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Strategic Global Intelligence Brief for December 4, 2019

By Chris Kuehl, Ph.D., NACM Economist

Short Items of Interest—U.S. Economy

Few Takers for Expanded Offshore Drilling
A year or so ago, there was a statement from the White House that suggested the U.S. was going to go full tilt towards more offshore drilling. There was limited enthusiasm from the energy sector as there has been a decline in demand and it was feared that bringing more capacity online would only result in lower prices. The other issue is that few states are supporting the idea. It was not shocking to see opposition from the Northeast states or from the West Coast states, but even the more conservative states in the Southeast have been wary and do not want development in areas that have recreational or development potential. There has even been reluctance to disturb environmentally sensitive areas.

Household Spending Is Up
This was not a big shock given all the retail activity of late, but it still a good sign as far as the status of the consumer economy going into next year. There has been an increase in durable goods purchases as well, although not the kind of purchase that has been common the last few years. The car, boat or recreational vehicle has given way to the purchase of a new washing machine or dishwasher and some new electronics. The consumer has been snapping up the latter in anticipation of higher prices next year due to tariffs. Thus far, the retailers are offering a lot of sales, but warning about price hikes.

The Return of the In-Store Expert?
As the brick-and-mortar stores watch more and more business migrate to the online option, they are asking a basic question. Why would anyone venture out into the traffic and crowds when they can sit on the couch and order? Turns out that people still want some advice. Stores cut costs a few years ago by hiring unskilled, cheap labor trained to operate the cash register and little else. Now, there seems to be an effort to think about in-store expertise. There are efforts to train people to actually assist the customer with a purchase.

Short Items of Interest—Global Economy

Russia Opens Massive New Pipeline to China
The project is the largest undertaking since the collapse of the USSR. There have been many times when it seemed the whole thing would fail. The 1800-mile pipeline will deliver natural gas to China instantly, turning Russia into the top supplier of gas. The project cost $55 billion and has served both an economic and political purpose. Russia was dependent on the European market and now that is not as vital. This pipeline is entirely within Russia and China, as opposed to the pipeline to Europe that runs through Ukraine. The two states were once bitter rivals, but this is cooperation on a grand scale.

Eurozone Readings Still Down
For the 10th month in a row, the Purchasing Managers' Index for the eurozone has been in contraction territory, but the glimmer of good news is that the pace of the decline has slowed a little. It is still a major concern that Germany is mired in low numbers and no other nation has been able to compensate for that decline. The optimists among the analysts are asserting the worst of the downturn may finally be at an end, but there are many pessimists that hold there is still room to fall—especially if the Trump threats are carried out.

Who Rallies Behind Who?
The threats to impose tariffs on France over the imposition of a new digital services tax has forced many to take sides. Prime Minister Boris Johnson of the U.K. is one of them. As France has called for EU solidarity on the issue, Johnson has elected to back France. That will create renewed tension with Trump. It is assumed that Johnson thinks he needs the French to work out a Brexit plan and he doesn't want to alienate Macron—even at the risk of angering Trump. The reality is that Trump has promised the U.K. a big trade deal, but has not delivered and Johnson seems to have lost patience.

Will This Never End?
The statements issued by Trump regarding trade have long since lost credibility. There have been dozens of assertions that a deal was imminent—big deals, phase one deals, partial deals. In the end, there is no deal at all and the tariffs continue to be imposed. It seems nobody has a clue what is on Trump's mind—certainly not the negotiators ostensibly trying to figure out what the strategy is. The latest statement sent global markets tumbling as Trump seemed to hint that he was willing to wait until after the elections before making a deal with China—effectively extending the trade war for another year. That is the word today. It could well change tomorrow. With all the maneuvering and gamesmanship, it has been hard to remember what the core issues are supposed to be. Many analysts suspect there are no real core issues at stake right now—this has become a very personal battle between Trump and President Xi of China. Both men are far more interested in appealing to their core constituencies than in reaching a deal.

Analysis: When all of these trade issues erupted, there were four areas of interest as far as U.S. negotiators were concerned. All four of them have been issues for many years. At the top of the list was the persistent trade deficit the U.S. runs with China. This was something that developed in the late 1990s and the early 2000s as China took significant market share away from nations like Sri Lanka, Bangladesh, India, Brazil and others. Some U.S. manufacturing also suffered from that Chinese competition. The U.S. has been lobbying for years to get China to buy more from the U.S. The second issue has been the inability of the Chinese to protect intellectual property and U.S. technology. There have been many years of counterfeiting and outright theft. Issue three has been the Chinese support for its export sector through subsidies and other supports such as maintaining a low-valued currency. Finally, there is the advantage China maintains through its lax environmental standards and exploitative attitude towards labor.

In the last several months, these core issues have been supplanted by everything from concerns regarding the Chinese technology company Huawei to the treatment of protestors in Hong Kong. Not that these issues are unimportant, but adding them to the trade debate serves only to muddy the waters and makes a deal nearly impossible to achieve. It seems the markets are starting to understand that a deal is simply not in the interest of either Trump or Xi—even if a deal would be good for their respective economies.

Brazil and Argentina Get Slammed as Well
This move by Trump caught everybody off guard—most notably Brazilian President Jair Bolsonaro who has referred to himself as the "Tropical Trump." The motivation for imposing new tariffs on imported steel and aluminum from these two nations is a claim that both are deliberately manipulating their currencies downward so as to put pressure on U.S. farmers. It is certainly true that Brazil and Argentina compete with the U.S. in agricultural markets as both produce lots of soybeans, corn, livestock and so on. The fact that their currencies have been trending down has helped them sell these goods on the global market, but it would be hard to argue that either of them has chosen this strategy to affect the U.S. farm sector. Both are highly dependent on imported goods and the currency devaluation has cost their economies a great deal.

Analysis: Argentina has a new left-leaning government led by the Peronists. It is easy to understand why Trump would want to punish a government that continues to support Maduro in Venezuela and has been pushing for the restoration of Evo Morales in Bolivia. The fact that Brazil has been a target of Trump's ire is harder to explain given the supposed close relationship with Bolsonaro. It was only last week that Bolsonaro asserted the U.S. was on the verge of a trade deal with Brazil as he trumpeted his close alliance with Trump. Now it seems Brazil is on the outs. Of the two nations, the Brazilians have the most to lose as they are the No. 2 or 3 exporter of steel to the U.S. in any given year.

Hopes for Economic Recovery in Brazil
The latest data from Brazil is not about to provoke dancing in the streets, but it is significant that Brazil's growth beat expectations by a respectable margin. The growth in the third quarter was 0.6% and 1.2% year-over-year. The assessment was that growth would be less than half that. The country has a very long way to go given the severity of the recession, but the plans put in place by Finance Minister Paulo Guedes seem to be having an impact. His approach has been heavily oriented towards increased privatization and deregulation. That seems to have stimulated a lot of activity in sectors such as agribusiness and construction.

Analysis: The decision by Trump to impose tariffs on steel imported from Brazil may take some of the wind out of the sails of this recovery as it suggests the U.S. is no longer in the mood to back Bolsonaro. Many of the key sectors of the Brazilian economy compete with sectors in the U.S. As China has halted soybean imports from the U.S., it has stepped up imports from Brazil. Also, the manufacturing sector in Brazil makes much the same thing as the U.S. given the focus on sectors such as aerospace and energy. The consumer still lags in Brazil as it has been hit by higher levels of unemployment as well as by sharper hikes in inflation. The reforms that had been promised by Bolsonaro have stalled in the face of fierce opposition. Now he is dealing with a whole variety of corruption issues. Given that he campaigned on a pledge to root out this corruption, the fact that close colleagues are getting swept up does his reputation no good.

What Motivates the Trump Trade War?
This is an interesting question, but one that is impossible for anyone other than President Trump to answer. In the last week the Trump that seemed prepared to boost the U.S. economy with a trade deal or two vanished and was replaced with a Trump that was more bellicose and confrontational than ever before. The deal with China that seemed imminent just a week ago has now been delayed for perhaps a year. The alliance with Brazil's Jair Bolsonaro is over as the U.S. moves to impose tariffs on its steel exports to the U.S. A fight has been amplified with French President Emmanuel Macron and there are renewed threats against European cars and car parts. Even the USMCA now seems in jeopardy as Trump has once again challenged both Canada's Prime Minister Justin Trudeau and Mexico's President Andres Manuel Lopez Obrador. Why?

Analysis: The slowdown in the global economy has been acute and the trade war has been the culprit for the majority of this decline—both directly and indirectly. It is clear enough that an end to the hostile trade and tariff policies would result in a boost for the economy of the U.S. as well as for most other nations. Not that the issues that provoked these trade and tariff wars are unimportant. China manipulates its currency and subsidizes its exports. U.S. companies face tariffs and restrictions in Europe and are taxed unfairly in many cases. European companies are supported by subsidies in many cases. The point is that there are other ways to approach these issues, strategies that do not tear the global economy apart. The Organization for Economic Cooperation and Development (OECD) has been developing a new system for taxing multinational companies. The process has involved Treasury Secretary Mnuchin. It was on the verge of an agreement, but that has been delayed in the wake of the latest explosion of trade warfare. Again, the question is why.

Theory one is that Trump is simply playing extreme hardball and trying to reverse the trade trends of the last 50 years. The U.S. was the free trade champion and maintained an open approach while the rest of the world cheated and undermined many of those free trade principles. Once these nations realize the U.S. is serious about that level playing field, they will make the required adjustments. Theory two is that all this is for domestic consumption. The Trump base has not benefited from the globalization process for the most part. They are the ones that lost their jobs and they are the ones that are making the sacrifice so that consumers in the U.S. can buy cheap imports. Making deals with China or Europe or anyone else will not delight those in Trump's base. The third theory is that Trump takes all this as a personal affront and therefore something that requires a counterpunch. The threats to impose massive tariffs on France came only after President Emmanuel Macron criticized Trump's comments on NATO.

In truth, there are probably elements of all three motivations involved. The upshot is that these policies are starting to hurt the U.S. as much or more than the intended target nations.

Slump Appears to Be Intact for Manufacturing
There had been some faint hope the worst might be over for the U.S. manufacturing sector as optimists asserted the latest Purchasing Managers' Index (PMI) readings would be higher than they were last month. Nobody was expecting them to get back into expansion territory, but it was thought they would be a bit less contractionary. That was not the case as the latest PMI was actually down a bit from the low point set in October. The reading was at 48.3 and is now at 48.1 when many thought the numbers would improve to 49.1 at least.

Analysis: The factors which have dragged these numbers down for the bulk of the year are the same as affecting the data now. The trade and tariff war compromised the global economy and sank growth numbers to levels not seen since the recession. That has meant a sharp decline in the export activity for the U.S. This decline is not as crippling as it has been for economies such as Germany's as the U.S. is only 15% dependent on exports while Germany (and most of the other economies in Europe) are 50% dependent on exports.

The manufacturers in the U.S. are generally more dependent on business and industry demand as opposed to consumer demand so the robust position of the retail community has not done them as much good as one would assume. The consumer is upbeat thus far this year, but the per consumer spend has been down and there has been less interest in the big-ticket items. The manufacturer in the U.S. has been affected by lower demand for vehicles, the struggles in the farm sector and slowdown in the energy arena.

The Peculiarities of Cats
Our son has two new cats. It seems his wife (and he) disliked the peace and quiet that comes with a home without cats and elected to replace those lost to the inevitability of age. This provokes an endless round of observation as they reveal their quirks. One tends to lay down like a frog with back legs splayed out and also adopts a sitting posture that resembles a committed couch potato—all that is missing is a can of beer and the remote. The other cat is the quiet one, but doubtless gets his buddy to attempt various transgressions.

Back in the Kuehl household we have the "big kitten" and his attraction to furry slippers, He regularly vanquishes them and protects us from whatever threat is posed by them. He also enjoys a rousing game of "bounce the superball at 5:00am." That is one weird sound to hear at that hour—especially when combined with the desperate calls of Sven the Perpetually Hungry. One would think we didn't feed him four or five times a day (and by "we" I mean my dedicated wife). The heated bathroom floor has been activated for the winter and we know where to find Spike at any given hour. He also enjoys sitting in front of the fire in fetching poses. The nightly lap competitions are entertaining as well, but mostly they argue over Mom's lap as Scoot owns mine and drives away all potential interlopers before covering her eyes and breaking into a deep snore that rivals a chain saw. Who needs a TV with all this entertainment? As for our son—he is training them both to watch hockey with the same intensity he displays.

Synchronized Slowdown
The outlook for 2020 is not an optimistic one to be sure, but neither is it a total loss. The decline has been near universal and the U.S. is now set to join the parade. While the rest of the world was already slipping, the U.S. held its own in 2018, but the decline started to manifest this year and will accelerate in 2020.

An Unexpected Economic Drop off in November
Strategic Global Intelligence Brief for December 3...
 

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Sunday, 26 January 2020