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Strategic Global Intelligence Brief for July 15, 2019

Short Items of Interest—U.S. Economy

Jobless Rate Doesn't Tell Us All That Much
For many people, the rate of unemployment is the only measure they know or care much about. The bulk of the economic data that gets released seems pretty arcane, but everyone can relate to whether they have a job or can get one. The problem is unemployment data is not telling the story of the economy as accurately as it once did. The expectations that came with a very low rate have yet to be met—the Phillips Curve is not working. It has always been assumed that a low rate of joblessness would be followed by higher wages as business would be forced to pay more to attract applicants. That has not happened and wage growth has been stagnant. A big part of the issue is many of the new jobs are poorly paid jobs in the service sector. There have also been many companies hiring people with less than ideal qualifications. Thus, these people do not command those higher wages.

Radical Economics
This is the point in a political season that wild ideas begin to circulate, especially when there are many candidates striving to capture the attention of voters. The Democrats still have over two dozen possibilities and they are developing some very controversial plans. One of these is the notion of reparations to be paid to those who have been historically disadvantaged. Most of the attention has been focused on the legacy of slavery and the assertion that members of the black community should be compensated. The argument has swiftly spread to other groups with similar claims—Native Americans can make a strong case and so can the Hispanic population disenfranchised by the expansion of the U.S. Chinese immigrants brought to work the railroads, Irish fleeing famine, those facing religious persecution, Japanese whose ancestors were interned during WWII. It is hard to find any group that would not be able to assert they were disadvantaged at some point.

Retail Numbers Due
Tomorrow, the U.S. will get another look at the consumer as retail numbers will be released. The data last month was not spectacular, but it was respectable. The sense is this month may be weaker as the consumer has been expressing more trepidation about the future of the economy despite the continued good news on the employment front and the stock market performance. Later in the week, the University of Michigan releases its consumer confidence survey. Most assume it will be somewhat less robust than it was last month. This is usually a time when consumers are more active and bad readings will set off some alarm bells.

Short Items of Interest—Global Economy

Turkey Tries to Dodge Sanctions from the U.S.
The government in Turkey is reeling. President Erdogan has been watching his party lose key elections in the largest cities and his popularity is at a very low ebb. The attempt to diversify the country's relations may backfire badly as the U.S. has taken a very dim view of the decision to purchase a missile defense system from Russia. There is little love lost between Erdogan and Trump and the possibility of sanctions remain. Turkey has tried to reiterate its commitment to NATO, but this move doesn't help make that case.

Iranian Brinkmanship
The hardline clerics and the military are testing the waters in Iran and have elected to engage in a campaign of threats to force the U.S. and Europe to bargain. This tactic is already backfiring as the Iranians are now forcing Europe into a closer alliance with the U.S. A few months ago, the Europeans were trying to save the nuclear deal and find a way to cooperate with Iran, but that desire is eroding as Iran attacks their ships and other assets.

Hong Kong Leader Stays
Chief Executive of Hong Kong Carrie Lam offered to resign over the mass protests in the city, but China rejected the offer. She stays and for now, the Beijing authorities will back off.

Supply Chain Shifts
There remains a good deal of uncertainty regarding the trade relationship emerging between China and the U.S. There have been threats of tariffs and there have been actual tariffs. There have also been cases where tariffs have been lifted. Major attacks on companies such as Huawei have been followed by conciliatory gestures. It has been very hard to keep track of the policies put in place and even harder to determine what the U.S. actually wants from China. There have been very specific demands that China purchases more from the U.S., but nobody knows how much is enough. China has indeed stepped up its purchases, but the latest message from the U.S. suggests that there has not been enough. At other points, the Chinese have been confronted with demands that they cease appropriating technology and engaging in industrial espionage. There has been pressure to change their position on Taiwan and to cease support for North Korea, Venezuela and Syria (among others). The conflict between President Xi Jinping and Trump serves them both politically. That ensures the confrontation will continue. Meanwhile the business communities in both nations are reacting with the attitude that conditions will only get worse from this point. Even should Trump lose in 2020, the Democrats will not be in a position to reverse policy towards China without raising political ire—there are many in the Democratic Party that are as anti-China as some in the GOP.

Analysis: The most immediate and obvious reaction has been the shift in supply chains. It is important to recognize two points. The first is the U.S. only started to run these enormous deficits with the Chinese in the late 1990s. That deficit exploded in the decades to follow, but it is vital to understand that the U.S. had a major trade deficit long before the emergence of China as the "manufacturer for the world." Prior to the late 90s, the U.S. ran a deficit with dozens of nations willing and able to provide the cheaper consumer goods Americans wanted. One of the nations that supplied the U.S. was Japan, but their manufacturers shifted towards higher-value goods. Eventually, these companies relocated to the U.S. in order to be closer to their market. China essentially took market share away from all these nations. Today, these nations are more than eager to take that share back. Dozens of major and minor companies in the U.S. are moving away from China as a supplier and are establishing new supply chains in places like Vietnam, India, Mexico, Sri Lanka and others. These new supply chains are less efficient than those in China, but if the new business is consistent, that will change in time. The advantage that China had (and still has) is its infrastructure. The government invested in roads, rail, airports and seaports. It achieved much lower levels of total landed costs. The supply chain shifts will encourage that kind of development and investment in these other nations.

Much has been made of this shift. The assertion has been that once a company alters its supply chain in this way, there will be no going back, but that is likely not true. The decisions to move to China in the first place were taken quickly and the decisions to leave China have been just as swift. China still has the superior infrastructure and a generally good reputation as a supplier. This means supply chains could shift back as quickly as they left, but the politics will have to settle down. At the same time that companies in the U.S. are changing, there are changes in China as well. The pattern that Japan experienced may be a lesson for China.

Japan started out in the post-war years as a manufacturer of cheap consumer goods. The reputation of the output was not that good. Over time, Japan lost market share to countries that could offer cheaper labor and overall lower production costs. Japanese manufacturing set about the task of competing with the U.S. and Europe to make those higher-value items. They were very successful at taking market share. Eventually, these companies had larger markets in the U.S. and Europe than at home and many companies shifted production to the places their consumers were. Now, these companies employ more people in the U.S. and Europe than they do in Japan. That may well be the fate of the Chinese economy as well. Already there are Chinese companies moving their operations to the U.S. or other nations so that they can dodge the tariffs and other trade restrictions.

When the trade wars started, there was a sense this was all bluster and bombast. It was first assumed that Trump would back off once his advisors convinced him this was hurting his base. It was also assumed that farmers and manufacturers and others would turn on him once they saw what these policies were costing them. Analysts underestimated the enmity that many feel towards China. Many still blame China for lost jobs and many still object to the many human rights violations. It is becoming obvious that maintaining a close supply relationship with the Chinese will come at a cost—both economic through the costs of trade, and through the increased public opposition to doing business there.

China at Slowest Growth Pace in Almost 30 Years
At first blush, it appears China is growing at twice the rate of the U.S. After all, the U.S. is growing at under 3% and will likely end the year at somewhere around 2.5%. Meanwhile, China is growing at 6.2%. That would seem to indicate the U.S. is growing only half as fast. The reality is that 6% growth in China is recession—the equivalent of zero growth in the U.S. What constitutes recession in a given country varies—it is not just the numbers. Recession means the economy is not able to sustain job expansion and can't support enough activity in the business community.

Analysis: In order to keep pace with population growth, the Chinese economy has to generate at least 1.3 million jobs a month as compared to the U.S. need to generate between 250,000 and 300,000. At 6.2% growth, the Chinese are struggling to create enough jobs. This worries the leadership in Beijing. Especially given the rapid expansion of robotics in China.

IMF Continues to Push for Monetary Stimulus
The selection of Cristine Lagarde as the new head of the European Central Bank (ECB) means the International Monetary Fund (IMF) will be getting a new leader as well. In many cases, this kind of change at the top of an organization brings major policy changes. For a while, it appeared this was the direction the ECB was heading. The front runner for months had been the head of the German Bundesbank—Jens Weidmann. He had been an ardent foe of Mario Draghi's accommodative policies and lobbied hard against the various bailout efforts undertaken by the ECB. He was against buying government bonds from the struggling nations of the south and he worked to get interest rates up. His elevation would have made a big difference to Europe as well as the overall global economy. Now that Lagarde is the choice, there will be far more continuity as she has been aggressive in demanding that central banks and global legislatures move swiftly to bolster growth through stimulus and loose monetary policy. She will continue down the same path as Draghi and may even push the idea harder. Her departure from the IMF may signal a change in that organization's policy, but not at the moment. Her immediate successor is David Lipton. He has been solidly behind her approach thus far. He is the acting head of the IMF and has reiterated the stance taken under Lagarde—central banks need to push growth and expansion—even at the risk of setting off inflation threats. He will not remain as head of the IMF, however, as tradition has long held that the head of the IMF will be from Europe and the head of the World Bank will be from the U.S.

Analysis: Several names have been circulating already, but none have indicated they are serious candidates as yet. Given that few thought Lagarde was in the running to take over the ECB, it is quite possible none of these people will get the nod in the end. The views of those thought to be under consideration are fairly consistent—there is not really a radical in the mix at this point. The one interesting factor may be the opinion of the developing nations. The IMF and World Bank have been the exclusive property of the U.S. and Europe, but they do the majority of their work in Latin America, Asia, Africa and the Middle East. These nations want more influence and may have more impact on the choice of leader this time around. The head will still be from Europe, but connections to the developing world will count for a lot.

Some of the people said to be under consideration include Mark Carney—former head of the Bank of Canada and the Bank of England. He is Canadian, but also holds Irish and British passports. Kristalina Georgieva is from Bulgaria and is currently the chief executive of the World Bank. She is one of those with ties to the developing world. Jereon Dijsselbloem is a former Dutch finance minister and heads the Eurogroup of 19 European Finance Ministers. He would likely be the most hawkish of the potential candidates. Mario Draghi is in the mix and that would be an interesting job swap with Lagarde. Wolfgang Schauble is the former German finance minister and would also be a hawk that would reverse some of the IMF's stimulus emphasis. Euclid Tsakalotos is the former Greek finance minister who negotiated the latest Greek bailout. He is not all that popular with the Germans and other hawks, but the developing nations like him. There is a possibility that Trump will demand that the new head be an American holding the same view as the U.S., but this attempt will fail as Europe will unite behind their own candidate to block any such move. In fact, any attempt by the U.S. to upset this tradition may result in Europeans deciding not to select an American to be deputy director as has been the pattern in the past.

Currency Wars
The latest salvo from the White House has been prompted by the continued strength of the dollar. The rise has been steady and all efforts on the part of the Trump team to talk it down have failed. The reaction from Trump has been to attribute the appreciation of the dollar to some kind of mass conspiracy on the part of the world. He has threatened sanctions, tariffs and trade wars if the rest of the world doesn't cease engaging in "currency manipulation." The reality is the dollar has gained strength for the simplest of reasons—the U.S. economy is among the healthiest in the world, the booming stock market is luring overseas investment and the interest rates set by the Fed are higher than many of the other central banks.

Analysis: Should the Fed decide to lower rates at some point later this year, the dollar will lose a bit of its appeal, but as long as the U.S. economy keeps perking along, the dollar will remain strong as global investors will continue to want to engage with that growth. There is a sure-fired way to see the dollar decline—a way that doesn't involve sanctions, threats, tariff, trade wars and open hostility towards every nation on the planet. All that has to be done is tank the U.S. economy into a serious recession and the dollar will slide right away.

It was, to put it mildly, a tense moment. Granted, flying tends to bring out the worst in many of us, but this incident went further than most. It started when a plane landed early enough, but was swiftly taken out of service due to the fact that some teenager decided it would be funny to plug up the toilet and cause a nice little flood. He and his mom were being escorted off the plane when one of the passengers waiting in line exploded. He laid into the kid and his mom with a profanity-laced tirade. For a moment or two, it looked like these two were going to get the beating of their lives. They swiftly slunk away before it reached that point and the guy instantly shifted his personality as he very politely asked the agent if it would still be possible to get to Detroit that evening despite the delay. It was his daughter's birthday you see.

"Sorry about that reaction, but sometimes you need to use the only language these kids understand." I can't say that I blamed him for the outburst—I was certainly thinking much the same thing he was expressing. Too often, we are helpless against the explosion of rude and destructive behavior, and for some, that passivity is not an option. I don't know what the appropriate response is. Once upon a time there were more societal inhibitions—at least I remember the reactions I got when I chose to get out of line. Refusing to give my seat up to an elderly woman when I was about 14 got me a smack across the face from another elderly woman and she had the entire bus on her side.

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Saturday, 07 December 2019