Strategic Global Intelligence Brief for July 11, 2018
Short Items of Interest—U.S. Economy
What Ends the Trade War?
At this moment, it would appear that China and the U.S. are preparing to get locked in a death match regardless of what analysts warn. There has been an intense round of accusations and bombastic threats. It would seem that backing down is not in the cards. At some point, both China and the U.S. will be facing serious economic consequences from this trade war. It will be in their best interests to find a way out. This will likely hit the U.S. first in the form of much higher inflation given that inflationary trends are already showing up. The pressure will be significant by as early as Q1 or Q2 of 2019.
Near Universal Support from Fed for Rate Hikes
It was not that long ago that one could divide the members of the Fed's Board by whether they were hawks or doves. The hawks like Jeff Lacker, Tom Hoenig and Charles Plosser (among others) were uncomfortable with the extended period of record low interest rates and wanted to push them back up. They were opposed by the doves like Charles Evans, Eric Rosengren and Janet Yellen. Today, one would be hard pressed to find a bona fide dove as all of the members are supporting higher interest rates—the only conversation is over how high they should go and how quickly.
Warehouse Crisis Deepens
Remember the way that J.I.T (just-in-time production) was going to completely change the world as we know it? There would be no need for warehousing anymore as the products would always be scheduled to arrive just as they were needed. So much for that prediction! The shortage of warehouse space has not been this acute in over 35 years. The fact is that people have delicate supply chains and worry about disruptions—especially now with trade wars breaking out every five minutes. The majority of companies are trying to have the surplus they might need regardless of what triggers the shortage on the production side.
Short Items of Interest—Global Economy
Escalating Trade War Sends Markets Plummeting
It is not a full-on collapse to be sure, but the markets are no longer being patient. The planned tariffs against China and Europe and other U.S. trading partners are getting close to the bone and will have an impact on every global economy. There will be shortages and there will be higher prices paid—often much higher. The global economy is also losing some of its resiliency due to the trade inhibitions. The pain has been minor thus far, but those days are soon to end and everybody will feel the impact.
Remaking Horn of Africa
The news from this part of the world has been unrelenting in its reports. There has been little but war, famine and strife. Suddenly, there's a ray of hope from a most unlikely source. The new leader of Ethiopia, Abiy Ahmed, was not an opposition leader nor did he overthrow the old regime. He was selected by the ruling party and has their support. He has moved very fast to change the patterns that rip this region to shreds. Now, he has basically ended the war with Eritrea single handedly by giving up the contested territory and signing a peace deal. Ahmed has also inserted himself into the Sudan issue as he tries to get these leaders to the negotiating table. He is a reformer and a very busy one.
Canada Lifts Rates to 1.5%
The Bank of Canada (BoC) has pushed rates up in response to a stronger economy and the emerging threat of real inflation. The worry is that there are enough issues facing Canada in the next few months that caution might be the watchword. If the U.S. blows up NAFTA or elects to punish Canada further, it will slow that economic progress and the BoC may be tempted to lower rates again. The problem is this may not be enough stimulation.
What Is NATO for Anyway?
The North Atlantic Treaty Organization (NATO) was founded 69 years ago—1949. That date should provide some clues as to what the organization was all about from the very start. It was one of many reactions to the Second World War and the environment that existed with that war's end. Part of NATO was designed to keep the European states from visiting yet another global conflict on the planet as had happened with World War I and II. At the same time that NATO was constructed, there was the start of what was to become the European Union—called the European Coal and Steel Community (ECSC). The stated motivation for the ECSC was to ensure that no nation in Europe would be able to start building its military prowess without the others noticing. It was specifically pointed at Germany and France on the assumption these two would be likely to go after one another if given half a chance.
Then there was the looming threat of the Soviet Union and the assumption that it planned to continue the march of communism across the whole of Europe if it were not stopped. Remember that the USSR had turned Poland, Czechoslovakia, Hungary, Romania and Bulgaria into vassal states and had actually absorbed states like Estonia, Latvia and Lithuania. In addition, Finland and Austria lived on borrowed time. Greece narrowly escaped being another of those vassal states, while Yugoslavia remained out of the Soviet orbit, but was a communist dictatorship under Josip Broz Tito. NATO became the bulwark between the USSR and the western world. It was assumed for decades there would someday be a hot war between the Soviets and the Americans fought on the land of the European allies. NATO truly developed as a military alliance during the Korean War as there were significant numbers of troops from member nations playing a major role in that conflict—almost a quarter of the casualties were from NATO nations.
Analysis: In 1987, the mission of NATO changed as the USSR ceased to exist. This is not to say that Russia was not a threat as it has continued to advance its goals by whatever means are deemed necessary, but it has been distracted from an attack on Europe by the desire to bring the old empire back together. Thus, the intervention in Georgia, Ukraine and in the Central Asian Republics occurred. The three Baltic states quickly joined NATO as a means to protect against Russian threats. But the core mission had started to change even before the end of the Cold War. NATO members started to look at deeper threats to their security such as terrorism and insurgencies in parts of the world that held significance to member states. This is largely what led NATO to back the U.S. in Iraq war I and II as well as in Afghanistan. The NATO mandate has extended to anti-piracy efforts off the coast of Somalia and in the Mediterranean. There have also been efforts in Libya and Syria at various moments. The nations that have contributed the most to these efforts include Great Britain, France, Italy, Turkey and Poland. Germany has been active as far as monetary contributions, but it still has a constitution that prohibits German troops from participating in any combat activity outside Germany.
Even smaller states have played a major role as either part of NATO or as UN Peacekeepers. Check out a movie called The Siege of Jadotville—the very accurate account of a group of Irish troops in the Belgian Congo during the violence that surrounded the assassination of Patrice Lumumba. The point of this very brief history is to point out that NATO has functioned as a very close ally to the U.S. for nearly 70 years. Member states have sacrificed lives in operations that were American in origin and were part of the U.S. strategy as NATO members are committed to each other's mutual defense. While it is true the U.S. spends a great deal more money on NATO than other nations, the U.S. percentage of spending is less than many. Smaller nations will not spend as much as the U.S., but as a percentage of their total budget, they are more engaged than the U.S.
It baffles most analysts that President Trump has taken such a negative position on NATO as his assertions are simply not credible or accurate. It is perfectly within the rights of the U.S. to want to spend less on NATO. Few would really object to such a decision given that nearly every nation in Europe has had to face budget constraints. The objection is to the insinuation they are not shouldering their share of that burden. The thousands of soldiers who have been killed in support of U.S. objectives over the last seven decades leave countrymen behind that would beg to differ with Trump's assertion. Furthermore, several of these states spend more on defense as a percentage of their national budget than does China or even Russia.
Is there a place for NATO these days? As long as Russia has designs on countries like Estonia, Latvia, Lithuania and others it would seem so. As long as the U.S. wants to avoid dealing with the Middle East and the threats of terrorism alone, there seems to be a function for NATO. It seems a remote possibility now, but should there be another intra-European conflict, NATO would be there. Right now, it is NATO battling piracy and human smuggling of illegal migrants.
Attacking Germany—Again
There is certainly no love lost between Chancellor Angela Merkel and Donald Trump. We may never really understand the animosity that President Trump expresses against the Germans, but they have become accustomed to it. The latest blast takes the Germans to task for pushing a new gas pipeline to Russia and for not spending more on defense.
Analysis: The Germans have responded by pointing out the pipeline makes Russia more vulnerable than Germany. The Germans can always buy their gas elsewhere if they must, but once that pipeline is in place, the Russians can only use it to sell to the Germans. As for spending, the Germans keep pointing out their constitution prohibits much that a military would do. This is the constitution the U.S. imposed at the end of World War II.
Possible Outcomes as Regards Brexit
The universe of possibility when it comes to the Brexit deal has started to narrow a little bit. Analysts now assert there are five options that appear most likely to develop. These range from one extreme to the other. It would seem logical to assume that one of the middle ways would be preferred, but there is no guarantee that cooler heads will prevail as this has become a highly emotional debate with serious economic implications.
Analysis: There is the total failure option. It seems to revolve around what happens with Northern Ireland. This has been close to a solution before, but at the last minute, the two sides harden their stance and the issue remains. Either the U.K. or the EU will have to give way on this one or the whole process collapses. The British want all of Ireland treated as a single entity with common rules and regulations that apply to Ireland and Northern Ireland, but the EU wants specific rules for just Northern Ireland. That would mean a hard border between the two Irelands. The U.K. fears that such a hard border will provoke another round of separatism for the region. The EU fears that leaving the Irelands united in the EU gives the British a way to escape the penalties for deciding on Brexit in the first place.
The second scenario is a deal similar to what the Canadians have with Europe, but with perhaps a carve-out for transportation. This is a hard exit and one where the British are refusing to enter into a customs union. This is the harshest reaction from the EU and is definitely opposed by the business community in both the U.K. and EU. This scenario also puts pressure on the Irish border. The customs union is setting the British relationship with Europe back by several decades.
Scenario three is a customs union after the transition—one that protects the Northern Irish from isolation from Ireland. The U.K. withdraws from the EU, but Northern Ireland stays in. The British assure the EU that they will pull out completely once there is a way to create the hybrid system that can't be pulled together right now. The political issues get solved this way, but the business community is still left somewhat in the lurch.
The fourth option is for the EU to sign on with Prime Minister Theresa May's plan. This provides nearly unfettered goods access between the EU and the U.K. The option leaves much of the current business community untouched in both the U.K. and EU. There are even hints that there will be some mobility for EU citizens wanting access to the U.K. This has been rejected repeatedly by the Europeans, but as they see an even harder position emerging in the U.K., they may want to do a deal with May before there are no good options at all.
The fifth scenario is the Norway model where the British withdraw with some assurances of concessions to Northern Ireland. Once this has been negotiated, there is an immediate effort for work out a deal along the lines Norway enjoys—membership in some key areas but strict limits. This has worked for Norway as it has the oil that many in Europe covet. It is not certain, however, the U.K. has the same lure and attraction Norway has been able to exploit.
Brexit and U.K. Politics
The impasse that has marked the debate over Brexit in the U.K. has been creating one political crisis after another for Prime Minster Theresa May. The resignation of David Davis started another round of protest and bombast that threatens to further split the Conservative Party. Boris Johnson has been the most vocal critic of May and the Brexit process. He has resigned his post as foreign minister over the issue. His attack was as pointed as it has yet been and he has clearly set himself as her rival. She was selected to be the leader of the Tories since she was seen as something in the middle, but this has become such a polarizing issue that there is no room left for that middle stance.
Analysis: Johnson may not be ready to push her aside, but he is moving that way. It is not clear that he has the support yet within the Tory party, but if the EU insists on one of the options that leaves the Northern Irish situation in limbo, he will get more backing. He is not quite the British version of Trump, but he is certainly a populist in his rhetoric and policy. That means a Britain that is far more antagonistic towards Europe; one that would seek to do damage to the EU if at all possible. The EU has started to understand that losing May would not be in their best interests.
Getting to Know a Person
One of the most unexpected pleasures gleaned from writing this newsletter and this column in particular is the way it allows me to make friends with people I haven't met yet. I realize that I focus on lots of personal stuff in the column. I also have come to realize that this piece is the most often read of the whole publication. Still, I am always somewhat surprised when new acquaintances talk about my cats, my wife's singing and gardening and my harrowing travel stories. They know a lot about me. That certainly streamlines the "getting to know you" phase. I can just sit back and learn about them.
I suppose that is one draw as far as social media is concerned. I have learned a lot about people I thought I knew pretty well once they start sharing on Facebook or Instagram or through their tweets. Sometimes I wish I had not learned quite so much, but that also reminds me to realize we are all more than meets the eye. It all depends on what prompted an interaction in the first place. I know most people through my presentations. When they see the dirty, sweaty me on the weekend buying more mulch, they are somewhat taken aback. To the members of my wife's chorus, I am the guy married to the cute redhead singing soprano who takes tickets at the performance. To every cat that has ever needed a rescue, I am the chump that might be talked into it. As we interact with people and find reasons to disagree and even dislike those people, we have to remember there are other reasons that might persuade us to feel differently.
