Strategic Global Intelligence Brief for August 13, 2018
Short Items of Interest—U.S. Economy
Enjoy It While It Lasts
The second quarter numbers did not really astonish people as there had been more than enough signaling that something good was in the offing. It would have been a very bad thing had there not been a reaction given the stimulus that was coming from the tax cuts. At the start of the year, the thinking was that growth would be close to what it had been for the last decade—somewhere around 2.5%. Now, the estimate is for 3% growth for 2018 as a whole. The majority of analysts do not expect that pace to continue into 2019, however. Most see a slowdown by the end of this year—a result of issues like the tariff and trade wars, the rise of inflation and the fact that the tax stimulation will have had its impact and will start to fade.
Budget Gap Widens Very Quickly
The budget deficit is on track for the biggest increase in decades, but there is no overarching economic reason for this to be the case. There is no recession adding to the required levels of government spending. The gap grew by 21% in the first 10 months of the year. That gap will widen further by the end of the year. The budget deficit is up 79% over what it was last year and those numbers were not considered good. The concern that politicians once had over issues of debt and deficit seem to have utterly vanished as there have been major tax cuts that blew a hole in revenue, while at the same time there were billions in additional spending.
Home Prices Falling in Hottest Markets
The hottest markets in the country are now the ones seeing the steepest drops in price. This has affected the western states as much as anywhere. The reasons for the slide are complex. The reason that prices have been so high has been the desirability of the west coast. But that advantage has been fading as prices skyrocket for homes at the same time that utility costs rise and other cost of living issues become a bigger factor. Add to that the well-publicized issues of drought and fire, and business has been rethinking location. If there are fewer companies hiring, the draw of the state starts to dwindle.
Short Items of Interest—Global Economy
Saudi Arabia and Russia Diverge
It doesn't seem that long ago that Russia and Saudi Arabia claimed to be on the same page as far as oil production was concerned. There has always been tension between the oil producers depending on how badly they want that revenue. All of the producer nations wanted that per barrel price back up and knew they had to restrain the market so that shortages would cause the price to rise. However, the more desperate states could not afford to reduce output. That left the big guns to go silent and Russia agreed to reduce alongside Saudi Arabia. Russia can't afford to support that plan any longer and has stepped up their daily output while the Saudi policy has really not changed. It is still trying to restrain output.
North Korean Initiative Slowing
Those who were skeptical of the arrangement that President Trump and Kim have come to are not really gloating as they see the whole thing start to unravel. It would be in everybody's interest to see the North truly restrain its nuclear ambitions. The problem is that Kim is not doing anything he promised outside of a few meaningless gestures. The whole of his nuclear weapons development infrastructure is fully intact. He has already gotten what he wanted from the U.S. and South Korea. At the moment, it appears that Kim has successfully duped the U.S. and all the others unless he gets hit with renewed sanctions.
Investment Offers to Zimbabwe Vanish
With the overthrow of Robert Mugabe, there was a glimmer of hope that investors would come to the country and help build a new economy. Then the crackdown on the opposition after the election occurred and those investment offers have essentially all dried up. The country is back in crisis again.
Rewriting the Trade Manual
The assertion through the Trump campaign and after he took office was that the U.S. had engaged in a wide variety of trade deals which were ultimately not in the best interests of the U.S. His priority would be to see these deals replaced with something that is more conducive to U.S. growth and would lower the size of the deficit the U.S. runs with the world as a whole. From the start, his plan was met with skepticism as trade deals have to be worked out with other nations and they may not think the current system is all that bad. Further, there was some failure to understand what the U.S. was trying to accomplish with these deals. Although the U.S. does have a trade deficit with most nations when it comes to good the U.S. tends to run a trade surplus when it comes to services. That is somewhat attributable to these past deals. Rightly or wrongly, the U.S. seemed to assume it was no longer going to be competitive as a manufacturing nation in the 1980s and started to position its economy as service based. It often traded access to the U.S. manufactured goods sector in exchange for a favorable position for its service sector companies (law, accounting, finance, insurance, telecoms, etc,) There were also situational needs. NAFTA came to be in part due to the oil crisis of the 1970s when the U.S. faced the prospect of eternal dependence on crude oil from the Middle East and Africa. In return for assurances of access to Canadian and Mexican oil, these nations were offered concessions as far as accessing the U.S. market. Today, we need their oil far less than we once did.
Analysis: If the various trade deals that have been suggested are examined, the track record is not very good. This is not all the fault of the Trump team as it takes two to get a trade deal done (more than two if this is a multilateral deal). There are many nations that simply do not like what the U.S. has to offer and they have the leverage to hold out for something better. There are others where it is not clear the U.S. even wants a trade deal despite claiming this is the ultimate aim.
The most controversial negotiations have been with China. It is not at all clear the U.S. really wants a deal with them. China has been positioned as the enemy; it serves a domestic political purpose to have them categorized as such. Relations with China have always been awkward as they are strong rivals and also trade partners. The two are locked in a high stakes game of chicken as they both attack with tariffs and other trade restrictions. It will come down to which nation can handle the pain longer. Given the power of the U.S. consumer, the guess is that China will outlast the U.S.
There has been no deal with the European Union either. That is a bigger worry as this involves roughly a quarter of U.S. exports and imports—$722 billion annually. There had not been much progress on the talk prior to the arrival of President Trump as the French tended to make demands the U.S. could not accommodate. The barriers now are basically the same, but with the added pressure of steel and aluminum tariffs and the threat of tariffs on cars and other items. This deal seems very distant.
There has been no deal with Mexico—neither a rewrite of NAFTA nor a new separate deal. This is a $564 billion relationship with a $76 billion deficit. There have been many years when there was a surplus as far as Mexican trade was concerned. This depended on how much oil the U.S. purchased and how much food. The drought in the U.S. has meant higher levels of food import of late. Likewise with Canada, there is trade worth $588 billion each year and a narrow deficit of $23 billion. Most are commodities bought from Canada and the manufacturing trade that goes back and forth between the two nations.
One can add several other nations that had been working on trade deals with the U.S. but have seen them fizzle. There has been no deal with Japan, Brazil, the U.K., India, Australia, Saudi Arabia, Turkey and so on. The only deal made was with South Korea, but it has not been ratified and is now in trouble due the steel tariffs and the threats against auto imports.
The Return of Mercantilism
Remember this from those dim and distant economics and history classes? It conjures up images of clipper ships and the days when the sun never set on the British Empire, doesn't it? To be talking about mercantilism as the 21st century unfolds seems anachronistic at best and somehow absurd. But that is where we seem to be with the policies that have been espoused by more than a few nations—China, Russia and the U.S. What exactly is meant by mercantilism in 2018 and what is it supposedly supplanting as far as a global financial and trading system? What exactly is so wrong with this system and why does it appeal anyway?
Analysis: There is not exactly universal agreement on what constitutes mercantilism in the modern era, but there are thought to be seven principles that most analysts can agree on. The first and most obvious is closed borders protected by extensive use of tariffs and various non-tariff barriers such as regulation. This is motivated by a belief that closed borders will protect local business and jobs as domestic companies will produce what the consumer wants as opposed to importing that item. The second principle is extensive state interventionism. This has long been the pattern in command economies such as China or Russia. It is based on the assumption that free markets do not work and that only government knows what is best for the economy and the population. It is choosing which industries thrive and which do not through everything from tax policy, regulation, market access, subsidy and restriction of competition. This has been part of what has been labeled as the president's industrial policy—favoring steel makers over manufacturers as an example. The third principle is also characteristic of the President Trump's approach. The idea is to avoid consistency and predictability as trade and business are treated more as a game to be won than as a means by which to respond to supply and demand. The policy is to keep people guessing and off-balance through perpetual negotiation.
The fourth principle is to eliminate the independence of the central bank. The bank should come under the direct control of the president and the Executive branch so that it follows the policy edicts of the central government. The U.S. Federal Reserve remains independent, but that status has been questioned by the president and others in Congress. Some of the Fed's autonomy has been chipped away recently. The Bank of China is barely independent and Russia's central bank is just another tool for Putin. The fifth principle is the deliberate use of the central bank's interest rate policy to intervene in the value of the currency. The U.S. has long steered clear of manipulating the dollar this way, but President Trump has been vocal about wanting to do just that. The Chinese have been roundly criticized for their actions regarding currency value—and have been accused of currency manipulation. Russia has consistently tried to alter the value of the ruble to promote more exports. The idea is that a lower-valued currency will be good for exports and will reduce the level of imports by making them too expensive.
Principle number six is to ignore deficits and debt with the assumption that all these policies will stimulate such growth that these debt and deficit issues will simply go away. The U.S. is headed for a deficit that is $70 billion more than it was last year and there are no plans to address or reduce it. The U.S. would have to grow at between 5% and 7% per year to deal with the current debt and deficit. Thus far, the U.S. has managed to hit above 4% three times since 2011 and above 5% only once (second quarter of 2014). The 10-year average for U.S. growth has been 2.5%, respectable numbers but not robust enough to deal with those debt numbers. China has a debt to GDP level of over 250% and would have to grow at 12% a year to retire it. The seventh principle is that wealth redistribution has no place in the modern economy. The focus is on creating wealth. If it tends to concentrate in the hands of a few, that is just the way it is. It seems odd given the origins of societies like China and Russia, but the wealth gap in these nations is wider than it is in the U.S. with almost all of China's wealth in the hands of the elite as well as all the political power.
Prior to the emergence of this mercantilist approach to global trade and economics, the dominant model was termed liberal market economics. Not that most countries adhered strictly to those principles. It is the rare nation that adheres to all the mercantilist principles all the time. The change is that this has become the U.S. approach when it was once the system preferred by the state-run economies of the communist world.
Wages Finally Start to Rise but so Does Inflation
It has often been asserted that inflation is best described as wages chasing prices. We are starting to see that develop. The wage hikes that have been expected and awaited for the last few years have finally started to show up as there has been an annual hike in wages of 2.9%. This is still not rapid, but it comes as prices of key goods are rising even faster. The earner that has received that 3% pay hike (and not everybody has) is now watching that advantage erode as inflation gobbles up that increase. The core rate has not even started to change, but the consumer is feeling the impact of the real rate as it considers the price of food and fuel—both have been rising.
Analysis: The patterns in the past have been vicious and hard to restrain without some radical intervention by the central banks. The wage earners that have leverage begin demanding higher and higher wages as do those that have salaries and payouts that index to inflation. Otherwise, they fall behind as far as spending power is concerned. That gives the producers more room to hike prices as they are also seeing their costs rise. Thus the chasing assertion—prices chasing wages and vice versa. The big losers are those income earners that do not have leverage and those producers that can't hike their prices even as their costs go up.
Ride Share Companies Face Similar Taxi Issue
Those who have been dependent on taxi cabs to get around in new cities know this issue very well. The cab driver knows full well the passenger is not familiar with the city and therefore takes longer and more time consuming routes to the destination in order to run up the fare. That seemed to be a problem of the past when ride share options appeared as they charged by the ride and the passenger knows from the start what the ride will cost. It now seems that some drivers still employ the "long way" strategy so they can bill Uber or Lyft more. In some cases, they even stick that extra to the passenger.
Analysis: The most common method for foiling this strategy is to use one's own navigation software to determine the best route. If that differs from the driver's choice, you can ask why.
Cat Patience
Now that I am in recovery from all that nonsense that started the year, I find that I must wear some pretty fashionable items. The latest is a machine that is helping my damaged lymph glands recover. Right now, those in my neck have lost their ability to move stuff along due to the radiation so my neck swells up and I have stuff stuck in my throat. The machine pulses away and moves it for me, but I am wearing this fetching headgear that looks for all the world like a 1940s football helmet and a big pulsing vest apparatus. Today was the first day and it created a new situation for Scoot.
She is my morning writing buddy and takes her position every day without fail—flopped on my desk within easy reach of my left hand—which is expected to be busy with giving her the attention due. Today, she was confronted with the man in the nylon mask and it took her by surprise. Lots of careful sniffing later she decided that it was not a threat to her and therefore acceptable. She continued to stare at the hoses and the parts that moved, but there was no attempt to flee. Spike was another story—he took one look and bolted from the room. I have not seen him since. They have all had to adjust to my changing visage. The trach tube I wore for a few weeks had a bright purple tip that Scoot found to be fascinating. She kept trying to knock it off. That begged the question—why is the tip of this thing bright purple. Am I supposed to think of having my throat cut and a big plastic device implanted as some of fashion statement? There were no opportunities for flesh tone or maybe clear? Maybe the designer has cats!
