Strategic Global Intelligence Brief for January 27, 2020
By Chris Kuehl, Ph.D., NACM Economist—
Short Items of Interest—U.S. Economy—
Can Fed Develop an Old Tactic for Today?
One of the concerns expressed by many within the Federal Reserve is it lacks enough ammunition in the event of another recession threat. The traditional tool was to lower rates to stimulate borrowing, but with rates as low as they are now, there is not much the Fed can do to jump start business activity. This has the Fed looking at other tactics and techniques—including one that was employed in the late 1940s and early 1950s and has been used fairly recently in Japan. It involves capping yields on Treasury bonds—starting with the short-term bonds and possibly expanding to include the long-term bonds. This is not an imminent move—it is a matter of the Fed looking at the experience in Japan and the U.S. in the 1950s to determine if that would really provide a stimulus.
Business Activity Gains Momentum
The latest iteration of the Purchasing Managers' Index (PMI) from Markit shows there has been a rebound as far as U.S. business activity is concerned. This is their "flash" version of the PMI. It may differ from the final version, but for now the news is most welcome. The reading for the U.S. is now 53.1, although the manufacturing sector fell a little from 52.4 to 51.7. The growth that has taken place has been in the service sector. Generally speaking, the Markit version of the PMI has been a little healthier than the one from the Institute for Supply Management (ISM). The ISM version has been below the 50 line for the last five months. The expectation is it may be weaker again at the next release date.
Financial Stress Reduced
There has been some controversy with the Fed's policy of injecting vast sums of money into the overnight market in the last few months, but the end result has certainly been encouraging. The measure of financial stress the Fed uses has fallen to the lowest level on record—back to the start of the system in 1993. It now sits at negative 1.3. This suggests all that money has taken a lot of the heat off the financial system, which was the plan the Fed had in mind.
Short Items of Interest—Global Economy
An Aggressive Turkey
In the last couple of years, the regime of Reccip Tayyip Erdogan has become increasingly embroiled in the affairs of nations throughout the region and has moved sharply away from its former NATO allies. There have been interventions in Libya and Syria and conflicts with the U.S. and Europe. There have been vicious attacks on Kurds and other ethnic groups Erdogan has targeted, while his autocratic approach has intensified. This has been taking place at the same time the economy has been stalling. This leads analysts to assert that all of his bellicosity is designed to distract the population from the failures in the economic realm. It has certainly altered the perception of the country in the region and the world.
U.K. Housing Market Surges
The Brexit mess has created a lot of concern in the U.K., but it has also led to some degree to lower mortgage rates as banks struggle to deal with the possible fallout. This has led to a housing boom as people rush to take advantage of the moment. Rates are low causing more people seeking to buy homes while the prices are low. These prices are expected to rise as the deal with Europe is finalized and millions of expats decide to return home.
Trade Deal will Not Get Mexico Out of Slump
The passage of the USMCA has been hailed by Mexican President Andrés Manuel López Obrador as the key to stimulating growth in the Mexican economy. To some degree he is correct, but analysts point out that the real issue is that he has made investment in Mexico far harder than it once was. Even with the trade deal with the U.S., there is very little enthusiasm as far foreign engagement. Without that, there is not much for Mexico to work with.
Why Does a Viral Outbreak Challenge the Markets?
The outbreak of the coronavirus has caused markets to stumble all over the world. There have even been reductions in the price of oil. There is no question this disease is dangerous as it has already killed at least 80 people and has sickened many more. The question is why this particular health issue has been able to disrupt the global economy so dramatically. Each year, there are around 646,000 deaths attributed to the flu worldwide, what makes this outbreak different and more of an economic issue?
Analysis: There are four elements that combine to make a viral outbreak into a threat to global economic activity. The first and perhaps the most important is the unknown factor. It is a new disease—at least new as far as its impact on people. It has existed for a very long time, but seemed to be limited to animals. Now, it has jumped to people. At this stage, it is not even known how it is transmitted for certain. It could be transmitted through the air or it may require physical touch of some kind. Nobody knows how virulent it is or how rapidly it could spread.
That leads to the second point. In order to exercise a maximum level of caution, there are few alternatives to using isolation and inspection. It is possible millions of people will need to be quarantined. There are already travel bans in place in China and there are inspections of flights coming out of China. At some point, there will be expanded inspection protocols if the disease spreads; millions will be impacted.
As people react to the threat and the counter measures, there will be decisions that affect economic activity. Plans to visit a given area will change and willingness to meet with people from certain regions will develop. There are many people who will be extremely cautious and will elect to stop traveling altogether. Some will have a good reason to do so as they may have compromised immune systems or they may be very old or very young. Many will just be fearful in general.
Finally, there will be the sheer cost of reacting and treating the disease. The money spent will swiftly add up and will likely run into the tens of millions of dollars as medical personnel are engaged as well as researchers and the entire health care infrastructure. The concern that lies behind all of this is that there could well be other viral outbreaks in the future as the world has already seen a wide variety of new and deadly diseases appearing in an age where global travel is very common. There are 800 million people flying somewhere in the world every year.
Trade Deal Between the U.K. and U.S.?
Since the start of the Brexit process, the British have offered the possibility of a new trade deal with the U.S. as a means of coping with the economic implications of separating from Europe. The Trump response has been somewhat enthusiastic, but there have been very few details. Now Treasury Secretary Steve Mnuchin is asserting such a deal could be completed by the end of the year—but there are still few details.
Analysis: The major impediment to a deal between the U.S. and U.K. is the two economies are very similar. Both are manufacturing and service economies. Most of the important trade partners for the U.S. sell commodities and cheaper manufactured goods—this is not what Britain sells. The U.S. will want to sell farm output to the U.K., but the British protect their agricultural sector. The British will want to sell their industrial output, but these goods will compete with the U.S. manufacturer more than goods from China and Mexico do now. This will not be a simple trade deal to pull together.
Depopulation and Populism
Some 20 or 30 years ago, the collapse of communism in East Europe was universally hailed as the start of a new era of democratic progress. The stultifying regimes were gone and it was assumed there would be a renaissance of sorts as the east and west rejoined one another in harmony with an emphasis on democracy and free market values. As is so often the case, things did not work out quite as planned. The past was not that easy to move on from and these nations were not able to catch up to their new western brothers as quickly as hoped. At the same time, Western Europe started to encounter their own crisis situations with Brexit, the collapse of the southern-tier economies and the slowdown of the European economic engines (Germany and France). Today, the nations of East Europe are anything but comfortable in their position. They are mostly led by populists and nationalists that are unimpressed with the patterns and norms of the western Europeans. Nowhere is this more obvious than in the population discussion.
Analysis: One of the most intense confrontations between the east and west has been over immigration. The decision by the German government to accommodate millions of refugees and migrants from the Middle East was motivated by a desire to do something about the Syrian civil war, but it was ill-conceived and Germany was soon overwhelmed. The expectation was that several hundred thousand Syrians would seek asylum in Germany, but millions came and they hailed from all over the Middle East, North Africa and South Asia. Germany demanded that other states join in the effort to cope with the influx. This was not something these states had any interest in whatsoever. They lacked the money and resources and there was considerable opposition to the cultural implications.
The leaders of these nations have been making the case that their population crisis is very real. There has been a sharp decline in the size of their populations as the birth rate has plummeted since the end of the communist regimes. There is considerably less support for families and economic conditions have been poor—that affects the decisions people make regarding the size of their family. In addition to the low birth rate, there has been considerable out migration as many people have elected to leave and seek a new life in the western regions of Europe. This creates a threatening combination of factors—declining domestic population plus new waves of immigrants from regions with radically different cultural norms. This has fueled the rise of nationalist and populist politicians that can play to these fears.
What Will Trip Up China?
Is this still the century of Pax Asiatica? It was only a few years ago that everybody seemed convinced the baton of world leadership was passing from the U.S. to China. The U.S. was wallowing in a recession that China seemed to have escaped and the role of the BRIC (Brazil, Russia, India, China) nations was seen as paramount. Today, that assertion is not rendered with the same confidence. China's growth is half of what it was just a few years ago and it is mired in a series of internal crisis situations—Hong Kong protests, virus outbreaks and environmental threats to name just a few. Has China's moment come and gone already?
Analysis: It is obviously far too early to assert that China is losing sway in the world. There are also plenty of reasons to worry about the ability of the U.S. to retain its own position of influence, but there seem to be two major issues that will drag China down in the years ahead unless it finds ways to cope.
The first and most obvious is the very nature of their system. Authoritarian rule has never been as stable as it looks. The imposition of an iron hand on society takes a great deal of energy and tends to generate frustrations and opposition. The months of protests and demonstrations in Hong Kong illustrate the limitations. The Chinese will either have to give in or crush the demonstrations, but they have already crippled one of the nation's most important economic drivers. There is widespread ferment in China and it costs a lot to keep it under control.
The second issue is more of a global one. The issue of climate change has become the defining one for the century. There is no doubt there has been as radical alteration in the world's environment and there is no doubt human activity has contributed to that impact. The Chinese economy has been the major factor as this has been a very fast-growing system that is highly dependent on coal. If China does not find a way to reduce that consumption, there is little that will change in the world as a whole. Dealing with climate change may be a global concern, but the two nations that will have to take the lead in finding ways to reduce the impact will be the U.S. and China. That will place a strain on both of these systems.
What to Look Forward to This Week
There is not a great deal of new data expected this week, but there will be some important releases nonetheless. The data should point to some trends at the very least. Tomorrow, there will be a report on durable goods. The expectation is there was some modest growth in December—around 0.2%. This will contrast with the 0.2% decline noted for November. The sense is manufacturing may be settling into a steadier pattern—not as fast as it has been in previous years, but at least the slide may have been halted for the time being.
Analysis: On Thursday, the Commerce Department will release the first estimate of fourth quarter GDP. It is expected to be in the 2.1% range again—about where it was in the third quarter. This is far better than the earlier estimates which assumed that growth would be below the 2% threshold. The challenge has been that business investment has continued to be slow while consumer spending has remained robust. In previous years, the consumer eventually fades if business doesn't keep expanding. When will that slow business activity start to affect consumer mood?
On Friday, the Commerce Department will release a slew of information that pertains to personal spending, income and inflation. This will be the data from the Personal Consumption Expenditure index, the preferred measure of inflation for the Fed. Thus far, the rate of inflation is lower than the Fed goal of 2%. That has been baffling to a degree as there should have been more reaction by this time.
Why Do People Sacrifice?
There are many reasons people choose to enter the service of others and many ways this can be accomplished. There are those who join the military or become police officers or firefighters. Others go into the medical profession or join the clergy. This is only a partial list of the jobs that can be taken that are focused on service. Many of them are dangerous and difficult. There are millions of other options as far as making a living and millions of us do for others in some way or another. What makes people willing to offer the ultimate sacrifice?
I have the distinct honor of speaking before a group of retired military officers each January. MOAA is a national group and the KC chapter has been inviting me for years. These are veterans from a wide variety of services, eras and postings. Not all saw combat, but many have. All were prepared to do their duty. Today, they are many things besides being vets. They were businesspeople, lawyers, doctors and they are now all grandparents as well as parents. Many are still active in their post military careers. What they have in common is belief in something bigger than themselves and something important enough to make a sacrifice for. We collectively owe them a lot—people just like ourselves who have been willing to do what it takes to preserve the way of life we enjoy.
We further owe the other people that sacrifice—the police and fire people, the doctors and nurses, the ministers and the social workers and the legions of volunteers in all aspects of our lives. We have the life we enjoy because of the efforts of millions of strangers. They have the life they lead because we too are serving in whatever capacity we can.
December Durable Goods Orders
The durable goods numbers have been improving for the last couple of years, but the pace of business investment has been slowing of late. This is not a crisis slowdown as yet, but it is unusual for the consumer side of durable goods to be playing this kind of dominant role for this length of time.