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Strategic Global Intelligence Brief for August 9, 2018

Short Items of Interest—U.S. Economy

No Change in Producer Prices This Month
The level of producer prices stayed the same as it was last month; a bit of a surprise given all the turmoil that has surrounded tariffs and trade wars. It was thought that steel and aluminum would further jump start these prices, but apparently, the hikes were registered last month and there was not much additional activity. The price of fuel has gone up as well, but not as fast as it had been rising earlier in the year. The good news is that the Producer Price Index (PPI) has not been skyrocketing, but the bad news is that it has gotten quite a bit higher than it was. It still signals that inflation pressures are building. As the trade disputes become more serious, they may start to bite more as well. Right now, the rush to purchase to beat higher prices has served to lower the overall price hikes.

Higher Priced Homes Losing Ground Fast
When it was noted that home prices had been rising fast and continuously, there was a lot of concern about the potential for a bubble akin to the one that triggered the big decline in the latter part of the last decade. There is now evidence that higher-priced homes in those hot areas where housing demand has been high are seeing the fastest decline in pricing. That will serve to deflate any emerging bubble. It seems that these homes have become so expensive they are even pricing the wealthy out. The more traditional home buyer is not even in the same universe. The impact in the more expensive markets is rapidly spreading as people seek to get as close as they can but still be where they can afford the housing. Commutes are getting much longer in many of these hotter housing markets and will continue to accelerate.

Political Takeaways
Now that the primaries are over, it is open season for the analysts and pundits as they try to piece together what they think this all means. There is always a lot of variety in these positions, but two suppositions tend to stand out. The first is that it seems both Democrats and Republicans are still searching for common ground within their own parties. There is a moderate left and a more radical left. Members of both positions won elections on Tuesday. There were ardent Trump supporters and those Republicans who follow a more traditional position. Both made gains. The party that heals its own wounds will do best in November. The other issue is that economics was not the big issue in the primaries and may not be the biggest issue in November either.

Short Items of Interest—Global Economy

Turkish Economy Stutters Further
Things are not looking great for President Erdogan in Turkey—at least as far as the economy is concerned. The currency has lost more ground and is far lower against all the countries with which it trades. This will make selling easier of course, but the price paid is less opportunity to import. The country has long been dependent on a significant level of imported commodities and intermediate goods. The uneasiness stems from the sense that Erdogan is prepared to push the rift with the U.S. too far. The demand that Erdogan release a prominent critic is not getting much traction in Turkey, but that threatens to isolate him further.

Lombok Earthquakes and Indonesian Development
The country has been struggling to get its economy on track for a long time. It had been hoped that progress made this year would carry over, but much of what has stimulated the Indonesians is tourism. The earthquakes and tsunami waves are hitting one of the most popular of these tourist destinations. It will take hundreds of millions to rebuild and the government simply doesn't have that money.

China Will Continue to Buy U.S. Oil
The U.S. has become one of China's most important sources of oil. That has meant China will not place tariff barriers in place that would interfere with that flow. The U.S. has rapidly entered the top 10 for Chinese oil suppliers.

Trade War Options
Over the course of this past year, it has appeared that President Trump is locked on and committed to a series of trade wars with every nation where the U.S. has ever done business. The standard mantra is that all the deals made in the past were the "worst ever" and that the U.S. has been systematically exploited by every nation on the planet—evidence to the contrary. It has made for good campaign fodder for a section of the U.S. population that has been feeling more than a little insecure about their economic future. These insecurities are real and justified—even as the economy sets new records for growth—but the culprit identified by the administration is not the right one. If the trade policy followed by the U.S. now matched the president's rhetoric, it would be a fairly simple matter of learning how to function in semi-isolation with a highly protected and disengaged economy. But the policies developed thus far wander far from the bombast and the tweets. It is hard to tell if there is a policy in place, or if this is more of an ongoing series of negotiations leading to some unspecified outcome.

Analysis: This was most evident with the steel and aluminum tariffs. The initial announcement held that all imports into the U.S. would be subject to the tariffs. Then several nations were granted exemptions for a month or so. These exemptions were subsequently withdrawn. Since then, there have been vague promises they might be lifted again for certain countries provided they did something the U.S. wanted. What exactly that something is has not been specified as yet, but it appears Europe, Japan, Canada and Mexico are exploring the possibilities. Canada and Mexico are engaged in a long drawn out process to determine the future of NAFTA. That is expected to be a bigger issue now that Mexico has a new president—one that has not been a big fan of the U.S. in the past. There was a very angry threat issued against Europe over the export of cars to the U.S. It simply vanished over a weekend in July when the head of the European Union met with President Trump. Of course, there is nothing to keep Trump from bringing it up again and re-imposing the tariffs and threats, but for now, the action has at least been delayed.

The most consistent trade conflict has been with China. That battle escalates every day—at least in terms of threats. The U.S. has taken steps to impose tariffs on over $60 billion of Chinese imports to the U.S. China has matched these tariffs each time so that more than $60 billion of U.S. goods have been affected. The accusations between the two states have become acrimonious. It certainly looks like a real trade war has emerged that will affect the two nations for years to come. Neither China nor the U.S. has felt the impact of the dispute yet. In fact, the threats have stimulated a great deal of business for both and led to one of the biggest deficits the U.S. has run with China in years. This has been due to the number of exporters and importers rushing to get their goods where they want them before the tariffs kick in. The U.S. has never sold so many soybeans to the Chinese as it has this year, but these sales will come to an abrupt end in a matter of weeks. The same process will take place as far as all the Chinese goods coming to the U.S. right now.

The question that hangs over everybody is whether this is a real fight to the end or just another positioning play. Does President Trump really want the U.S. to stop importing from China altogether? What is the real desire of the U.S. as far as these trade conflicts are concerned? Is it protection for intellectual property? Is it more access to the Chinese consumer? Is it protection from the subsidized Chinese manufacturing sector? These are all issues that can presumably be negotiated and discussed. The fear is that Trump really has no goals or desires as regards China or any other nation for that matter. This is all pandering to a political base that has come to believe that all of their ills can be blamed on China and on trade in general. If the motivation for President Trump is the latter, he will have no issue with destroying the global trading system and putting the U.S. economy at great risk. That is the most nerve wracking part.

CBO Tries to Send Stern Warning
It seemed like only yesterday that Republicans were wedded to the notion that spendthrift policies were generally a bad thing. For several years, the GOP bucked the trends that usually govern responding to a recession. The textbooks all agreed that when an economy is confronting a recession, the response would be to cut taxes to the bone and spend money like a drunken sailor on leave. The object of the game was to flood the system with cash. The Federal Reserve would try to help out by lowering interest rates. The GOP-dominated Congress chose not to do this and worried instead about the impact of all that spending as the U.S. would have to borrow money to do it. One wonders where that GOP went.

Analysis: Even as the economy was clearly showing it was in solid growth mode with two quarters of over 3% expansion in 2017, the decision was made to push money into the system. There was a major tax cut and major increases in spending. All of this was carried out by the same GOP that asserted these policies were destroying the country just a few years ago.

The latest report from the Congressional Budget Office (CBO) is a strident one and sounds an urgent alarm. If the tax cuts are extended and the spending rate holds at where it is now in the U.S., there will be deficits between 7.1% and 10%. These are third-world country numbers that put the U.S. in fiscal crisis. The vast majority of analysts hold that a nation's deficit should never exceed 3%. The U.S. has been at or around 4% for the last couple of years. The tax cuts have an expiration date, but these are often overturned by legislators who don't want to be accused of hiking taxes. That leaves spending cuts. Given the amount of the deficit, the only way that these cuts make a difference is if they apply to spending on Social Security, Medicare, Medicaid and the military as well as cutting everything else to the bone.

Asian States Learn Talk Is Cheap
The statements that have been made by China over the last few years promised to dramatically alter the economic and political landscape in the Pacific. For years, the Chinese have sought more influence in the part of the world they assert is their natural sphere of influence. The economic struggles affecting China always meant that other nations managed to put their priorities ahead of China's. Japan was the dominant power through the first half of the last century. After the Second World War, the U.S. stepped in to be the dominant player. Even Russia has had more leverage than China on more than a few occasions. As China has become richer and more influential, it has sought ways to blunt the influence of its rivals. These aggressive declarations have generally involved military pressure, diplomatic maneuver and economic incentive. The Chinese effort to militarize the South China Sea has been evident. There have been all manner of veiled and not-so-veiled threats directed at Taiwan and even Japan from time to time. Diplomacy has been active as China has tried to peel allies away from the U.S.—just as It has with the Philippines and to a lesser extent Malaysia and Indonesia. The most important weapon was supposed to be money. China set up organizations to rival the World Bank and other development institutions. It promised more than $6 trillion in some form of aid and assistance to the nations of the Pacific.

Analysis: It was this promise of aid that provoked the U.S. to begin pursuit of the Trans-Pacific Partnership (TPP). The U.S. effort was stymied by domestic opposition within the U.S., but it certainly did not stop China from trying to assert its own economic dominance. The problem is that China has not been making good on these promises. A recent study indicates that less than a sixth of the money promised for aid has been forthcoming. Most of what has been allocated has been in the nature of loans that will have to be repaid to China. The original assertion was that this Chinese aid would come with no strings attached and most would be outright grants. There would be attention to actual business development so these recipient nations would be able to build their economies. Instead, there has been little money without strings and the vast majority of the projects have been giant infrastructure deals. These have included new roads, dams, port facilities and airports. The projects are highly visible, geared towards invigorating trade. Almost all the work is done by Chinese companies with Chinese workers.

Needless to say, the Asian states counting on China to play a bigger role and compete with the U.S. for influence in the Pacific have been disappointed. Many have asserted it was the U.S. withdrawal from pacts like the TPP that triggered this Chinese slowdown. There may be some truth to this, but the fact is that China had been slow to distribute this promised largesse even before the U.S. elected to step away. China simply doesn't have the money to make good on these pledges right now—not with looming trade wars that threaten to cut into their budget. There is also evidence China has demanded concessions from these nations that they are not prepared to provide.

Sanctions Hit Russia Again
Perhaps there was a move by Vladimir Putin to favor a Trump presidency over one led by Hilary Clinton, but thus far, it is hard to tell that Russia has benefited much. The U.S. has continued to increase sanction pressure alongside the European allies for Russian transgressions that have little to do with the U.S. The latest set was imposed over the Russian attempt to poison a former spy who had defected to the U.K. These latest restrictions caused the ruble to fall to a two-year low and forced a big loss in the Russian markets. The mood of investors seems to be negative in the medium to long term as they think Russia will be considered a target for the U.S. and Western nations for a long time.

Analysis: The real weakness for Russia is that it doesn't sell much on the global market other than commodities like oil, industrial metals and food. None of these are imports the U.S. can't get elsewhere. The trading partner for Russia is Europe. There, relations are strained more often than not. Sometimes people even seem to forget who has what leverage in a given region. Much was made of Germany's vulnerability as it was accepting gas and oil via pipeline from Russia. It is actually the other way around. If Russia cuts Germany off, that gas or oil can't go anywhere else—it is aimed at Germany. The Germans can simply replace the Russian oil and gas with supplies from anywhere else—coming through other pipelines and by cargo ship. Germany holds the upper hand over Russia when economics are at stake.

More Student Adventures
A friend of mind had the opportunity to talk with a class of high school kids the other day. It started out as one would expect—a bunch of bored faces staring at this old guy like he was from another century. They probably thought he owned the last rotary dial phone in existence. He immediately started into a tirade directed squarely at their generation. He accused them of all being pampered, lazy and entitled—destined to play video games in their parent's basements for the rest of their lives. He was insulting and accusatory and could see that most were somewhere between angry and irritated, but none said a word. He stopped the rant and turned to them and simply asked: "Are you going to let me get away with this? I can see you are upset and frustrated, why don't you interrupt me and challenge this?"

We know why—students are not sure what they can do in class or there is that lingering thing about respecting elders. Nobody really wants to invite confrontation, but he went on to provide them with tools they could use to react. They encounter this kind of bias every day and don't have to fight every fight, but should pick a place to make a stand from time to time. By the end of the class, he had them primed to defend themselves and their whole generation from those who would denigrate them without knowing a thing about them. It is a good lesson for all us all. We let demagogues rant and rave, while we avoid confronting their lies and innuendos. The problem is that sooner or later these fanatics are the only ones people hear from. That damages what we stand for as a nation.

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