By Chris Kuehl, Ph.D., NACM Economist
Short Items of Interest—U.S. Economy
Tax Policy Arguments Continue
Despite almost a year of negotiating, there is no end in sight as regards the development of tax breaks. The sense now is that a deal will have to wait until after the first of the year, as there has been no progress on the issue in the Senate. Several industries are waiting to see what happens or doesn't happen, but at the top of the list has been bio-diesel, restaurants and medical device makers. The tax break for bio-diesel expired two years ago and has slowed its development drastically. A tax on medical devices will return next year and there are a host of mistakes in the 2018 tax law that should be corrected. The debate is over ideology and whether there is revenue balance.
Rise in Consumer Inflation
It has been years since anyone expressed any real concerns over the rate of inflation in the U.S.; as a matter of fact, there has been more concern over deflation. The latest data from the Consumer Price Index has started to change that perception. Last month, the CPI showed a gain of 0.4% and this month, there has been another increase of 0.3%. This brings the annual increase to 2.1%. This is not runaway inflation to be sure and there has been no hint that it is high enough to get the attention of the Fed. However, it certainly puts inflation pressure back on the table as far as concerns regarding 2020.
Bull Run to Continue?
This is the time of year that investment houses start to predict what to expect in the following year and the majority of them hold that the markets will continue to grow and extend the long bull run. Most expect to see the markets calm a bit and few expect there will be as many record-setting days as occurred last year. Morgan Stanley is the largest of the firms that buck the trend as they are suggesting that a bear market is just around the corner. They see a slump created by the slowdown in global growth.
Short Items of Interest—Global Economy
Germany Not Convinced of "Green" Strategy
As many had expected, the Germans have expressed less than enthusiastic support for the planned emphasis on "green finance" by the ECB. As Cristine Lagarde took her new post, she indicated the institution would be taking issues of climate change into consideration as decisions were made on financing. The Germans have been very quick to assert that relaxation of standards can't be tolerated. This is the same message they are sending to the European Commission no relaxation of budget standards for the sake of green initiatives.
Mexican Security Official Charged
Only a year ago, the U.S. was hailing Genaro Garcia Luna as a key ally in the fight against the Mexican drug cartels and now he is under arrest. He has been charged with accepting bribes from the Sinaloa cartel and for actively aiding them in their operations. This high-level corruption is extremely common and over the years, there have been dozens of officials in the police and military who have been caught. In most cases, they were exposed by rival cartels, not by the authorities. There are few institutions that can be trusted as the cartels have either bribed or threatened their way into these positions of influence.
France Pushes Ahead with Pension Reform
The current system in France is one of the most convoluted and expensive in the world. There are over 50 separate systems involved with the government and all have different rules and perks. Each and every time there was any hint of labor strife, there was a concession made via the pension system. Some retire at age 50 with twice the wage they earned on the job. Some plans offer full retirement benefits for people who worked only one day—a perk that many a politician's relative has taken advantage of. The reform effort has provoked strikes, but thus far, French President Emmanuel Macron has not backed down from the attempt to create a universal system.
What Happens if the Trade Wars End?
This has been another week of hints and suggestions and comments and gestures regarding the trade and tariff wars that have preoccupied the business community and the politicians for the last year. The deal with China is imminent and then it is not. Tariffs will be imposed and then they will not be and then they are back. It has been utterly impossible to predict the direction of the Trump policy as it changes by the hour. The markets hang on every tweet or utterance as investors seek any kind of clarity at all. The bigger question at this point is whether any of this back and forth matters. Have trade relations changed fundamentally regardless of who is in office and their strategic intent may be?
Analysis: There is a compelling argument to be made that trade relations have been unalterably changed by the actions of the U.S. and other nations over the last few years. This assessment is based on the fact that business is impatient and is concerned with making profit and earning revenue. The politicians may worry about deficits and where jobs are created but companies do not. They want to keep their costs as low as possible and they want their consumers to buy as much as possible. The reason that production shifted to China in the first place was to capture their lower costs of production.
The tariffs and trade restrictions have made doing business in China harder and more expensive and companies have reacted very quickly by shifting their supply chains to other countries. If China has become more expensive it makes Vietnam, Malaysia, Mexico, Haiti and dozens of other nations more appealing. The overall deficit with the rest of the world has not changed much although the deficit with China has been reduced. The U.S. will continue to import when the goods can be obtained more cheaply in other nations. The difference will be in terms of which country expands its exports to the U.S. and which see these exports decline.
It has been argued that there has been a turning point reached already. Once alternative supply chains are developed it will be harder for China to recapture that market share. The fact that doing business with China has become a political issue only accelerates the transition as companies are not interested in getting caught in more of these disputes in the future. It seems there will be no going back to the position China occupied just a few years ago.
USMCA Moves Ahead
The United States, Mexico, Canada Agreement has finally been endorsed by the Democrats in the House and will soon move to a vote. This is the replacement for NAFTA but is a far cry from what was originally envisioned. Given that this is now elections season, everybody will be declaring victory and asserting they got precisely what they wanted from the deal. The group that may have mixed feelings about the agreement will be the business community as they had hoped for more clarity on trade relations between the three nations and ended up with more complexity than before.
Analysis: In the beginning, the GOP position was aimed at restricting the exodus of manufacturing to Mexico and greater access to the resources available from Canada. The U.S. wanted more Canadian oil, gas and metals while restricting exports of food and lumber. The auto industry had established a major presence in Mexico, and that was seen as a threat to domestic production. The Democrats wanted stricter labor standards imposed on Mexico as they were also in favor of less migration of manufacturing capacity. There was also substantial support for improved environmental protection in Mexico.
To get all this means an extensive system of regulation and inspection. There will be a major increase in oversight and companies will be required to comply with dozens of new rules. Failure to comply will be costly and it will be years before the regulatory agencies and courts know exactly what is and what is not permitted. The bottom line is that this is an agreement but it is far from a free trade agreement. Most of the changes made to the NAFTA deal have been to satisfy political goals and have little to do with making business easier between the three neighboring states. Furthermore, the many provisions of the old NAFTA remain to be worked out.
Tariff Extension to be Delayed?
The latest signal from the trade negotiators has been encouraging but this really doesn't mean all that much given the behavior of Trump through the past year. The current system calls for an expansion of tariffs on Chinese goods on Dec. 15 but the sense is that both the U.S. and China are prepared to postpone this action until next year. That is assuming that Trump doesn't suddenly reverse course and impose new ones.
Analysis: The issue for both nations has been simple at least in this round. The U.S. wants China to buy quite a bit more from the U.S. especially agricultural output. The Chinese are willing to do so but they want these purchases tied to reductions of tariffs and there has yet to be an agreement on how much China is to buy and how many tariffs are to be lifted. China has been trying to apply its own pressure on the U.S. by signing big deals to buy from Russia and Brazil. The Chinese economy is getting hit hard by inflation that is connected to the higher costs of pork. The swine flu epidemic forced the country to kill off as much as a third of its hog population and that has limited demand for soybeans. As the piglet population rebuilds this spring the need to import will increase.
Warnings from Paul Volcker
There have been very few economists with the influence enjoyed by Paul Volcker. At a point when most would be enjoying the obscurity of retirement, he remained deeply engaged in the affairs of the U.S. writing very prescient commentary just weeks before his death. His last essay has very pointed criticisms and urgent warnings. His opposition to Trump is well known but his concerns go far beyond the current occupant of the White House. His fear is of the attitudes and beliefs that brought Trump and those like him to power. Below are some excerpts from that essay as published in today's issue of the Financial Times.
Analysis: "Today, threats facing that model have grown more ominous, and our ability to withstand them feels less certain. Increasingly, by design or not, there appears to be a movement to undermine Americans' faith in our government and its policies and institutions. We've moved well beyond former president Ronald Reagan's credo that "government is the problem", with its aim of reversing decades of federal expansion. Today we see something very different and far more sinister. Nihilistic forces are dismantling policies to protect our air, water, and climate. And they seek to discredit the pillars of our democracy: voting rights and fair elections, the rule of law, the free press, the separation of powers, the belief in science, and the concept of truth itself."
These are concerns that have been commented on in the pages of the BIB for years. It is our right to have opinions and to disagree with one another on priorities and the course of action to be taken to deal with the issues that concern us. It is not our right to ignore facts or to fabricate information. It is not our right to manipulate reality to fit some preconceived notion. It is not remotely productive to simply demonize those with whom we disagree or to disparage the very system we must count on to solve our biggest challenges.
We are imperfect creatures and thus our institutions can be imperfect. The systems we depend on are ours to assess and improve upon but of late there seems to be no desire to make anything better or more efficient only to attack and dismantle and ridicule. Volcker worried about this trend to his dying day.
Destroying the World Trade Organization
At the end of the Second World War there was an assertion that much of the impetus for this catastrophic conflict was rooted in economics. The rise of German resentment, the revolution in Russia, the weakening of colonial empires all had to do with economics and the crisis of the Great Depression. In response the leaders of the world called a meeting at Bretton Woods and created the "sisters". The International Monetary Fund, World Bank and the General Agreement on Tariffs and Trade. GATT would later metamorphose into the World Trade Organization. It was determined that lack of an arbiter on issues of trade led to major abuses and ultimately exploitative trade practices and isolation.
Analysis: The WTO is facing the gravest threat in its history as the Trump administration seems bent on its destruction. The assertion has been the WTO rules against the U.S. far too often. The facts do not support this assessment. The majority of the cased brought before the WTO process have been settled in favor of the U.S. and for the most obvious of reasons. The U.S. has been at the forefront of free trade for much of the last six decades and many other nations have been far more protective and discriminatory. Under Trump, the U.S. has shifted away from free trade and toward protectionism and criticism of the WTO has intensified.
The tribunal that rules on these cases will soon lose two of its members and that ends its ability to make decisions. The Trump White House has refused to approve new appointments since 2017. As of Dec. 10 there will no longer be a process to deal with trade disputes and there is nothing to stop nations from pursuing trade policies that attack other nations. The expectation is that subsidies will dramatically expand along with dumping of product, discriminatory regulations, tariffs and every other kind of trade restriction that can be conceived.
The nation that will be most harmed by the end of the WTO is the U.S. as this economy is the most thoroughly globalized. One example of the impending impact involves Boeing and Airbus. The WTO has just ruled that EU support for the airplane manufacturers violates the rules of the WTO and that is a big victory for the U.S. and Boeing. That decision will be rendered null by the lack of an effective WTO and Airbus will be free to gather up as much subsidy and support as it desires at precisely the same time that Boeing is reeling from the 737Max controversy. The future suggests two major airplane makers Airbus and one from China. Boeing will fade.
Dealing with Outrage
Over the last several weeks there has been a war of sorts playing out on my Facebook pages. It is essentially an outrage war. A comment was made regarding the treatment of Michael Vick arguing that his cruelty to animals should make him forever a pariah. The comments were not exactly excusing him but argued over "outrage priority". What is worse? Cruelty to animals or cruelty to children? Sexual assault or police brutality, genocide or discrimination, warfare or famine. Each contribution sought to place one outrage as more serious than the other. It strikes me as absurd in the extreme.
The sense is that there is "outrage overload" that we can't handle all this and soon just ignore all of it. I understand the concept of outrage fatigue as there seems to be nothing that any one of us can do about any of it. The platitudes seem trite the exhortations to just do one thing to try to make a difference but that is the reality. We can only do what we can and we will have to pick our battles. We have to trust that if millions of us do that one thing that there will be change and improvement. The important thing is that we keep getting outraged and that we keep wanting the world to be safe for everyone and everything as overwhelming as that can seem.