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Strategic Global Intelligence Brief for January 29, 2019

Short Items of Interest—U.S. Economy

Implications of a Cooler Housing Market
The housing market has not fallen into the deep freeze yet. There seems to be enough demand to keep that from happening. The market has indeed slowed; there is a lot less economic activity than was the case a year or so ago. The higher price of homes, the shaky stock market and periods of higher mortgage rates have managed to overcome the good news items such as unemployment and generally confident consumers. As the market cools, the biggest worry is that some of the mortgage lenders will start to falter and require bailouts of some kind or another. The Fed has been watching traditional banks closely, but the nonbank lenders have not been under the same scrutiny.

Economic Data Delays
For 35 days the government statisticians have been idle. That is going to compromise analysis for a while. Most of the big data releases have been delayed and some have been pushed back by months. The data on GDP, personal income, jobs and many other factors will not be available. That means analysts will be flying blind for a while. This seems an issue for the wonks, but nothing that should concern the average person. The problem is that policy is motivated by that data. Without it, there is a good chance that decisions are delayed longer than they need to be. The plan now is to catch up as quickly as possible, but that process will be thwarted if there is another shutdown when the three-week reprieve is expires.

Coal Production Slated to Tumble
Under the plans that Obama drew up to shift energy policy in the U.S., there was an expectation that coal production in the U.S. would fall by 18%. The latest assessment by the Energy Information Agency holds that coal output will fall by 21% over the next few years despite the fact Obama's plan has been scrapped. It is simply a matter of what utilities are choosing to invest in. The fuel of choice is natural gas, while coal is being phased out. This is partly due to pollution concerns, but it is also pure economics as gas has been price competitive. Many still hold out hope for expanding nuclear power as the transition between fossil fuel and renewable energy, but there remains intense opposition to the nuclear industry.

Short Items of Interest—Global Economy

Eurasian Economic Union Struggles
The creation of an organization that linked the new Russia with many of the states that once constituted the old USSR was supposed to "re-Sovietize" this area, but that is not how it has worked out. The members of the group have been very reluctant to adhere to Russian plans and have very little in common with one another other than their past. The jockeying for power seems to dominate all discussions. There has been little progress on trade deals or mutual investment. After four years, there is very little to point to as an accomplishment. Some members are already discussing withdrawal.

Kabila Still Controls the DRC
Despite the opposition of the Catholic Church and criticism from the majority of other African states, the regime of Joseph Kabila continues to hold sway in the Democratic Republic of the Congo (DRC). The independent observers have described the election as flawed at best and utterly corrupt at its worst. The hand-picked successor to Kabila, Felix Tshisekedi, is a flunky who will do exactly as he is told by Kabila and thus there will be no change. The opposition will soon turn to violence as has been the pattern for years. Then, the DRC will have yet another civil war to contend with.

French Consumers Worried About Jobs
The confidence level for the French consumer has fallen sharply over the last few months. The worry that seems to motivate this decline is fear of high unemployment.

Will China Give In?
As of now, the trade talks between the U.S. and China have resumed, but there has not been much confidence attached to the conversation as yet. The U.S. has now outlined the concessions it wants from China and the Chinese have started to indicate where they might have flexibility. The problem is these talks are as much about politics as they are about business and economics. Both President Trump and Xi Jinping get some mileage politically from the confrontation and have some incentive to keep the conflict going. Trump's supporters despise China on many levels as they essentially hold the Chinese responsible for all the ills of the U.S. manufacturing community. Xi's supporters see his stance as standing firm for China's role in the world—no longer subservient to the U.S. or any other nation in the western world. The economics of the confrontation are not as useful for either the U.S. or China as both are losing billions of dollars to the impact of tariffs and trade wars.

Analysis: At this point, the U.S. is focusing on three areas. Two of the three have evoked a reasonably positive reaction from China. The third has most definitely not been accepted. The first issue is protecting intellectual property. China has started to show some willingness to enforce some of the protections that had been built into the system but generally ignored. The second is buying more from the U.S. China has indeed stepped up its import of U.S. goods while hinting that far more would be imported if the tariff wars were to stop. The third demand from the U.S. is referred to as "structural change." It is as broad as it sounds. The U.S. wants the Chinese to end or reduce the system of subsidies, protections and government assistance provided to Chinese companies that engage in export or compete with the U.S. This is a very complex and challenging request as every nation—including the U.S.—engages in this kind of business protection.

The issue is a matter of degree. China subsidizes whole industries with millions of dollars—the steel sector as an example. Money to set up a steel operation is provided by the government. Then, the output is purchased by the government. When too much steel accumulates, the government sells that steel at a steep discount in the global market and prices the rest of the world producers out. Other steel producing nations engage in protective measures as well. The Japanese back their steel operations with subsidies and cheap loans. Brazil has state-owned steel operations. Even the U.S. has government assistance to help pay for steel pensions and assisted steel development with loans and other incentives. Of course, the tariffs on imported steel constitute direct assistance to the steel sector, but many assert this is only a reaction to other nations and their protections. The point is every nation takes steps to promote and protect its industrial and business communities. The difference between the U.S. and China is a matter of degree, which makes the negotiations tough. What should the U.S. be demanding of China given that ending all support is unrealistic?

The economic data released this year indicates the Chinese are suffering more of an economic reversal than the U.S. at this point. Growth is not expected to be above 6.2%. For China, that is tantamount to recession. The U.S. and the European nations are said to be facing recessionary conditions when growth is between zero percent and 1%, but China faces these issues when growth falls under 6% due to the fact the country is still a developing nation in most respects. Recession basically means the economy is not growing fast enough to provide jobs. The U.S. has to grow fast enough to generate around 200,000 jobs a month, but China needs to generate around 1.3 million jobs a month. In recent months, the Chinese have been curtailing a variety of foreign investments so as to keep that money active in the domestic economy. They have been reducing their investments in the U.S. and have pulled back on a wide variety of projects in Africa, Asia and Latin America.

Certain sectors of the U.S. economy have been affected, but the pace of growth in the U.S. has continued to be robust—if a bit slower than it was in 2018. The farm sector has felt the decline the most as China has been imposing tariffs on imported soybeans and other farm products. The fact the U.S. doesn't sell all that much to China is now coming in handy as there is not a lot of damage the Chinese can inflict.

The Economic Cost of Political Wrangles
The U.S. and the U.K. have been locked in bitter political disputes. If one looks around the world, it is clear they are hardly the only nations to cope with these partisan wars. The Swedes have been without a government for nearly six months due to an election that failed to deliver a clear majority. Brazil is mired in corruption accusations affecting almost every major politician in the country. France is fighting over Macron's labor reform efforts. Germany is dealing with the end of the Merkel era and so on. There is nothing unusual about the intersection of economics and politics, but of late, there have been many attempts to quantify just what that impact might be.

Analysis: The Congressional Budget Office has tallied up the costs of the government shutdown that gripped the U.S. for over a month, and it is significant. The economy lost about $3 billion in the last quarter of 2018 and $8 billion in the first quarter of this year. This meant the loss of roughly 0.2% of the first quarter GDP. Around $8 billion of that loss will likely be recovered as government workers receive their back pay, but the majority of the over 22,000 companies that do business with the federal government will not be able to recover what they lost. This means that the shutdown cost the economy at least $3 billion. The rebound may prove to be more anemic than expected as there is a good chance the shutdown will resume in three weeks if Congress is unable to reach an agreement on border security. The government workers that are getting paid again will not be spending much until they know they will continue to have regular checks.

Meanwhile, the British are tallying the costs and projected costs of the Brexit mess. It has been estimated that the decision has already reduced the British GDP number by half and has cost in the tens of billions of pounds. The currency has been weakened by the dispute, which means higher priced imports as well. If there is a hard exit with no agreement, the cost to the British economy will be enough to send the country into a recession. French protests and riots against the Macron reforms have cost the economy at least .03% of it Q1 GDP growth. There has also been a slowdown in Sweden as the country struggles to create a workable government.

The fact is that emotions run high when these political issues are at stake. For those who support the border wall, there is nothing more important. Any economic pain is worth it. Those who have a strong opinion on Brexit will not change their opinion because there is economic damage. On the other hand, these same people are very likely to suffer the most from these economic reversals as there will be companies compelled to lay people off or shut down altogether. Government services that people count on will be curtailed—everything from airport security to farm subsidies to tax refunds.

It is not possible to separate the politic from the economic. One influences the other constantly. The challenge is that economic impact is felt by the majority, while the political issues are generally motivating a minority. The majority has a hard time putting their priorities first as the minority is always highly motivated and become more potent political actors.

What Breaks the Stand-Off in Venezuela?
Thus far, the military is standing with Nicolas Maduro in the confrontation over who is the legitimate leader of the country, but that support is based on two important factors. The first is whether they would be held culpable for crimes in the event that Maduro is deposed and Juan Guaido is named leader. The many violations that took place under Maduro were executed by the military and the secret police. They do not want to face prison or worse. The second issue is whether they will continue to be paid. The Maduro regime is very close to being absolutely broke. It seems only a matter of time before it loses the ability to pay. Guaido has been making it clear that amnesty will be granted to those who break with Maduro now, but there will be no such guarantees for those who wait. He has also sought to ensure that money will flow when he takes formal control, but he has only received vague assurances from the U.S. and other nations.

Analysis: The financial sanctions have been stepped up and are as draconian as they can be. The country has seen nearly all of its assets seized and has been utterly cut off from the global financial community. The only support it can get is coming from three nations that have little spare cash of their own. Cuba is broke, Russia has curtailed its engagement so that it can focus on its activity in the Middle East and now China has been pulling its money back home to shore up its ailing economy. Maduro is rapidly running out of options. If the military elects to abandon him, he will have to flee.

Cold Weather and the Economy
It has been a while since the U.S. has had to contend with the Polar Vortex. This has always sounded like a good name for a new Star Wars episode, but it is really no joking matter as it will have profound economic implications. As the bitter and dangerous cold descends on the U.S. and Canada, it will compromise business as people will not be able to get to work and there will be many machine failures and breakdowns. There will be more injuries and more health issues. In the past, these brutal cold outbreaks have cost as much as a hurricane or massive flood.

Analysis: There is a silver lining to all of this winter's cold and misery. In past years, a very hard and long winter has presaged a very active spring as far as consumption is concerned. It seems that people attempt to address their cabin fever by buying things as soon as the weather improves. There will be large purchases of lawn and garden gear and more purchases of warm weather clothing as people jam those winter coats back into the rear of the closet. There will likely be more people traveling as well. Some of this has been taking place already as people try to escape the winter by heading south to someplace warmer than it is at home. That pattern will last until the summer arrives and people start complaining about the heat and wishing for a nice cool day to break the humidity.

Traveling from One Climate to Another
The last few weeks have been interesting as far as going from one climate to another. In the course of a few days, I went from Milwaukee and 10 inches of snow to the 65-degree weather of Dallas. I get these contrasts pretty regularly. It is always interesting to get the local population's reaction. Mentioning a snowfall of 10 inches to someone in San Antonio will evoke a shudder and a vow never to travel further north than the Oklahoma border. To someone in Buffalo, this isn't even worth mentioning as any snow less than a foot is considered nothing more than a flurry.

The shoe is often on the other foot come the summer and the arrival of brutal heat and humidity. It is not as if the northern states don't get a taste of that hot weather, but it doesn't show up in April and last until November. In the great scheme of things, I handle cold better than heat, but have noticed that my tolerance for either extreme is not what it once was. I wallow in the joys of central heating and air conditioning. There are members of my family who earn my undying respect for their tolerance. My grandson, the large animal vet, is the real yeoman given the conditions he must endure as he ministers to the livestock.

This is the time of year that I worry about furry friends who can't escape the cold. I know many of those abandoned and feral cats and dogs will not make it through the next few weeks. It breaks my heart. I also worry about the animals that people fail to take care of. I am filled with utter contempt for those who would expose these animals to this killing cold.

Democrats and Republicans Unwilling to Compromise
It has been obvious that the border wall issue is politically volatile. It is essentially a litmus test for both sides. The majority of both Republicans and Democrats are in agreement on one aspect of the debacle—there is no room for compromise. The reaction by Trump supporters was telling as he came under virulent criticism for "caving" to the Democrats. He is not leading this effort—he is being led by those who constitute his base. The same holds for the Democrats. If Pelosi and Schumer give in to the wall demands, they will be likewise vilified. Even the independent voter is unwilling to give ground. This would seem to suggest that another shutdown in three weeks is very likely.


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