Strategic Global Intelligence Brief for July 2, 2018
Short Items of Interest—U.S. Economy
Manufacturing Still Surging
There may come a reckoning at some point and there may be several factors at work right now that are making the manufacturing sector grow faster than would seem logical. The point is that these factors are driving the economy at a rapid clip, while there is no real sign of impending doom. The latest Purchasing Managers' Index has broken into the 60s—rarified air as far as the sector has been concerned. The New Orders Index has already been there for a while. That signaled to most it would not be too long before the whole index reached that point. The current reading is 60.2, up from the 58.7 marked last month. The anomalies that may have to be worked out revolve around some defensive production as companies are afraid that tariffs and trade wars might compromise their supply chain sooner than later. They want to be prepared.
Major Growth in Q2—Is That the Peak?
Not that we want to sound like all the other naysayers, but here goes. The second quarter is very likely to provide the fastest growth seen since 2014. That is as encouraging as it is concerning. This activity is certainly welcome after a lackluster Q1, but has the pace of growth exceeded the natural capacity for the U.S. economy? It seems there are lots of headwinds that will be manifesting. Job shortages, excess inventory, trade disruption, compromised supply chains and more expensive commodities like metal and oil will start to drag on that growth. Was the Q2 performance the last gasp of the tax cuts or did it change things more profoundly? At the moment, there is no evidence of an impending reversal, but there are definitely warning clouds.
Markets More Fearful than Impressed
It is just one day. We all know about the constant volatility of the markets, but the recent performance is interesting nonetheless. On a day when much of the incoming data points in a positive direction—the PMI, capacity news, car sales and so on—there was a dip in the markets as this good news is overwhelmed to some degree by the bad news of an imminent and expanding trade war. The moves that President Trump has made would be barely justified under the best of circumstances, but the accusations and insults thrown at various world leaders have made these trade disputes personal and much harder to back away from. The win by Andrés Manuel López Obrador in Mexico has many on edge as well, given the already existing animosity between the U.S. and its southern neighbor.
Short Items of Interest—Global Economy
Provocation or Not?
Apparently, it comes down to a matter of perception. Just a few weeks ago, Kim Jong-un made a promise to Trump that North Korea was shutting down its nuclear program for good. The U.S. immediately rewarded the regime with the decision to call off the joint military exercise it holds annually with the South Koreans. Some sanctions have been lifted already and other concessions have been made. Meanwhile, the North Korean military has expanded its missile bases and has restarted parts of the nuclear weapons facility. Is this a violation? Nobody knows as Trump did not demand a signed deal, so it will have to come down to whether Trump accepts these moves as innocent.
South Koreans Utterly Reject Migrants
A group of Yemeni refugees has triggered riots in South Korea as this country is extremely hostile to the arrival of these refugees. The decision to allow them on to Jeju Island was supposed to be a gesture toward helping resolve the crisis in the Yemeni region, but there is no tolerance for these refugees from either the left or right of the political spectrum. South Korea is like Japan in terms of rejecting this kind of migration or any other kind for that matter. The already draconian laws on migration will soon get tougher yet.
German Showdown
If Angela Merkel is not able to mollify her Bavarian Christian Union allies, their leader will resign from his position as interior minister and the coalition will splinter. That will be the end of the Merkel government unless she cobbles together another coalition with the Social Democrats.
Three AMLO Scenarios
Now that Andrés Manuel López Obrador (AMLO) has been elected Mexico's new president with a majority that exceeds that of any president in the last four decades, there is an expectation in Mexico that will test the new regime. Not only did AMLO win by a landslide, it appears that his Morena party has won a majority in the legislature. The once-dominant PRI has lost so many seats that it is now smaller than the little parties that backed Morena as coalition allies. The issues dominating Mexican politics were abundantly clear throughout the campaign; however, addressing them will be an enormous task. The top of the list was corruption as the population became convinced that all of the PRI was corrupt beyond redemption. This pattern of abuse had robbed the country of the money needed to really address growth. The second major concern is the violence that has beset the country from the ongoing drug gang wars. The issues of the economy have also been important, but have been less of a factor at least for the time being. It has also been pointed out that voters strongly supported the nationalism and populism of the AMLO campaign—especially as regards reaction to President Trump and the U.S. Each and every time Trump attacked Mexico and immigrants or mentioned the wall, the support of AMLO jumped. Efforts by Enrique Peña Nieto to be diplomatic with President Trump were considered weak. AMLO has talked a far more aggressive game.
Analysis: Rooting out corruption and ending the drug war will not be something that can be accomplished quickly or easily. Many comparisons have been made between AMLO and the former President of Brazil—Inazio "Lula" da Silva. López Obrador has to hope that the comparisons do not include the political end of Lula. Like AMLO, the Brazilian was a firebrand leftist leader most of his career as he headed the Worker's Party. During a period very similar to the one in Mexico today, he saw an opportunity to be more than a critic on the outside and metamorphosed to a candidate centrists could support. He traded his Castro-style fatigues for suits and was elected. In the end, his party was no more immune to graft and corruption than were his predecessors. It all fell apart under his hand-picked successor—Dilma Rousseff. AMLO will need to keep a tight leash on his supporters, which is far easier said than done.
The country with the most pressing interest in the policies of AMLO will be the U.S., and for the most obvious of reasons. The negotiation of NAFTA has been essentially stalled as nobody wanted to cut a deal with a lame-duck leadership in Mexico, but now that AMLO and Morena are in charge, what can be expected as far as relations between the two nations?
Scenario one is the most commonly cited, but it has some elements of wishful thinking as well. Much has been made of the likely makeup of the new Cabinet and the leadership in the Mexican legislature. Most of the economic positions have been filled by U.S.-trained economists and technocrats who have been vocal in support of free trade and NAFTA. The relationship with the business community in Mexico will be strained, but perhaps not as much as thought. The most likely point of contention is AMLO's push to raise wages dramatically in Mexico. This will not be popular with business, but it will be to the unions and the population as a whole. It is also likely to get the support of the Trump team as this has been one of the demands associated with NAFTA. The U.S. thinking is that companies leave the U.S. to set up in Mexico to exploit the cheap labor. This is the "transformed" AMLO—willing to work with all sides as Lula did at first in Brazil.
Scenario two holds that AMLO may not have wanted to see his party do quite this well. If he still had to mollify elements of the PRI and PAN to pursue his goals, he could point to these compromises as necessary for the greater good. Now that his party and some smaller members of the coalition are in the dominant position, he will have to respond to the more radical voices that will be in control of the legislative agenda. There is little sign of moderation in that group. This scenario holds that he will be more confrontational with the business community and with President Trump as the members of Morena despise the U.S. administration and certainly don't trust the business elite.
The third scenario is that AMLO soon realizes that he will need a great deal of help to deliver on his promises—especially as regards the power of the drug gangs. The U.S. has been nominally involved with combating these gangs, but Mexico has been very sensitive regarding U.S. police and military engagement. As the most important of the left-wing leaders, it is conceivable that he can make this kind of overture. That may have the added bonus of getting more cooperation with the U.S. on trade issues as well.
Oil Prices Not Coming Down as Expected
The decision by the OPEC members (at least most of them) to step up production again was supposed to contribute to a reduction in the per barrel price. Much has been made of the U.S. pushing the Saudi Arabians to take the lead on this issue. In fact, the Saudi decision was more internally driven, but the real issue is that prices have remained high.
Analysis: The prevailing wisdom is that these prices will indeed come down, but perhaps not until much later in the year. The simple fact is that there have been issues in a number of oil-producing states which has created a shortage even as other OPEC states and Russia have stepped up their production. Libya, Iraq, Iran, Nigeria and Venezuela are only producing a fraction of what they are capable of and have brought to market in the past. Most of these issues are temporary, but reduced output from Venezuela is here to stay and the sanctions will continue to limit what comes from Iran. The other states are also unlikely to see a complete end to the civil strife and insurgency that has served to inhibit oil output.
Is Automotive Sector Next?
Analysts are now suggesting the steel tariff effort was only a preparation for the more significant policy step of imposing tariffs on imported cars. It is obvious that auto exports are far more important to various U.S. trading partners than is steel. In particular, any such restriction on imported cars would hit Mexico, Canada, Japan, South Korea and Europe hard. The U.S. remains the largest market for vehicles in the world, although the growth rate has slowed as compared to the pace set in China, parts of Asia and elsewhere in the developing world. Nowhere on the planet is there saturation like that in the U.S. That is partly what has been worrying carmakers here and elsewhere. Will the U.S. consumer start to slow its demand for cars as interest rates rise and inflation starts to play a bigger role?
Analysis: There are few sectors in the global economy with more significance than the vehicle market. The last several decades have seen wave after wave of efforts to protect one's own market and exploit others. The U.S. employed a complex series of tariffs and quotas to block the import of Japanese cars in the 1970s and 1980s. The Japanese fought back with restrictions on U.S. car imports, found ways around the U.S. rules and built operations in the U.S. Today, if one looks at the list of "American made" cars one will find that three quarters of the top 10 are built in the U.S. as part of global manufacturers such as Toyota, Nissan, BMW, Volkswagen and others. U.S. carmakers such as GM make more cars in China than they do in the U.S. and U.S. companies like Chrysler are part of Fiat. The car market is truly a global one in every sense of the word.
This does not stop people from trying to intervene on behalf of this industry and with far more justification than when intervening on behalf of steel. There are few industries that account for more economic activity or jobs—both directly and indirectly. The carmakers are basically car assemblers these days as they do very little of their own manufacturing. These parts are turned out by thousands of suppliers that can sometimes be responsible for an entire assembly or a single bolt of a certain size. The auto sector affects every single state in the U.S. In every other nation, the business is equally widespread. There are tariffs and restrictions and regulations and all manner of subsidies offered by almost every nation in the business of producing a vehicle. The U.S. eventually backed away from the strict quotas on imported Japanese cars under the pressure from U.S. consumers and the fact that Japanese car companies were setting up shop in the U.S. That was a winning strategy in some respects and a losing one in others. It turns out that cars made by Toyota and Nissan in the U.S. were every bit as well made and popular as those imported and put pressure on the Big Three U.S. automakers anyway.
It is quite true that many nations discriminate against U.S.-made imports and we block imports in a variety of ways as well. We decry the subsidies these carmakers get and conveniently forget about the taxpayer rescue of both GM and Chrysler. It is a game that all play. What does President Trump seem to want from these states? Most analysts assert that he is less interested in blocking imports than he is in opening up these foreign markets to U.S. companies—carmakers as well as parts makers. Just as the U.S. has a strong lobby protecting the domestic car industry so other nations have their own strong lobbies for their own companies. Is there room for adjustment of these barriers? Of course there is. Is this kind of confrontational approach better than quiet negotiating? Only time will tell.
Resurrection of New Deal Program Imminent
China has responded to the trade war with the U.S. by imposing restrictions and tariffs of its own. The targets have been carefully chosen to have the maximum political impact. The Chinese will sharply limit the amount of agricultural import from the U.S. and have gone heavily against the soybean sector. This is an important crop to the U.S. as far as maintaining its $26 billion trade surplus in farm goods and China has long been a major buyer. If that market vanishes, the farmer in the U.S. will be badly impacted—especially this year. The prices are already low. If the U.S. is frozen out of the market, that is adding insult to injury. The Chinese have alternative sources for their soybean needs, but the farmer has no alternative market to sell to.
Analysis: A program set up in 1933 allows the Department of Agriculture to borrow over $30 billion that can be paid to those farmers that have been hit by this trade war. It is not something that will thrill those who are already concerned about the size of the U.S. debt and deficit as it will add substantially to both. The longer-term fear is that China will change their buying habits permanently and the U.S. will lose a major market altogether. Most farmers express a desire to make money by selling what they grow, but there will be takers for that largesse, although most don't see consumer demand filling that gap. Those who are already concerned about the size of the debt are very much against this tactic.
Another Job I Do Not Want
I am sure that I have mentioned this a time or two, but it bears repeating that I am quite proud of my grandson—the kid with ambitions to become a veterinarian when he was 12 years old (along with thousands of others that age). He is now 32 and works as a large animal veterinarian in rural Missouri. I hear some of his stories at family dinners, but not all of them I am sure. In the last few weeks, I have become a big fan of those vet shows that are on Nat Geo Wild and Animal Planet, but none are as much fun as the Incredible Dr. Pol. He is what my grandson is so I get some insight into the life he leads. It's one that I would NEVER be able to do. Never mind the constant visits to the north side of a south bound cow, there is just the sheer physicality of the job.
I am always struck by those who can deal with people and animals at their worst moments. These are not animals one is called upon to cuddle—they are in distress and want nothing to do with that vet visit. There is a lot of real danger in this job. This is on top of dealing with loss. I have lost a few pets over the years and it has torn me up every time. I see the looks on the vet's faces and know what my grandson has had to go through with his clients—almost worse that seeing a sick family member pass. As humans, we know what is coming and can prepare—the animals don't and just expect their owners to make it all better. Sometimes we just can't. There is far less trauma in my world of economic graphs and charts.
