Strategic Global Intelligence Brief for August 17, 2018
Short Items of Interest—U.S. Economy
Housing Bounceback but Not Much of One
The June housing numbers were very weak. That set off a number of alarm bells from those who have been watching the impact of the housing sector on the U.S. economy. Most of the analysts were convinced that July would be a lot better. The consensus view was that there would be a rebound of around 8%. There was indeed a rebound, but a very anemic one of just 0.9%. The drop in June was over 12%. The sense was June was an anomaly and July numbers would be back to more normal levels. This kind of half-hearted recovery has many analysts in a bleak mood as it appears all those headwinds consumers had been battling are indeed doing damage. The housing market is much more expensive and mortgage rates went up. It doesn't fire the imagination of the consumer much.
China Trade and Natural Gas
One of the unexpected casualties of a trade war between the U.S. and China is likely to be the U.S. natural gas business. The development of oil in the Bakken and Eagle's Ford has been accompanied by a massive flow of natural gas—far more than the U.S. can absorb at this point. The price of gas has fallen and is getting dangerously close to being unprofitable. The U.S. producers have been working for years to develop a market for U.S. gas in China. This much we know, but the billion-dollar price tag is daunting. Both want to maximize their value. That has meant that oil companies would like to see the plan operant. If the U.S. and China cut off this deal, the U.S. will see this intricate dance with China falter and will have to figure out what to do with the extra. If prices go up, there will be howls of outrage throughout.
This is the point at which the U.S. election is supposed to turn towards the center and towards economic issues. The traditional mantra for a general election has been that the economy rules. Any other president would be sitting in a very good position going into the mid-terms because of the success of that economy. However, with only months to go before the November vote, the economy is not the issue. Most have become complacent and have just assumed it will be good. That has left the two parties in a weird place where amorphous cultural issues dominate. President Trump's focus is still on issues that are either personal (Russia investigation), conspiratorial (the "swamp" and the deep state) or deeply partisan (immigration, culture wars).
Short Items of Interest—Global Economy
For much of the developing world over the last several decades, the rise of their population has been an enormous asset as they have focused on educating that population and getting them to work. This has been the story of the Chinese surge to the top. It has also been the pattern in India and much of Latin America. The story in Africa has not been as sanguine. The hope had been that an urbanized and educated population would spur development, but the continent has struggled with how to get these young people to work in jobs that develop their region or country. Millions of educated people under the age of 30 are living marginal existences and barely able to eke out a living. More than anything, Africa needs foreign investment—trillions of dollars' worth.
Massive Floods in Kerala
India is getting hit with yet another massive flood event—one that has already displaced some 175,000 people and killed over 200. The region is generally used to getting monsoon rains. In fact, it counts on them, but this year they have been more intense and long lasting than usual. The region has been unprepared for the onslaught.
Turkey Facing U.S. Sanctions
It is safe to assume that the relationship between the U.S. and Turkey is over until one or both of the leaders has departed. The Trump attack on President Erdogan has set the Turkish leader into a rage. There is no room for either to maneuver at this point. It is now safe to assume that Turkey has gone from being a U.S. ally to an enemy.
Where Are We With Trade Deals Today
If there is one thing that can be said about the trade deals that have been under discussion for the bulk of the last two years, it is that there is never a dull moment. Once upon a time, these agreements were negotiated in meeting rooms and over meals by teams of diplomats. Nobody in the country really knew that much about them unless they were in an industry that was specifically affected. They were certainly not headline-grabbing stories. That started to change during the campaign when President Trump's approach focused on trade agreements as the reason for most of the nation's economic ills. Lost your job at the factory? Blame China and not the fact you have been replaced by a robot. Can't find a T-shirt made in the US of A? Blame trade deals rather than the fact that other countries have much lower costs of production. Politicians have been mentioning deficits for years, but it has only been the last two that have seen the trade deficit presented as evil incarnate as opposed to a response to the fact that U.S. consumers are essentially insatiable. At the start of the term, there was a very aggressive tone taken on virtually every trade deal the U.S. has been a party to—NAFTA was going to be scrapped, a new deal would be put together for Europe, the Trans-Pacific Partnership (TPP) would be abandoned, China would become the new trade enemy and so on. Some of that aggression has produced a strong response—such as the imposition of steel and aluminum tariffs. Many other trade moves have still not happened. What is the situation today?
Analysis: From the beginning, there have been two schools of thought about what President Trump is trying to accomplish with these trade tactics. The first takes him at his word and assumes he really does think these are the worst deals imaginable and are wrecking the U.S. economy. This assumes he really is as dedicated to protectionism and isolationism as he appears to be. The other approach assumes this is more tactical than strategic. It assumes President Trump is at heart a negotiator and firmly believes the tactics of real estate bargaining apply universally. Search for leverage, play hardball to see who wants something more than the other, never assume the deal is done until the very last moment.
In many ways, it seems the latter approach remains dominant. NAFTA talks have been stalled for months. As long as they are, the current deals stay in place. The latest comment from the White House has been there is no hurry to get something done. It had been assumed the U.S. would want to see a deal in place before Andres Manuel Lopez Obrador takes office, but President Trump has stated he gets along fine with the firebrand leftist and sees no reason to rush. The Canadians are not at the table this time, but the statements from the U.S. and Ottawa seem to suggest there is room for maneuver once the Mexican situation sees some progress. There are reports that the U.S. and China have started talks up again, although nobody has ventured any opinions as to what might be on the agenda. The threats leveled against Europe faded somewhat when the head of the EU visited the U.S. In a meeting that was not supposed to amount to much, President Trump's threat to impose tariffs on cars and car parts vanished—at least for the moment.
This kind of trade interaction has been extremely hard for many companies. There have been reactions that have affected patterns in the global economy. The lack of certainty has left companies very unsure of their next steps. The steel sector is a good example. The tariffs on imported steel were ostensibly designed to protect the domestic industry in the U.S. The problem is that much of the steel used by manufacturers and by construction is of a type and grade that is not produced in the U.S. It has been assumed that U.S. steelmakers will rush to start producing that kind of steel now they have some protection from foreign competition. That is not how it is working out, and for a very simple reason. The steel makers in the U.S. do not trust the actions of the administration and they certainly don't trust the actions of Congress. They have been down this road before as George W. Bush imposed similar tariffs that were lifted a few years later. The investments that steel makers made were therefore wasted. They are unlikely to make that mistake again. The upshot is that this steel will continue to be imported, but at a higher price to the end consumer who buys the product containing that steel.
The good news is that trade deals will not be as draconian as many had feared since President Trump will likely extract some of the concessions he has been seeking. The bad news is that trade is now extremely uncertain and volatile. That is not a preferred strategic position for business to be in.
How Much Damage From a Trade War?
This would seem to be an easy question to answer, but of course it isn't. The tariffs and the imminent trade war will not affect the vast majority of economic activity in the world. Even those that are most concerned about the medium- and long-term implications are suggesting global growth will fall by only 0.7%. The International Monetary Fund (IMF) and Organization for Economic Cooperation and Development (OECD) have continued to assert that growth will be between 3.5% and 3.8% this year. Why is there such angst over the impact of the trade wars?
Analysis: The simple answer is that the pain will not be evenly distributed. The vast majority of the U.S. economy is internally based and will be unaffected by the trade wars—at least directly. The restrictions on exports will drive prices up and that inflation will affect everyone, but the tariffs and trade spats will be only part of the inflation issue. The sectors that are most affected will be those that export or rely on imports—naturally enough. More than that, there will be differences according to global market. If the U.S. farmer is restricted from selling to China, can there be a substitute market in India or elsewhere? If a product becomes more expensive due to import tariffs, will the consumer be able to find a replacement? If not, they will just to have to pay the additional costs.
What Exactly Is Inequality?
There is really not enough room in this issue to fully explore this deep philosophical issue. The reason we bring it up anyway is that there has been a considerable emphasis on one aspect of inequality when it comes to economic policy. The gap between the rich and the poor has widened considerably over the last few decades. This feature is not unique to the U.S. economy only. The widest gap that exists in the world today is that which separates the upper 1% in China from the lower 25%. It is considerably wider than any gap that exists in the U.S. or Europe. What exactly is inequality and what can government be expected to do about it?
Analysis: To begin with, inequality exists, always has and is perfectly normal. We are not all the same height. That will give some of us advantages as far as playing basketball and reaching things on high shelves. We are not equal in the eyes of our fellow man as we also have preferences. Some people are more attracted to intelligence or a sense of humor than looks. We do not get too concerned about this kind of inequality as there is nothing we can do about it anyway. The focus for most people is how inequality shapes their lives.
The most widely accepted measure of income quality is the Gini coefficient. It is a statistical measurement of dispersion throughout a given population. A reading of zero indicates that everybody in a given population has exactly the same income. A reading of 100 says that one person has all the money. The higher the Gini coefficient, the more income inequality there is. What makes this tool so interesting is that the same technique can be employed to measure anything. You could establish a Gini coefficient for foot speed with zero being everybody running at the same speed and 100 being Usain Bolt.
Globally, the Gini coefficient is very high—65—but it has been falling pretty rapidly over the last few decades as the economies of the emerging nations have developed. The numbers are a little hard to verify, but the estimate is that during the 1800s the Gini was close to 90 as almost all the world's wealth was concentrated in the colonial powers of Europe. The Gini for the U.S. is about 40 with Britain at 36 and France at 29. China is a little hard to gather data from, but the estimate is they have a Gini of 42. This is not a perfect measurement of course as it is hard to collect data on income everywhere in the world, but it is seen as fairly accurate when applied to developed economies. The bigger complaint is that it doesn't measure other elements of life that might be more important than income. There have been attempts to measure happiness, health and longevity. And since I know you are now curious, the Gini measurement was based on number of partners in a lifetime. and Britain won with a Gini of 58 compared to just 43 for France and 36 for the U.S.
The assertion is that income inequality is a problem in and of itself, but research suggests that levels of inequality matter very little to people if they feel they are secure financially. In other words, a person who is well off enough to have a home, a car, the ability to send their kids to college and have some money for a vacation will care very little about the fact that some other person is extremely wealthy. The issue of equality only emerges when there is not enough money to provide that secure life. Part of the reason that populism and concern over income distribution has emerged is that many people have watched their security compromised. The list value of their homes during the recession dropped, their investments tanked for a while, people lost their jobs, costs went up for things like college and health care, and insecurity took over.
Good and Bad News for Summer Employment
This summer sported the lowest rate of youth unemployment in years—just a hair shy of 10%. This number had been climbing every year, but this last summer those that were seeking a job were very likely to have found one. The bad news is that there were substantially fewer young people looking than in past years. This has been a trend for some time now as people under the age of 20 are either attending school or simply living at home with few financial obligations.
Analysis: The good news for the economy as a whole is that there is a generation that now has some work experience under their belt. The employer ranks that kind of experience as high or higher than education as this is what assures the new boss that the employee has an idea what the demands of work are—timeliness, team work and the like. The bulk of these summer jobs were in traditional areas such as retail, food service and entertainment, but there were some new entries such as health care and outdoor work. The number of young people taking part-time jobs in hospitals doubled from five years ago. The rise in lawn and garden services also drew a lot more young workers than in past years.
Attacking the Messenger
There seems to be considerable confusion regarding the role of the press and media. The confusion is somewhat understandable I suppose, but it doesn't take much to grasp the important distinctions. There is a whopping huge difference between reporting and analysis, but it seems that people can get the two confused. The reporter is giving you the facts of a situation with very little or no interpretation—there is a fire at such and such an address. They are not opining as to whether it is a good thing or bad and will only add information when more is made available. The analyst is the one who looks at the fire and speculates about its origin, the importance, what it might mean for people and so on. Everything in the pages of this newsletter is analysis—I am not breaking stories or revealing unknown facts. I am looking at these facts and interpreting them through my own lens.
Attacking the press is really quite ludicrous. The facts are the facts. Complaining that somebody has revealed them is short sighted and highly detrimental to a functioning democracy. The analysis of those facts can be fair game, but the appropriate response is to simply disagree with the analysis as one offers an alternative assessment. If one disagrees with an analysis or opinion expressed, they are doing exactly what a democracy demands. The interpretation of an event or policy is personal. It is the responsibility of the consumer of that analysis to decide whether they accept it or wish to offer an alternative explanation or interpretation.