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Strategic Global Intelligence Brief for August 23, 2018

Short Items of Interest—US Economy

Near Universal Call for Higher Rates
So much for the reaction to Trump's displeasure with the Federal Reserve. In the last few weeks he has become vocal about his opposition to the Fed's stated intent to hike rates. He would not be the first president to object to the Fed playing its traditional role of party pooper and the Fed's Board members have reacted the same way that most of their predecessors have. One by one the members of the Fed's governing board, members of the Open Market Committee and the heads of the 12 Fed banks have reiterated their support for the current policy of hiking rates by a quarter point in September and December of this year and of rate hikes in 2019 that would likely bring the Fed Funds rate close to 3%. Trump asserts these hikes will likely slow the growth of the U.S. economy, and he is quite right. The Fed doesn't disagree but holds that risks of inflation and continued speculative activity among investors merit a raise in rates to cool off the economy.

U.S. Believes it has Leverage Over China
As the latest set of trade talks between the U.S. and China go underway, both nations are checking their rival's resiliency. The U.S. has concluded China has to keep its growth numbers up or risk political ferment, and that means giving way on some key issues so they are not cut off from trading with the U.S. China is well aware tariffs and trade wars are affecting key parts of the U.S. economy, and they are counting on those affected to express their opinions to Trump. In truth, both have much to lose and gain and much will depend on where each nation is on this cycle. The U.S. is vulnerable in the rural areas as these are the markets China buys from, and this has been a bad year in terms of drought and other cost considerations.

Most Pressing Issue for Fed is Long Term
As concerned as the Fed is with the short-term threat of inflation and widespread speculation, the real issue for the assembled members is the ability to deal with the next recession. It has been a very long time since the end of the last recession as the economy technically started to recover in 2009. This has been an odd rebound as it has never been able to gain much traction and growth has been slow. It is expected that another downturn appears in late 2019 or perhaps 2020. The Fed needs rates to be high enough that cutting them will make a real difference and that means having them as high as 4% to 5%.

Short Items of Interest — Global Economy

Close to a Deal on NAFTA?
The clock is ticking as far as a new North American Free Trade Agreement (NAFTA) is reached. As there is a new President in Mexico due to assume power Dec. 1, there is pressure on both sides to get a deal done very soon as the U.S. Congress can only vote 90 days after the new agreement is hammered out. That would be the end of November and very close to the end of Enrique Pena Nieto's turn in office. After that, the U.S. will have to contend with the demands of Andres Manuel Lopez Obrador, and his leftist ideas stand to be far more complex. The hint from Mexico is that there have been breakthroughs but there has been no corroboration from U.S. negotiators.

South Africa is Latest to Take Offense at Trump
Nobody has any idea what prompted the latest offensive tweet from Trump as it would seem he has his plate full with domestic issues. He commented he was concerned about the seizure of farms by the South African government and the killing of white farmers. This is not happening in South Africa today, and there have been no reports of targeting white farmers. At the time that apartheid fell apart and a new government came in, there was a massive effort to redistribute farm land from the white owners to the black population who worked the land, but that was in the mid '90s. The leaders in South Africa have been shocked by the allegations and have promptly denounced them. It seems Trump saw mention of this on a website that has consistently espoused white nationalism.

More Changing of the Guard Around the World
It would be a gross oversimplification to attribute the problems that are threatening to take down several governments this year solely to the immigration issue, but it is astonishing the degree to which this issue has been the driver of politics in nations all over the world. In the next few weeks it is likely the Australian government of Malcolm Turnbull will fall apart and his chief tormentor is his former Immigration minister. The Social Democrats will get the lowest tallies they have received in Sweden in decades, and the party that has taken a very hard line on immigration will soon be essentially the kingmaker in Swedish politics. The government of Angela Merkel is not teetering on the brink, but her rivals within her own coalition have been using the immigration crisis to attack her. Brexit was essentially about immigration into the U.K. from eastern and central Europe, and the issue of the southern border has been driving U.S. politics for several years. It gets less attention in the Asian region, but that is because most of these countries have extremely strict policies against migration. Japan has accepted approximately 25 refugees from Syria a year (the U.S. has taken around 25,000 and Europe has taken close to 2 million). China is also very hard on refugees and tolerance is low in most of the other Asian countries. Even India has been very strict about migration from places like Bangladesh and Burma of late.

Analysis: What has made this issue so important now and is there something significantly different about the situation in 2018 than existed before? There has always been migration from poorer nations to richer ones as there are always people who want a better and more financially secure life. There have always been wars and conflicts that turn people into refugees seeking some kind of safety and security. What has made the current situation so much worse, or is it actually worse?

The analysis of refugee movement and migration patterns show there is not a lot of difference between the numbers of the last few years and those of past years. As a matter of fact, there have been many periods in the past few decades where the numbers have been far higher. These migrations have generally mirrored some kind of natural disaster like a widespread drought or some kind of massive political turmoil as during the break-up of the African colonies. The U.S. has been seeing far fewer people coming across the border than in past years, but it isn't clear whether this is due to stricter enforcement of the laws or a decline in the desire to make the risky trek into the U.S.

The most likely explanation of the issue at the moment is that it has coincided with other economic concerns and has been elevated to a status not experienced before. There are thought to be three groups that have made immigration the key political issue it has become. The first are those who have been directly affected by the arrival. These are people who currently hold the marginal jobs that will be offered to the migrants, and more often than not they live in the neighborhoods that will house the newly arrived. The second group are those who feel challenged by the cultural differences. Some of these critics live where the refugees will be living and have to confront the differences directly, but most are being driven by rumor and allegation. They have no real contact with the new arrivals and seem prepared to believe any rumor circulated. The last group is made up of those who are essentially xenophobic. They usually have no direct contact with these groups and simply believe rumors and innuendos.

German Frugality Attacked
Germany has a massive current account surplus, and this has been maintained for years. The usual assertion is the frugality of the German government and the natural caution of the German consumer is the major factor, but recent studies have shown consumers in Germany are not that far off the pace of other nations, and the government has not been quite as frugal as it has been in past years. The real issue seems to be the behavior of the German business community. They have collectively been very reluctant to invest and have been saving the majority of their revenues, but nobody really knows what they are saving for.

Analysis: German business has been falling behind in terms of investment in new machinery, and there has been less hiring than had been expected. Some of this is the natural caution that is always manifested in Germany, but there is motivation beyond this as there continues to be concern about the advances of a trade war and the potential for more inflation. Although many see this frugality as a mistake and an inhibitor to global growth, there is really not much that can be done about it. It is not likely Germany will try to force spending.

What is the Real Issue as far as Corporate Competition is Concerned?
As is generally the case, there is a lot of agreement on the nature of the problem but very little on what the solution should be or even what caused the problem in the first place. This week the assembled central bankers and other finance officials from around the world will be meeting in Jackson Hole, Wyoming, for their annual meeting sponsored by the Kansas City Fed. This is traditionally the meeting to take on the big philosophical and political issues nobody really has time to delve into. This year's topic is broad and very current. The assertion is there is something deeply flawed in the way big corporations are conducting their business, and it is proving detrimental to the global economy. The assertion is all this frenetic merger activity has created a highly off-balance system that has limited competition, led to high profits but lower investments and a substantially lower share of the national income going to the workers. This is the trigger for the wage gap and a host of other social ills. The conclusion many have already come to is this is all related to the lack of competition, and therefore the central banks need to step in and play a role of some kind—akin to the role they now play as far as the banks in their countries are concerned.

Analysis: Critics assert this is a rush to judgment and fails to look at other factors. If the competition issue is not the real problem, it will do little good to try to address it. The basic argument as far as competition is concerned is there has been too much concentration of power, and this has led to lower capital investment, a decline in labor's share, slower rates of productivity, slower rates of wage growth and a general lack of economic dynamism. The concentration has gone so far as to remind people of an old economic system called mercantilism. This is a system is far less open to competition in any form and features a closed trading system with very close cooperation between government and business. It is a monopolistic structure that fends off every attempt to diversify rewards and spread wealth. The U.S. was once an exemplar of the liberal free market system but has been drifting more toward the mercantilist framework every year, and rivals such as China have been there for years. The assertion is steps have to be taken to break up this power, just as the central banks have been working to break up the largest banks as their troubles soon become the troubles of the economy as a whole.

There are other theories regarding these issues, and the assembled financial players are cautioned to avoid jumping to conclusions before exploring other possibilities. To begin with, there are marked differences between what is defined as competition. Even if there are fewer large chain retailers than before, the fact is local communities have just as much choice as they did before as all the national chains are competing in these same communities. The evidence for lack of competition is usually the mark-up on prices and whether this is higher than would be justified in a more competitive environment. It has been shown very few companies have been able to achieve a competitive position that allows high mark-ups as there are always larger and equally global competitors threatening their market prominence.

One alternate theory is the growing importance of companies with intangible assets and what they are doing to those that are still reliant on the old ways. The online merchants like Amazon have a fraction of the cost structure traditional companies are saddled with, and there are dozens of other examples that have thrust technology into the middle of the equation. Uber has all but destroyed the taxi business, and the music industry continues to try to stay ahead of the technology that can bypass the old ways music was marketed and sold.

There has also been criticism of the current policy of corporate governance, and even President Trump has weighed in on the issue with his critique of the quarterly report. The company that is publicly traded is now expected to be hitting close to 10% return on investment regardless of economic conditions. This leads to short-sighted strategies that employ cost cuts as a means to satisfy these quarterly demands even as the move compromises long-term strategy. The focus on activist shareholders at the expense of everybody else is a destructive pattern but a very common one.

More Signs Housing Market is Slumping
The reassuring thing about making consistent predictions is if one sticks to the story long enough it will come true. For most of the past few years, there has been a consistent assertion that the housing market was about to cool off. All the headwinds were in play—everything from higher prices to more expensive mortgages to some uneasiness on the part of the consumer. Yet nothing really changed, and the market kept chugging along. There has now been four straight months of decline in the sales of existing homes, and that is a pretty definitive signal the bloom is off the rose.

Analysis: Sales were down by 0.7% from last month and are down by 1.5% from last year's numbers. The combination of higher priced homes and a severe shortage of homes in the most popular areas has combined to slow this market down considerably. The first sign of distress was the lack of starter homebuyers, but now there has been a decline in the sales of more expensive homes. This has been the longest slide in sales of existing homes since 2013. This is not yet considered a major crisis and as expected there is a lot of difference between the various markets, but the boom in sales had been providing a lot of activity for the economy and that engine is sputtering to some degree.

Political Commentary
No—this is not what you are thinking. I get enough of my perspectives and attitudes in these pages as it is. This is really more of an observation of other people. I have remarked more than once that I meet and talk to a lot of people, but I am not sure I can claim they represent a wide cross section of the country. They are nearly all professionals of one kind or another—accountants, bankers, credit managers, lawyers. Those who do not fit that category are business owners or executives of one kind or another. They are from all over the country, and they most definitely have their own opinions and ideas. Within all this diversity there are a number of common threads, especially when it comes to politics.

The most common complaint is politics seems to be nothing other than empty slogans and attacks on the other party. The example many cite is the common refrain heard in every stump speech: "I will create jobs," or some variation on the theme. It is as if when elected they plan to hire 150,000 people to be on their staff. The reality is that business people hire others and they hire for the most basic of reasons. They have something that needs doing, and they get the person who can do it. Jobs are not "created"—they are offered when there is something to be done. Growth of a given business means there is more to be done. If the politicians really want to focus on jobs, they need to focus on what businesspeople need so they can hire. The need growth and they need a pool of labor that can be employed to further that growth. This is not a simple equation as every business needs different motivations, but it would certainly be a step in the right direction to address what really motivates job "creation."

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Friday, 18 January 2019