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Strategic Global Intelligence Brief for February 4, 2019

Short Items of Interest—U.S. Economy

Fed Changes Its Tune
To be honest, the Fed has indicated all along that it would be governed by the numbers and by little else. This has been standard operating procedure for the Federal Reserve since its inception and is a characteristic shared with all the major central banks. Rates will be hiked when there is a real and present danger of inflation and rates tend to be lowered when there is a recession in the offing. There are other motivations for raising and lowering rates, but these are mandated issues the Fed must address. Until very recently, the major issue was the emergence of inflation, and the economy has been looking pretty solid. Now there is less fear of an inflation hike although there are still many signs that will need to be closely monitored. For now, the bigger issue is the slowing of the economy. That would suggest to the Fed that an interest rate hike right now would be inappropriate.

On the Other Hand
Remember the old adage about wanting a one-armed economist so they can't say on the other hand? That would be appropriate to recall right now. The Fed has been sounding dovish and unwilling to hike rates again right away. At the same time, however, there was another robust jobs report that exceeded expectations even as the government shutdown affected some 800,000 people. The overall unemployment rate is now at 4% as more of the discouraged and marginal workers are coming back to the job market. This increases the potential for wage-driven inflation. That would have the impact on overall inflation that might persuade the Fed to hike rates again sooner than later.

Impact of Marginal Workers
The unexpected gains in the workforce have been stimulating and constitute good news for the most part, but there are some dark clouds involved. The major issue is that many of those getting hired are not qualified for these new jobs. That likely means a significant percentage will not last in these new positions. Those that stay will not be fully productive for many months and perhaps longer. More worrisome yet is that when the economy starts to slow again, these will be the first workers let go. That may make their future emergence from the ranks of the discouraged that much harder.

Short Items of Interest—Global Economy

Brazil's Central Bank Expected to Keep Rates Low
Brazil has a major issue as far as inflation is concerned. It is not the first time this has affected the country—not by a long shot. The problem is the country also has a major issue with growth. There is no desire to make it harder for business to get the money they need for expansion. The central bank is meeting later this week and is expected to leave rates where they are—at an historically low level. This helps fuel inflation, but for now, that seems the price to pay although it is not yet clear where the new Bolsonaro government stands on the issue. He certainly wants growth, but not brutally high prices.

Germany Relies on the Consumer
It is not the least unusual for the U.S. to put most of its faith in the performance of the consumer to resurrect the economy, but that has not been the pattern in Germany in the past. It has always been the export sector and the industrial export sector in particular that drove growth. Now, that has become problematic as many of Germany's most lucrative markets are shriveling. China has slowed and so has Europe with the U.K. falling off the map. Even the U.S. is not what it once was. There are even threats to the German auto sector. That leaves the thrifty German consumers who are not generally big spenders.

Japanese Critique of the Childless
Taro Aso has put his foot in it again, but privately many agree with him that Japan's families are too often childless and too small. He says it is because women are too selfish.

More Pressure on Maduro. How Does This Affect the U.S.?
The politics of Venezuela have been marked by high drama for decades. At one time, the oligarchs ruled the nation and lived grand lives thanks to the bounty provided by the nation's oil. The oil that came from Venezuela made them the No. 5 or No. 6 exporter in the world, but today they are ranked No. 12. Venezuela saw a 69% decline in output from last year alone. In 1999, the government was overthrown in a coup led by Hugo Chavez—a colonel in the nation's paratroop corps. He ushered in a new, leftist regime that he referred to as Bolivarian. He had the overwhelming support of the poor who had gained not at all from the country's oil wealth. For 20 years, Chavez ruled with a combination of an iron fist and abundant generosity towards the poor who had been his early supporters. This was accomplished with the oil money the nation regularly acquired. Much of that oil was sold to the U.S. despite the enmity between the regime in Caracas and the U.S. Chavez was a big supporter of Cuba and vice versa and played a major role in supporting leftist regimes in Ecuador and Bolivia as well as movements all over Latin America. He died in 2013 and named Nicolas Maduro as his successor. From the very beginning, it was apparent Maduro's only talent was as a sycophant to Chavez as any real rival to Chavez was somehow done away with or exiled to some task that kept them away from the seat of power. The economy was not doing all that well under Chavez, but the oil money kept flowing and covered a multitude of sins.

Analysis: The nation has been in crisis for years, but has reached catastrophic levels in the last year or two. It has been estimated that over 85% of the population now lives in total poverty, inflation has exceeded 10,000% and Caracas has become the murder capital of Latin America. This has all become too much for the population and has led to the installation of a rival president—Juan Guiado. He is the president of the National Assembly and the only politician who has actually been elected in a somewhat fair election. The U.S. has recognized him as the real leader and now so has most of the other Latin states (other than the other left-leaning regimes) and Europe. Thus far, China and Russia continue to back him, but neither has been as generous as they have been in the past.

The two areas that most affect the U.S. involve the nation's oil output and the drug trade. For nearly the entirety of the Chavez/Maduro rule, the oil exploitation has been destructive to the long-term viability of the resource. There have been two types of oil development—that which is easy and of high quality and the more difficult to extract and refine. The country used to try to balance the two, but under Chavez, the entire focus was on getting the easy oil to market. Now all that is left is the heavier and poorer quality oil. To get this will require substantial investment and expertise which U.S. companies can offer, but not with the current regime in power.

The Maduro regime has also been an ally to the cocaine producers and cartels, offering them protection and even participating in the distribution effort. The collapse of this regime would have a serious impact on their operations.

There is a substantial Venezuelan Diaspora in the U.S.—primarily in Florida, but present throughout the country. These are the business people and citizens who fled the horrors of the country but fervently want to return if the opportunity presents itself. Their connection to the U.S. is now very deep. That bodes well for future interaction with a country led by someone like Guiado.

New Leader in El Salvador
The U.S. has rarely been all that concerned with the leadership of nations in Central America—at least not since the Cold War ended and the U.S. quit trying to install regimes that would oppose the USSR and Cuba. The neglect has come back to haunt the U.S. as these are the nations from which the migrant caravans have been streaming towards the U.S. The vast majority of those coming north are fleeing not only poverty, but political violence and the power of the drug gangs.

Analysis: The new president of El Salvador is the former mayor of San Salvador—Nayib Bukele. He ran a campaign that differentiated him from the two dominant political groups who have been fighting each other for years. On one side was the party supported by the military and the other side was made up of the former guerilla groups that fought the military. Nothing ever seemed to address the nation's problems. In the week leading to the vote, there were many murders and the drug gang actively worked against Bukele as they have insinuated themselves with both the other parties. His alliance is a center-right party that is strongest within the business community, but he will now seek help from the U.S. and other nations.

Some Solid Economic Indicators Coming This Week
The government shutdown has affected some of the data releases that would normally have been pouring in from a variety of government agencies. For some reason, the government's statisticians are not considered essential so they were either furloughed or placed on temporary leave. The good news is they are back to work (at least for now) and there are other organizations that provide the kind of data companies need to execute their strategic plans. Among those will be a report from the Institute for Supply Management and some data from the central bank of Brazil. This will be on top of the data that comes from the Labor Department and the Commerce Department.

Analysis: First up is the Purchasing Managers' Index (PMI) data for the service sector. It will be released Feb. 5. The expectation is it will show growth of around 56.7, slower than the numbers registered in the December report when it stood at 57.6 and much lower than the 60.7 notched last November. The fact is any number over 50 indicates growth, but these data points are trending down; not a good thing. The manufacturing report was issued last week and was in better shape this month than was the case the month before—it now stands at 56.6 after coming in at 54.3 in December. The poor performance noted in the service sector has been attributed to a variety of factors—mostly a slowing in the retail and construction sector as well as some impact from the government shutdown. Of the 22,000 companies that do business with the government over 90% are in the service sector. Most of these companies took a hit during the month-long closure. Unlike the government employees who have been promised back pay, these companies will get nothing at all and will simply be out the income they had expected to earn. The construction impact will ease a little as the weather improves and the building season starts up again, but there is not much that spurs retail until deeper into the spring and summer.

On Feb. 5, the Commerce Department releases the delayed numbers on the trade deficit. It is expected to be a little better than it has been. The deficit has been much worse than it has been in 10 years despite (and likely because of) the efforts to impose tariffs and trade barriers. The natural response of any business that relies on overseas supply of a good or commodity is to acquire it when the price and availability are optimal. Given that the tariffs were announced but not imposed immediately, the importers in the U.S. and the exporters around the world had an opportunity to do as much business as they could before the taxes were imposed. Imports have surged to levels not seen in over 10 years, but these may start to ebb as the tariffs take hold. It is also the case that most of the companies that needed these foreign imports have a stockpile to last them for a while so the level of imports would be likely to decline even if the tariffs are not imposed. The export side of the equation has been affected by the strength of the dollar and by U.S. trade policy. It has become more expensive to buy from the U.S. as the dollar has gained in value, but the other factor is that the U.S. now has a reputation for being highly protectionist at the same time that other nations are reaching out with more trade deals—such as the one between the EU and Japan that reduced nearly all tariffs to the lowest level in 50 years.

Jobless claim numbers will be released Feb. 7. They are not expected to be much changed from what they have been. The government shutdown will not affect this data as government layoffs are reported separately. These will be the numbers that come from the private sector. The issue that will attract the most attention will be potential layoffs from those 22,000 companies that do business with the government. Many of them reported they had been forced to reduce the size of their staff—at least temporarily. The question is whether that layoff is reversed now that the government is back to work.

Vistage Reports Increased Trepidation Among Small Businesses
If you are not familiar with Vistage International as an organization—it is a group that aims to bring the leaders of small- and medium-sized businesses together for peer and mentor support. The majority of its members have revenues between $1 million and $20 million, so they represent the heart of the small business sector—the average Vistage member has between 5 and 100 employees. The poll that Vistage sponsors along with The Wall Street Journal gets response from 765 firms. At the moment, confidence is lacking as far as the future of the U.S. and global economy.

Analysis: Fully 36% think the economy will do worse this year than last year and only 14% expect conditions to improve. Among the issues that have created the most concern are politics, inflation, labor shortage, trade and overall slowdown in the global economy. The sense is that politics will be nothing more than intense partisan wrangles from this point forward and nothing will be done to address the economic needs of the country. Inflation is already showing up and is related to the labor issue as it has become harder and more expensive to find new employees and costlier to hang on to the existing workforce. Roughly three quarters of these companies either rely on imported goods or they sell to overseas markets. They have been negatively affected by the tariffs and trade fights. They have also been affected by the slowing of the European economy as well as the economy of China. They expect the slowdown in these nations will at some point cause a similar slowdown in the U.S. Most indicate they are engaging in defensive activity already—reducing their investments in new equipment, reducing their hiring efforts and eliminating their expansion plans for the time being. This kind of slowdown can be something of a self-fulfilling prophecy as it slows the economy down.

Oh Boy! Another Rant!
One of the things that has long perplexed me is the fact that so many companies choose to punish loyalty. There are those little incentives offered by the occasional company, but most seem to reserve their best deals for those that have never had anything to do with them. The new subscriber gets the deep discount and the special packages, while the longtime customer gets the price hike. This is happening despite the knowledge that many people regularly quit one provider to take advantage of a new deal only to quit them later to go back to the original provider to get their deal. Meanwhile, the loyal customer is made to feel like a chump.

As in many cities, the local newspaper has been under attack from the digital world and has suffered. The once thick and informative publication is little more than a leaflet these days, but for a longtime subscriber the price has gone up steadily to the point that a daily delivered paper costs five times what it can be had for at a newsstand. That is unless of course one goes through a discount operation and saves oneself over $300 for a 26-week, seven-day delivery. This policy shows up everywhere. It certainly makes sense to entice the new consumer, but how does it make sense to ignore and mistreat the longtime consumer? It is as if one decided to pay the new guy $20 an hour and reduce the pay of the existing workers to $10 so one can afford the new guy. Would anyone be shocked that the existing staff decided to quit altogether? Would anyone be shocked to know that loyal customers are not so loyal anymore?

Immigration Issue

As the U.S. continues to grapple with the issue of illegal immigration (and the U.S. is far from alone as far as this challenge is concerned), the issue is that motivations have been changing drastically. Only 10 to 15 years ago, the No. 1 reason that people from Latin America sought to enter the U.S. illegally was for economic reasons. They wanted to work in the U.S. and earn more money than they would be able to back home. Today, the motivation is to escape violence at the hands of drug gangs and warring political factions. The U.S. continues to erect barriers that assume the economic motivation—relying on disincentives. If somebody is fleeing for their life, they will be not be discouraged by much of anything as whatever it is will be preferable to execution at the hands of a drug gang or paramilitary. The only way to stop this kind of migration is to stop the source of the motivation. The chart shows the 2015 homicide rates for Latin America and the Caribbean.

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Tuesday, 19 February 2019