Strategic Global Intelligence Brief for January 22, 2019
Short Items of Interest—U.S. Economy
Flagging Consumer Confidence
For the last couple of years, the consumer confidence level has been high and, in many respects, higher than would have been expected. The sense has been that consumers pay close attention to only a handful of factors as far as the economy is concerned—jobs, prices and the behavior of the stock market. There are other issues that penetrate from time to time but only if they have become a big enough issue to dominate the nightly news. The fact is that jobs data has been as good as it has been in decades, the inflation threat has not manifested and the markets have been volatile but always seem to rebound. The latest data has shown that other factors are affecting the mood of the consumer now and the attitude is starting to trend negative. The trade wars, government shutdown and what seems like total paralysis in government have now become bigger concerns.
Fed Worries About Overall Confidence
It has become a common lament from the members of the Federal Reserve and that was amplified most recently by Lael Brainard. Uncertainty is not good for the economy, not good for the business community and not good for the consumer. There are many things that a business can cope with and most have contingency plans in place for almost anything they think they may encounter. However, if they simply have no sense of what to prepare for, the default response is to hunker down and wait. That means consumers don't spend, business doesn't invest or hire and expansion plans are placed on hold. It is the estimate of the Fed that many companies are cutting back simply because they don't know what comes next.
Manufacturing Output Surged at the End of 2018
The caution that business is expressing regarding 2019 was not in evidence at the end of last year. The latest industrial production numbers have been released and they show that factory output was up by 1.1% at the end of last year. There was also some improvement in the mining sector (oil) and in utilities but the real gains were in manufacturing. The motivation for the gain was a combination of consumer demand and a reaction by manufacturers eager to get their output levels up while conditions were still favorable. There was also evidence that U.S. exports were better than expected as foreign consumers were still buying despite the higher prices created by tariffs.
Short Items of Interest—Global Economy
Move to Hike Wages Stalls in Japan
A year or so ago Prime Minister Shinzo Abe began a campaign to get wages up in Japan. His thinking was that the economy needed more input from the consumer. There are several ways to stimulate the consumer but the most common can be the most controversial — lower taxes. This has already been tried, and Abe wanted a different approach based on higher wages so he tried to pressure the largest companies into raising wages. Thus far, they have resisted and it appears this tactic is going to fail.
Rumors of a Coup Attempt in Zimbabwe
Emmerson Mnangagwa was elevated to the presidency when longtime dictator Robert Mugabe was ousted but throughout most of the Mugabe reign Mnangagwa was a loyalist and in charge of security. The country continues to struggle financially as the promised investment has not arrived. There are those who want him ousted as well but it is not clear whether there was an actual coup attempt or simply expanded protests. The government has cracked down hard on these demonstrations.
Europe Promises Hard Border in Ireland
If the U.K. fails to reach a deal on Brexit the EU has stated that it will impose a hard border in Northern Ireland and the expectation is that this move would seriously damage the peace process in that part of Ireland.
Slow Growth in China—What Does This Mean?
The Chinese just released growth data that shows the country is growing at the slowest pace it has seen since 1990. The 6.6% pace is essentially a recession for the Chinese economy as anything 6% or under is too slow to keep up with employment demands. The idea of "recession" is not exact—it is when an economy is too slow to keep pace with job needs and too slow for business to make suitable profits. For the sake of statistical convenience, the U.S. is said to be in a recession when there are two straight quarters of zero growth but the reality is that huge swaths of the U.S. economy will have fallen to the point of inadequate job growth and business expansion when there is national growth of between zero and around 1.5% growth. As a developing nation, the Chinese are coming from a much lower base and can thus have growth rates that would make a developed nation appear to be on fire and still be in economic crisis. The questions that really matter at this stage are why the Chinese economy has shrunk, what China plans to do about it and what impact their economic reversal has on the rest of the world.
Analysis: There is nothing simple about a country as large as China slowing down. It remains the second largest economy in the world and will still sport a GDP of close to $13 trillion this year. The assessment is that five factors have contributed to the slowdown and some of these issues are shared with other nations including the U.S. and those in Europe. The first issue is by far the most important and that is the slowdown in consumer spending as consumption accounts for almost three quarters of the Chinese economy. The consumer is the driver in most economies but in China that percentage was once closer to 60% (while in the U.S. it is close to 85%). The consumer in China has been concerned about a hike in the level of unemployment from 4.8% to 4.9%. These are the official numbers and analysts assert that the real rates are higher yet as China undercounts the involuntarily part time and the underemployed. At the same time, the consumer is confronting higher debt levels as they have been trying to protect their lifestyle with increased borrowing—a tactic that the U.S. is all too familiar with.
The second issue is Xi Jinping's effort to address the overall national debt. The heavy reliance on outside investment and the aggressive lending by Chinese banks resulted in high debt levels and Chinese leaders started to get concerned about the booms and busts around property values and other financial instruments. The crackdown started three years ago as the government pressured banks to ratchet back on lending. It worked but perhaps too well. The threat of property bubbles has eroded somewhat but now the pace of growth may be too slow and the latest moves by the Bank of China suggest that there is an effort to reverse course and stimulate more growth activity. It remains to be seen whether this will invite the perils of bubble investment.
The third issue is the trade and tariff threat. This is not quite the issue the U.S. has tried to assert but it has been a factor. The Chinese economy may well be transitioning from an export-based system to one that relies on its own consumer but exports are still very important and the U.S. remains the most important market for these exports. The trade spat has been an issue as much for the threat than for the actual damage done thus far. The potential loss of a key market has slowed investment and made the export centered businesses nervous. They also worry that China will make concessions that will hurt them even more in the long run.
The number four issue has been building for a long time and it is one that affects the U.S., Japan, Europe and other developed economies. There is a labor shortage in China, especially in regards to the skills that are needed in a modern economy. The pattern of the past was to recruit people from the rural areas to work in the factories aimed at the export sector. Today, these companies have to compete with the highly automated and technologically advanced companies from the rest of the world and these largely unskilled rural workers are inappropriate to the needs of the economy. The other problem is that China has a rapidly aging population and now has a large and unproductive retired population supported by a smaller and smaller working population.
The fifth issue is related to the issue of trade and tariffs but not entirely. China faces a great deal more competition than was the cases a few years ago. The smaller countries have tried with some success to emulate the Chinese and now compete to manufacture those export sector goods the western states demand. As the U.S. and Europe impose trade restrictions on goods from China, they have to locate other source countries and there have been many eager to step up to the plate. Vietnam, Sri Lanka, Bangladesh, Malaysia and many others in Africa and Latin Americas are among those places.
Shutdown is Crippling Business
The majority of the focus has been on the government employees that are now without a paycheck for a month, but at least they have the knowledge they will get back pay at some point. The business community is simply losing money by the 10s of millions of dollars, and that will not be money they can recover.
Analysis: There has been a shutdown of new IPOs, new loans are not being processed or approved, regulatory authorities are not issuing permits and contractors are not being paid. The FDA has stopped issuing approvals for new drugs and inspections of food have been halted or delayed. The entire business community is suddenly stalling out as the government has ceased to carry out its functions. Where these are still being handled the employees are not being paid and the rate of absenteeism is nearing record levels. It is already estimated that this shutdown will peal as much as a point off GDP growth, but we may never know for sure as the part of the government that collects that data is also shut down.
IMF Downgrade as Davos Begins
The meeting of the World Economic Forum in Davos, Switzerland, has been characterized any number of ways over the years. To the conspiracy minded it is a cabal of global leaders and business people plotting how they plan to take over the world with black helicopters and mind control gas. To the left it is a capitalist orgy of exploitation bent on finding new ways to destroy the working man. To most of those who attend it is a chance to network and get various issues on the table while enjoying the finer things at a five-star resort. There is always a crisis du jour, and there are always those nations that are in deeper chaos than others. This time the atmosphere seems unusually tense, and that is in part due to the those that are missing. The U.S. has no real delegation here as the government shutdown has paralyzed the process, and there are European leaders missing as they have their own crisis situations to cope with.
Analysis: As a starting point for the meetings, the IMF releases its assessment of the global economy for the coming year and this version is not very encouraging. There is a sense that several factors will combine to make 2019 a lot less robust than 2018, and the IMF has been quick to point out that many of these are self-inflicted wounds. The downgrade from 3.7% to 3.5% is certainly not sending the global economy into recession, but the IMF has been concerned because the majority of these issues have been policy related. There is also a growing sense that too many governments are becoming actively anti-trade, and this doesn't bode well. The report from the IMF focuses on three major issues, and all are to some degree policy related. This is not like the downturn that gripped the economy in 2008-09 when it was economic factors and failures in the financial system that combined to send the world into a crisis.
At the top of the list has been the aggressive protectionism that has been pushed by many of the largest economies—the very same that were once considered champions of free and open trade. The tariff and trade barriers erected by the U.S. have been directed at friend and foe alike: China, Mexico, Canada, Europe and so on. There has not even been an attempt to hide the intent. The policies of the Trump administration have been directed at protecting certain sectors of the U.S. economy, but many of these plans have failed to achieve the intended outcome because the U.S. is a nation thoroughly engaged in global trade. The moves to protect steel makers were supposed to protect jobs and encourage expansion, but instead thousands of manufacturers were put at risk by higher prices and they responded with less hiring and layoffs.
The second major issue has been the fights that have gripped the U.S. and U.K., and to a lesser extent, other nations. The government shutdown in the U.S. is only the latest example of political dysfunction in the U.S. as the battles deteriorate into personal vendettas and nothing of substance is done for the country as a whole. The British and Europeans are mired in Brexit and can't seem to avoid an outcome that will cripple the British economy. Populist governments in Poland, Italy, Hungary and elsewhere set these nations back as well.
Issue number three is the sharp decline in Europe and many of the emerging markets. The reason for the declines vary, but political wrangling has been a factor in Europe while economic issues dominate in other situations. The fall in the price of oil hurt those nations that depend on that source of income, and there are also worries about how the trade war between the big states like China and the U.S. will affect them. Slower growth in China will pull down growth all over Asia as these states rely on the Chinese market. The Latin states are not getting as much from the U.S. as has been the case in the past.
New Nafta Deal in Trouble in Congress
The creation of the USMCA was supposed to be an accomplishment for the Trump team, but it is now starting to fray as it faces deep opposition from Democrats in Congress. This opposition is anything but a shock given the mood of politics in the U.S. at the moment. The creation of this alternative to NAFTA was done with almost no consultation with Congressional Democrats, and now that is a major problem. There are those within the opposition who want more extensive regulation on labor and the environment and do not want a pact that doesn't improve that situation in Mexico. Others are upset with the fact that steel and aluminum tariffs have not yet been lifted against Mexico and Canada.
Analysis: The bottom line is that Democrats and Trump Republicans are at war, and there is no desire to give even an inch on issues like this one. The only hope for passing this kind of trade pact comes from the remote possibility that moderates emerge.
I have to admit it—I have become a weather coward over the last few years. I revel in the fact that I do most of my work at home and when there is a nasty storm brewing, I can just hunker down and let it pass without having to brave it. This strategy only works when I am not traveling, and this week, I fear that my luck is about to run out. I am in Appleton, Wisconsin, this morning and have a presentation that will take me to about noon. That is when a major storm is due to arrive, and that is when I am scheduled to drive back to Milwaukee so that I can do a presentation on Wednesday.
At this point I supposedly miss the brunt of the mess as it is expected to get worse later in the day, but I am in a little Toyota Corolla and not my own trusty SUV. Yuck. I have reached that point where I trust my fellow drivers not at all. I have observed their inability to drive when weather is good and can hardly wait to see what joys wait me on that 100-mile trek. I am sure all will be well, but I am eagerly awaiting the opportunity to dump the car at the airport and count on Uber to get me around the city for the remainder of my stay. The next fun part will be worrying about the flight home on Wednesday, but I will save that crisis for later.
Trade War Impact
The IMF has been very clear regarding its projection for the global economy if the various trade wars continue to be fought – especially between the US and China. The impact on these nations will be negative regardless of the rhetoric and promises of the politicians that have been advocating a tough line. There is no doubt that China often plays fast and loose with trade norms and laws and the IMF has been urging change in China for a long time. The issue is whether the Chinese can be bludgeoned into cooperation and past history has shown that this tactic is never successful.