Strategic Global Intelligence Brief for August 10, 2018
Short Items of Interest—U.S. Economy
Small Jump in Consumer Inflation
Yesterday, we talked about the stability of the Producer Price Index (PPI) and commented that it involves a lot of variables. The Consumer Price Index was also subdued with a gain of just 0.2%. This was slightly more than the action in the PPI, but far from cause for real alarm. The point is that inflation is continuing to manifest as far as the consumer is concerned, but it has not started to really accelerate. That leaves the Fed to stay on track for the interest rate hike in September without being compelled to do anything else this year. The factors that are driving core rates a little higher range from more expensive education to additional health care costs. The "real" rate has gone up faster and is being driven by oil prices as well as some food costs. The core rate, on the other hand, has risen faster than it has in 10 years.
U.S. Could Set a Tariff Record
If all the tariff threats are actually carried out, the U.S. will have set a record that has not been broken since the end of the Second World War. The Trump team has threatened a whole slug of tariffs thus far, but many have not been implemented for a variety of reasons. The U.S. continues to be in negotiation with many of the trading partners; most likely not all of these tariffs will be implemented. If they are all imposed, the U.S. runs the risk of being a highly isolated state with very little influence in the world trading system.
What Do We Even Call This?
It has been very hard to get a handle on what passes for U.S. trade policy these days. Part of the issue is that there are wide differences between the various members of President Trump's inner circle. It is hard to tell if the dominant attitude is that of Director of the White House National Trade Council Peter Navarro or Secretary of the Treasury Steve Mnuchin. Then, there is the tendency to use trade deals as leverage for something else—without always knowing what that something else is. The fact is that trade policy has long been subservient to other national goals, but at least in the past, the other goals were a little clearer.
Short Items of Interest—Global Economy
More Pressure on Turkey
Later in this issue, we look at the emerging financial crisis in Turkey that has driven the lira to all-time lows against the U.S. dollar. Now, the situation is likely to get even bleaker as President Trump has piled on with a declaration that he will double the tariffs that have been applied against Turkish steel. The Turks are one of the major exporters of steel to the U.S., especially rebar. These tariffs have already affected construction costs, and that will accelerate. The additional attack on Turkey seems related to the fact that Turkey has arrested an American whose case has become important to the evangelical community.
Japan Sees Return to Growth
One can hear the sigh of relief from all over Asia and the world. In the first quarter, it appeared that Japan was sinking back into its former deflationary malaise—not good for the region or the world. The Q2 numbers will reveal that Japan is back to growth of at least 1.9%, far better than had been expected just a few weeks ago. The driver is an unexpected surge of consumer activity that has made up for loss of some export momentum. Japan has been concerned about losing its position in the export sector of the U.S. With all the tariff conversation, that will continue to be a major fear.
Is Kabila Really Leaving
Joseph Kabila has been delaying elections in the Democratic Republic of Congo for two years as he decides whether he will run and extend his 17-year rule. He has decided to allow the elections, but has decided not to run. Instead, he has anointed a successor that has been with him for most of the 17 years and has no base of his own. The sense is that Kabila will make sure that Emmanuel Ramazani Shadary wins. Then, Kabila will rule through him as a proxy. The shattered country continues to be one of the most violent in all of Africa.
Will Turkey Precipitate the Next Big European Crisis?
The situation in Turkey deteriorates almost daily. The currency (lira) fell to an all-time low against the dollar when it lost 12% of its value overnight. It rallied a little after that, but remains down by 35% over the course of the past year. The government of Reccip Tayyip Erdogan claims to be engaged in serious efforts to bolster the economy, but it has been to no avail. Yields on the government's bonds are now at 20% and still climbing. This is at least as bad as it was in Greece a few years ago. Europe has much the same concern as was manifested during that crisis. The most immediate concern is that Europe and banks are exposed to all this because they have done a lot of lending in Turkey and possess a lot of assets. The ECB does not see this situation as threatening to the entire European banking system as was the case with the Greek crisis, but they have warned that select banks are dangerously exposed. These include BBVA in Spain, UniCredit in Italy and BNP Paribas in France. There are many other banks in Europe that have exposure to these three. That makes their relative health a big deal.
Analysis: The situation that precipitated this crisis has been laid squarely at the feet of the Erdogan regime. Since his recent election, Erdogan has become increasingly autocratic and immune to criticisms from outside his own inner circle, and certainly from the rest of the world. He even appointed his son-in-law to head the finance ministry. By all accounts he has been significantly out of his depth. The central bank has been all but emasculated and is no longer really seen as independent.
Erdogan has been resorting to old tricks to shore up his power and his base. The government is spending vast sums of money on social programs and development projects that are in areas where his support has been strong or where he wants to make inroads. The problem is that Turkey doesn't have the money to do all this. That has forced it to borrow and that borrowing has rapidly swung out of control. The government has created a massive deficit and debt issue and has dragged the entire financial system down in the process. The Erdogan regime has been leaning heavily on the central bank to keep rates very low despite the fact the inflation rate has been climbing steadily. The previous bank heads wanted to try to slow that rate down, but they were accused of trying to stall the economy, which was deemed unacceptable to Erdogan.
The other problem is that Erdogan has become more and more imperious and has been making enemies of countries he needs as allies. The U.S. is upset with him over the arrest of an American who was linked to the movement that earlier tried to overthrow Erdogan. That abortive coup attempt was snuffed out in days, but is still being used as an excuse to go after anything and anyone that would venture a critique of Erdogan's policies. He has alienated the U.S. and Europe and has not made any strides as far as replacing the largesse from these nations. The issues in Turkey are not serious enough to drag Europe down as there has not been the same level of bank engagement with Turkey as there was with Greece. Turkey has always been more peripheral to Europe than Greece. Still, a wholesale collapse will have a major impact on those large banks that were engaged with Turkey.
So Much for That Reduction in Russian Oil Production
It was about a year ago that Russia agreed to join with the Saudi Arabians and other OPEC states to reduce oil production. This was an attempt to get per barrel oil prices off the floor and back to at least $60 or $70. The plan worked since the timing was good. At the same time that this production was declining, there was surging demand and the price recovery was swift. Now the word from Russia is that production is back to levels not seen in years.
Analysis: This is the almost inevitable cycle. Low production creates bottlenecks as far as demand is concerned. If that demand surges, the temptation is high for oil producing states. With the effort to reduce output from the Russians and OPEC came a decision by those non-OPEC nations to get in gear and produce to meet that need. The U.S. oil sector is booming again; likewise in Canada and Mexico as well as Europe. The almost inevitable development from this point is the fall in the per barrel price as all the oil players rush to protect and establish their market share position.
Reactions to Current Foreign Policy Initiatives
To be honest, it has always been a bit hard to put a finger on what exactly the current foreign policy is. The one aspect that seemed the most unique has been the personalization of relations. President Trump is not one that works through his diplomatic corps; what matters is his personal relationship—very similar to the way he long did business. In the first two years of this regime, the hallmark has been bold policies based on personal conversations. President Trump wants to revolutionize U.S. relations with Russia and North Korea and others through establishing rapport with their leaders.
Analysis: Thus far, there has only been very slight and mixed progress. Kim Jong-un has played his part as willing negotiator, but evidence has begun to suggest that Kim has continued to develop his nuclear capabilities and has been belligerent about it. Vladimir Putin was the real goal, but now relations are as strained as ever since the U.S. imposed more rounds of sanctions to protest the Russian attempted murder of a prominent critic of Putin. The plan seemed to be to get something to address financial issues if there was palpable movement towards protecting and promoting basic civil and community rights. Russia has been furious with these sanctions, but these are seen as having come from the legislature. That leaves them in a better position.
How Fast and for How Long?
When the U.S. economy hit a GDP growth rate of 4.1% in the second quarter, there was almost immediately a chorus of assessments from the economic community that revealed a lot more about that economic community than the economy itself. One group got giddy with the possibilities and asserted that growth of 5% and even higher was now imminent. There was another group dismissing the 4.1% surge as an anomaly and unsustainable as they predicted the economy would settle back to the 2.5% average of the last 10 years. Then, there were those in the middle who asserted 5% and even 4.5% was too robust to be sustained, but thought the 2.5% average as too low and too slow given the drivers that have been appearing this year. Let us all remember my favorite definition of an economist—someone who explains tomorrow why the predictions made yesterday were wrong today. Why is there such a wide variety of opinions regarding economic growth?
Analysis: The easy answer is that there are a lot of variables these days and conditions keep changing. There are also many of these variables that start out promoting growth, but will at some point become inhibitions as the various forces in the economy change. Three important factors are in play. There is a lot of disagreement as to whether their impact will be generally positive or negative. There are also controversies over how long certain policies will last and what the lasting impact of that policy will be. The three factors that will dominate short-term thinking and forecasting include the development of inflation, the impact of trade and tariff wars and the role of governmental stimulus.
The inflation threat is probably top of the list, but it has been hard to get an accurate read on timing and seriousness. It is clear enough that inflation has already been felt in the price of fuel and the overall price of food, but these prices have continued to be volatile. That is why they do not get figured into the core rate. To the consumer, however, these are the most important of inflation markers. The core rate has remained relatively low and close to the position the Fed has preferred at 2%. It is about twice that high for the headline rate which includes the price of food and fuel. The latest driver for inflation is the most important and has been slow to develop. Wages are starting to climb, although the pace has remained slow. At some point, it breaks loose as higher commodity prices affect the consumer and people begin demanding wages that keep up with these inflationary moves. All eyes will then be on the Fed and their reaction to the threat. Those who see much higher growth in the future think the Fed will not react very strongly to inflation and will not push interest rates all that high. Those who see far slower growth assume the Fed will react to higher levels of inflation the way it always has—with several sharp interest rate hikes. There has been supposition within this group that rates would go up as many as five times next year. Those who are neither overly enthusiastic or underwhelmed are taking the Fed at its word and think that rates will go up twice more this year and maybe twice next year.
The second important determinant of growth is likely to be the eventual outcome of the trade and tariff wars. It has been almost chaotic to this point as nobody really knows what to expect even in the short term. It has been a constant process of negotiation with declarations of intent changing almost weekly. The tariffs on metal have been imposed, revoked and imposed again with hints of another set of exemptions. The ban on cars from Europe was dropped, but the threats remain. Many companies are reacting to all this in predictable ways—trying to acquire as much as they can before the tariffs start or they are trying to sell as much as they can. The U.S. has never shipped more soybeans to China in such a short time as farmers try to beat the restrictions. Much of that second quarter growth was due to this frantic import and export activity. That will not motivate the Q3 and Q4 numbers.
Finally, there is the impact of the government stimulus at the start of the year. Most analysts agree that it was somewhat ill-timed. Efforts like these are generally geared towards dragging an economy out of the middle of a recession so it would have been more appropriate to have seen this in 2014 or 2015, but back then, the GOP worried about deficits and debt. That concern seemed to evaporate once Obama was out of office. Suddenly, there was support for tax cuts and spending. The effort did what it was supposed to do as business invested and expanded, but the impact of this plan has a limited shelf life and will not have such a major impact the rest of the year.
Some Medical Observations
Now, in the repair portion of my treatment protocol, I have noticed a few things about this process and the people involved. In the first phase, there was not much for me to do but show up. They operated, chemo treated and radiated me. I just sat there or laid there and received whatever cocktail was called for. Now, I am in the self-help phase as I contend with the aftermath of all that stuff. My neck lymph glands are shot and that gives me lymphedema. I lost a lot of weight all at once and with that a lot of old strength and stamina. Once, I saw a lot of doctors. Now, I see a lot of therapists.
I noted that my doctors were pleased I was in reasonably decent shape at the time this started as they would have had to change the treatment to something less effective. I could tell they were puzzled by people who simply choose to ignore warnings until the point their health is broken. I am amazed that some of the people I least expected to take this position consistently ignore instructions given them by their doctors and others. I have mentioned that to the therapists I work with as I am not always as reliable as I should be. I am supposed to wear a device three hours at a time for the swelling on my neck and don't always. I have exercises I don't hit as reliably as instructed, but am told over and over again how much more attentive I am to these instructions. I would think they would accuse me of being a slacker.
I am reminded of my failings by my charming and dedicated wife. She had a 97% tear in her rotator cuff a few years ago after a bad fall. Due to her age (a phrase she despises), they told her she would be lucky to get some movement back after surgery. Less than a year later, she had 100% movement. When asked if the exercises hurt she responded with "of course they hurt. No pain, no gain." It is hard to keep up with that—let me tell you!
