Strategic Global Intelligence Brief for July 27, 2018
Short Items of Interest—U.S. Economy
Impressive but Not Quite as Much as Expected
The Q2 GDP numbers are in. And they are impressive at 4.1%. This is not as robust as some had expected and even predicted, however. Some were certain that growth rates would be as high as 5%—many had set their sights on 4.5%. In truth, anything over a 4% rise would mean almost doubling the rate from the previous month. This is certainly impressive, but the caveat is that it is only one month and one that has same very special circumstances driving the data. There were a tax cuts at the start of the year that finally trickled down to consumers in the second quarter. Most important, there has been a dramatic surge in exports as companies that saw tariffs down the road were trying to acquire product before bans and tariffs drive up costs. It is not likely this pace holds through the third and fourth quarters.
What Holds Growth Back From Here?
There are many things that could hold growth back and return these GDP numbers to that long-term trend of 2.5% growth. In any given quarter, one or the other of these becomes the deciding factor. At the top of the list is the labor supply situation and what that does to the productivity of the economy. Right now, there are major job shortages because companies can't find the people they need. This affects their efficiency. The second factor is the presence of an active consumer—always a fragile situation. Inflation is headed this way sooner than later. That takes the wind out of the consumer sail. The fact that retail is transforming is not making this process any easier either.
Trump Jumped the Gun—Why He Should Not Have
The president has been breaking with a number of long-standing traditions when it comes to economic announcements. He has jumped the gun on interest rate conversations and has commented on GDP numbers before the numbers are released. The reason this is not a generally good idea is that investors look for this information to inform their decisions. It has been deemed fairer to have this information embargoed until a specific time, which in turn affects what they will or won't invest in.
Short Items of Interest—Global Economy
Forming a Coalition in Pakistan
Imran Khan came close to having enough seats to form a government, but is just short and will need to add a smaller party or two to his group to have control over the parliament. The second-place party is out as they have declared they will be in opposition. The party that placed third is connected to the Bhutto family and was roundly attacked by the other parties for their bribery and graft accusations. The fourth-place finisher added their six seats to Khan's 115 out of 272. A total of 133 are needed to govern. Right now, Khan has 127.
Continued Financial Chaos in Venezuela
The order had been to lop three zeroes off the bolivar. Now, the plan is to lop off five. The currency is going to be backed by a crypto currency that will be backed by the oil reserves that the country is unsure how to bring to production. The currency is utterly useless and has been abandoned for all practical purposes as it has been replaced by barter and direct trade. The country is now seeing 85% of the population under the poverty line, while 65% do not have formal jobs as they aren't being paid.
Can Zimbabwe Be Salvaged?
Many would suggest that it can't be rescued from the destruction of the Mugabe years. Even with the best of intentions and massive goal support, the effort will be enormous. There is no sign that the world is willing to put that kind of money into Zimbabwe. Thus the expectation is that it remains an utterly failed state that slides back to dictatorship.
Who Won That Round?
As expected when the diplomats and politicians start to explain a deal, there is the assertion from both sides that everybody won. It was so obviously a "kumbaya" moment and everybody walked away with exactly what they wanted. That is, of course, patently untrue. It will take a while to sort out whether Europe or the U.S. got the better deal. To be honest, there has not even been an agreement provided for signatories—it has just been feel-good rhetoric. In that environment, it is easy for all involved to claim an a victory. On the eve of the meeting between Trump and Jean-Claude Juncker, president of the European Commission, the expectations were very low. Most thought nothing other than reiteration of previous positions would take place. Do we have a sense now of what actually happened?
Analysis: Some aspects of the talk have become a little clearer, but until there is a plan submitted, the issue is mostly atmospherics. The Trump position going into the meeting was extremely hostile towards Europe; these states were not handled as allies in any sense of the word. The rhetoric was as harsh with Europe as it has been with China. This has never been justified based on any facts. The U.S. differences with China are very real, however. It can be shown over and over again that China will engage in all manner of subterfuge to advance their economic advantages. There may be good reasons to try to work with China, but it is also clear that the U.S. and China are far more like enemies than friends. Europe doesn't fit that description at all. In fact, the U.S. has more barriers against European imports than Europe has bans or tariffs on U.S. imports to the European Union (EU). If there is no level playing field with Europe, it is because the U.S. has tilted the field in its favor for years.
Juncker was not coming to the U.S. in a conciliatory mood. He was instead prepared to stand fast and demand the U.S. shift its thinking to reflect reality. It is not clear what triggered the abrupt about face although it appears that it was President Trump who made the initial overtures. Juncker was the one hastening to catch up with the new mood. Given what we can glean from comments—what do we know? Bear in mind that without some firm written agreements in place, this is all speculation. Given Trump's actions in the past, there could be a complete reversal tomorrow.
There are perhaps three motivations that explain the president's decision not to go after Europe with additional tariffs despite the weeks and weeks of accusations of unfair practices and the like. The first is that opposition within the U.S. was far greater than Trump had expected and he was worried this might compromise other positions and efforts. The U.S. carmakers opposed the tariffs vociferously—they had been expected to support them. The pro-trade members of the GOP also became far more pointed with their critique. They started to hint they would take steps to undercut what President Trump has been trying to do. The second theory holds that this was the expected outcome all along and that the threats were a negotiating ploy as much as anything else. The president's approach is not traditional in the world of diplomacy—at least as far as dealing with friends and allies—but it is common enough with states where the U.S. has conflicts. Trump uses the carrot and stick and leads with the stick. Europe faced economic pain if it did not accede to U.S. demands. It seems the EU found cooperation to be more viable than not. Finally, there are those who see this as internecine warfare within the ranks of the administration. The Peter Navarro [Director of the White House National Trade Council] camp of nationalists and isolationists may be winning as far as strategy for China, but the internationalists such as Secretary of the Treasury Steve Mnuchin, Chair of the Council of Economic Advisers Kevin Hassett and others are holding sway when it comes to Europe.
Will There Be an Italian Exit?
The most pressing issue on the minds of the European Union leaders (besides what to do with Brexit, Russia, immigration, etc.) is whether the populists who now govern Italy will want to follow the lead of the British and pull out of the EU. As damaging as the British withdrawal was, the exit of the Italians would be more traumatic given the fact that Italy has been a charter member and has clearly benefited from membership for decades. It is one thing to part ways with the U.K. given the years of awkward interaction between the EU and the U.K., but connections between Italy and the EU have been lucrative for Italy.
Analysis: Current Prime Minister Giuseppe Conte has been telling everyone he can think of that Italy counts on the EU for its leadership. It has relied on the UN and other institutions to bail it out of one financial mess after another and it has needed money from the rest of Europe to survive. Now that outstretched hand is getting bitten hard by those same politicians.
GDP Numbers—What to Expect and What Do They Mean?
By the time you read this, the GDP data for second quarter will have been released. We will all know just how close economists and others came to predicting the actual number. There has been a surprising level of volatility. Even this week, there was a rather large range of possibilities and lots of variance as far as the analysts were concerned. The GDP numbers for the first quarter were anemic to say the least—hanging at 2.2%—below the 2.5% average that has been the norm for the last decade or so. Almost as soon as the second quarter started, there were signs of a solid turnaround stimulated in no small part by the tax cuts. The business community reacted right away to those cuts and demand was high for all manner of industrial machinery. The return of the energy economy was a big help as well. The missing part has been the consumer as retail numbers continued to disappoint through much of the quarter. That reluctance to spend started to erode as the summer vacation period began and has been contributing to a better set of expectations for the Q2 data.
Analysis: As the growth manifested, the analysts started to get pretty excited and reported that based on some of the preliminary data there was a good chance second quarter growth would be well above 4% and perhaps as high as 5%. That enthusiasm has faded a little as more data became available. The majority of those who chose to venture a prediction now see a range between 3.5% and 4.5%. This has prompted Trump to break with yet another tradition as he has been extolling the accomplishments of his administration before we really know what they might be. The actual numbers came out this morning (after this story was written). By now, those who follow economic data releases know full well that GDP numbers are ever-changing as more detailed information becomes available. There will be two revisions of the data released today and yet another look about a year from now—just to make sure all the available information has been accounted for.
Beyond all this, there is the argument that GDP is something of a blunt instrument when it comes to measuring an economy the size of the U.S. The U.S. GDP is now close to $20 trillion. That makes it roughly twice the size of the No. 2 economy—China. Each of the 50 states has GDP numbers that match numbers of other countries. France and California have comparable economies and so does Texas and Canada. The total U.S. GDP could well be hitting numbers around 4.5%, but there would still be many states that would sport growth numbers both below and above that level.
The measurement of production is certainly a common and time honored means by which to evaluate the performance of a given economy, but it has long been criticized for not really capturing the details that make up quality of life for a given nation's population. There have been all manner of efforts to capture that kind of data, but few have been universally accepted. For the foreseeable future, the world will continue comparing performance according to GDP numbers.
The two major questions that will follow the release of this data will be what happened to provide such a high growth quarter and what are the chances that third and fourth quarter numbers will be in the same ballpark? The first of these is easier to answer—at least partially. The tax cut is the major factor as it dumped a great deal of cash into the hands of the business community as well as into the pockets of consumers. The business community spent their share pretty quickly although many of the larger companies focused on stock buybacks and internal compensation as opposed to actual business expansion. Consumers have been slower, but they started to get in the game as the vacation months rolled around. The longevity of this boom will depend to some degree on the tax cut as well. If, as many economists opined, the cuts came too late in this recession, they may serve to overheat the system and leads to inflation serious enough for the Fed to take action. If rates rise and inflation begins to affect other banking decisions, there will likely be a slowdown. It could easily start to manifest as soon as the end of the year. That would drag down those GDP numbers in a hurry. Most of those watching the U.S. expect really good numbers for Q2, better than average numbers for Q3 and results closer to the 10-year norm of 2.5% in Q4.
Who Pays Attention to GDP Data
Each time there is a large release of economic data, there are various institutions that pay close attention and may even shift their priorities. The status of the jobs number will often trigger the Federal Reserve to act in a new way and there are legislative reactions to changes in export numbers or the debt and deficit. As eagerly as GDP data is anticipated, there is rarely a reaction of much significance. Nothing drastic usually changes as far as policy is concerned. The Fed doesn't really pay a lot of attention either.
Analysis: The bottom line is that GDP numbers are really too big and all-encompassing for a strategy to develop. It takes an immense amount of economic energy to shift the growth rate of the entire country—at least in the short term. The moves that would be significant enough to move this needle would have to be immense. Generally, government action and reaction have only short-term influence. It is assumed that a given quarter of GDP activity was set in motion about two to three quarters prior. As influential as the tax cuts were in boosting the activity in Q2, the moves that led to this month's robust readings were taking place a year ago with the expansion of exports, additional hiring, improved consumer demand and the like. This is what worries people about the GDP of the future—some serious headwinds are starting to manifest now and might have a real impact by the end of this year and early in 2019.
Fear of the Unknown
Once again, I eavesdropped my way right into the middle of an interesting conversation. It was a bunch of work colleagues waiting to fly somewhere. Fears were the topic. It started with the incredulous observation that one of these people at the firm was so afraid to fly he elected to drive 800 miles to attend this meeting (and 800 miles home). The others could not believe a fear could do that, but suddenly all kinds of fear issues started to emerge—ranging from genuine terror to just avoiding certain foods, behaviors and places.
After a while, I joined in and started asking more questions. I offered my fears up for analysis as well. The common theme was that people did not know how to handle what they don't know. When there is something we know nothing about, it intimidates us when we can't figure out what it means to us in the immediate future. This issue of not knowing is the killer. The irony is that we end up most afraid of the things and people we know the very least about. I was talking to a woman who was deathly afraid of bees, so I talked to her for quite a while about beekeeping and the behavior of these girls. By the end of that conversation, the woman admitted she was still likely to be nervous, but felt far less real fear as she had no idea what bees did or were motivated by.
Many people are afraid of other people. That fear leans towards bigotry. The fear is based on ignorance more than anything else. That lets us substitute rumor and half truths for fact and reality. The secret to conquering fear and prejudice is knowledge.
