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Strategic Global Intelligence Brief for July 17, 2018

Short Items of Interest—U.S. Economy

Industrial Production Rises
This is one of those measures that can be misinterpreted from time to time. It combines three sectors that are very different in terms of what they respond to, although they also have quite a bit in common. Industrial production includes manufacturing, utilities and mining. The latter category also includes oil and gas development. Right off the bat, one can see there are some changeable factors that can affect these numbers. Utility demand is highly seasonal with the peak usage taking place right through the summer months. The gas and oil development tends to be cyclical as well. Only manufacturing sees roughly the same performance from one month to the next. This month there was better performance from the industrial economy—rising by 0.6% over the previous month and 3.8% over the course of the last year. One of the big jumps was energy, but the manufacturing sector alone was up by 0.8% after having fallen by 0.1% in the previous month (June).

Fed Still on Target to Hike Rates
Nothing in the most recent data suggests the Fed should alter its current course when it comes to rate hikes. The threat of inflation has only strengthened and there has yet to be a real slowdown reaction to the tariff and trade wars taking shape. If anything, these disagreements between trading partners will boost the chances that a slowdown is imminent. That could provoke inflationary tendencies. Fed Chair Jerome Powell is taking the lead as far as selling the concept, but he seems to have few opponents.

Retail Activity Is Up—You Can Thank Transportation
The level of retail sales was up a respectable 0.5% after languishing last month with its revised pace of 1.3%. The major factors that figured into these better numbers are all transportation related. The price of gas and diesel went up, and in some places by significant levels. That added to the retail coffers as did a surge in car sales. It is still early days, but there has been some evidence to support the notion that people are once again selling their large vehicles in order to get hold of that fuel sipping one.

Short Items of Interest—Global Economy

Spanish Prime Minister Launches Two-Year Plan
The new PM of Spain brings the Socialists back to power for the first time in decades. He already faces a massive task. His victory was not so much a personal mandate as rejection of the opposition, so the voters are impatient and want change now. His plan calls for higher taxes, the closure of loopholes and a more comprehensive look at what the government pays. This will be controversial, but the sense is that Spain faces a once-in-a-lifetime goal. This gets Spain out of the worst of that debt crisis and may even start to erode the demands for higher standards.

Japan and EU Move to Cement Trade Relations
It is estimated that the combination of Japan and the EU can provide a consuming platform that rivals that of the U.S. It is no secret that U.S. trading partners are feeling betrayed by the Trump White House and are all seeking greener pastures.

Cuba Has a Long Way to Go
In many cases around the world, it has been pretty evident that socialism is not an easy system where progress is seen. Most topple sooner than later and the victory belongs to the capitalistic and the entrepreneurial. It seems that it really isn't the attempt to develop a fair society that dooms socialism—it is the creation of a stultifying bureaucracy that is dedicated to making things not work.

Learning From Down Under
The prevailing wisdom has long been that economic growth has to come complete with cycles. There will be periods of growth, but these will inevitably give way to periods of reversal. Recessions are therefore normal and not necessarily to be feared. The U.S. has had some long periods of growth, but they always end up faltering for a while before another period of growth begins. The current growth period has been one of the longest the U.S. has experienced in over a century. It has lasted 120 months or 10 years. Only the long run in the 1990s rivals it. To be honest, there have been long periods within this growth period that can only be described as anemic, but it has been growth and that is what matters. Is this latest and longest period about to come to an end? Is that end as inevitable as many seem to assume? Perhaps not! Those who argue that these growth periods are not necessarily equipped with an expiration date will often point to Australia—a country that is now going into its 27th year of growth and shows no signs of an end to that run. What are they doing differently than the U.S. or the economies of Europe, Japan or China for that matter?

Analysis: To be sure, the Australian economy is far different from that of the U.S. or the other states. It is far smaller, more commodity dependent and has unique connections to different parts of the world—from the Near North to its fellow Commonwealth partners (Britain, Canada, India, etc.). There may still be lessons that can be applied, however.

Perhaps the most important step taken by the Australian Parliament was the decision to pay down its debt during the good times so that it would have money ready to use when times were not so good. The debt was 32% of the national debt in 1984. At that time, the country decided to get that debt down to 10% of GDP. Contrast that with the U.S. which is now at 110% of GDP. If you want to make yourself a little more ill, realize the U.S. had a debt of 38% of GDP in 1984. It would have been very easy for the U.S. to have adopted the same strategy Australia applied. The U.S. spent more government money and lowered taxes, while the Aussies left spending and taxes where they were. Analysts have long asserted that the limit to a nation's debt should be 60% of GDP. The U.S. is now at twice this level.

This cautious policy served Australia very well in 2008 when the global financial crisis was swallowing up the rest of the world's economies. The government swiftly engaged in the kind of comprehensive stimulus plan that is recommended by most economists. They cut taxes, hiked spending and ended up dumping $52 billion into the economy—the equivalent to 1.6% of their GDP. This was in contrast to the far slower and more anemic response from the U.S.

The Reserve Bank of Australia (RBA) also took a different approach to interest rates and that gave them more ammunition when needed. They started to hike rates far sooner than did the U.S. Federal Reserve or the other global central banks. They not only wanted to make sure they had room to cut rates should a recession loom, they also wanted to blunt the kind of housing bubbles that played such a disastrous role in the U.S. and Europe (and is still affecting China). The RBA was able to drop rates at the right time and fuel bank activity while the other banks were left with only tiny reductions that had little impact.

Finally, there is the rather unique position the country has as far as trade—especially with China. The Aussies run a trade surplus with China due to the levels of raw materials and commodities sold to the Chinese. Much of China's coal and iron ore come from Australia. There is a great deal of food imported by China as well. Another area not to be overlooked is tourism and education as Australia is a favored destination for Chinese tourists as well as students. The connections that have been made over the years are on display almost daily as many Chinese business and political leaders were educated in Australia.

Of course, there are threats to worry about here as anywhere. Right now, the government has been operating with a deficit for several years and has had to borrow more than it would prefer as the price of commodities have sagged a bit in recently. Still, the troubles facing Australia are imminently manageable.

Will China Shift Gears and Will It Help?
There is mounting evidence that all these trade war preparations are dragging the Chinese economy down to a degree. The growth notched in the last quarter was still within their comfort zone, but is down from where it was just a few months ago—6.7% vs. 6.8% growth. The watchword for the last year or so was credit restraint as the government had been getting worried about too much debt and the potential for more bubbles bursting. Now, there is a desire to ramp things up with some stimulus to offset the impact of the tariffs and trade wars.

Analysis: The big question is whether this new policy will be able to move fast enough. The banks will have to reverse course, while the business community will have to react to the new availability of funding but at a time when there may be less business activity due to the restraints on trade. The Chinese are certainly equipped to survive a trade war and for an extended period of time, but it is also clear the tariffs will have an impact on certain industrial areas. It has become a matter of which nation can handle the pain longer. The bets are on China if only because the government can mandate more cooperation than can the U.S. The next step from the Chinese business community is to find other nations with which to do business, but that is far easier said than done. The U.S. is the consumer-driven market that made China what it is today. Without that U.S. demand, it gets tougher.

Russian Meddling—A Perspective
The stunning press conference with President Trump and President Putin has once again fired up the political world. To some, this was tantamount to treason. Others assign this to the fact that President Trump remains naïve in the ways of global diplomacy. I have to confess right from the start that I have a bias when it comes to the issue of Russian meddling. I am a child of the Cold War in every sense. The conflict between the U.S. and the Union of Soviet Socialist Republics was the constant threat growing up. There was no illusion about our relationship with the Soviet Union—they were enemies and constituted a threat to everything held dear by the U.S. Then, I became a Soviet and East European Studies major in graduate school, learned Russian and continued that orientation into doctoral work. I was all set to spend a lifetime studying the "Evil Empire" and was ecstatic when the fall of communism began in the late 1980s. I had no illusions as to how quickly things would change. When the former KGB officer Vladimir Putin ascended to power, I knew that Russia was essentially an extension of the old USSR.

Analysis: Putin denies the Russians tried to meddle in the U.S. elections of 2016. If he is to be believed, it would be the first time the Russians and the Soviets before them had not. This is a nation we have been at war with for the better part of a century. That history has been replete with spies, informants, sleeper cells, disinformation campaigns and political blackmail. There was most likely meddling by Russia in this last election as there has been in every other election. Sometimes, this meddling and interference has been more effective than at other times, but front organizations have contributed money, attacked and backed candidates, have tried to blackmail key people and so on. Moreover, we have done the same to the Soviets over the years by backing protests and demonstrations against the leaders. That is to be expected between enemies. Make no mistake, however, the U.S. and Russia are enemies in almost every sense of the word.

Asserting that the Russians did not meddle is the job of its leader, but why would the U.S. president agree? There are rationales that extend from one spectrum to another. Perhaps President Trump is out if his depth and was manipulated by Putin. Another possibility is that Trump wants to put this activity aside and find ways to cooperate. Frankly, this has been the way many U.S. Presidents have dealt with China over the years. This was not quite as blatant, but many meetings have taken place with the heads of China and very little has been said about their human rights issues or their espionage activity. China has been engaged in serious attacks on U.S. business for years and has regularly engaged in cyber warfare. We have other issues where we want Chinese cooperation, so we downplay these issues as long as we think we are gaining in other areas. Is that what is happening with Russia?

The only way to know whether this is the strategy is to observe the actions of the Putin regime. If there are moves made to address U.S. concerns, it might be the case that a deal was made to whitewash the meddling issue in return. The issues the U.S. wants to see action on would involve reduced Russian support for the Syrian government, a back-down in the Ukraine, elimination of threats against the Baltic States and those in the Caucasus. Maybe it means Russia works to lower global oil prices. If there seems to be no adjustment of Russian policy, one is left with the other theories. That doesn't say much about the ability of the U.S. president.

What to Expect From an Intelligence System
The debate over what President Trump is trying to accomplish with Russia and North Korea revolves around the information provided by the U.S. intelligence network. In fact, all of the foreign policy decisions made by this or any other president revolve around the information provided by that network. In the U.S., this is a large and diverse set of agencies and bureaucracies. With all the attention that has been focused on this group of late, it may be reasonable to ask the basic question—what do we expect from them?

Analysis: An important starting point is to understand that information sought by the intelligence system is exactly the information that other countries wish to keep secret. That means that there will be interpretation of fragments of data and with that interpretation, there comes the risk of being inaccurate to one degree or another. The intelligence community can only provide a best guess on what will happen in the future, but most of the time, it is possible to extract a fairly accurate conclusion based on past patterns and known current positions.

Deep Understanding
It started with The Incredible Dr. Pol and the obsession took off from there. Now I am also watching programs called Yukon Vet, Bondi Vet, Vets Gone Wild, Rocky Mountain Vet and so on. I can't seem to get enough. The stories are pulling at the heart strings and can almost be too graphic for me. I like the stories and the animals and the opportunity to observe the world where my grandson (a vet) lives. I also notice some really admirable character traits. I love animals as much as the next guy and probably love cats even more than that next guy. But I watch these shows and know I have my limits.

These vets rarely get to see the animals we know and love. Our animals are the ones that wag their tails in glee. They purr in our laps and greet us every day as if we are the best possible thing that could happen to them. When the vet gets involved, our little buddies are in trouble—sick or injured and definitely not happy. They snarl, bite, kick and scream and do everything in their power to get away from the vet. Besides the fact the vet gets all this daily grief, they remain steadfast allies to the beasts and maintain a big heart. Talk about instant forgiveness.

Here it comes—the connection to our human world. We encounter a lot of people who are not very friendly. Some of them are just plain mean. We generally react in kind. But the truth is that we may be seeing people at their worst. Therefore, we aren't seeing them at all. We should learn from our vets and give each other the benefit of the doubt. For all we know, the scowling guy at the airport has a stone in his hoof and the less-than-friendly cashier may have gotten into it with a porcupine.

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