Strategic Global Intelligence Brief for August 15, 2018
Short Items of Interest—U.S. Economy
Small Strong Retail Start to July
After cresting slightly above 4% in the second quarter, there has been endless speculation among economists over whether this rate of growth will be repeated in Q3. Roughly half think that Q2 was the peak and roughly half hold that this is just the start of things to come. The key to the growth in the second quarter was a combination of strong exports spurred by companies that were worried about the imposition of tariffs and the impact that will have on their future plans. Also key was the awakening of the U.S. consumer. It took longer than expected, but the consumer finally seemed to react to the tax cuts and got busy with spending. The July numbers suggest that consumers remain motivated to spend, which is good timing. We are now in the midst of back-to-school. That is often a harbinger of things to come as holiday spending increases.
Productivity Levels Exceed Expectations
It isn't quite a dramatic breakthrough, but the productivity numbers are up and better than expected. The consensus view was that productivity levels would be up by 2.6%, but they jumped to 2.9% on the back of technology and robotics. This is good news for the economy, but there are some caveats. The level of productivity is measured by computing the output of goods and services for each hour of labor worked. There are generally two ways to boost productivity. One is to hire more people and have them produce more, but that assumes the workers are trained and skilled from the start and can immediately contribute. The more common reason is that automation and robotics have made jobs easier and made workers more efficient. It also means fewer workers are needed, which in turn, makes it that much harder for low-skilled people to find work.
Student Loan Crisis Eased a Little
The improved economy and the lower rate of unemployment has eased the threat of a student loan bubble bursting. The fact remains that this generation of students is far more likely to delay some of the standard purchases as they figure out how to make those payments. The total amount of student loan debt in the U.S. is now at $1.4 trillion, but there are fewer people in arrears. The big issue is these same people are the ones delaying the purchase of a house or other big ticket item.
Short Items of Interest—Global Economy
North and South Korea Move Ahead
The two countries are wasting no time as far as moving to another phase. The South Korean government is planning to open both road and rail links to the North despite the opposition of the U.S., which has now started to become irritated and impatient regarding nuclear weapons development. Promised closures have not happened and there has been no sharing of intelligence between the U.S. and North Korea. Kim is getting billions in economic aid, but thus far has not had to give up anything for it.
New Zealand Bans Foreigners from Buying Homes
The fear has been that foreign owners are going to cause home prices to inflate to the point that people will struggle to find a home. Overseas investors have been buying large estates. That has concentrated the sector into those high-priced sectors while little attention has been paid to the middle of the road buyer. The ban is expected to help keep prices low, but it also severely limits foreign interest.
India's Currency Falls to New Low
The rupee has hit an all-time low and has dropped by 8.6% this year already. Investors are impatient with the pace of reform that Narendra Modi promised. His tardy start has already cost the markets. The fear is that the Indian deficit is going to hit all-time numbers as well. Modi and the government assumed a healthier economy and seem to be having a hard time meeting the expectations they set. They want to flood the markets with cash. That definitely worries those who remember Indian inflation situations.
Europe's Infrastructure Crisis
The latest tragedy is the collapse of a toll highway bridge in Genoa that has resulted in the deaths of several people thus far. As is usually the case, there is a sudden flurry of accusations and calls for inquiry into the company charged with maintaining the bridge and highway. The real issue has been building for years. It is not just something that Europe has to contend with. The U.S. has been allowing its infrastructure to deteriorate for years and years, and has started to pay the price. The American Society of Civil Engineers has graded the system in the U.S. as D- and has threatened for years to move that all the way to F. Analysts in Europe assert that over 60% of the bridges in use in Europe are in need of urgent repair and the issues of infrastructure go far beyond that of roadways. In just the last year, there have been collapsed schools, stadiums and even hospital facilities. These have not resulted in deaths, but there has been injury, and the costs of repair and replacement have been high.
Analysis: The issue has been the same in both the U.S. and Europe. The last 10 years have been a decade of very slow growth and very slow recovery from the recession that started in 2008-2009. The majority of governments also chose this moment to address their budget crisis. For many years, the watchword was austerity. In country after country, budgets for infrastructure were slashed—to develop new systems and to repair old ones. The fixes that were undertaken were often little more than band-aid treatments designed to buy a little more time. The lack of investment was evident in some of the richest nations such as Germany, but the most egregious breakdowns have been in countries hardest hit by the financial crisis—Italy, Spain, Greece, Portugal and even France.
Now that this neglect has become acute and failures are turning deadly, the governments are facing even more drastic choices. There is no more money than there has ever been, but fixing these problems will be far more expensive than they would have been if routine maintenance had been taking place. The expectation is that more of these failures will occur—affecting the urban areas as well as rural ones. The reaction will be angry. Lots of pledges and promises will be made, but these howls of outrage are a smokescreen covering up the fact that politicians have been siphoning money from these projects for years.
The U.S. had relied on the gas tax to finance highway repair and construction, but that money source was shown to be inadequate many years ago. The fact is that cars get better mileage and people are spending relatively less on fuel than was the case before. It is has been said that state highway departments have a picture of the Chevy Suburban in their offices with a sign that says, "Our hero." The gas tax has not changed in years; there are now serious moves at both the state and national level to hike that tax so it can pay more for the needed work. Unfortunately, the need now is so great it would take an increase of between $1.00 and $1.50 a gallon just to make a dent in the needed repair work. The majority of the proposals are suggesting a hike of maybe 10 to 15 cents a gallon.
Spain Starts to Get Nervous Over Migrant Issue
There has been a stark difference between Spain and Italy when it comes to the issue of migrants. Both countries have new political leaders and both made migration a big part of the campaign, but in radically different ways. The right-wing coalition in Italy between the Northern Alliance and the Five Star Movement has been cracking down on migrants. Ships have been denied permission to land even when they have been in imminent danger. The migrant camps are not supported by the government and are squalid and dangerous. Meanwhile, Spain's new leader is Socialist Pedro Sanchez. He ran on a platform urging sympathy for the refugees. Needless to say, the contrast has not gone unnoticed by the migrants.
Analysis: The preferred route to Europe was generally through either Greece or Italy as these were the nations closest to the bulk of the migrating population. The Greek route lost its popularity as the central and east European nations implemented strict border controls that made moving on from Greece very difficult. Italy was next up. Many tried to reach the southern tip and Sicily as a first step towards the rest of Europe. Now, Italy has cut that route off and the next step is Spain. This means migrants have to make their way through various North African states—some of which are in total chaos. Libya is exceedingly dangerous and Algeria is overtly hostile. Morocco has been slightly more supportive, but the government wants them to move on quickly. Now Spain is getting very large numbers of refugees and migrants. It has started to overwhelm the ability of the country to accommodate. Sanchez has not suggested a reversal of policy, but his opposition is making this an issue every day.
Is the U.S. Losing Allies?
The U.S. has traditionally been a fairly patient ally when it comes to most countries. This was especially the case during the Cold War years when the only thing the U.S. required from the nations it did business with was a stated opposition to the USSR and/or Communist China. Such a position would open the floodgates to everything from diplomatic recognition to substantial economic and military aid. Those were the years when the U.S. had a great many "strange bedfellows"—nations with miserable human rights records (Chile under Pinochet, Zaire under Mobutu and so on). These were nations that had access to the U.S. market, but which denied the U.S. access to their own. The only litmus test was anti-communism. With the collapse of the USSR, that motivation ended and new relationship rationales developed. The U.S. became a bit more hard-nosed and sought interactions that benefited the U.S. economy in some way. The U.S. has had a long and complex relationship with countries that provide oil regardless of their internal politics and how often they clash with other foreign policy plans. The U.S. continued to have a bias towards those nations that were ostensibly trying to develop as democracies regardless of how halting that process was. In the last few years, the criteria for U.S. support include taking a strong position on terrorism—especially that connected to Islam extremism. Once again, the U.S. has some odd allies that don't seem to share much as far as core values, but they are on the "right" side when it comes to the war on terror. These are mostly military regimes and dictatorships in North Africa and the Middle East.
Analysis: Under President Trump, there seem to be new rationales as far as remaining a close U.S. ally. Most of the relationships the U.S. has been engaged in have been called into some question. It is tempting to ascribe all of this to the notion of the "America First" policy, but there are some other reasons as well. It is certainly true the U.S. has become a far more isolated and protectionist country in the two years that Trump has been in power. Longtime allies in Europe have been shunned and criticized to the point it would be hard to identify a European leader with even a neutral position on the U.S. Many are actively opposed to the U.S. and have taken steps to reduce the interaction and cooperation that was once taken for granted. The nations that are part of the emerging market world have received the cold shoulder treatment and complain of being utterly neglected by the U.S. Remarks from President Trump have been dismissive and often insulting. It is clear that Latin America, Africa and much of Asia is off his radar. That doesn't mean other parts of the U.S. government have taken the same position, but it is worrying to these leaders when they can't get the attention of the president at all.
Beyond the focus on the U.S. to the exclusion of other global issues, there is the changed nature of power since the collapse of the USSR. There is no focus now. The contest between the U.S. and Soviet Union was a traditional one that placed emphasis on the strength of the military, which then placed emphasis on the economy. Now the U.S. has shadowy enemies that can't be attacked with missiles and nuclear weapons. Our biggest geopolitical rival, China, is also a major trade partner. The U.S. has considerable economic clout, but there are more contenders than before and nations assert they have alternatives. The Trump administration has elected to go hard after Turkey and seemed to expect Erdogan to swiftly capitulate, but he has instead turned to Russia for help. Not that Russia has the money the U.S. has, but lately, the U.S. has been stingy with its aid anyway. Erdogan now sees a future with Russia. This means a major NATO ally is now courting Russia. It is very likely the U.S. will lose its bases and positions in Turkey unless some kind of rapprochement is reached. This would seriously compromise the ability of the U.S. to project force in the Middle East as it would have no base of operation. It is clear enough that the U.S. wants something different from its allies, but not at all clear what that something is—economic, diplomatic or political.
Import Prices Down Despite Trade Rows
It is all a balancing act after all. There are forces that will drive import prices up or down, and more than occasionally, they contest with one another. The cost of imported goods has been rising in reaction to the tariff and trade mess, but at the same time, the U.S. dollar has been gaining strength as investors assume the Federal Reserve is going to continue hiking rates. These developments essentially offset one another. That situation is not expected to last much longer as many of these higher-tariff expenses have yet to kick in. As they do, the costs of imported goods will continue to rise and the stronger dollar will affect demand for U.S. exports. That will end up making the trade deficit worse.
Analysis: Although there has been an excess of hand wringing regarding the trade deficit, there are really very simple ways to reduce the numbers, but unfortunately these options also mean a weaker U.S. economy. If interest rates were to remains stable or even fall, there would be less demand from investors driving the dollar value up. But that also means the U.S. economy has weakened again and needs the help of the Fed. If the U.S. economy stutters and the consumer is less active, there will be less demand for imports as well. Much of what the U.S. buys from the rest of the world is either commodities like oil and industrial metals, or it is consumer goods that can be produced more cheaply than in the U.S. The growth of the U.S. economy over the last year has made the deficit situation worse as there is higher demand for all the things the U.S. traditionally buys from the rest of the world. In the grand scheme of things, the U.S. population is likely to favor better economic growth over a lower trade deficit.
Who Are the Unaffiliated?
Now that the main event is shaping up, the U.S. will be "treated" to another round of election fun. If you thought the ads were vicious in the primaries, "you ain't seen nuthin' yet." As with every election over the last several decades, the final outcome will come down to a group that has many names: the unaffiliated, the independent or the disengaged. As things stand in the polls right now, the GOP generally has about 30% support—these are the people who adore Trump and will not hear a word of opposition against him. Nothing the Democrats say will sway them in the least. Another 30% are virulently anti-Trump and anti-GOP. There is nothing that will make them vote against the Democrat on the ballot. That leaves the great difference maker—the 40% that has not yet decided.
There are lots of reasons to be in that 40%. There are those who really do follow politics and see things they like and don't like about the candidates. They will be trying to sort their priorities to the bitter end. Then you have the clueless. They may not even bother to vote. If they do, the motivations will be simplistic and often based on very little. There are those who are further to the left than the Democrat running and those who are further to the right than the Republican running. They will either have to hold their nose and vie for someone they don't support or choose not to vote at all.
As with most elections, it will come down to the last week. If something dramatic occurs, it could swing the vote if the people in that 40% notice and care to vote in response. If there is no terror attack or natural disaster or economic calamity, it will come down to how people see the local race and how many people elect to go to the polls.
