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Strategic Global Intelligence Brief for April 22, 2019

Short Items of Interest—U.S. Economy

Reactions to Tariffs
There is no more consistent and powerful law in economics than the law of unintended consequences. The fact is nobody really knows how people will react to a given change although there is generally some historical precedent that can be used as a reference. One example of this, as it pertains to the tariffs that have been imposed on goods from China, is that of washer and dryer purchases. The tariff imposed on washers was 20% on the first 1.2 million units shipped to the U.S. and a 50% tariff on all those that came later. There was no tariff imposed on dryers. The response was that both washers and dryers went up by between 12% and 15% because these items are nearly always sold as a pair. The tariffs cost the U.S. consumer around $1.5 billion thus far this year.

Existing Home Sales Down
There was a 4.9% decline in sales of existing homes in March. This is of greater concern than what happens in the new home market as the bulk of sales activity takes place in the existing home market. The decline was far sharper than had been expected, but analysts knew there would be less activity despite the fact that mortgage rates have declined. There has even been some easing of the price in this category. The problem now is that fewer people are qualifying for mortgages and there are fewer people who have the ability to buy a home given the need for a larger down payment and the added costs involved with home buying.

Rents Rise Nationwide
For a variety of reasons, homeownership has become less and less appealing to a wider segment of the population. That has put a new emphasis on rental property. It has resulted in record rental rates in a large number of urban areas where there is a severe shortage of available units, but also in more suburban locales where demand is outstripping supply. The Millennial buyer has long been illusive as they resist setting down to a traditional home at this point. Now, there is also resistance from the Boomer generation as they elect to leave their homes behind for some form of senior living or at least smaller and simpler housing where the duties of home ownership are somebody else's problem.

Short Items of Interest—Global Economy

No Joke—Zelensky Is Ukraine's President
In the end, it was not even close. The insurgent campaign of the political novice was responsible for a landslide victory. Volodymyr Zelensky overwhelmed the incumbent Petro Poroshenko. He once played the president in a satirical TV show and now holds the office for real. The big question is whether he is really his own man or nothing more than a stalking horse for some of Ukraine's most powerful oligarchs. They are the ones who bankrolled his effort, but he also has the knowledge that millions of people voted for his outside message and his assertion that he could "clean up the swamp." He is a populist in the same vein as others in Europe such as Bepe Grillo in Italy and Marine Le Pen in France.

Protests Explode in France
It is now a war between those who want France to honor its traditions and rebuild the Notre Dame cathedral and those who assert that money would be better spent addressing the many social ills facing France. These protests are an extension of the other "yellow vest" riots and demonstrations. They have featured the same kind of violent expression—burning stores and cars and attacking authorities.

Sri Lankan Authorities Report Global Jihad at Work
Among those who have been detained for their role in the bombing of churches and hotels were many who are not from Sri Lanka, but have connections to the global terror groups that have been active in the Middle East. Several are linked to ISIS and Syria. This gives further proof that this is a shift in ISIS tactics now that they have been driven from their old territories.

Far Reaching Implications of Sri Lanka's Terror
The massive and coordinated bombing attack in Sri Lanka stunned a world that has become almost inured to this kind of tragedy. The death toll has already risen to 300 and is expected to go higher as the investigation continues. The focus of the assault was very clear—the Christian community and westerners in Sri Lanka. The targets were three Catholic Churches in the middle of Easter services as well as three luxury hotels that cater to western tourists. This is a nation that is certainly no stranger to sectarian violence as there has been an ongoing war between the Tamil and Sinhalese populations that over the years has claimed thousands of lives. This attack was different in terms of motivation and target. The Christian population is small in Sri Lanka, but influential in terms of business and overall economic development. This is also a nation that depends very heavily on tourism for its national income and attacks such as this one all but destroy that potential.

Analysis: Part of the raging controversy now is the government's reaction to warnings that had been issued prior to the attack. It seems that the intelligence community had reason to think that some kind of assault was imminent. That assessment has been reinforced by the fact that 25 suspects have already been rounded up. It is not clear whether these are people who have been directly connected to this attack or if they are simply people with some ties to terrorist organizations or movements. At the time of this writing, there had been no claim of responsibility from any specific group, but the authorities have concluded that Islamic radicals were behind the attack.

There are certainly devastating consequences for Sri Lanka as this tragedy has decimated a small, but influential community. It will all but kill tourism for an extended period of time and will even affect the number of business people willing to visit the country. The bigger issue is the direct attack on the Christian population as it reinforces a trend that has been manifesting in other parts of the world. There has always been an element of religious conflict, but the terror organizations have been equally violent towards select local ethnic groups and religious affiliations. The wars in the Middle East have been as much about the Shiite-Sunni split as about Islam vs. Christianity. The battles in Sri Lanka have been between Tamil and Sinhalese (Islam vs. Buddhist). Now the attacks on Christians are taking a higher priority in the terrorist plan, which provokes an even stronger response from the U.S. and Europe.

There have been many self-congratulatory statements regarding the U.S. "victory" over the ISIS terrorists, but analysts have been warning for years that defeating groups like this can be next to impossible. They simply change their tactics and revert to standard guerilla activity. The fear is many of these terror groups will now return to bombings and assaults that are designed to terrorize and cause panic.

Oil Prices Rise as Pressure Builds on Iran
The U.S. has decided to put additional pressure on Iran by removing the waivers that had been issued for several nations buying oil from Iran. These waivers will expire in May. That will mean these countries will either have to stop buying oil from Iran or face the financial penalty for violating the sanctions. The countries operating under these waivers include China, Japan, Turkey, South Korea and India as well as some smaller oil importers. This statement from the U.S. caused an immediate spike in the per barrel price for crude. The latest cost of Brent crude is now in the mid-70s. Even WTI is now in the 70s. Most expect this hike to continue until the per barrel price is in the 80s and maybe the 90s.

Analysis: In the last few months, there have been several issues that have caused the price of oil to rise. The decision on the part of the Russians and OPEC to cut production was one major development. Since then, there have been growing fears of much reduced output from the likes of Libya, Algeria and Venezuela. The global supply of oil has been reduced by between 10% and 15% and the market is responding. This comes at a bad time for the U.S. as this the start of the summer driving season, a period when gas prices tend to rise anyway. The estimate at this point is that gas prices will jump between 25 cents and 30 cents a gallon and could easily be above $3 a gallon within the month.

That is also enough to start triggering commodity-led inflation, although there has been less movement in other commodity areas. The U.S. has the ability to compensate for some of that production loss, but not immediately. There is certainly an incentive to let prices rise as the U.S. oil producers have long wanted to see prices in the 80 to 90 dollar a barrel range.

Broken System? Repairable?
For the better part of the last several decades, former World Bank Chief Economist Joseph Stiglitz has been a polarizing figure in the realm of economics. He was also chair of the Council of Economic Advisers in the Clinton administration and won the Nobel Prize in 2001. He is most definitely defined as a liberal economist and has made no secret of his attachment to the theories of John Maynard Keynes and Paul Samuelson. This placed him pretty firmly on the left for many years, but in today's environment, he has suddenly become a standard bearer for a more centrist view given the rise of those who prefer an openly socialistic economic system. His latest writing has been something of a response to those who assert that everything about capitalism and the free market is rotten to the core and needs to be replaced outright by some kind of state-managed system akin to what exists in China or once existed in the USSR. His fundamental assertion is that the current system has been distorted and parts of it are broken, but not irreparably. What is required is a return to fundamental principles.

Analysis: His basic assertion is as follows. "A progressive capitalism based on an understanding of what gives rise to growth and societal well-being gives us a way out of this quagmire and a way up for our living standards." His bottom-line assertion is that there are two ways to develop wealth—one is to recognize that the only real source of success is to rely on the creativity and innovation of the population. This approach broadens the economy and allows a greater number of people to gain and prosper. The alternative is to grab a bigger share of the economic pie through the exploitation of others. That can be everything from misusing workers to seizing market share to controlling some input. It also involves manipulating the political system to provide an unfair advantage and to keep competitors out.

The most consistent challenge faced by a market-driven system is the lack of an "even playing field." In theory, the market creates competition that evens out this playing field. A company that is exploitative will struggle to attract workers when there are alternatives that are not exploitative. Companies that do not provide what the consumer wants at the price the consumer wants to pay will be replaced by companies that do. The problem is this market-driven system can be altered and rendered ineffective through a variety of techniques. The government can make it harder for competitors to develop by subsidizing certain segments of the economy. The reality is people do not have the choices it is assumed they have. Even when there is a market-based response that provides what consumers clearly desire, there will be many who lose their livelihoods and many that do not like the evolution. Ride sharing killed the taxi industry and online shopping is killing the mall and the department store. In both cases, the consumer led this transformation.

Stiglitz asserts that government and its role in the economy is at the heart of this debate. The basic assertion is government has to choose sides. Currently, the role of government has been to protect those who have the majority of the wealth and influence. This is manifested in the tax code and the welter of subsidies and programs designed to protect and defend the status quo. The U.S. asserts that it is an entrepreneur-friendly environment, but the reality is that those starting anything more complex than a coffee shop or a tech shop working on an app will struggle. There will be no rival carmakers or aircraft manufacturers or pharmaceutical companies. Nor will there be any technology companies to challenge Apple. The majority of the Fortune 500 are parts of an oligopoly at best and some have a monopoly position.

Stiglitz wants a reform that puts the government on the other side—as a protector of competition and the overall population—as workers and consumers. This means regulatory attention to prohibit exploitation and creation of dangerous products. It means protecting the ability to compete against any company so there are choices. It means swapping out corporate welfare for something that benefits all. If this seems easier said than done, you have identified the fundamental challenge with systems that rely heavily on the government to maintain fairness.

The fact is that no system will be perfect and most will not even come close. Stiglitz is arguing that our current system of capitalism and the free market has flaws which are serious ones. That doesn't mean that shifting to a state-run society is any better. He argues that it would indeed be worse. The only real option is accepting the fact that imperfections exist and will need to be dealt with as they arise. The first step is to recognize what is broken and what should be changed.

More Distress in Housing Sector
The pace of new home building has fallen off over the last several months. Judging by the data just released regarding building permits, that situation is not going to change anytime soon. The rate of new building permits fell by 1.7% nationwide. This is the point where we remind readers of what they already know—home building is the ultimate local market. What is taking place in one city is not necessarily what is taking place in others. There are still many hot markets where activity is strong, but now, there are more communities that have slowed than has been the case before.

Analysis: Two factors determine whether a given market is hot or cold. The most important is the factor that has always ranked very high—availability of jobs. The fastest-growing communities are those where there has been significant job expansion. The second major factor is the potential "draw" of that city or community. This is often hard to pinpoint, but usually revolves around some form of entertainment or activity. Places that have a good reputation for one's leisure life are growing. The attractiveness is often demographic-specific with Millennials moving to outdoor-focused areas and retirees to warm weather locales.

Playing by the Rules
This can be a very controversial and emotional topic for many. It certainly was over the weekend when the subject came up with my stepson. He is most definitely a person who plays by the rules and always has. He and I think alike in that respect. The assumption is that one works hard and does what is expected of you. It therefore galls both of us to see people game the system and exploit those who behave as they are expected to. He works with and supervises people who actually laugh at those who are working. They refer to them as the chumps too stupid to figure out how to get paid for doing nothing at all. He lacks the power to do anything about it.

The challenge is that there are people in our own family who violate the rules with impunity. My brother-in-law worked the bankruptcy system as he purchased thousands of dollars of electronics, furniture, new cars, etc. right before declaring bankruptcy and stiffing everyone. He worked the system in the past so that he could avoid working for years. My granddaughter is a very lovely woman, but works the welfare system so that she can avoid work. On the other hand, my grandson works himself to death as a large animal veterinarian and is paying off his student loan debt with those 70-hour weeks. He then watches people suggest that those who chose to major in underwater basket weaving have their loans forgiven.

I started out my academic career as a Soviet and East European Studies major. I had opportunities to be in the old USSR and behind the "Iron Curtain." I observed one thing over and over. If the system rewards indolence and laziness and fails to reward hard work, there will come a point when even the most hard-working person stops wanting to feel like a chump. They stop working as nobody else around them works anymore and they are getting the same as the hard worker. We have not fallen that far, but there is far more of this attitude than there used to be.

Oil Prices
Forecasting the price per barrel of oil is anything but an exact science. Too often the charts look like this one. Reports of month-over-month volatility give way to an estimate that looks like a nice flat line. The reality is volatility will be part of the future as well. The important thing to take away from forecasts like this one is whether there is a generally upward or downward trend. The EIA assumption is that oil prices will be heading up in the coming year—not this smoothly of course, but heading up nonetheless.

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Wednesday, 22 May 2019