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Strategic Global Intelligence Brief for August 19, 2019

By Chris Kuehl, Ph.D., NACM Economist

Short Items of Interest—U.S. Economy

Market Reactions

All sorts of issues are affecting the markets as the week begins. The rally last week was due to the latest veer in the Trump tariff policy. The investing community has started to take the threats of more and more tariff activity as "all bark and no bite." The delay in many of the consumer-oriented tariffs shows Trump is more sensitive to the needs and wants of the domestic economy than anything else. The latest statements by the Apple CEO regarding competitiveness signals Trump may well back off more of these. Bonds have seen a return to slightly higher yields and gold has fallen along with the yen. It seems fewer investors are seeking safe havens. Most are returning to some of the higher risk alternatives.

Small Movement in Oil Prices

There has been a little more angst in the oil markets as the tensions ratchet up in the Middle East. The tanker seizure and another set of drone incidents have escalated the confrontation between the U.S. and Iran, making the markets slightly more apprehensive—nothing compared to the kind of volatility that would have been expected a few years ago. The fact is that supply continues to outpace demand, and that is expected to continue to be the case as long as the global economy struggles. The U.S. has more than enough oil to satisfy its needs and the rest of the world has reduced the amount it needs.

The RV Index

There are many indicators used to address the question of whether a recession is imminent. Some are rooted in the markets—the inversion of the yield curve as an example. Some are downright silly, such as the Vixen Index. One that has been fairly reliable has been the RV index or simply stated, the sales of RVs. In each of the last few recessions, there has been a decline in the sales of recreational vehicles a year or so prior to the recession and right now, these sales are in decline. Part of what has made this marker work is that Baby Boomers are the prime purchasers of the RV, and they are also the prime consumers for the economy as a whole. Will RV sales be as important when the dominant consumers are either Gen-X or Millennial buyers?

Short Items of Interest—Global Economy

Germany Headed for Formal Recession?

The Bundesbank has added its voice to those that are predicting the imminent German recession, and they perhaps have the bleakest of outlooks as they expect the downturn to be protracted and serious. The culprit as far as the German economy is the slowdown in global trade. The German economy depends on exports for 55% of its GDP in an average year and at the moment, the country is watching all of its major trading partners struggle. German exports to China and Japan have fallen off, and they have also seen a reduction in trade with the U.K. and the U.S. The Germans sell expensive manufactured goods to the world. These are the most sensitive to changes in the status of economic growth.

An Interventionist Policy Emerging?

For the past few decades, the U.S. has been a steadfast advocate of a non-interventionist position on the dollar. The U.S. has assailed other nations for being currency manipulators and just targeted China for taking steps to reduce the value of the renminbi. Now, there are those in both the GOP and Democratic Party that are thinking of doing some currency manipulation of their own. Trump has been railing against the strong dollar for the last two years and now others are joining the chorus, despite all the considerable risks of such a policy.

Why Greenland?

The interest in Greenland seems to have come from a report from the Defense Department that identifies control of the Arctic as the next big strategic issue. Right now, the Danes have a major position because of Greenland, which is the main reason they have no interest in a sale.

What Really Drives the Economy?

For the next year, there will be a great deal of political conversation regarding the state of the U.S. economy. After all—that old saying is still current— "It's the economy, stupid." The notion behind that little quip is simple enough because it suggests that when the average person enters the voting booth next November, they will be reacting to how they feel about their economic situation. Do they have a job? Do they have enough money to buy the things they want or need? Are they worried about higher costs for things like food, fuel, college tuition or a new car? The next question is which candidate or party will either improve their economic position or preserve what they have. Therefore, both parties will be working overtime to sell that voter on how good they are on the issue of the economy. The real question is how much the politicians have to do with the workings of the economy in the first place. Do they deserve praise when things are going well? Do they deserve blame when they aren't?

Analysis: In the most basic sense, the politicians don't have that much to do with the day-to-day of the economy. What really matters is the decisions made by some 330 million Americans as well as the decisions of tens of millions of people all over the world. The consumer rules in the U.S.; we all know that by now. Consumption accounts for between 70% and 80% of economic activity in the U.S., and it is safe to say that no consumer consults the positions of their elected leaders before they go to the grocery store, decide to buy a new truck or even move across the country to take a new job.

Over the years, it has been established that there are several major motivations for consumers. The top of the list is employment security. If people believe their income is secure, they are confident enough to buy things and most importantly, they are confident enough to go into debt to buy homes, cars and a host of other things. The second thing that matters is inflation because the consumer notices when prices are going up or down. For years, the factor that would create the most volatility in the consumer confidence numbers would be the price of gas. A nickel's change up or down would alter people's moods dramatically.

The third factor that matters is taxation and here is when things get complex. The vast majority of people accept that taxes of some kind are necessary, and they understand that tax revenue is what government requires to provide services such as police and firefighters, water, schools, highways and so on. There is intense disagreement over what should be a priority for the government. To one voter, the strength of the military is paramount; to another, the issue should be repairing the nation's highways or providing early education to children. The even bigger disagreements will come over who should be taxed and by how much. Nobody wants to be taxed—even those that understand the necessity. It is absolutely certain that nobody wants to be taxed unfairly. Some assert the rich need to be taxed more heavily and others point out that half the population pays no income taxes at all. Sales taxes are regressive but administered fairly, tax breaks are supposed to encourage certain behaviors and some taxes are designed to be punitive so that people will not engage in certain activity. Taxation is tasked with a lot of responsibility: finance the government, encourage activity, and discourage activity. All the while, they must be "fair" when nobody really agrees on what government should do, or what activity should be encouraged/discouraged. There is absolutely no agreement on what is "fair."

At the end of the day, the political players have very little to do with the first two motivators for the consumer/voter. The job creation is done by the businesses that hire people and depends on what the potential employee has to offer. It is largely the individual's decision whether to pursue education and training as well as their decision on how to conduct their work life. The politicians do not have much to do with inflation either; that is a factor of wages, commodity costs and the decisions of producers as well as the willingness of consumers to spend more. The part of the economy that politicians can impact most directly is taxation. That is the key mission of the legislature after all: setting fiscal policy. As the voter tries to decide what potential leader best suits them, it is well to remember that much of their future role as politician will revolve around taxation—how to raise revenue, from who, what it will be used for and how much will be needed. At this point in the conversation, neither side is being honest. One asserts that taxes can be slashed without affecting the services that people want and the other asserts that taxes can be increased dramatically without affecting the financial situation of that voter. Both are wrong.

Adding Layers of Complexity

The trade and tariff war between the U.S. and China is certainly complicated enough already. Neither Presidents Donald Trump nor Xi Jinping can give much ground to the other if they wish to protect their domestic situation. It had already appeared that both sides were digging in for a long slog, but recent statements from both make it abundantly clear that no solution is in sight.

Analysis: Trump has now tied the situation developing in Hong Kong to the trade talks and has indicated that further trade related sanctions will be considered if there is violence in that city. It is vague at this point—calling on China to find a "humane" solution but it is a threat nonetheless. The Chinese have countered by tying the trade talks to the U.S. sales of F-16s to Taiwan. The Chinese have never liked the connection between the U.S. and the Republic of China but it has never been linked to trade relations prior to this. Neither the U.S. nor China seems to be leaving any wiggle room for the other and this translates into a protracted trade war regardless of the small gestures and delays that have manifested from time to time.

Lip Service or Real Strategic Shift

There is a new statement of purpose for the members of the Business Roundtable. By this time every person who has ever worked for a corporation or business has been exposed to the development of such a "statement of purpose." Committees meet for weeks and months and a really cool and comprehensive document emerges so that it can be posted on the wall and inserted into all the manuals and, at that point, it is promptly forgotten. It is really easy to claim commitment to all kinds of lofty goals and very hard to remain committed to them when the company is striving to make profits and compete. There are exceptions to be sure—the companies and organizations that really do strive to adhere to these rules of conduct. Will the Business Roundtable be one of those?

Analysis: For decades the mantra of the corporation has been very simple. It was best expressed by Milton Friedman in his many writings. The only mission for a corporation was to work on behalf of its shareholders. These are the people and institutions that invest their money in that company and without them the company will cease to exist. The assumption is that any company committed to its shareholders will automatically do its best to succeed, and that success will require the company to treat its consumers with respect, take care of its workers, react to community needs and the like. Most of the time that is quite true as companies that abuse consumers, abuse workers and ignore the community will not last very long. But there are plenty of examples of companies that do not conduct themselves as they ought to.

The members of the Business Roundtable are some of the largest companies in the world—200 of them. They have combined revenues of $7 billion and that would make these 200 companies the fourth largest economy in the world (behind only the U.S., the European Union and China). The have just altered their statement of purpose to place shareholders on a par with four other groups. Now the company must consider the consumer, worker, supplier and community as a whole. The major question at this point is what this really means. To be more than some kind of public relations gesture would require some radical restructuring of these companies.

Not to pick on any one company but GM is a member of long standing in the Business Roundtable. What would it mean to adhere to these new goals? Does the consumer deserve a much less expensive vehicle with no recalls? Do the workers all deserve a substantial raise and more vacation time and free meals and child-care on site? Do suppliers deserve top dollar for the parts they supply to the company? Does the community deserve investment in state-of-the-art pollution control and very high corporate taxes so the community has a revenue base? It is hard to argue that any of these are undeserved but they will all contradict one another. The costs of giving the community, workers and suppliers what they want will make the product very, very expensive, and that is not good for the consumer. The shareholder will get far less for their investment and would be justified in leaving GM off their list.

This was the point made by Friedman. It is not that considering the desires and demands of consumers, workers, suppliers and the community at large is a bad thing but it is utterly impossible to please all of them at the same time. In the end, the consumer loses if GM no longer makes cars, workers lose if there is no job, suppliers lose if there is nothing to supply and the community loses if there is no company employing its citizens and paying taxes. The mission of the company is to succeed and prosper and to do so means paying attention to all these groups but with its survival and growth as the ultimate goal.

Operation Yellowhammer

It is a government study that was recently leaked to the British press. The fact that it was leaked is a statement in itself and illustrates the deepening divide between the regime of Boris Johnson and the British bureaucracy. The report is extremely sobering despite the fact that analysts tried to use the most benign data when assessing what happens to the U.K. should the exit from the EU turn out to be a no deal crash.

Analysis: The estimate is that Britain will be hit with a wide variety of shortages—everything from food to medicine to fuel. Almost 75% of all medicine used in the U.K. comes from Europe and close to 65% of fuel is imported. The ports will be clogged by delays and what now takes an hour or two will likely stretch to two days or longer. Airport delays will increase by three or four hours on a routine day. There will be a severe labor shortage that will combine with the higher costs for imports to spark runaway inflation. There will be a hard border in Northern Ireland which will trigger a return to the violence that gripped the region for decades. This report is a near total repudiation of everything that Johnson and the Brexiters have asserted.

Knowledge and Indecision

It has been remarked that the most intelligent person is the one who knows what they don't know. The fact is that knowledgeable people are frequently the least sure about what they know as they are fully aware that issues are complex and that variables keep changing. To ignore these changes and remain utterly convinced of one's original idea is a sign of intellectual weakness—not conviction. Those that know the least are often the most convinced of their position while those that have a deeper understanding realize there is always more to the issue.

We would all prefer it if there were simple answers to every question and we desperately seek these simplistic solutions. The problem is that there are no simple solutions and attempting to impose one only makes matters worse. Dealing with complexity is hard and most people react to it in one of two ways. The most common is to simply ignore the issue altogether and focus on something else. The other reaction is to grab hold of some idea and decide that it is the panacea regardless of evidence to the contrary. Solving a complex problem requires a great deal of work and commitment and it is very often overwhelming but the fact is that we have to try.

To put it in very personal terms there is one's health. I have a chronically sore back and hips. I have learned to just deal with the pain and have used a variety of symptom relievers. What I really need to do is address the weak muscles in my back and legs through an extensive regimen of exercise but that is complex and time consuming and I have to push myself to do it. Much of the world is the same challenge—solutions are complex and time consuming and we have to force ourselves to address them.

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Sunday, 15 September 2019