise of mega-cities with their voracious food demand is also ushering in a new era of urban farming that promises to bring food production closer to consumers.

Rising transportation costs, coupled with more productive plants designed for small-scale farming, will make it practical for food to be grown in small backyards, on balconies, and in public vegetable gardens. Some experts even believe that by the end of the century, skyscrapers will integrate hydroponic methods for producing vegetables, fruits, and fish.

For any type of investment, prices are determined by a complex mix of factors. In the case of the housing market, the primary factors are underlying fundamentals, investors’ access to capital, and investor psychology.

The real-estate investment bubble inflated out of proportion to the actual values of homes, in synch with a euphoric investing mood that reassured home buyers and real estate speculators that prices would keep going up, and then up even more.

To make matters worse, the Federal Reserve Bank’s short-sighted interest rate cuts lowered mortgage rates to record lows. This made even the most overpriced homes seem affordable, even as evidence piled up that the bubble was not sustainable.

When the house of cards collapsed, just as the Trends editors forecast it would, housing prices, access to capital, and investor confidence all plummeted. However, we are now at the precise point when housing is becoming a sound investment again, for three reasons:

1. The underlying fundamentals show that prices are finally returning to the level at which homes can be bought at a good value.
2. Investor psychology has not yet caught up to this new reality. Put simply, most people still haven’t overcome the trauma of seeing their property values collapse as though their homes were built on quicksand.
3. Even though credit remains tight, there’s a benefit to the scarcity of this resource: The competition for choice properties is virtually non-existent.

The combination of these three factors means that there are plenty of bargains for people who are both ready and able to buy, and yet relatively few people are willing to take advantage of the opportunity. Supply is up, demand is low, and it’s a perfect buyer’s market.

Let’s take a quick look at these three factors, and then we’ll discuss how you can profit from this opportunity.

We know from past experience that every major economic bubble has to correct back to the long-term trend line and often pass through it before a recovery occurs. That’s exactly what’s happened in the case of the housing bubble.

Since the peak of the housing bubble in June 2006, prices have been steadily falling.¹ From June 2007 to December 2008, the national average home price declined by a 13.8 percent average annual rate. Since then, the average price has been slipping by an average of 4.4 percent per year. As a result, housing prices are now at levels not seen since October 2002.

However, when we take inflation into account, the freefall in prices is even more dramatic. According to data compiled by Mike Shedlock of Sitka Pacific Capital Management, “real,” or inflation-adjusted, housing prices have plunged to a level that was first reached in March 1998 — when investors were pouring their money into dot-com stocks rather than “spec” houses and condos.² This means that all of the appreciation of the past 14 years has dissipated. Of course, that’s bad news if you own a home, but it’s excellent news if you are in a good position to buy now.

The second factor is that investor psychology has made both real-estate speculators and ordinary home buyers fearful of buying a home, whether to “flip” it for a higher price in the future or to live in it. After all, when prices are dropping by an average of 4.4 percent per year, it makes more sense to invest your money in the stock market and to live in a rented home.

Based on the most complete transaction data available (accumulated by Lender Processing Services), nominal home prices in January 2012 had fallen to a level first surpassed in August 2002. More importantly, home prices adjusted for the Personal Consumption Expenditures (PCE) Index had fallen to a level first surpassed in March 1999, and prices adjusted for the Consumer Price Index had fallen to a level first surpassed in March 1998.

However, just as investors in the stock market can miss the biggest gains by being afraid to buy when everyone else is selling, the same is true of home buyers. A contrarian approach is often the best strategy to profits. The key is to know when the market is about to bottom so you can avoid taking losses as the market continues down, and to ensure that you don’t miss any profits on the way up.

It is very likely that we are near the bottom right now, with perhaps a few more months of continued declines before the upward trend begins. Home prices should post modest gains in 2012, with greater appreciation to follow in coming years.

For those who can recognize the opportunity, the challenge is to secure the credit that might be needed to seize that opportunity. According to the National Association of Realtors, “cancelled contracts” to buy existing homes were at 31 percent in February, which is three times the normal level.³ These figures suggest that, despite record-low mortgage rates, home buyers still face very tight credit conditions.

Tight credit conditions would also explain why “cash-only transactions” accounted for 33 percent of purchases in February, versus a traditional share of about 10 percent. Those with cash are able to take advantage of the buyer’s market, without having to get a mortgage from one of the many banks that are still too timid to write loans for even the most credit-worthy home-buyers.

The good news is that today’s buyers no longer face fierce competition for every attractive property. At the height of the bubble, it was common for buyers to submit offers for houses and condos, sometimes sight unseen, as soon as they came onto the market, and at prices higher than the seller’s asking price. Today, there are relatively few buyers and many sellers, and the risk of getting into a bidding war over a property is almost non-existent.

In light of this trend, how can you profit? Please consider the following forecasts:

First, now is the time for those with cash and credit to enter the market to buy properties.

People who have liquid assets or credit scores that permit them to buy homes at today’s 30-year mortgage rates, can scoop up bargains because the existing inventory of homes is high, new home building is picking up, and the number of buyers remains low.

Second, buyers who take advantage of today’s real-estate bargains will realize a huge ROI in the coming decade.

The smart strategy is to rent out the homes for the next few years while the housing market remains relatively stagnant. Then, when the cycle turns upward again and prices rise — and they inevitably will as aging homes are replaced and aging Baby Boomers downsize to smaller homes — you can sell at a nice profit.

Third, the window to purchase at rock-bottom interest rates will not be open much longer.

Because of growing concerns about inflation, the Fed is likely to raise rates even earlier than some expect. The PPI was up 0.4 percent in February, the largest increase in five months, with most of the gain due to energy prices. Meanwhile, “core” prices, which exclude food and energy, were up 0.2 percent in February, after rising 3 percent from a year earlier and rising at a 3.6 percent rate over the prior three months. Overall producer prices were up 3.3 percent from a year earlier. As a result, the Fed will feel increasing pressure to raise rates as the economy heats up.

Fourth, we won’t have to worry about another U.S. housing bubble for at least another generation.

Why? As Shedlock notes, the collapse of the housing bubble has scarred consumers in the same way the Great Depression did 80 years ago.⁴ The memory of the crash will keep home buyers from becoming irrationally exuberant.

After decades of growth based on a booming exports business, China must make a difficult transition from an export-driven economy to a consumer-driven economy.

Consider that in February, China imported $146 billion worth of goods, an increase of 40 percent compared to the same month a year earlier.¹ Meanwhile, its exports went up only 18.4 percent, to $114.4 billion. In other words, the country that built the world’s second-largest economy by running massive trade surpluses actually posted a trade deficit of more than $30 billion for the month.

With worldwide demand growth for its exports slowing, China has no other choice: It must focus on building a strong domestic market for the goods it produces. By creating a huge consumer class within its own borders, China won’t need to rely entirely on exports for economic growth or political stability.

Let’s first discuss how China can make the transition from the export-driven model to a consumer-driven model. Then we will examine how businesses should target the new Chinese consumers.

While this transition is inevitable, the question is how China will make the transition without a hard landing that will disrupt the global economy.

To understand China’s limited range of options, it’s important to realize two critical facts about its economy. The first critical fact is that consumption accounts for only a relatively small share of China’s Gross Domestic Product. China has an extremely high savings rate because its culture encourages people to save rather than spend. Because interest rates on savings are tiny, the effect is that its economy has come to rely on cheap capital for its growth: The government takes the money that its population saves and invests it to fuel growth in the country’s GDP.

As a result — and this is the second critical fact — China has built a mountain of internal debt that many observers believe is unsustainable. According to Michael Pettis, a professor at Peking University’s Guanghua School of Management who specializes in Chinese financial markets, every country that has used an investment-driven growth model like the one China is still following has created a debt burden that either caused an economic crisis or a “lost decade” of minimal growth.² The only way China can keep its debt from growing is to increase the level of consumption.

Pettis also points out that, on a global level, there must be an equilibrium between savings and investment. If a country like China has greater savings than investment, other countries must have greater investment than savings. In other words, there must be a balance between countries that are under-consuming and countries that are over-consuming.

The Share of Chinese Households in Each Income Level Will Shift Dramatically by 2020

Until recently, that wasn’t a problem for China. While it was under-consuming, the United States and many European countries were over-consuming. But that’s no longer the case. Because of the economic downturn, Western countries have cut their consumption.

As long as this is the case, the only way to restore equilibrium to the global economy and prevent a catastrophe is for under-consuming countries like China to increase their consumption. Since China is by far the world’s leading under-consumer, it will have to make the adjustment, because there are limits both to how much it can borrow and to how much of a trade imbalance other countries will tolerate.

For these reasons, China will need to increase consumption as a share of GDP within the next 5 to 10 years. To do that, it will have to reverse the flow of capital: Instead of transferring wealth from Chinese households to the government in the form of high savings rates and low interest rates, China will need to transfer wealth to those households so they will increase their consumption.

Pettis identifies five strategies that Chinese policymakers could use to enable this change:³

1. China can reverse the transfers gradually, by slowly increasing real interest rates, the value of the yuan, and wages; or by slowly lowering income taxes and sales taxes.
2. It can reverse the transfers swiftly, by abruptly hiking real interest rates, the value of the yuan, and wages; or by quickly lowering income taxes and sales taxes.
3. It can directly transfer wealth from the “state sector” to the “private sector” by privatizing assets and then using the money gained from the transactions to increase household wealth.
4. It can assume debt from the private sector as a way of boosting private sector wealth.
5. It can slash its investments in production, and then create government jobs for people who are put out of work in the process.

The Change in Income Distribution Will Vary Across Cities and May Suggest New Markets

No matter which of these options China chooses — which might include a hybrid of these alternatives — the effect will be to decrease the government’s share of GDP, while boosting consumption’s share. The result will be a growing consumer base with the ability to buy not only Chinese products, but global goods as well.

With an eye to this inevitable transition, how should Western companies get ready to approach these newly empowered Chinese consumers?

The first step in answering this question is to realize that there are actually three classes of Chinese consumers today. This was one of the major findings emerging from a recent landmark study of Chinese consumers by McKinsey & Company.⁴ Over the past seven years, the consulting firm interviewed more than 60,000 people in 60 Chinese cities as part of its annual consumer surveys. What emerged from this is a comprehensive look at the Chinese consumer of 2020.

From 2010 to 2020, the real disposable income per household for Chinese city-dwelling consumers is expected to double, from $4,000 to $8,000. This will bring these Chinese to the same standard of living as people living in South Korea. While the urban Chinese will still lag far behind today’s Japanese at $26,000 or Americans at $35,000, they will have comparable buying power to Americans as recently as 1950.

Just as significantly, McKinsey found that there are currently major differences in income levels among the three classes of Chinese urban consumers they identified. Those differences will continue to exist at the end of the decade, even as the number of people in the upper two classes will grow dramatically.

• Today, the vast majority of China’s population is made up of so-called “value” consumers, who have annual household disposable incomes between $6,000 and $16,000. That’s enough to cover basic living expenses, but not enough for luxuries.
• The second class of Chinese consumers consists of “mainstream” consumers, with annual household disposable incomes of $16,000 to $34,000. These households, which are similar to what most people think of as the American middle class, have more purchasing power than “value” consumers. This group represents only 6 percent of the population, or 14 million households.
• The third class is even smaller, with just 4.3 million households. These “affluent” consumers have household incomes of more than $34,000, and represent just 2 percent of the population.

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Until now, multinational companies could pursue one of two strategies:

1. Use their existing business models to market their existing products to the 18 million households in the “mainstream” and “affluent” segments; or
2. Change their business models to create lower-priced products to target the much bigger market of 184 million households in the “value” segment.

However, by the end of this decade, China’s transition toward a consumer-driven economy will create changes in the sizes of these three classes, which will require a rethinking of strategies for selling to them, as we will discuss in a moment.

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Looking ahead, we offer the following forecasts:

First, as wealth shifts from China’s government to its households, there will be a massive shift of consumers from the “value” to the “mainstream” class.

By 2020, McKinsey expects that 51 percent of the urban population will consist of “mainstream” consumers, compared to just 6 percent today.⁵ This market will encompass 167 million households, or nearly 400 million individuals, which is a population larger than that of the United States. China’s burgeoning “mainstream” consumers will suddenly be able to buy cars, computers, and other goods that they could not afford when they were in the “value” segment. This is in line with a World Bank estimate that the number of middle-class consumers in emerging markets will increase to 1.2 billion by 2030, versus 420 million today. In Asia, the World Bank projects spending by the middle class to soar from $5 trillion today to $30 trillion at the end of the next decade. The growth of the “mainstream” class means that more companies will be able to market their existing products to Chinese consumers without stripping them of features or functions.

Second, the proportion of “value” consumers in China will drop from 82 percent of households in 2010 to 36 percent of households in 2020.

Companies targeting these consumers with lower-end products will still find a vast market of 116 million households, or 307 million individuals. For companies using a business model that allows them to pursue a low-cost-provider strategy, there will still be a fortune at the bottom of the pyramid, even though the base of that pyramid is shrinking. This strategy may also enable multinationals to address the 400 million rural poor that have been largely left behind by China’s growth-to-date.

Third, by 2020 the proportion of “affluent” consumers will grow from 2 percent to 6 percent of the urban population.

While this may seem like a relatively small market, in a country as large as China, it represents 21 million households, with 60 million consumers, and they will have an appetite for luxury goods. Companies targeting these consumers will need to focus on the status and prestige that their offerings provide.

Fourth, the government’s policies for increasing consumption will stimulate strong growth in consumer purchases in discretionary categories.

McKinsey projects annual growth of 13.4 percent in these categories between 2010 and 2020 as the number of consumers who can afford these goods continues to multiply. For example, sales of luxury SUVs are expected to grow by 20 percent per year, and the overall Chinese market for luxury cars is expected to grow so fast that it will surpass Japan as the world’s #1 market as early as 2015.

Fifth, in many cases, a sound strategy for multinationals will be to acquire local companies to gain access to their brands and their insights into Chinese consumers.⁶

For example, Johnson & Johnson’s 2008 acquisition of Beijing Dabao Cosmetics Company allowed it to take over a brand with a loyal consumer following rather than trying to compete with it. As the buying power of China’s three consumer classes, totaling 767 million people, continues to surge, the value of such acquisitions will soar and the bidding for them will intensify.

National competitiveness is defined as “the extent to which a nation’s companies can succeed in the global marketplace while its people enjoy a high and rising standard of living.”¹ By that definition, the United States has exhibited strong national competitiveness virtually since its inception.

There are many factors that have created and continue to help maintain these economic conditions.

Contrary to what many believe, lower wages and cheaper currency are not the primary factors that enable a country to be competitive — and that’s a good thing, since the U.S. has neither. A nation’s competitiveness is tied most closely to its long-run productivity, which explains America’s historic run as a top competitor.

That’s because the U.S. possesses the key ingredient that feeds productivity growth: innovation. Driving this innovation is a unique combination of strengths in:

• Entrepreneurship
• Higher education
• Management quality

These strengths flourish because they are exercised in an open, democratic society that rewards people based on merit. As a result, the U.S. has, for generations, been a magnet for the world’s top talent, which has helped push its upward economic spiral.

Intense domestic rivalry has also contributed to the boosting of productivity while, at the same time, causing the more productive companies to edge out the less productive ones, resulting in a more dynamic and resilient economy

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However, it’s important to remember that, in this era of globalization, competitiveness is not a zero-sum game.² The advancement of one country does not come at the expense of another country. There is not a fixed amount of demand over which the producers of the world fight, with the winning country gaining the prize and the losers walking away empty-handed.

In fact, it is many countries working in concert that produces long-term productivity gains and rising living standards. As one country improves productivity, new demand for goods and services is created, which offers an opportunity for firms in other countries to meet.

For example, as productivity raises wages in India, demand for products such as pharmaceuticals from New Jersey and software from Silicon Valley also rises. This type of synergistic competition increases global prosperity as a whole.

The flip side is that many countries can suffer when an economic powerhouse such as the United States declines in terms of competitiveness, especially if this drop is due to a decrease in innovation.

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Innovation and productivity growth in the U.S. are also the product of:

• The best management practices in the world.
• Capital markets that have remained the most vibrant even during the financial crisis.
• Well-endowed universities that work closely with business.
• Strong property rights that have enabled people to pursue new ideas.

Many of these factors, however, are now eroding, and we’re increasingly having to rely on the stronger components to make up for growing weaknesses in other areas.

For example, while the U.S. remains strong in higher education, entrepreneurship, innovation infrastructure, and intellectual property rights, it is struggling in its ability to attract and retain R&D and advanced manufacturing, which are also key components in the battle for competitiveness.

In a recent Harvard Business School survey, alumni were asked about location decisions in the previous year that involved the United States.³

• 57 percent indicated that the decision they faced pertained to moving an existing activity out of the U.S.
• 34 percent reported that their decision was a choice between locating a new activity outside the U.S. or inside.
• 9 percent faced a decision about whether to move an activity that was currently located outside the country into the U.S.
• After all was said and done, these executives chose the U.S. as the location only 32 percent of the time.

The reasons given for choosing locations outside the U.S. were telling. Not surprisingly, 70 percent cited lower wages. But what portends trouble for the U.S. were some of the other reasons given for moving activities outside the country:

• 31 percent based their decision on better access to skilled labor.
• 30 percent were motivated by higher productivity of labor.
• 25 percent responded to lower tax rates.
• 22 percent based their decision on fewer or less expensive regulations.

These responses represent the underlying structural changes that have put the United States on a trajectory toward weakened competitiveness. This, in turn, is negatively impacting America’s ability to maintain, much less raise, our standard of living. We can clearly see these trends manifested in a number of economic performance measures. Consider these five examples:

• First, labor productivity growth began slipping even before the financial crisis. Relative to other advanced economies, U.S. labor productivity growth had been strong into the early 2000s, but then began to drop. Over the past four years, it’s only been sustained by rising unemployment and falling workforce participation, both ominous signs for long-term competitiveness.
• Second, the U.S. has been losing global market share. In the decade from 1999 to 2009, America’s relative share of global exports dropped across the board, including many significant sectors, such as aerospace and defense, information technology, and communications equipment.
• Third, job creation in private-sector employment has dropped to historically low levels. Growth has virtually stopped in industries that face direct foreign competition.
• Fourth, wages have been stagnant for more than a decade. In 2007, even before the economic downturn, U.S. median household income, in real terms, was below 1999 levels. Since then, it has dropped further. The two decades leading up to 2007 saw anemic growth at a 0.5 percent annual rate. Middle- and lower-income workers faced the toughest foreign competition and have been the most affected.
• Fifth, managers on the front lines of international competition are not optimistic about the future. In the Harvard survey of alumni, 71 percent of respondents predicted a coming decline in U.S. competitiveness when asked to assess the country’s future performance in the global marketplace. A sign of this decline that we touched on earlier is that two-thirds of the time the U.S. now loses to other countries when competing to host business activities.

2011-2012 Global Competitiveness Index for the United States

These economic performance measures reveal significant cracks in our economic foundation that need to be addressed. At the macro-competitiveness level, two of the biggest cracks are:

• High levels of government debt.
• A primary education system that is delivering results that are not world-class and are out of line with the large amount of money spent on it.

At the level of micro-competitiveness, the cracks include:

• Eroding skills in the workplace.
• Inadequate physical infrastructure.
• Rising regulatory constraints.

Together, these failings are offsetting our strengths in innovation and entrepreneurship, which themselves are seen as declining.

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Although the potential for long-term productivity is created by macro foundations, it is microeconomic conditions at the regional and local levels upon which productivity actually depends. Business is most affected by these conditions, which means for a nation to be competitive, it needs:

• Modern transportation and communications infrastructure
• High-quality research institutions
• Streamlined regulations
• Sophisticated local consumers
• Effective capital markets

Equally important are strong clusters of firms and supporting institutions. Information technology in Silicon Valley and energy in Houston are clear examples.

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Respondents to the Harvard Business School survey confirmed these stresses by voicing concerns about eroding business conditions in the U.S. Specifically noted were:

• The complex tax code
• An ineffective political system
• A weak public education system
• Poor macroeconomic policies
• Convoluted regulations
• Deteriorating infrastructure
• Lack of skilled labor

Uncertainty about future regulations and taxes was also mentioned as a big concern for the U.S. business environment.

In a separate survey of senior executives at a dozen multinational companies who chose locations for their business activities, the concerns echoed those of the Harvard alumni. The issues the executives have with the U.S. include skills shortages and government policies that make doing business in America expensive, slow, and uncertain.

The widespread view that governmental policies are hindering rather than helping America’s competitiveness by making it less attractive to businesses is both true and disturbing. Most notably, we see that returns on investment and hard work are being reduced, and the allocation and use of human capital and physical capital is being distorted by taxes.

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Today, the U.S. is failing to attract and retain many of the high-end activities that have traditionally contributed to our strength.

A primary reason is the impact of poor policies put in place by the government, which have not addressed weaknesses in the business environment. The result has been a slide in the attractiveness of investing in the U.S., and a nullifying of significant competitive strengths the U.S. possesses. Included in these poor policies has been a failure to eliminate distortions in the international trading and investment system that work against the U.S.⁴

A second factor in the failure to attract and retain high-end activities has been a tendency of companies to overlook advantages of U.S. locations in the rush to globalize.

Because the factors are complex, it’s been too easy for companies to focus on easy-to-grasp concepts, such as labor cost, and fail to give weight to other important, but harder to quantify, factors, such as local productivity and shipping costs. These less than optimal decision-making processes have led to biases that work against the U.S.

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Beyond the failings of government and business to foster global competitiveness, there are several other factors outside the country’s control.

For example, the growing prosperity in other countries has turned them into desirable markets, which attracts foreign investment. This emergence has the potential to positively affect the U.S. economy as new, growing markets offer:

• Customers for U.S.-made goods
• Partners in free and fair trade
• Sources of innovation

But at the same time, companies that increase their global presence weaken their connections to their countries of origin. This is true for the United States and elsewhere. As low-value-added manufacturing is relocated overseas, those emerging foreign markets do little in the short run for the laid-off manufacturing worker in the Midwest.

Another factor that is difficult to mitigate is a short-sightedness on the part of American companies that overlook or underestimate the hidden costs of locating activities outside the U.S. Factors in the decision, such as low wages or taxes, are perceived as immediate benefits, but negative factors are not always readily apparent, and can take years before their full effect is realized.

A recent report from AMR Research revealed that despite anticipated cost savings, 56 percent of companies that chose off-shore production locations actually experienced an increase in total costs. On the other hand, many companies simply assume that circumstances for a U.S. location are fixed. However, improving the productivity of a U.S. site is quite often a viable option, making it a better choice than moving off-shore.

Despite America’s eroding short-term competitiveness, Harvard’s Michael Porter and others argue that this slide is by no means inevitable. There are many steps that can be taken to stop and even reverse this trend.

At the root of it, productivity needs to be increased, and that should be a central goal of all our economic policies. Innovation in products, processes, and management must be paramount.

Specifically, there are three areas where government policymakers can act to reinforce our key strengths:

• First, immigration restrictions that are keeping innovative, highly-skilled workers out of the country need to be revised.
• Second, any regulation that stifles innovation without providing an offsetting benefit needs to be removed.
• Third, the U.S. system of intellectual property protection needs to be revised to do a better job of preventing foreign IP infringers from selling in the U.S.

Business leaders also have to do their part on many fronts. For example, location decision-making processes should be improved to make certain that all the implications of choosing a specific location for an activity are objectively evaluated from a long-term perspective. Often, a location within the U.S. will suit a company’s needs as well, if not better, than off-shoring.

Businesses need to be careful to avoid “subsidy traps,” such as attractive tax breaks that yield a positive NPV over a short time horizon, but preclude valuable longer-term options. Such subsidies are often a sign that a location has little else to offer.

Finally, companies need to consider upgrading their current U.S. locations rather than proliferating sites. U.S. locations can often offer access to resources that simply can’t be matched overseas. For example, companies located in the U.S. can take advantage of world-class university systems, strong intellectual property protection, sophisticated managerial talent, easy access to capital, and a huge domestic market.

Given this trend, we offer the following forecasts for your consideration:

First, the potential exists for the U.S. to be a top competitor again.

In spite of decisions by America’s leaders in government and business that have had a negative impact on the country’s strengths, the decline in competitiveness is not a foregone conclusion. The U.S. still features the most productive large economy in the world, and offers the largest market for sophisticated goods and services. This environment not only stimulates innovation; it acts as a magnet for investment.

Second, the U.S. will only recapture its former competitiveness when politicians quit sacrificing that competitiveness in order to curry favor with short-sighted special interest groups.

It’s all too easy for politicians to offer solutions that sound simple and may paper over the problems. Admittedly, even if the deeper challenges that have been outlined are not really addressed, the economy will still achieve an anemic recovery. However, America’s global competitiveness will continue to decline, as will its relative standard of living.

Third, American competitiveness will revive only if we choose enhanced competitive positioning over short-term job creation.

Improving competitiveness does not simply equate with “job creation.” Employment can be increased in the short run, artificially, by focusing on labor-intensive local industries, such as construction, which are not exposed to international competition. However, this does not improve productivity in strategically important areas and will not, therefore, produce sustainable employment that raises our standard of living. Instead, if the focus is on creating productivity-enhancing conditions for companies, high-wage employment will grow, foreign investment will be attracted, and sustainable growth in demand for local goods and services will be created.

Fourth, in the coming decade, American companies will exploit trends in global economic forces that favor U.S. competitiveness.

Along with correcting the problems cited earlier that the U.S. faces as a “location of choice” for businesses, we need to recognize other global factors that will begin to tip location decisions back toward the U.S. Some of these include wages that continue their rapid rise in emerging economies, transportation and logistical costs that are increasing, and product life-cycles that are shortening. All of these make U.S. locations more attractive. In addition, with more experience in off-shoring, the true and hidden costs are becoming apparent, and many companies are finally able to make more informed decisions. To a larger degree than before, we will see companies choosing U.S. locations.

Fifth, the most competitive advanced economies will attract the sophisticated, skill-intensive mobile business activities that companies value most.

If the U.S. determines that this is a key battleground, the chances of improving competitiveness will increase. R&D, sophisticated manufacturing, and skill-intensive traded services will be the most sought-after activities, since they generate the most value per worker. In addition to supporting higher wages, they also attract follow-on investments and benefit the local economy with technology and skill spillovers. By contrast, far lower wages are produced by low-end activities, such as simple assembly or routine remote customer service. These are also susceptible to relocation because of rising local costs. The proof of the return of U.S. competitiveness will come when companies choose U.S. locations for their high-end mobile activities.

This trend is the second installment in a multi-part series dealing with systematic innovation and new technologies, as well as the business models to which they are giving rise. Part One appeared in Trends, under the title “A New Golden Age...When People Least Expect It.”¹

In that discussion, the Trends editors explained that we are at the turning point in the latest of the half-century techno-economic waves that have repeatedly destroyed industries based on old technologies and created new industries based on new technologies. Each of these waves consists of three phases:²

• Installation — when an initial boom leads to a bursting bubble.
• Transition — a period of disappointment when the assets of the bubble are revalued.
• Deployment — when the dominant technology matures and becomes the foundation for everything else in the economy.

We reviewed each of the four prior waves. Then we examined the Installation phase of the current wave, based on digital technology. Finally, we talked generally about what would drive the Deployment phase of the current cycle and result in a long, sustainable boom. However, Part One stopped short of discussing specific technologies and markets.

Here in the Economic Update 2012, we present Part Two of this series, addressing those actual technologies and markets. The intention is to highlight a broad spectrum of emerging industry opportunities that offer enormous advantages in the coming decade and underpin our broader optimistic outlook. Among those, four industries offer such enormous potential that we chose to devote whole segments to them in the May 2010 Trends issue:

• Mobile computing applications
• Personalized medicine, including targeted diagnostic tools, preventive care, and treatments
• Automated language translation
• Neuromarketing

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At the heart of this whole discussion is the matter of innovation. As the Trends editors have previously demonstrated, innovation has actually been accelerating over the past decade.

This point was driven home in an MIT Technology Review³ article by Steve Jurvetson — and he should know as well as anyone. Wired magazine named him “the world’s number one most influential geek,” and he is the managing partner of the venture capital firm Draper Fisher Jurvetson. In that role, he evaluates more than 5,000 business plans submitted to his firm each year.

Just to take one example of how innovation is accelerating, consider the 100 percent improvement in computing price-performance every 12 to 18 months, known as Moore’s Law. While this phenomenon was originally derived from the increasing density of transistors in integrated circuits, Jurvetson argues that the broader version of Moore’s law has held up consistently, all the way from 1890 to 2010. In the process, it’s added immeasurably to other industries, including entertainment, communications, aerospace, medicine, finance, and even agriculture.

Five Business/Technology Revolutions 1771-2031

Consider the field of biotech. When the human genome project began in 1990, many predicted that it would take thousands of years and cost countless trillions of dollars. Such an estimate seemed realistic, based on the state of technology at that time.

Moore’s Law — The Fifth Paradigm

Steve Jurvetson

What it didn’t take into account was the fact that technologies in that field were undergoing an accelerating pattern of innovation. The government project took just 11 years, and cost $3 billion. But a private entrepreneur, Craig Venter, started his company, Celera, in 1998 to sequence the genome on his own, and he finished at the same time as the government, at a cost of just $300 million.

As new technologies are spawned by such advances — for example, medical imaging — they destroy old technologies, predictably causing economic downturns. Many commentators react to those downturns with “gloom and doom” predictions, but in fact, they are the harbingers of new periods of economic fruitfulness that are based on the invading technology.

Further evidence of the coming boom appeared in a DailyFinance.com,⁴ article which pointed out that the markets are already reflecting this newly accelerating pace of technology. Since the lows in March 2009, for example, Apple’s stock has risen by 154 percent, eBay is up 130 percent, Amazon rose 99 percent, Hewlett Packard boasted a 91 percent increase, and Google rocketed up 87 percent.

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What other new technologies are about to make an impact? As John Mauldin recently pointed out in his newsletter, there are six areas that you should be paying attention to:⁵

• Special-purpose service robots, likely appearing first in the elder-care space
• Nanoscale materials, already proliferating in consumer product applications
• Biotech innovations including adult stem cells that are closely related to the personalized medicine trend
• Distributed power technologies including traveling wave nuclear reactors and fuel cells.
• Quantum computers
• Synthetic life forms

One of the most logical applications for this new type of robot appears to be “the personal assistant/companion.”

We’ll begin with robot technology, an area that has not made much progress in the marketplace since industrial robots took Japan by storm in the ‘80s. Finally, computing and sensory capabilities have advanced to the point where robotics is ready to break out of the manufacturing realm and enter the broader economy. Robots exist now that can walk on ice, ascend stairs, and recognize objects in their surroundings, performing tasks such as picking up a glass from a table. We take for granted our ability to tell the difference between the glass and the table, but it is no mean feat to program a robot to do so.

One of the most logical applications for this new type of robot appears to be “the personal assistant/companion” that can clean the house, shop for groceries, monitor the human inhabitants’ activities, and respond to emergency situations. Research shows that the elderly find the concept appealing, and demography is certain to create a huge and rapidly growing market in North America, the EU, and Japan. Speech recognition, GPS, computer vision, and other sensory systems are finally approaching levels that will make this solution reliable and cost-effective.

Nanoscale materials, like graphene, are finally reaching a level of development that will open the floodgates for game-changing commercial applications.

Nanoscale materials are also finally reaching a level of development that will open the floodgates for game-changing commercial applications. For example, batteries made from carbon nanotubes offer 400 times the storage capacity of conventional batteries for a given weight. Nanotubes also promise to increase computer speed, while dramatically reducing power consumption. Even more exciting is the near-term possibility of filtering the salt out of sea water, thereby making it safe to drink and derailing the coming global water crisis.

Following the pattern set in motion by the human genome project and Craig Venter, biotech innovation is accelerating rapidly. There is now a machine, which costs $750,000, that can map a person’s entire individual genome in a week. But Ray McCauley, head of Illumina, which makes that sequencer, predicts that by 2013 you’ll be able to get your own genome decoded for $100 and that the price will rapidly drop to just one dollar.

Artificial Life Forms Designed to Manufacture Drugs & Fuel

There’s an incentive for such dramatic progress: A $10 million X-style prize has been offered for the first team to sequence 100 human genomes for $10,000 each in a maximum of 10 days. The deadline is 2013, and many reputable scientists believe that someone will claim that prize. This is probably true, since the power to sequence genomes is doubling every six months, while the cost is dropping just as fast.

By 2013, sequencing machines will be able to decode your personal genome for $100 or less.

This biotech revolution is already spawning so much business activity that it is difficult to keep track of it. China recently bought 128 of the Illumina genome sequencing machines, clearly with big plans in mind to try to dominate this field. At the same time, leading stem cell developers, such as BioTime Inc. and International Stem Cell Corporation, are going to China and Russia to get their human trials completed, since the FDA’s red tape makes it far too slow and expensive to do that work here in the U.S.

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Another area to watch in this field is the growing movement that we might call garage biotech. Just as computer chips became cheap enough for hobbyists like Steve Jobs to take over computer development in the 1970s, so today the experimental equipment used for genetics is getting cheap enough for people to set up labs in their garages. While the business of putting a fluorescent gene into a bacterium used to be a long, arduous, and expensive process reserved for government-funded laboratories, people are now doing it in their basements.

A group of teenagers in New York recently used their at-home genetics lab to test fish from various restaurants and uncovered the fact that the type of fish listed on the menu is not necessarily what is served on the plate.

The implications of hobbyists doing serious genetic manipulation are as promising as they are sometimes alarming. Consider the possibility of terrorists with the ability to genetically engineer diseases.

Terrapower’s traveling-wave nuclear reactor is fueled with U-238 waste (A) and a tiny amount of enriched U-235. The U-235 starts a heat-producing nuclear reaction whose neutrons collide with U-238 atoms, converting them into plutonium-239. The plutonium quickly decays back to U-238, producing most of the energy. The reaction moves like a wave (B) along the fuel, generating heat for decades, until all the uranium is spent (C). Molten sodium metal (D) absorbs and carries away the heat to drive a steam turbine.

But when it comes to the usefulness of these at-home advances, consider them like apps for your iPhone. They’ll be cheap and plentiful.

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Anything having to do with energy is a hot topic these days. But most of those technologies, such as wind and solar, are decades away from being able to cost effectively fulfill the world’s needs. Not so with nuclear energy, which is here today. As reported by CNET,⁶ Bill Gates funded a new corporation called TerraPower, which is working with Toshiba to build small nuclear reactors for use in developing countries.

This new technology looks like a game-changer. It’s called a traveling wave reactor that can run for up to a century without refueling. Conventional reactors have to be refueled every four to five years with enriched uranium, the stuff of atom bombs. This makes them expensive and potentially dangerous. Traveling wave reactors use nuclear waste, which is not suitable for producing bombs.

An isotope of uranium called U-238 is converted into energy-producing plutonium-239 by a wave that travels through the fuel supply. Then the plutonium is immediately used up as the wave travels, creating heat to power the reactor. As a result, the fissile material is created in a very small supply and is almost immediately destroyed. This offers developing countries the potential for true energy independence, without the risk of nuclear proliferation.

Another breakthrough that will supercharge the deployment phase of the information technology wave is the development of quantum computers, which we’ve previously highlighted in Trends. They use quantum mechanical effects to perform their computational functions. And they use so-called Q-bits rather than binary data bits to solve problems.

By 2020, state-of-the-art quantum computers will have a processing power equal to the sum of all the computers that exist in the world today.

In 2005, the National Security Agency published its “Superconducting Technology Assessment,”⁷ identifying Single Flux Quantum technology as “the most promising technology in the continuing for faster processors.” The present rate of progress in that research should produce a doubling of the number of functional Q-bits a machine can simultaneously process every year for the next decade. That will lead to quantum computers in 2020, each of which will have processing power equal to the sum of all the computers that exist in the world today.

D-Wave, a company supported by venture capital from Draper Fisher Jurvetson, is pioneering the development of quantum computers. The D-Wave machines use superconducting metals instead of semiconductors, and they run at extremely low temperatures in a magnetic vacuum. These machines will initially be used for solving extremely complex problems at the highest levels of science.

Another game-changing technological innovation is synthetic life. While the Trends editors have been tracking this technology for nearly a decade, it only burst into the mainstream news in late May 2010 when Craig Venter and his team unveiled the first organism with a genome created entirely by humans from laboratory chemicals. A little more than two years earlier, Craig Venter announced in The Guardian⁸ that his lab had created a synthetic chromosome out of laboratory chemicals. It was a single DNA molecule that contained 381 genes, which is the minimum number necessary to support any type of life. The synthetic chromosome was put into a living bacterium, where it functioned normally.

Around the same time, Science⁹ magazine reported that a team of researchers in the U.S. had synthetically built the DNA of a common bacterium, again working from scratch with laboratory chemicals. These breakthroughs pave the way for technologists to program living systems in the same way they now program computers for various functions. Now that a new life form has been successfully created by completely reprogramming a cell, it’s only a matter of time before researchers build synthetic organisms for a wide range of amazing applications, ranging from producing vehicular fuel via photosynthesis, to manufacturing drugs, to cleaning up toxic waste sites.

In light of this trend, we offer the following five forecasts for your consideration:

First, over the next 20 years, there will be so many new threats and opportunities that most business professionals and investors will be overwhelmed.

The Deployment boom just ahead will be characterized by accelerating technological innovation and enormous creative destruction. It will be a time of great change and confusion, in which great wealth will be both created and destroyed. In this rush of technological change, those who survive and thrive will be those who can do the best job of sorting information and separating the signal from the noise. Expect to see a whole category of businesses crop up that do nothing but sort out and aggregate information about new technologies and the merits of various business approaches.

Second, the intersection of information technology and the life sciences will be particularly exciting, but U.S. firms cannot be complacent about maintaining leadership.

This includes specific industries like synthetic life and personalized medicine. The applications abound, and the research is mature enough to scale up. The United States now has a clear lead, but we will have to move quickly to maintain our status. With China’s purchase of large-scale genome sequencers, it is clear that they aim to seriously challenge U.S. supremacy. And, since the largest single cost of doing biotech R&D is labor, China has a built-in advantage with its huge, low-wage population of technician-level researchers. Companies are already moving off-shore for more favorable approval procedures. The U.S. and its FDA will have to make changes fast to remain leaders in this field.

Third, while today’s emerging energy technologies look promising, it’s likely that something even more exotic will emerge to dominate this market.

Fuel cells and the smart grid will clearly make power distribution more reliable and efficient. Traveling wave nuclear reactors are definitely in the cards as a possibility over the next five- to ten-year period, while wind and silicon-based solar are likely to remain marginal. But don’t be surprised when a brand new energy technology appears, seemingly out of nowhere, that will completely change the field of energy production, use, and storage. This is an area of intense research worldwide, and history shows that when that much human creative effort is directed at a problem, novel solutions appear. While it’s impossible to predict at this point what shape that innovation will take, those who identify the new winner early on will win big.

Fourth, robotics will inevitably become a big business outside of manufacturing, but on a longer time scale.

Because of the large leaps still needed in so many sub-specialties, it may be 10 years before the mass market for the envisioned personal assistant/companion emerges. And it may only emerge hand-in-hand with the enormous power of quantum and molecular computing that provides a platform for true artificial intelligence. When AI is combined with the ever-advancing physical technology of robotics, then a truly practical robotic personal assistant will become a reality.

Fifth, most experts will come to realize that the Deployment phase of the information technology wave was made possible by the investments made in the Installation and Transition phases.

Today, the over-investment in fiber-optic networks and failed business models a decade ago looks pretty unwise. However, creative destruction

has redeployed those tangible and intellectual property assets to form the foundation upon which the next boom will be built. That firm foundation is what gives the Deployment phase its stability. So it will not end in a bursting bubble, but in the loss of momentum as infotech saturates every phase of life, and progress inevitably shifts to the “sixth wave” of technological revolution.

The nature of work in America is undergoing a radical transformation. As recently highlighted in The Futurist,¹ it’s the most dramatic change since the Industrial Revolution. This new paradigm requires workers to be far more skilled in technical matters than in the past. The need for these talented workers will grow for at least another decade, and probably a lot longer.

As a result, we’ll have to rethink nearly everything, from the way we educate our children, to the way we go about looking for jobs, to where we look for them. Many of the jobs that we’ll be looking for — and especially those that our children will be seeking — don’t even exist yet. Many others that do exist are quite new.

We’re now in an economic recovery and, contrary to some reports, the future of the American economy looks bright. The Congressional Budget Office estimated recently that the real U.S. gross domestic product could grow from $14 trillion today to $20 trillion a year by 2019.² But who will benefit from that — and what will the job market look like?

During the Great Recession, traditional measures of unemployment rose to roughly 10 percent. If you include people who’ve stopped looking for work and those who are under-employed, unemployment figures rise to at least 15 percent. But the paradox of the new jobs paradigm is this: There are really plenty of jobs out there. But the kind of workers those jobs require are in short supply, even while the type of work done by legacy employees is drying up. Consequently, we have an over-supply of low-skilled workers, and an under-supply of high-skilled workers. This “skills gap” is only going to widen as time goes by.

So far, the U.S. economy, despite its strong base of high-tech industries, has done a fairly poor job of educating the nation’s youth to prepare them for the coming wave of scientific advances that will be essential for highly technical industries. Right now, many of America’s high-skill jobs are going overseas to people in Europe, Japan, and Singapore, where the level of education in science, math, and engineering is higher. Simultaneously, U.S. industries are being forced to import talent from those places, as well as India, to fill existing jobs that too few American workers are trained to do.

In the meantime, China is churning out 600,000 new engineers a year and India graduates about 400,000. Today, the educational standards in those countries don’t stack up to those in the U.S. Experts estimate that only 10 percent of China's engineers are up to U.S. minimum standards. However, those standards are improving as India and China expand their own high-tech industrial sectors. At the same time, hundreds of thousands of foreign students are getting advanced degrees in the United States and often returning home to work for advanced technology companies or to start their own businesses. Going home is attractive, because a shortage of these high-skill workers, especially those with management expertise, has driven up wages. That means that U.S. firms are having a harder and harder time importing the talent they need. So even with an increased number of H-1B visas, there simply won't be enough skilled people to go around. That's why we desperately need more home-grown talent!

A snapshot of the U.S. employment picture is illuminating. Take early 2008, when the economy was still doing pretty well. Unemployment stood at just 5.6 percent, and there were 3 million jobs that were advertised and stood unfilled for more than six months. Those were not front-line jobs at McDonald’s. They were positions that required a good high-school education, plus two to four years of college or an apprenticeship of two to three years.

Fast forward to May of 2010: Unemployment stood at over 9 percent, with upwards of 15 million people out of work, and yet there were still 3 million jobs available and unfilled. The discrepancy is the result of a mismatch between the employment needs of companies and the educational system in which students grow into adults.

Education Does Matter! Age 25 and Over. U.S. Unemployment Rate (seasonally adjusted) by Education Attainment

For example, in mid-2009 the unemployment rate for high-school dropouts was about 15 percent. Among high school graduates, 10 percent of them were unemployed. People with some college, but not necessarily a degree, suffered 7.3 percent unemployment. Meanwhile, only 4.8 percent of those workers who had earned a bachelor’s degree or higher lacked jobs. As recently reported in Fortune, Boeing, Google, Genentech, Cisco Systems, Ernst & Young, Booz Allen Hamilton, KPMG, and PriceWaterhouseCoopers all have plenty of jobs open for highly skilled people in specific areas that they can’t fill.³

In addition to this mismatch between the education of unemployed workers and the skills that employers need, demographics play a role in the growing talent gap. The United States, Europe, Russia, and Japan all have low birthrates and rapidly aging workforces. Even China and India, with their huge populations, will not be able to churn out enough skilled workers to meet their own demands, let alone ours.

Demographics alone could lead to a global talent crisis without any of the other factors being considered. The live-birth replacement rate for human populations is 2.1 children per female.

According to the CIA World Factbook, Germany is producing just 1.4 children per woman, while Russia and Japan are at 1.4 and 1.2, respectively.⁴ This not only leads to a shrinking talent pool, it puts the additional burden on workers of supporting an ever-growing number of people who have retired.

This year, some 79 million Baby Boomers began reaching the traditional retirement age. In the next decade, two-thirds of the vacant jobs will be the result of Boomers retiring, and some companies will face having to replace their entire workforce in the course of 10 years.

Another factor is the impact of young people’s attitudes toward work and education. Generation X and Y produced a population that is not as focused on work as the Baby Boomers were. Members of these generations want to balance a “good life” with their work. While lots of female professionals are graduating now, many of them want to take time off from work to raise children.

Moreover, there seems to be a cultural bias against learning science and math, which will typically become requirements for good jobs going forward. From the mid-1950s to the ‘70s, there was a great deal of emphasis placed on learning science, math, and engineering, as the U.S. struggled with the space race, the arms race, and the Cold War. Many government programs were in place to produce a highly technical culture full of people with advanced degrees. This resulted in a high-tech revolution that continues today.

But the Cold War ended, space exploration was marginalized, and the emphasis on science and math began to wane. Consequently, the next two generations suffered an “educational slowdown.”

Today, the rate of high school dropouts in the U.S. is 30 percent. Half the students in the 50 largest cities in the United States do not graduate. Those that do graduate are not even prepared for many entry-level jobs.

In 2008, the Alliance for Excellent Education found that only half of high school seniors who took the ACT tests were ready to read at a college level. As a result, 20 to 40 percent of college freshmen had to take remedial courses in reading, writing, and math because their high schools had not prepared them to go to college.⁵ While a lot of high school graduates go on to college, only one-fourth of U.S. college students actually earn a degree.⁶ That’s the lowest rate among the developed countries.

A picture of the future emerges in the experience of executives at Advanced Micro Devices, who wanted to build a new plant in the late 1990s and went in search of a location. California seemed an obvious choice, since it is home to Silicon Valley and AMD. But they couldn’t find enough skilled technicians to run the plant there. Texas, with its high-tech nexus in Austin, was another candidate. Once again, all the good high-tech people were already spoken for.

The company eventually built its plant in Dresden, Germany, in 1999. AMD went through the same exercise again in 2004, finally building a second plant in Germany. The lesson? The educational system in Germany is a pretty good match for the future of employment worldwide. The one in the United States is not.

According to a study of medical technology called MedTech 2020, the United States is poised to lose out on many of the great advances in medical technology that are set to take place in the next few years.⁷ Among them, imaging technology will represent the largest market; but Asia is expected to lead in that technology, leaving both Europe and America behind.

Meanwhile, Europe is expected to take the lead in telemedicine. The U.S. will also lag in regenerative medicine, prosthetics, active implants, and lab-on-a-chip technologies, as well as countless other high-tech medical advances, if it does not work to correct the situation.

Between today and 2020, it is expected that 74 percent of all jobs created in America will be high-paying jobs for high-skilled workers. While there will be a need for 123 million of those talented people, only 50 million Americans will qualify. By contrast, low-paying, low-skill jobs will shrink to just 26 percent of the total jobs in the U.S. Worst of all, just 44 million people will be needed for those jobs, but 150 million or more candidates will be seeking those jobs.

To resolve this mismatch, companies, individuals, and governments at the federal, state, and local level need to launch aggressive measures to increase the number of students who will graduate with advanced degrees in science, math, and engineering. Meanwhile, they’ll need to provide technical skills for many of the 150 million people who are now expected to have only marginal skills.

This will require a substantial investment of money and time, but it must be done. Models for this already exist in places like Santa Ana, California; Fargo, North Dakota; Danville, Illinois; and Mansfield, Ohio, where community-based and nongovernmental organizations are working to forge partnerships between businesses and educational institutions to align the talent pipeline with the jobs that will need to be filled.

In light of this trend, we offer the following five forecasts for your consideration:

First, dramatic changes will unfold in the U.S. educational system by 2020.

As history shows, America is imbued with both flexibility and resilience. Spurred by high unemployment and a shortage of qualified applicants, businesses and government will enable a grassroots movement to overhaul the educational system and bring it in line with the employment needs of the future. This movement will place a new emphasis on science and technology in schools with added incentives for students to stay in school long enough to qualify for genuine “entry-level jobs.” For an analysis of how this might be achieved, please refer to our discussion of the trend titled “Disruptive Innovation Meets the American Education Crisis,” which was included in the June 2008 issue of Trends.⁸

Second, in the meantime, companies and individuals will be forced to adapt to the evolving employment environment.

Companies seeking to hire from the limited talent pool will find new ways to attract it. They’ll rethink the old model of having everyone in the same place at the same time to get work done. The eight-hour workday will take many new forms, such as a 14-hour window in which any worker can put in his time from any location. Because of mobility and always-on communications, Generation X and Y workers will be much more able to balance work and life. A possible model for change is an experiment by the city of El Paso, Texas: By adding two hours to the workday, the city is operating with a four-day workweek, saving $100,000 in energy bills and pleasing workers because they always have Fridays off.

Third, many American workers — whose skills are no longer in high demand — will become multinational, going where the jobs are.

For example, in 2009, when business in the U.S. slowed, IBM instituted a program under which employees who were going to be laid off anyway could elect to move to other countries where IBM was hiring. According to InformationWeek,⁹ the effort, called Project Match, paid the employees’ moving costs. While the pay was often less in foreign countries, many people gravitated to it for the adventure and the change of scenery.

Fourth, companies will grow smaller.

As previously highlighted in Trends, large industrial firms won't be needed in such large numbers in a knowledge economy. That will allow small firms to control much larger resources, as a core group does the core work and an ever-shifting cast of contractors, part-time workers, and free-lancers does everything else. Company affiliations will be ephemeral. Roving high-tech teams will hire out to companies as a unit to come in and tackle specific work on a project-by-project basis. New industries will evolve out of this situation, specifically those that can broker this sort of temporary, mobile workforce.

Fifth, companies will play a more proactive role in people’s education.

With each wave of technology becoming shorter and more disruptive, employees will have to be retrained repeatedly. Learning a job once — right out of school — will become rare. Life-long learning will become a critical success factor for most corporations and for most individuals. Much like today’s doctors, technologists and engineers will engage in on-going education to stay abreast of developing trends. Corporate universities, traditional educational institutions, and new online educational providers will all play crucial roles in shaping this revolution.

Beginning in 2006 and continuing to the present, the housing market has experienced a cataclysmic meltdown as massive as the collapse of the “tech bubble,” but far more pervasive. You already know a lot about that. The questions now are: Where do we stand? What lies ahead? What broader demographic, economic, and attitudinal factors are likely to determine housing’s future? What does this mean for you?

For example, September 2011 sales of existing homes came in right as the consensus expected, at a 4.6 to 5.0 million unit annual rate.¹ A large portion of sales came from distressed properties, such as foreclosures and short sales. But fortunately, the inventory of existing homes was down 13% from a year earlier and the number of homes available for sale in September was at the lowest level for any September since 2005. With respect to the prices of existing homes, the Case-Shiller Index, which measures seasonally-adjusted prices in the 20 largest metro areas, was unchanged in August 2011 and down 3.8 percent versus a year earlier. The FHFA index, which measures prices for homes financed by conforming mortgages, declined 0.1% in August and was down 4% from a year earlier.² By August 2012, we believe these price indices will be up slightly from current levels.

Meanwhile, new home sales increased 5.7% in September and beat consensus expectations.³ The best news in this report was that the months’ supply of new homes declined to 6.2 in September. With the exception of the surge in sales in early 2010 due to the one-time home-buyer tax credit, this is the lowest months’ supply reported since 2006. Meanwhile, the absolute number new homes for sale was at the lowest level since the government began keeping records. On the price front, the median price of a new home was down 10.4% versus a year earlier, while the mean average price was down 9.9%.

Whether you’re looking at new or existing homes, both prices and unit volumes have declined sharply since the peak in 2006. And, foreclosed homes and empty subdivisions still litter the landscape. In short, the housing market is in shambles. However, there is plenty of reason to believe that U.S. housing is now in recovery mode.

Looked at this way, it's notable that home building soared 15% in September 2011, bouncing back after the unusually harsh weather we saw in August.⁴ However, most of the increase was due to a 51.3% spike in multi-family units, which are volatile from month to month. Another positive from this report was that although single-family homes under construction hit a new record low, total homes under construction increased for the second time in the past three months. This is only the second time “total homes under construction” has increased since 2006! What this shows is that the bottoming process is playing itself out and home building should trend higher over the next couple of years. As we've said previously, based on population growth and “scrappage” rates, home building must increase substantially over the next several years to avoid eventually running into shortages.

The Trends editors believe 2011 represents the peak year for foreclosures. Foreclosure tracking firm RealtyTrac Inc. predicted that roughly 1.2 million homes would be repossessed by lenders in 2011.⁵ But the specific number hinges on the unemployment rate. As more jobless homeowners facing foreclosure find work, that could push the number of filings down. On the other hand, if we assume unemployment stays above 9% going into 2012, 2011 could set a foreclosure record as banks increase their foreclosure filings to make up for the delays caused by the “robo-signing scandal” in 2010. Regardless, the number of potential foreclosures isn't a bottomless pit. And the number of foreclosure filings is likely to head down beginning in 2012.

Meanwhile the cumulative number of repossessions associated with this economic cycle could balloon to about 6 million by 2013. Lenders have repossessed over 3 million homes since the housing boom ended in 2006. It's believed the number could top out around 6 million by 2013 as the housing market absorbs the bulk of distressed properties.⁶ As of mid-2011, there were about 4.5 million seriously delinquent loans not yet in foreclosure; those will eventually go through foreclosure unless the homeowners cure the defaults.

A big change that hit the market in 2010 to 2011 was the rise of so-called “strategic defaults.” A strategic fault is when a debtor with an underwater mortgage makes a decision to simply walk away from the property. A research report published by Morgan Stanley, said that as of mid-2011 “strategic defaults” would account for roughly 12% of all U. S. mortgage defaults, compared to just 0.7% back in 2007.⁷ Obviously this leads to a bad credit history and a certain amount of social stigma. In many states it can also lead to a default judgment that follows a home-owner unless they declare bankruptcy. However, in states like California and Arizona where it's impossible for lenders to get a default judgments against such creditors, an increasing number of homeowners are deciding to live with the bad credit score.

To-date, foreclosure abatement programs focused primarily on reducing payments have had relatively little impact because they have not reached nearly as far as the government originally forecast. Moreover, since these programs typically do nothing to address the mortgage principal, they really do nothing to minimize “strategic defaults.”

In light of this trend, we offer the following four forecasts:

First, in 2012 and 2013, “rental conversions” of distressed properties will represent one of the most exciting investments for those who understand the opportunity.

With rents up and both prices and mortgages rates down, it's the best time in 40+ years to buy a home. Nevertheless, economic uncertainty, high lending standard and fresh memories of the bursting bubble have more people wanting to rent than at any time in the past two generations. So, it's time to remember the words of Warren Buffett: “Be fearful when others are greedy and greedy when others are fearful.” In early 2006, the Trends editors warned home owners that it was time to sell their homes and rent. Those who followed that advice were very happy in 2008 and 2009. Today, the smart money will buy distressed properties at deep discounts and very low mortgage rates, and then rent them to others for handsome returns. This strategy will be particularly attractive in markets that are demographically and economically primed for healthy growth as the economy recovers. The key is to tap your personal knowledge of market opportunities so you can make the most of a specific market. To jump-start this market, US senators introduced a bill in October 2011 that would offer visas to foreigners who spend at least $500,000 to buy single-family houses, condominiums, or townhouses.⁸

Second, financial institutions will exploit the rental conversion strategy to convert desperate home-owners into paying renters.

Rental conversion is ideal for smart individuals who can cherry-pick markets. Banks, private equity firms and REITs could accomplish the same thing with a portfolio of bad mortgages. Under this scenario, the underwater homeowner is offered the chance to rent the property at market rates. So instead of getting a vacant home that it must dump onto a crowded resale market, the lender gets an occupied rental property. The homeowner signs a lease and gets out from under an onerous financial burden without destroying his credit. Obviously, the need to write-down the mortgage value to the current market value of the underlying home has kept most lenders from pursuing this approach. This will help keep many foreclosures from ever reaching the depressed market. However, given today's favorable interest rates and the long-term outlook for home prices, such a solution clearly beats having a homeowner mail the lender keys to an empty house. In a world where 10-year bonds pay about 2%, such an investment vehicle should be pretty attractive.

Third, rental conversions and other changes in the marketplace will prevent a 2012 or 2013 down-leg in prices.

Recognizing that a weak but sustainable economic recovery was already now underway, the Federal Reserve ended its $1.25 trillion mortgage purchasing program in late 2010. The Trends editors argue that home building, home sales, and home prices will all be up, on a national basis at the end of 2012, even if we suffer a slow-down in Asia or the EU. We base this on three pieces of evidence:

• The Fed is going to hang onto the vast bulk of mortgages it has bought for at least the next several years, and the Fed will buy new loans to maintain its balance sheet using the natural process of refinancing and principal repayment to provide the funds.
• Mortgage rates will not suddenly spike as long as banks remain flush with excess reserves. For confirmation look at the market: even after the Fed has ended its program of mortgage purchases, the “spread” between mortgage rates and the 10-year treasury rate remained small.
• Fundamentals argue for prices to slowly improve. For example, housing prices have fallen well below replacement cost and “fair value” in many markets. Based on rents, national average home prices are over 10% below “fair value” and are the lowest relative to replacement cost in more than thirty years. That’s why some of the places with the largest excess inventories, including San Diego, Phoenix, and Las Vegas, have seen gains in prices.

Fourth, because home construction fell to such extreme lows starting in 2009, construction will have to rise substantially to get back into “sustainable equilibrium.”

At the bottom of the building cycle, home construction was so slow that it would take nearly three centuries to replace all the existing housing in the U.S. Since the average life of a new home is just 73 years, tear-downs alone would inevitably shrink inventories pretty rapidly. Once the inventory adjusts to normal levels, 1.6 million new homes will need to be built every year just to keep up with the historical level of demand.

We’ve just been through the most serious financial and economic crisis since the integrated global economy began to emerge in the early 1990s. In earlier eras — even though international trade has inevitably suffered anytime a major national economy weakened until recently — recessions have been primarily national or regional in nature.

But in 2008, we saw the world's financial markets fall with amazing speed, triggered by a panic that started in the United States. Many were surprised, because it was widely believed that high-growth emerging markets would cushion the global slowdown caused by the developed economies. However, as the Great Recession unfolded, the emerging economies suffered from declining trade, shrinking capital flows, and slumping commodity prices just as the Trends editors predicted. More recently, creditor nations like China have been hit hard by an EU-centered debt crisis. As a result, the widely-held theory of “economic decoupling” has ended up shot full of holes.

A generation ago, this was unheard of. During the Cold War, the economic and political world order was characterized by a static tension between two superpowers; the United States and the Soviet Union. This ended with the collapse of the Soviet Union in 1991, and opened the world to the dynamic and interacting forces of a free market. Widespread changes in policy encouraged free trade, while competition paved the way for a more efficient and robustly growing economy. This opened the door to the possibility that free-market capitalism could spread to any willing nation, bringing with it a higher standard of living, education, better health care, and all the benefits that have been enjoyed in the developed Western world.

The model for this type of economy — and the benefits that it confers on nations that embrace it — is the American way of life. America has provided the model for the rest of the world to follow, because American products have proven to be the ones that people across the globe want.

The key technologies enabling and accelerating globalization are computerization, miniaturization, digitization, satellite communications, fiber optics, and the Internet. Those are all tied together under the integrating influence of the World Wide Web, while competitiveness is defined by speed. Speed defines the winners in commerce, travel, communications, and innovation. The speed with which companies can innovate defines whether or not their products are disruptive enough to become sustainable winners on a global scale.

A perfect example of this is digital photography. When it first came onto the scene, digital cameras were not very good. This allowed makers of film and traditional cameras, such as Kodak and Polaroid, to ignore the trend to their peril. Their customers were people who cared about the quality of the image. Nevertheless, a much larger market was embracing the ease of use of digital cameras, which in turn were being powered by the spread of photos on the Web. As digital photography improved, the incumbent companies were too far behind to catch up. Kodak and Polaroid were marginalized.

Thus, in order to compete in the new global environment, winning companies have to innovate at lightning speed to disrupt the incumbents, even if they are the incumbent leaders. This is the process that Joseph Schumpeter referred to as “creative destruction.” For nations to sustain themselves in the global economy, they will have to get out of the way and let the force of free-market capitalism do the work of creative destruction. That means doing away with inefficient industries and jobs, while letting newer, more competitive products, services and methods spread and grow. In that environment, top-down government control won’t work, because you can’t legislate innovation. The same goes for protectionism: Protectionism means stagnation.

Population to 2050: Developed and Developign World

The pace and impact of globalization have increased exponentially due to:

• the telecommunication band-width explosion
• the falling cost of transportation
• the shift from a manufacturing economy to a knowledge economy
• the freeing of knowledge and of new ideas by the Internet and always-on mobile communications

These trends mean that anyone can work on anything from anywhere in real time. The result is the emergence of the “global village” predicted by Alvin Toffler and Marshall McLuhan more than three decades ago.

At the same time, the 19th century equation relating raw materials and knowledge has been inverted. A century ago, products contained small amounts of knowledge applied to large amounts of material, as is the case when a car is produced out of steel. Today, a vast amount of knowledge is embodied in a very small amount of material, such as when a new drug, a synthetic life form, or a microprocessor enters the market. Moreover, unlike automobiles, which can take months to ship across the sea, the knowledge in those tiny products can travel around the globe in seconds.

This makes for both opportunities and perils. Countries that embrace these trends can flourish, while countries that attempt to resist will stagnate.

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An example of this dynamic in action can be seen in a comparison of the growth of India and China as economic forces in the world, as outlined in a report from Foreign Policy¹magazine. Despite three decades of modernization, China is still fundamentally a communist dictatorship with central planning. It grew with the help of foreign investment to become the manufacturing capital of the world. India, which has a social democratic political system modeled on Western Europe, has built an entrepreneurial culture and has far less foreign investment. Furthermore, while China’s per-capita growth in income outstripped India’s by almost two to one in the past three decades, India has a resiliency that China doesn’t have because it has placed the ability to make and retain money in private hands rather than with the government.

For example, according to The Economic Times,² the increase in unemployment in India during the global recession is expected to be far less severe than in other countries because of its exceptionally strong GDP growth and robust entrepreneurial activity. So, what little increase in unemployment it did experience has translated into leaner, more efficient companies during the recovery.

Meanwhile, according to MSNBC.com,³ Christmas of 2008 saw China already hit hard by the recession, as American consumers and others in developed nations took advantage of steep discounts on toys that previously commanded premium prices. China makes 9 out of 10 toys sold in the U.S. Toy manufacturing is based on a 19th century business model, where relatively very little knowledge goes into a large amount of material goods, which are slow and costly to move around. According to economic forecaster IHS Global Insight, Chinese imports of toys were down sharply in 2008, and the country had to close more than 3,600 toy factories, leaving hundreds of thousands of people out of work.

An example of this is the shutdown of Smart Union Toy Company in October of 2008 in the city of Dongguan, which is the hub of toy production in China. The managers of the factory literally vanished in the dead of night. When some 7,000 workers showed up the next morning, they had no jobs and no paychecks. The workers staged a near-riot, forcing the government to pay out some $3.5 million in salaries before order was restored. The following month, a riot erupted when the Kaida Manufacturing Company refused to pay workers. Some 600 employees ransacked the offices, and the company was forced to pay the workers.

As clothes, shoes, and other labor-intensive Old World products fall prey to the same dynamics, China is in for a rude shock. Some 40 percent of its economy is based on those antiquated types of manufacturing. So, epidemic unemployment in China quickly threatened to destabilize the entire regime. China’s only solution was a $546 billion stimulus program funding unneeded infrastructure projects, propping up uncompetitive State-Owned Enterprises (SOEs), and triggering a huge housing bubble that has yet to burst. (See the February 2011 Trends issue for more details.)⁴

On the other hand, by free-market dynamics and opening itself more fully to globalization, India has given itself a stability that China simply doesn’t have. India has eliminated tariffs, reduced bureaucracy, released phone service from monopolistic dominance, and opened new industries to entrepreneurs. So, despite the fact that people have made more money so far investing in China than in India, India has a much healthier long-term outlook going into the second decade of the 21^st century.

The Far Eastern Economic Review⁵surveyed 2,500 executives in a dozen nations to find out which Asian companies were leading in performance. Indian corporations rated highest, while only two companies in China made the top 10 list. Significantly, all the Indian companies were private, while the Chinese ones were not. The number one company on the list was a start-up in India called Infosys Technologies, headed by an entrepreneur known as the Indian Bill Gates, N.R. Narayana Murthy.

India, in short, is providing a model of how to harness globalization and thrive in it, even during a recession. China is offering a model of what not to do. Compare the results of a study by the World Bank: In China, 80 percent of all enterprises have difficulty obtaining capital to operate — and most of those enterprises are state-owned. In India, that figure is only 52 percent. In 2002, The New Republic⁶ reported that private companies in China can’t get loans at all in the current environment, and the loans that are given to state-owned companies time and time again turn out to be “non-performing.”

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All nations can learn lessons from the way various nations were able to weather The Great Recession. Anyone can profit in the best of times. It is the worst of times that defines the true winners and losers.

Given this trend toward globalization, we offer the following five forecasts:

First, while protectionism will continue, the brief “comeback” that began around 2008, this will merely slow the steady progress of globalization.

Gross Domestic Product 2030 & Per Capita Income 2030

The Great Recession has made protectionism politically expedient for the first time in nearly three decades. (We examined this trend in more detail in the November 2009 issue.)⁷ However, the genie of globalization is already out of the bottle. Free trade is now a much more powerful force than at any time in world history. More significantly, capitalist-style free markets are now more deeply rooted into more nations than ever before. As a result, we have passed the crucial tipping-point of global market integration. Going forward, only those economies that embrace free trade and competition will thrive and realize a better standard of living, along with an increase in global influence. Those that try to resist these forces will be marginalized.

Second, globalization will permit the world’s economies to compensate for imbalances in skills, capital, and consumption between nations.

Business models that optimize comparative advantage will become the big winners. For example, American IT companies are rehiring former employees who are willing to go to foreign countries to train local professionals. American universities train the premier scientists from around the world, and a very large percentage of them remain here to do their research. Chips designed in the United States and manufactured in Japan are integrated into products in China to be sold in Europe. Excess saving in East Asia and Europe will flow to India and the United States. Increasingly, U.S.-headquartered multinationals will coordinate and optimize all these functions.

Third, smart investors will continue to exercise caution in emerging markets.

The opportunities are big, but so are the risks as nations mature. Emerging markets are always more subject to external shocks and are not as resilient as established markets, such as the U.S. and the European Union. They can be destabilized by corruption, war, natural disaster, and other forces. Transparency is often practically nonexistent, so only insiders know what’s really happening. Bold investors may accept those risks in the hope of earning exceptional rewards, but caution is advised for the faint of heart.

Fourth, globalization will change the nature of education.

Nations that wish to tap the power of the free market will have to embrace the underlying forces driving it — communication, transportation, and knowledge work. This means developing a young population that is educated in science, math, and technology to form the basis for innovation and therefore wealth and status in the world marketplace. The imbalance of wealth in the world is dramatic. The richest nations are 400 times richer than the poorest. Still, through education, poor nations can jump on the globalization and free-trade bandwagon and begin to catch up to richer countries. Nations that fight the trend will wallow in poverty.

Fifth, information technology will supercharge the transition from a 19th century model to a globalized model.

Any business in any country can now hire a virtual workforce, employing people anywhere in the world in its efforts to innovate in a free market. That same technology will allow entrepreneurs worldwide to find the cheapest materials, the best markets for products, and an ever-increasing marketplace of ideas. Nations and businesses that embrace these technologies will be the big winners. Others will fall by the wayside.