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Strategic Global Intelligence Brief for December 16, 2019

By Chris Kuehl, Ph.D., NACM Economist

Short Items of Interest—U.S. Economy

Too Much Collateral—Too Little Cash
The repo market is largely unfamiliar with the general public, but it is certainly important to the banking system. This is the system banks use to do short-term loans. The banks borrow money overnight to handle the day's obligations and they use government bonds for that collateral. The government has now issued so much debt that there is far more collateral than is required and too little cash. This creates pressure on short-term interest rates—driving them up. The Fed has been required to inject cash into the system to keep that credit from drying up. The almost constant addition to the national debt and deficit has been straining the system in a wide variety of ways. By all accounts, this situation is going to get worse and worse in the next several years.

How Much Will China Actually Buy?
Statements from the White House indicate the Chinese have agreed to buy $40 billion worth of farm exports from the U.S.—a $10 billion increase from the largest level of exports the Chinese have ever brought in. The statement has not been backed up by Chinese comments; many U.S. analysts are exceedingly skeptical. China has stated it "plans" to buy more if the products are competitively priced, are of the required quality and are needed by China. That leaves at least three gaping holes in the deal. U.S. farmers are not at all sure what they should be planting in the coming months.

Discounts Out of Control
As the U.S. retailers start to examine this year's retail season, they are coming to some unfortunate conclusions. The assumption earlier in the year is that tariffs on Chinese consumer goods were going to create sticker shock with consumers. There was a conscious decision to go into the year with a limited inventory and try to capture all the early shopping with deep discounts. There have been more and deeper discounts than at any time since the start of the recession in 2008. The result is expected to be similar to 2008 with good revenue numbers, but very limited profits. The stuff that is selling is that which is on sale and there is less money made on these goods.

Short Items of Interest—Global Economy

Riots in India Intensify
The actions by the Modi government have been definitely anti-Muslim. That has been sparking protests and demonstrations in the Islamic regions. The fact is the Bhartiya Janata Party is nationalist and deeply antagonistic towards the Muslim community and Modi has been involved in anti-Islamic activity in the past. As his popularity has waned, he has relied more and more on that Hindu nationalist base. That has been triggering many conflicts in regions that have both Hindu and Muslim living in close proximity.

Slight Gain in Price of Oil
The OPEC/Russia attempt to raise the price per barrel of oil has largely fizzled. The price has risen slightly to $65, but the plan had been to get prices up to the $80 level. The decision to reduce output has not had the impact it might have a few years ago as demand has been down for some time and shows no real signs of recovery. The U.S. shale oil expansion has slowed, but it can be ramped up quickly if demand justifies it. The struggles of the global economy are not subsiding any time soon. Thus, there will be limited commodity pressure on inflation.

U.S.-U.K. Trade Worries
Now that Boris Johnson has won a resounding victory in the U.K., there is another move towards a trade deal with the U.S. underway, but not everyone is happy about this. The U.K. farmer stands to lose big as the U.S. gets more access to the U.K. and the U.S. manufacturer is not happy about the potential competition from British manufacturers who make roughly the same products for the same markets as their American counterparts.

Will Trade Deal Hold Up?
There are two schools of thought as regards the deal that has been struck between the U.S. and China (actually there are probably a dozen different interpretations). The first is that this is a very big deal and marks the end of these paralyzing trade wars. The assertion is President Trump got what he wanted and President Xi got what he wanted and all is now right with the world. This certainly seems to be the interpretation of the global markets, but there are those who assert all this enthusiasm is just wishful thinking on the part of investors. They take a negative view and assert that nothing substantive was agreed to because everything revolves around both the U.S. and China agreeing to abide by the pledges they have made—pledges they have made before and broken many times before.

Analysis: To note that both nations are deeply suspicious of one another would be the understatement of the year. The one observation that has clearly developed over the last couple of years is these nations see each other as rivals in every sense of the word and there is no desire to do anything that doesn't benefit one's own nation. Cooperation only takes place when absolutely necessary.

The most likely challenges to the deal will be: (1) China failing to buy the required levels of goods and commodities from the U.S. and (2) Trump imposing tariffs or failing to remove the tariffs that have been imposed. China has promised to buy from the U.S. many times in the past and there has always been an excuse as to why these purchases have not been made at the levels promised. The Chinese have asserted the products are unsafe or of poor quality. The farm output has been rejected for dozens of reasons. The assertion is made that the U.S. is trying to cheat China with inferior quality exports. The U.S. tariff policies have been mercurial at best, motivated as much by domestic political needs and personal caprice as anything related to trade. China does not trust the U.S. and the U.S. doesn't trust China—not a very sound basis for a successful deal.

The pessimists hold that this deal will survive a few months into the new year, but all will depend on election polls in the U.S. If Trump starts to see a slip in base support, he will have an incentive to stir up a new round of animosity towards China and will declare it is cheating, requiring a hard response from him. This could cause a negative response in the markets, but it would bolster his base support. That will be the major concern for Trump next year.

USMCA Still Not Assured
It may have seemed that getting the USMCA through Congress was the last major hurdle for the revamp of NAFTA, but the changes that were required to win support from the Democrats have infuriated the Mexican government and the chances for the pact have started to fade. The provision that has upset Mexico is the one that calls for the use of labor inspectors to ensure standards are met. This strikes Mexican authorities as highly intrusive and an opportunity to meddle extensively in Mexican business. The assumption is the U.S. inspectors will have far more on their agenda than labor standards. The U.S. has repeatedly tried to impose strict tariffs on goods from Mexico as a means to put pressure on Mexico to halt immigration to the U.S. and to fund the wall that Trump promised. There is a suspicion these inspections will be just another tactic to use toward that end.

Analysis: From the start of the negotiations, the Mexican position has been that panels be established to handle any disputes over interpreting the provisions of the USMCA. This has been a position Canada has supported as well. The old NAFTA agreement relied on these panels extensively as they were made up of representatives of all three nations. The deal the U.S. now wants Mexico and Canada to approve replaces panels with "labor attachés" from the U.S. with powers that include halting exports from companies seen to be in violation.

There is a great deal of incentive for Mexico and Canada to ratify the pact as neither nation can afford to be cut off from the U.S. in any sense. On the other hand, there is very little trust between the three leaders. Mexican President Andres Manuel Lopez Obrador is a leftist leader who has been deeply opposed to U.S. efforts to overthrow Venezuela's leader and disagrees with the U.S. stance on Argentina and Bolivia. There has been deep animosity towards U.S. immigration policy as well. Canada's PM Justin Trudeau is no fan of Trump given the support the U.S. gave to his opponent in the last Canadian election. The odds are that economic necessity will win out and the deal will get signed, but it is also likely that some serious concessions will have to be made. That potentially throws it back in the lap of the U.S. Congress. A declaration of success may have been a little premature.

A Whole New Approach to Trade?
There has always been a good deal of controversy involved with trade, it didn't just start with the Trump administration. By its very nature, trade creates winners and losers for companies in a given domestic economy. Those companies that can produce and sell to a global audience thrive when there is open access to those global markets. Many of the largest businesses in the U.S. have been wildly successful in those international ventures. Thousands of smaller companies have also cracked these multinational markets as well. U.S. consumers have been the biggest winner from global trade as they have been given access to goods from throughout the world and at lower prices than they would pay for the domestically produced versions. The losers in this scenario are the companies that have to compete with these foreign made goods. Many simply have been unable to and have gone out of business entirely. This has meant millions of lost jobs and the decline of whole industries unable to fend off the imports.

Analysis: There was never a conscious decision to favor an open trade policy vs. protectionism. There have been periods when one approach seemed to be favored over another, but usually there have been elements of both in place. Some industries were allowed to fade away and others were provided with extensive support from the government. The policy emerging since Trump took office has been far more focused on protection. There have been major changes taking place in the U.S. and global economy as a result. The question is whether these changes are "good" or "bad." The answer will depend on one's perspective and whether a given company now falls into the category of winner or loser.

The winners under a more protectionist approach will be those companies in the U.S. that have struggled to compete with foreign rivals. They will be facing less pressure from imports and will have the U.S. market to themselves. It is possible some industries that ceased functioning in the U.S. will make a return, but this will be a long process at best. Their inability to compete on a global basis will still limit them. The losers will be those companies that engaged in global business. They will lose market access throughout the world and will lose access to the imports they used to produce. The consumer will be the big loser if this trade shift accelerates. They will no longer have access to foreign products and the costs of maintaining their current lifestyle will increase. Estimates vary considerably (depending on what a given person or family buys) and have run between $3,000 and $8,000 a year. For all intents and purposes a protectionist policy based on tariffs, trade restrictions and other barriers is a tax on the consumer and a pretty steep one at that.

Three Releases to Watch This Week
The end of the year slowdown is underway as the holidays close in on their climatic end. This is the time of year that almost everything slows down except retail and transportation (as all those packages make their way to their destinations). There will be some data regarding that spend towards the end of the week when the Commerce Department releases consumer spending numbers. The expectation is there has been growth of 0.4%. This is not bad, but it is less than had been anticipated at the start of the retail season.

Analysis: In addition to the consumer data, there will be new industrial production numbers. These will be examined closely. For the last four months, the manufacturing segment of this measure has been down as has the mining segment (which includes the oil and gas sector). The only part that has been up has been utilities. The sense is that manufacturing may stage a bit of a comeback with growth of 0.8%. This would suggest the damage from the trade war has started to ease off a little.

There will also be data on job openings and new home sales. There are still far more job opportunities than there are people to fill them. This imbalance is still acute in sectors such as manufacturing, construction and transportation. The new homes sales numbers will be down, but that is no shock as this is not the time that most people think about moving. As in past years, there will likely be a recovery after the holidays are over.

Honing the Message
The polls thus far suggest Democratic candidates are winning support for part of their economic message, but falling short on other parts. There seems to be support for the notion of taxing the wealthy and corporations, but there is nothing new about this. There has always been support for taxing other people while lowering one's own taxes. The part that has proven challenging is deciding what to spend that revenue on.

Analysis: There has been suspicion that massive programs such as "Medicare for All" or free education for all will be far more expensive than assumed and will require far more taxing than currently suggested. There is also deep opposition to suggestions that student debt be retired universally or that large increases be made to various social programs. There is more support for expanded infrastructure development as well as workforce development, but even here, there are debates over priorities—new roads vs. mass transit or vocational training vs. college. These are not new debates and it will be a challenge for the candidates to navigate. Those who have taken a stand on some of these spending ideas have seen their support in the polls slip.

The Snow Effect
My hometown is somewhere between Miami and Duluth on the subject of snow. We are not at the level of raw panic at the sight of a few flakes—prepared to buy six month's supply of milk and bread. Neither are we as cavalier as the hardy Minnesotans who simply crank up their snowmobiles and agree to head out to ice fish. It snowed several inches yesterday and the weather people were nearly apoplectic. Churches canceled services, concerts were canceled and schools for today were shut down. The football game was played (complete with players making snow angels), but most everything else halted. There was no discernible run on foodstuffs, but the malls were deserted.

Our plans altered when the planned concert outing was canceled so we opted for the logical replacement—watching two Hallmark movies! Once again, I was reminded of how lucky we are to have the neighbors we have. The guy from across the street has a blade on his lawn tractor and does the driveways of everybody on the block—I haven't cranked up my snow blower in years! The geese hung around the bird feeder all day and the kids hit the snow hill pretty hard. At the moment, it is all pretty snow-covered landscape as I don't need to drive anywhere. I am sincerely hoping the clearing is complete by tomorrow as I prepare my last speaking engagement for the year—in St. Louis. In the meantime, I will just hum White Christmas to myself and enjoy the scenery.

U.S. and Mexican Economies Inseparable
The trading relationship between the U.S. and Mexico has been developing for years—well before the arrival of NAFTA some 25 years ago. Under the old agreement that relationship accelerated. Today, the border is almost non-existent for a wide variety of industries. It is impossible to separate the two economies now, but it is entirely possible to hamper further development. That would be to the detriment of the U.S. as well as Mexico.

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Tuesday, 11 August 2020