Strategic Global Intelligence Brief for January 30, 2019

Short Items of Interest—U.S. Economy

Fed Advocates Patience
The problem is that few seem to know what that really means. There are now reasons to both raise rates and to leave them where they are, or even lower them again. After several years of non-existent inflation, there are some solid signs that it has been developing. Wage rates are starting to come up and there have been hikes in commodity prices (especially metal). At the same time, there are signs that economic slowdown has arrived with a struggling housing market and slower expansion by business. The economy has not exactly slumped, but it could. That is enough for some to call for even lower rates. The word from Fed Chair Powell is as it almost always is when the Fed speaks. They will wait to see what the data says and will react appropriately.

Consumer Confidence Dips
For the third month in a row, the consumer confidence survey from the Conference Board has dipped. The same pattern has been noted with the survey from the University of Michigan. The motivation for this decline is not hard to determine as the respondents note concerns about the performance of the stock market and the impact of the government shutdown. In general, there is a sense nobody in government is looking at the economy anymore and they have become preoccupied with power struggles and personal animosity. This has made consumers nervous. Most expect the year to perform worse than last year.

Intelligence Community Rejects Trump's Assertions
Granted, the job of the president is in part to be a cheerleader for the nation and to put the best face on events to maintain confidence levels, but generally the statements avoid specificity. The nation's intelligence chiefs reported to Congress this week and universally disagreed with President Trump on issues such as North Korea, ISIS, Iran and Russia. The assertion that Kim Jong-un will give up his nuclear capabilities was rejected, the notion that ISIS had been defeated was criticized and Russia was held to be a far bigger threat than any other nation. Iran was seen as a threat as well, but the intelligence community also asserts there are reform elements there that can be developed. They universally rejected the assertion of a border crisis that would require an emergency response.

Short Items of Interest—Global Economy

British Businesses Losing Patience
Nobody seems to have a clue what the outcome of the Brexit talks will be, making the business community both nervous and angry. The wrangling in Parliament has deteriorated into personal attacks and ideological debates. Meanwhile, decisions have to be made by business. Most are now assuming the worst. They have been making plans to shift operations out of the U.K., lay people off and generally abandon their operations in favor of more secure locales. All are expecting weaker quarters with lost revenue and lower profits.

Eurozone Business Sentiment Sags
The latest assessment of the business climate in the eurozone is as low as it has been in the last two years. The analysis shows that business is worried about the current situation, but also worried about the future. That can be a deadly combination. It becomes a self-fulfilling prophecy as companies start to pull back on investment, hiring and expansion. That snowballs and soon other companies that are related have no choice but to pull back as well.

Saudi Arabia Hopes Money Still Talks
As the country tries to move past the scandal of Jamal Khashoggi's murder, Crown Prince Mohammed bin Salman has announced a massive $427 billion industrial development effort that he hopes will bring investors back to the country despite the killing. He is probably right as there are signs that most nations are eagerly looking for ways to engage with these projects. He has basically swept the issue under the rug and is not now facing anything other than a dent in his reputation as a reformer.

Can Trade Separate from Huawei Situation?
It depends on who one asks. To Secretary of Treasury Steve Mnuchin the two issues can be easily separated, but the Chinese have not shared this assessment. The indictment of a high-level executive from China's second-largest telecom company, Huawei, has stirred intense nationalism and anger among the Chinese. This may be more than the leadership wants to take on right now. On the other hand, Chinese Premier Liu He has not canceled the trade meeting with Trump's team scheduled next week, which would have been a common response only a few years ago. Both countries have reason to work out a deal, but both nations need to work out something that appears to be a victory in some sense or another.

Analysis: Huawei is accused by the U.S. Justice Department of stealing U.S. technology and violating the sanctions policy the U.S. has established to put pressure on Iran. The officials at Huawei have not really asserted they did not commit these violations as much as they assert that many others have done the same. They maintain that European businesses are deliberately flouting the sanctions against Iran to protest the U.S. decision to pull out of the nuclear deal. It has also been pointed out that Japan has stolen in the same way and was never attacked in this manner. China sees this as part and parcel of a very pointed assault on China itself.

The trade fight has reached an impasse of sorts as both nations have been feeling the impact. It is arguable that China has gotten the worst of it as the economy has slowed while exports have declined. Just how much the slowdown has affected the economy will be better understood Jan 31 when the Chinese version of the Purchasing Managers' Index comes out. It is expected to show a marked slowdown; one that stems from the export decline. The Chinese government has been pulling back on foreign investment around the world so this money stays in the country. There is evidence that China's ambitious plans for influence in Africa and Latin America have been stalled. The Maduro regime in Venezuela was getting a significant amount of help from China. That has now all but vanished. The decision may be simply that Maduro's days are numbered, but China doesn't have the money to throw around as it once did.

The impact on the U.S. has been muted, but that may not be the case much longer. The consumer is starting to face a wide variety of higher prices that stem from a variety of factors. Wages are finally starting to go up as the jobless rate has been low for over a year. There are higher prices in the housing sector and the various tariffs and trade barriers are adding to the cost of everything from cars to appliances and airplanes. Not that people buy a lot of airplanes, but the airlines do and they will be upping their fares sooner than later. If the costs of simple consumer goods begin to rise, the impact will be felt quickly. Access to cheaper goods from overseas suppliers generally saves the U.S. consumer between $5,000 and $8,000 per year. Add this to the impact of the slowdown and the general perception is that government is stuck in gridlock and the consumer could fade fast.

Most assert the trade talks between China and the U.S. will have to reach some kind of deal at this meeting or it could be months before another opportunity would present itself.

The U.S. and the World Bank
The more formal and descriptive name of the World Bank is the International Bank for Reconstruction and Development. It is one of the three "Bretton Woods Sisters" created at the end of World War II to both repair the damage from the war and guide the development of the global economy. Its mandate was to provide development loans to nations that were just emerging from colonialism. The International Monetary Fund (IMF) was mostly engaged in rebuilding Europe while the General Agreement on Tariffs and Trades was created to reduce trade barriers between nations. It later morphed into the World Trade Organization. The World Bank has been controversial over the years for a variety of reasons—mostly that it focused on huge development projects like dams and roads. These may not have been the most useful for the nations involved. On the other hand, that kind of project is great for western companies that do the engineering and provide the equipment.

Analysis: The tradition is that an American heads up the World Bank and a European heads up the IMF, but the U.S. choice at this stage is a man who has expressed doubt as to the need for the World Bank. That may trigger the other members to reject the U.S. choice and put forward a candidate who comes from the developing world rather than deal with a leader who seems to want to destroy the bank.

Is There Such a Thing as Free or Fair Trade?
The U.S. was once considered a champion of free trade and is now attacked by many as a protectionist nation. There are Republicans who deeply oppose the trade and tariff policies promulgated and those that celebrate the effort as long overdue. The same split occurs in the Democratic Party where trade policy is one of those things that cut across traditional political lines. What exactly is meant by free trade or fair trade? Not surprisingly, there are dozens of answers; very few can even agree on the basic idea. If one consults the textbooks, the issue of trade is neatly divided into two motivations, but this is rarely the way the real world handles it. There is trade based on "absolute advantage." This takes place when a given nation is the only place where a certain product or commodity is found. They can then trade that unique thing for other materials. The notion of "comparative advantage" is more complex and involves determining what a given nation does best. The U.S. could produce bananas in Florida and Hawaii and free itself of the banana import tyranny, but it is not worth it. The U.S.-grown fruit would be very, very expensive. It is simply more logical to buy it from Honduras or Ecuador. By the same token, the Hondurans could devote a huge amount of their GDP to building a commercial airliner, but it is simpler to trade bananas to the U.S. and elsewhere and use that money to buy planes.

Analysis: These simple constructs fall apart quickly. To begin with, there is not a single nation that has a true absolute advantage as there are always others that possess these rare items. Anything that can be manufactured can be produced anywhere there is a desire to do so. It is true that not every nation has gold or oil or rare earth minerals, but no nation has a lock on them either. It is also true that not every nation is capable of launching rockets to the moon, but there are several that can. The comparative theory would hold that developed nations would concentrate exclusively on the high-value and high-level outputs while leaving low-value production to others as well as most of the food production, but that is not what happens.

The impetus for most protectionism is a desire to insulate a segment of the population from competition. If a decision is made to import clothing from a nation that has far lower production costs, the average consumer will benefit from those lower prices, but the people that worked in one's own country making those clothes will lose their jobs. The political leaders have a natural desire to protect their constituents to some degree, although they have to balance that desire with the equally important desire to make their consumer/constituents happy. The push to protect becomes even stronger when the item has national importance—steel making for example. Every nation is to some degree protectionist as they are all trying to make their own nation stronger and their own population richer. There is inherent conflict when there is trade—just as there is when there is purely domestic competition. People lose their jobs to a competitor that does a better job and attracts more consumers. Few would suggest having just one restaurant in town so that their cooks and waiters would have a protected job.

For decades, it has been a goal of policy makers to bring order to the chaos of trade. This is why there have been numerous sets of rules and regulations designed to "level the playing field." Unfortunately, these can only go so far because countries are very different in terms of their assets. China can produce many products more cheaply than the U.S. simply due to the fact that Chinese workers are not paid as much as Americans (or Europeans or Japanese, etc.). The cost of living is also far lower in China (and other nations like them). The issue is when China does even more to give itself an advantage—giving subsidies to some sectors, stealing technology from rivals, banning imports that compete and so on. The Chinese are certainly not the only nation that does these things. That is why so many organizations dedicate themselves to halting the more blatant manipulations.

To make matters that much more interesting is the fact that not all trade deals are about economic issues or trade. The U.S. granted access to its market for years as part of its Cold War strategy against the USSR. A nation that agreed to support the U.S. position against the Soviet Union would be granted access regardless of what that might do to a U.S. company that competed with these imports. The end of the Cold War ended some of these deals, but other political motivations remain—fighting terrorism or taking a stand against some other unpopular regime.

Today, the mantra is "America First" and trade deals are anathema. If only it was that simple. The question now is which America is first—the manufacturer/producer that is getting protected from foreign competition or the U.S. consumer who will be paying higher prices for everything, now that imports are restricted. The worker is pitted against the consumer, but in fact the average person is both and needs attention paid to both sides of their lives.

Upcoming Labor Report
The Labor Department releases its latest assessment on Feb. 1. The expectation is that another 163,000 jobs will have been added and that the unemployment rate will remain at 3.9%. The big question will be where the hiring is taking place. Last month, the manufacturers led the way. There was abundant evidence they were hiring less than qualified people with the assumption they can be trained soon enough to be of use.

Analysis: The mantra of the employer now seems to be "hire attitude rather than aptitude." The people who ostensibly have the skills are apparently flawed and unwanted by employers so the search is on for those who are willing to work and willing to train so that they can become productive at some juncture.

Traveling from One Climate to Another
As I am of a certain age, I can point out that when I was a kid, we knew cold. It was often below zero in June. We regularly walked 30 miles to our one-room school house in a blinding blizzard—uphill both ways. We didn't wimp out just because we would get frostbite the minute we stepped outside. No sir! We laughed at the cold and did what we needed to do. Fetch water from the well and shovel the path to the privy. OK, so I really lived in a nice little suburb and the school bus was already warm by the time it picked me up!

It is interesting what people choose to do with these events. Not that I am dismissing the life-altering aspects of a bitter cold outbreak, but there always seem to be people on the edge of panic despite their warm homes and myriad protections. My concern right now is for my grandson—the large animal vet. He is out in this all day and has no choice. The animals he is working with are out there, so he has to be where they are.

I have heard the inevitable remarks about "global warming." There are the smug comments that suggest a few days of cold weather negates decades of research on climate change. In fact, this polar vortex experience is attributable to climate change. The polar vortex generally stays at the pole, but the loss of ice there has caused it to split and migrate and it has dipped south. It will not be the last time and the future will see far more of these events.

Growth of Technology in the Developing World

One of the crucial functions of the World Bank is providing data and research on a variety of topics that affect the developing world. These are often the only studies that are conducted on nations that have been referred to as the emerging market. The chart shows the exponential growth of technology in the developing world in just the last few years—everything from the internet to mobile phones, mobile banking and the like. It is apparent that there is a technology leap taking place in many parts of the world. That has many implications for expansion of business into and out of these regions.