Strategic Global Intelligence Brief for February 27, 2019

Short Items of Interest—U.S. Economy

More Sliding in the Housing Market
Housing starts were down by 11.2%, the steepest drop in two years. The majority of the data on housing has been pointing in this direction; however at this stage, it is not coming as any great shock. The price of homes had started to fall in 2018, but that was mostly within the large home market. There are still too few homes in the "starter" category. That has complicated an already chaotic market. Millennials have started to emulate the generations before them, but not in the expected numbers as many have delayed starting families and buying homes because of debt and the vagaries of the job market. This is expected to be a rough housing market, but as always, there will be substantial regional variations.

Who Has the Leverage?
The U.S. and China have been at odds for many years, but that has not stopped the two nations from becoming intertwined economically. The Chinese absolutely need the U.S. consumer to buy their output. That has been obvious as the Chinese economy has slowed in recent months. By the same token, the U.S. needs the goods that China produces to keep the U.S. consumer happy. The talks have been testy; it looked as if the impasse would extend, but now there are signs of U.S. compromise. The question is whether China can be trusted to keep its word this time. If they don't, what is the response from the U.S.? Once again, there are assurances that intellectual property will be protected and that technology will not be stolen, but this has been promised many times in the last 20 years. What will be different this time?

Expanding the Labor Pool
As has been repeated over the last several years, the U.S. economy has been stuttering to some degree due to the lack of available workers. That has created a lot of interest in previously unexplored pools of talent. There has been renewed interest in programs that place people who have left prison—even those with felony convictions. There is also more interest in people with disabilities. The challenge has been to avoid placing them in stereotypical positions and being open to having people find the right fit for their skills. It also means working at getting better education and training for people who have been marginalized to some extent.

Short Items of Interest—Global Economy

Limited Expectations in Hanoi
The latest meeting between Trump and North Korea's President Kim Jong-un is not expected to yield much of anything. Most see this as more of a propaganda move than anything else—for both men. The promises made by North Korea at the first summit have not been met—not one of them. There have been no new tests but lots of evidence to show further development of the nuclear weapons capability that has been at the center of the dispute. The U.S. has backed away from sanctions, war games with South Korea and has sent aid, but there has been no gesture in return.

Second Term for Buhari
Nigerian President Buhari has won a second term with 56% of the votes, but these totals have been challenged already by his main rival—Atiku Abubakar. There are nearly always irregularities with elections in Nigeria, but this election has appeared to be close to accurate although Buhari's winning margin was likely less than stated. His health had been an issue, but he seems to have been able to convince most that he was fit to stay on.

India and Pakistan Inch Closer to War
At this stage, there are few that believe that India and Pakistan will engage in an all-out war, but the conflict over the Kashmir region has intensified with Pakistan shooting down an Indian plane and both sides shelling each other's positions. The fear is that one of these skirmishes will be so serious it drags the two nations to escalate.

Meanwhile in the World of Brexit
For the last few years, the expectation had been that the U.K. and European Union (EU) would finally find a way to bury the hatchet and come to an agreement that was not too onerous for either side. Surely, they would. What purpose would be served by demanding an abrupt exit from the EU? The two sides in this debate have been locked in and neither has shown any signs of budging. Never mind that this failure will likely stir increased ferment in Ireland, will shove the U.K. into recession and will rob hundreds of European companies of their markets in the U.K. It will negatively impact almost every aspect of the EU and will send the U.K. into economic reverse. Still there was no move to compromise—until just now.

Analysis: Prime Minister Theresa May had been insisting that her deal with the EU be accepted by the U.K. She was not about to budge as she believed this was the best deal that could be struck between the Brits and the Europeans. Unfortunately, support from her own party evaporated and she has been forced to back away from the March 29 date for the settlement of this issue. This decision has not yet been made formally, but it seems May realized she had lost support for the plan she worked out with the EU. There was now a choice between a very hard exit and some kind of extension.

The real issue is that nobody has a clue as to what happens once the extension is granted. There is no indication that anybody has altered their position on the issue and it is hard to see where progress would be made. Many in the U.K. have been calling for a new referendum. Polls suggest that Brexit would lose this time. Opponents of such a plan are mostly from the camp of those who do not want to see the U.K. stay in the EU, but there are others who are concerned about the precedent. It would be as if the voters had been ignored—that governments would just keep bringing an issue forward until the voters "got it right." On the other hand, there are many who assert voters did not have the information they needed to make that decision in the first place.

The majority of those who voted in favor of Brexit were reacting to the immigration patterns that had been affecting the U.K. The flood of workers from Eastern Europe had threatened many who felt their jobs were in jeopardy. Others disliked the cultural changes that came with the arrival of new people. Some of the opposition to Europe was from the business community as they had been upset with the regulatory system imposed on the U.K., but this was not a major factor as far as how people voted. Now that people have seen what this withdrawal will mean to the British economy and to their jobs, the attitude has changed. Most surveys would have the population voting against a Brexit.

Even if the second referendum was called and the population changed their mind, it is not certain how the Europeans would react. They have been chafing at the British anti-European attitude for years. Many in Europe have little desire to accommodate the U.K. should a request be made. It is assumed that cooler heads will prevail, but this issue has turned very emotional and become a litmus test for one's nationalistic credentials.

Ready for Higher Oil Prices?
The OPEC states, along with cooperation from Russia and its mini-OPEC, have decided to push the agenda—and hard. For the past year, there has been considerable internal debate within the ranks of OPEC as many of the member states have been in real economic distress and can't survive long without their oil revenue. The Saudi position has been that cutting output is the only way to get the per barrel price back to a point that allows profits, but there had been resistance from Iran, Nigeria and Venezuela. Iran has now changed its position and supports the cuts, while Nigeria has been out of the loop as it worries about its recent election. The Venezuelans are in such chaos they barely have a say any longer. Meanwhile, Russia is backing the play.

Analysis: This production limit is not expected to be overly dramatic—at least not at first. The thinking is that output will be reduced in stages. The goal is to get the prices comfortably in the $80 to $90 range. Much will depend on the reaction of U.S. and Canadian oil producers. They can ramp up quickly and replace any of the oil that is withdrawn from the market. They would, however, benefit from more costly oil prices and may well elect to delay response until they start to see per barrel rates that will support their own profit goals. All of this is likely to mean pump prices rising to near $3 a gallon—especially as the summer driving season nears.

Understanding Economic Policy
Over the last year or so, there has been a sparring match taking place between President Trump and the Federal Reserve. The critique leveled by the White House has been far more pointed and accusatory than anything said by other presidents in the past, but it is not the first time a politician has had issues with the policy direction of the Federal Reserve. It is quite common for political leaders to object to the decisions of central banks all over the world. Trump's attacks are not even as pointed as those made in Britain, Europe, Japan, India and elsewhere. The reality is that economic policy mandates set for the central banks can be very different from the policy desires of those in political power at any given time. In fact, there are few areas of the government and political system that are as varied as those surrounding economic policy. General understanding of these varied policy goals can be rare.

Analysis: Janet Yellen was asked in an interview if she thought Trump understood economic policy and the role of the Federal Reserve. She responded with an assertion that he did not. Many of those who have been affiliated with the Fed have indicated the same thing and most extend that lack of understanding to the members of Congress. Every Fed chair is expected to appear before both Senate and House committees regularly and explain what they are doing and why. It has become abundantly obvious over the years that most of the members of these committees are essentially ignorant of the Fed's mission and express very little understanding of overall economic policy.

The basic challenge is that policy as pursued by the Fed and other economic institutions aims at creating an economic system that applies to the entire U.S. This inevitably means there will be winners and losers along the way. Those that are not benefited by a given Fed action will object and demand change, but the Federal Reserve is independent for a reason (as are most all of the other central banks in the world). The mandate for the Fed is simple enough in concept, but challenging in terms of execution. It is stated as promoting maximum employment and price stability. This translates into fighting recession on the one hand and inflation on the other. It is a delicate balance as too much attention to one of these two goals makes it more difficult to reach the other goal. If the only issue was promoting jobs, the Fed could push interest rates to record lows and leave them there while at the same time encouraging bank lending with low interest rates on their deposits and lower levels of reserve requirements. That would flood the economy with money to some degree (depending on the willingness of banks to lend and businesses to borrow).

This would also encourage inflation as there would be more money in circulation than the economy would be in a position to absorb. According to the Philips Curve, the low rate of unemployment would lead to higher wages and that would push inflation as well. Now the Fed would be facing that inflation cycle and their desire to maintain price stability would kick in. That would result in higher interest rates, higher rates for banks that have money on deposit with the Fed and higher reserve ratios. Throttling access to ready cash will slow the economy and inflation would be tamed, but in the process the slowdown will cause some businesses to shut down or cut back. That means fewer jobs and more unemployment. The Fed has to try to balance these two contradictory goals with a careful mixture of interest rates and other tools. Their decisions are based on what is best for the economy as a whole while understanding that some part of the system will be negatively affected by shifts in employment as well as pricing.

Generally speaking, there are challenges like this in every aspect of economic policy. This has become obvious as the U.S. continues to pursue protectionist trade policies. The tariffs that have been imposed on steel and aluminum have definitely helped the domestic steel and aluminum industries in the U.S., but these tariffs are being paid by the companies in the U.S. that buy the imported metal. That means higher prices for all the consumers in the U.S. Both Ford and GM have indicated that higher-priced metal has added over $1 billion in costs to their production. That hike will show up in the price of the vehicles they make. Each and every policy decision made as regards the economy creates a win for some and a loss for others. This means a lot of decision-making on the part of political leaders. Who is to benefit and who is going to lose? The answer usually has more to do with political clout than any sort of economic efficiency.

Consumer Confidence Rebound
The levels of consumer confidence have recovered after sliding at the start of the year. This has been the case with both the survey from the University of Michigan and the Conference Board. These are always tricky numbers to work with. Consumers are notoriously fickle and react to a host of factors that may or may not have a major impact on their lives. In past years, the price of gas at the pump would have a profound impact on levels of confidence. This time the issue seemed to have been the government shutdown.

Analysis: The peculiar part of this motivation is that the shutdown had very little impact on the vast majority of consumers. It was certainly a big deal to the 800,000 people not getting a paycheck. There were also millions of people affected by the fact that certain services were not available from the government during that period, but essential services were still funded. The impact was more psychological than anything else. The consumer was uneasy over the message being sent by this paralysis. The leaders of the country were locked in a battle that defied logic in the minds of most. Why was there not a compromise position available that would deal with border security without spending $500 billion? The impasse made people nervous regarding the government's ability to address any of the other key issues and thus confidence dropped. Now that a compromise may have started to develop, the consumer mood has started to shift again.

People and Their Animal Companions
I have no idea why so many of my conversations with people end up focusing on animals. Maybe it is the picture of "daddy's cat" on my phone or the way I casually bring up my new kitten every 30 seconds. I am just perplexed, but it turns out that people are only too eager and willing to relate stories of their dogs, cats, horses, birds, fish, and last night, their hamster. To get the full flavor of this story, understand that the woman relating it is a trucking company owner from Louisiana married to her truck driving husband and daughter of a trucker. She is by no stretch a pushover or someone who would be accused of being soft.

The hamster in question was their only pet at the time—now they have five cats and two dogs. The hamster had been with them for a little over two years—the usual lifespan for these guys. It was fading fast and she had urged her husband to hurry home if he wanted to say his good-bye. The little guy was nearly lifeless when he finally arrived, but he picked him up and held him close. For the first time all morning, he opened his eyes and made little cooing sounds and tried to snuggle in closer. A minute later he was gone. Both of these folks broke down and cried. Everybody at the table had tears in their eyes as we all remembered those pets and companions that are no longer with us.

I see this level of emotion with everybody I know who has a pet. Something about the unconditional love they give and their complete dependence on us. Having a relationship with an animal is also a testament to our resilience as we always know what is coming and we are nevertheless prepared to suffer that pain in exchange for the joy their little lives brought us.

Oil Prices Going Up
OPEC and Russia are committed to getting the price per barrel up to around $80, but it has been a long time since that level has been reached and there are plenty of reasons why the effort will fall short. On the other hand, the price per barrel has been moving up over the last several months as the U.S. producers have not been in a hurry to make up the difference. Trump's plea that Saudi Arabia moves to lower prices has been ignored. Russia has not been in a cooperative mood either.