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Strategic Global Intelligence Brief for August 21, 2019

By Chris Kuehl, Ph.D., NACM Economist

Short Items of Interest—U.S. Economy

Hawks and Doves at the Fed

The latest Fed minutes confirm what had already been concluded. There is far from unanimity on the subject of interest rate cuts at the Fed. Two of the members of the Open Market committee dissented from the decision to make the quarter point cut (Esther George and Eric Rosengren) and when all 12 of the regional heads were polled, there were half who remain unconvinced that lower interest rates make much sense. The Trump assertion that lower rates would trigger an immense surge in lending and expansion has been rejected out of hand by most. Even though the economy is showing signs of slowdown, the reason for the decline has nothing to do with access to money. This slowdown is due to a global recession threat, which is related to a trade war launched by the Trump administration.

The Changing Workforce

The impact women have had on the workforce has been profound in the decades since the 1970s when women entered in large numbers and stayed engaged. The latest data shows there are more women pursuing college and university degrees than men. The male still has an edge as far as graduate and professional school, but the gap is narrowing fast. The majority of people with no high school diploma or no college are male, and men are overrepresented in employment sectors that are in decline. This affects household dynamics because there are more women who are the primary earner. The social impacts are just starting to manifest and will affect everything from the equal pay debate to childrearing.

Small Banks Hit Hard by Yield Curve Inversion

The inverted yield curve doesn't cause a recession, but it indicates investors are expecting one and signals their behavior is changing. The smaller banks are asset dependent since they make the majority of their money through lending to businesses. The slumping bond yields affect the interest they can charge on these loans, cutting into their profits. These banks are already suffering from the low interest rate environment. It has discouraged people from depositing money in the banks, creating a real crisis for the small and community banks. The future looks rocky.

Short Items of Interest—Global Economy

Malnutrition Crisis in Venezuela

Aid organizations are asserting Venezuela is headed for a very long-term crisis. The food shortages that have hit the country over the last few years have resulted in widespread malnutrition for as much as 75% of the population. This has hit children very hard, and they will be dealing with the deficit for the rest of their lives. Even if the food issue was solved today, the damage has already been done and will hamper development for decades. There have been rumors that talks are being held between the U.S. and Venezuelan President Nicolas Maduro, but thus far, he seems unwilling to consider resignation and exile, which have been a demand of the U.S.

U.S.-Japan Trade Deal

Both the U.S. and Japan are rushing to finalize a trade deal that would affect the import of Japanese cars and parts. The deal is less involved than it was originally but would still be significant to Japan and its auto industry. The U.S. has threatened to cut off the U.S., but that draconian action appears to be off the table. Many of the other trade restrictions appear to be staying in place, most notably steel import tariffs.

No Give on Brexit from Europe

U.K. Prime Minister Boris Johnson has demanded that Europe rethink its position on Brexit—opening up the talks again—and the EU leaders have utterly rejected the call. The pointed response was that the U.K. was not in a position to demand anything and will need to change the tone of its conversation if it expects any concession at all.

The Role of the "Other" Government

A couple days ago, we discussed the role of government in the economy. I pointed out that despite the politicians and their claims of influence, the bulk of what happens in the economy is attributable to the decisions made by 330 million consumers and the tens of thousands of businesses that are seeking to satisfy the needs and wants of that consumer. It should be said that there are really two governments when discussing the status of the economy. There is the political side and then there is the vast bureaucracy that has been created over the last 225-plus years. There are approximately 23 million people employed by federal, state and local government—nearly twice the number employed by the entire manufacturing sector. The federal government alone is the single largest employer in the U.S. There are over 140 independent agencies of the federal government and 270 units in the Cabinet. Estimates vary, but the consensus is there are over 450 departments, sub-units and agencies at the federal level alone. It is safe to assume all of them have an impact on the economy in one way or another.

Analysis: There are many missions involved with all these units and people. There are departments that seek to advance and assist the development of business and the economy, and there are those that seek to establish some kind of fairness and control. There are those that focus on various kinds of redistribution and assistance for a wide variety of people. The list of missions and goals would fill several books and, indeed, the number of regulations promulgated daily do fill volumes. Not every regulation or rule affects every business, but each and every one of these government units influence some aspect of business and the conduct of the consumer.

In the majority of polls, the two issues that most engage the economy and the business community as a whole are taxation and regulation. The tax issue remains primarily in the hands of the legislature, but implementation of these tax schemes falls to the bureaucracy. Regulation is the key issue as far as the function of government. There are traditionally two motivations for the establishment of a regulation. The first has been to ensure that safety and security remain high priorities. There are regulations that affect product safety and quality, regulations regarding who can perform certain services, regulation related to maintaining national security and so on. These are generally welcome regulatory demands—nobody wants to be eating tainted food or living in unsafe structures or being made victims of shoddy work or those seeking to cheat and exploit. These regulatory efforts can also go seriously off the rails as with the welter of rules and regulations regarding the serving of coffee because a woman once managed to spill a cup in her lap at a drive through. The regulatory environment has been created by the very litigious society we now live in and it affects everything we buy.

The second major goal of regulation is the enforcement of some concept of fairness. This can be intensely controversial as few people will agree on what is fair and what isn't. There are rules about how big companies are allowed to get in terms of their marketshare and many rules as to who they can hire or fire, how much they can be paid, how many hours they can work or what their working conditions are. There are rules on discrimination and bias. There are rules as to who can be served or sold to and who can't. There are agencies dedicated to ensuring people are getting enough money and support. The largest part of the federal budget goes to what has been loosely referred to as "entitlements." These include Medicare, Medicaid, Social Security and related areas.

It is not the goal of this small piece to argue the merits or demerits of the regulatory apparatus or to discuss which of these make sense. That is a series of conversations for another time. The point is that all of this activity affects the economy in profound and subtle ways and are usually out of sight of the public. Each of these agencies and departments have a mandate and mission and will pursue that assignment with little regard for the greater impact. Deciding that fuel efficiency was extremely important and demanded the creation of mileage standards for cars sold in the U.S. resulted in automakers finding ways to make their vehicles lighter and more fuel efficient. That led to a much-reduced level of steel use in the construction of a car or truck. That meant reduced demand for steel and steelmakers in trouble. It also meant that vehicles were less safe in a collision and even small wrecks would do considerable damage. Every decision has a web of consequences and reactions. It is rare for all of them to be considered as the thousands of new rules and regulations come pouring out of the various governmental departments. In 2018, there were over 4,000 regulations issued by the federal government alone—an annual average.

There is No Recession in Sight but We Will Panic Anyway

The messages are decidedly mixed. In one breath the assertion is that the U.S. economy is healthy and robust and there is no sign of anything approaching recession but in the next there is a call to engage in some very radical moves to stimulate the economy to stave off that non-existent recession.

Analysis: Trump has been insistent the Fed continue to lower rates despite the fact they are already at near record lows and there is little evidence that reducing them would trigger any additional activity. There is talk of cutting payroll taxes or finding some other means by which to reduce tax. There has also been the suggestion that capital gains taxes be cut. If there is a recession in the offing there will be a demand for considerable government spending on everything from unemployment compensation to assistance for those whose financial situation is in jeopardy and reducing revenues now will make that kind of payout very problematic. The most effective stimulus right now would involve calling a halt to the trade wars that caused the global economy to sag.

Italian Government Collapses

The Italian government has been living on borrowed time for a while. The coalition that formed a year or so ago was never based on anything other than the fact the parties were considered outsiders in the Italian political world. Italy is no stranger to collapsed regimes as the average lifespan of an Italian government since the end of the Second World War has been less than two years. The coalition between the League and the Five Star Movement was a marriage of convenience and a rocky one from the start. The League is the successor to the Northern League and a party that is extremely right leaning and preoccupied with immigration. There has always been intense hostility towards the southern half of Italy and this put them at odds with the Five Star politicians from the start as the populists have been generally popular in the poorer south. It took months of wrangling to get a government in place with Giuseppe Conti as PM and the League's leader – Matteo Salvini as Interior Minister. Now the issue is whether the Five Star Movement can cobble together another coalition or will there have to be new elections – a course that Salvini is counting on.

Analysis: Over the last year the League and Salvini have gained popularity in the polls while the Five Star leaders have seen their influence wane. The two issues that have driven Salvini's rise have been immigration and his resistance to the EU. Italy has been a front line state for the waves of immigration coming from Africa and the Middle East and this influx has terrified the Italians – especially those in the north as they have little actual contact with the refugees and have tended to believe every outlandish assertion made by the right wing parties. The conflict with the EU centers around the Italian budget. Only Greece has a more serious debt problem and the Greeks have been working with the EU to gain control over that broken economy. The Italian government has not although Conte has tried to make some conciliatory gestures. Salvini has been defiant and has suggested the best course of action for Italy would be to pull out of the EU the same way that the U.K. is doing.

The average Italian is opposed to the austerity plans the EU wants imposed as they have been enjoying all that government largesse for years. The idea that pension payments would be cut, social programs pared, state employees fired and government spending in general curtailed is extremely unpopular. The government in Italy provides more assistance to a broader base of people than any nation in Europe – the result of years of weak governments appeasing whatever group of voters was needed to stay in power. The thought that Italy will need to pay its bills fills the population with dread and Salvini asserts that Italy will not have to. He is vague regarding how this day of reckoning is to be avoided.

The sense is that Italian President Sergio Mattarella will first try to get the Five Star Movement to form another coalition as he has indicated that he doesn't want to see another election. The politician that has emerged as the "kingmaker" is a familiar name in Italian politics but forming an alliance with former PM Matteo Renzi would be a bitter pill for Five Star as they formed in opposition to him a few years ago. He would likely demand a very prominent role if he was to bring his center-left group into the fold. Lurking even further in the background is Silvio Berlusconi and his Forza Italia. He could pull some of the right-wing support from the League or he could decide to form a coalition with them as he has in the past.

China Moves to Solidify Position in the Middle East

As important as the oil fields of the Middle East have been to China, this has not been a part of the world the Chinese have had much leverage in. It has long been the region most fought over by the Europeans, Russians and Americans while China was on the outside. That is now changing quickly. The latest assessment from the U.S. Defense Department asserts China is taking full advantage of the policies that have been pursued by the U.S. and other players to establish a new role. China has been the primary buyer of Iranian oil, and they have increased that demand. They are also developing closer ties to the other oil states in the Gulf and have been supportive when it comes to the Arab world's positions on Israel.

Analysis: Iran has been the target of China's interest, and there has been sharing of technology and significant investment in Iranian infrastructure. The U.S. has tightened sanctions on Iran with an eye toward forcing a regime change, but China has been weakening that effort by doing more business with Iran. The U.S. has lost its ability to pressure the Chinese with sanctions as the U.S. already has done its worst in the trade war with China. They have nothing to lose by challenging the U.S. sanctions on Iran.

Earning Trust

One can learn a lot from interacting with cats. That was the topic of a recent conversation between a couple of "cat daddies." We used to be somewhat rare as usually men grudgingly tolerated the cat that was brought into the household by the female side of the family. Now there are many more "cat guys" than there used to be. As we discussed our interactions, we noted the life lessons we learn daily.

To begin with, cats require a fresh start every day. It is not that they do not remember and appreciate the things one did for them yesterday but they know this is a new day and a new opportunity to demonstrate one's worth. One of the challenges in human relations is the tendency to take people and things for granted. You know the old saw: "familiarity breeds contempt." We forget to tell people we love and appreciate them and value them and over time they drift away. Cats will cure you of that temptation. They expect and demand affirmation every day, and if they don't get it, they will withdraw and ignore you—usually on a permanent basis. When a cat wants to play and interact one is well-advised to drop everything and engage; a good lesson for other relationships. We tend to think there will always be time to interact with friends and family, and we put this off until a more convenient time. By the time we decide the moment is just right, we discover those friends and family have moved on. Failing to respond to a cat's offer of playtime will soon result in the cat no longer offering to play. The bottom line is cats live in the present moment, and that is something we should all strive to do more of.

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Sunday, 15 September 2019