Strategic Global Intelligence Brief for June 1, 2018
Short Items of Interest—U.S. Economy
Job Report Solid—As Expected The rate of unemployment has now fallen to an 18-year low, although there is still an issue with how much people are being paid. The rate of wage increase was slightly higher than last month at 2.7%, but that remains highly anemic given a jobless rate of 3.8%. The economy gained a solid number of new jobs, but most importantly it did not lose many. The number of layoffs remains very low—there has not even been the rate of attrition that had been expected from retirement. The number of people in the "discouraged worker" category eroded again. That is a good sign except for the fact that most of them are taking jobs that do not pay all that well. The good news from this report is tempered by the fact that labor shortages are now acute in almost every category. What was once a major issue for sectors like manufacturing and construction now extends to health care and many of the professions.
Who Is Supposed to Benefit From Tariffs? The assumption has been that tariffs on imported steel and aluminum had been primary demands from the industry in the U.S., but that has never really been the case. It's not that U.S. producers of these metals were against these tariffs, but this action was never as important to the industry as other reforms. The big fear for the past few years has been the loss of market. Fuel-efficient cars mean lighter cars with less steel. Reduced construction activity (especially on the commercial side) along with the delays in various pipeline projects meant less steel use. Then there is the issue of scrap and what U.S. environmental laws allow. The tariffs will certainly make it harder for companies to buy imported steel, but if that results in manufacturers shutting down, the steel and aluminum sector loses even more market share. This still feels like a negotiation play on the part of the Trump White House—one that is likely to backfire.
Trump Is a Bad Protectionist The truth is that every nation engages in as much protectionism as it can practically get away with. It is natural to want to protect domestic business, preserve domestic jobs and restrict how dependent one gets on foreign supply. There are ways to do this that minimize the negative impact, but Trump is not taking that approach. He seems to want quotas rather than relying on tariffs. The threat to impose tariffs was essentially a way to force nations to do what South Korea did—agree to a quota in order to avoid the tariffs. This is not a good plan as quotas are unpredictable and don't respond quickly when there is change in demand. Most importantly, a tariff is paid to the U.S. That money goes to revenue, while quota systems just make things more expensive. Foreign companies essentially reap those rewards
Short Items of Interest—Global Economy
AMLO Surges in the Polls When Andrés Manuel López Obrador (AMLO) becomes the next president of Mexico, he may have to give a shout out to Trump for making all this possible. The latest salvo of trade attacks on Mexico by Trump has resulted in a major boost for AMLO's campaign. It is only a matter of a few months before Mexico has a far-left leader who will challenge the U.S. at every opportunity.
So Much for That Budding Romance It was just weeks ago that French President Emmanuel Macron tried to use Gallic charm to sway Trump. Today, that notion of Franco-U.S. friendship is in tatters. Nothing that Macron wanted from Trump has been forthcoming. This has left Macron vulnerable to his critics in France. Essentially, Trump threw him under the bus, backed up and ran him over again. The tone from France has become very icy indeed.
North Korea Makes Vague Promises Once upon a time, Ronald Reagan cut a series of deals with the USSR. He stated that one must "trust but verify." The verification part is what has been missing as far as talks with Kim Jong-un. Most expect this to be a major sticking point.
Last Week—No Trade War, This Week—A Trade War, Next Week—Who Knows? The battle is on, at least as of today. The global business community is feeling more than a little whiplash these days. One minute the Trump approach to U.S. allies is overtly hostile with all manner of confrontation and bombast around the idea of "America First." Then the mood shifts and all is sweetness and light. The story has been most obvious with the tariff conversation. The first iteration was all about the beleaguered steel sector and how the U.S. needed to pull out all the stops to save it. Never mind that imports make up just 25% of steel consumption in the U.S. Almost immediately, many nations were offered exemptions to the tariffs. The first to be exempted were Canada and Mexico, but soon the exemptions were offered to Europe and most other U.S. allies. The conversation then shifted to how these exemptions would be made permanent. Suddenly, that debate ended with Trump's declaration that the exemptions would all be imposed and we are back to 25% tariffs on imported steel and 10% on aluminum. At least that is the story today. If past is any prologue, there is plenty of room for another about face and another and another and so on.
Analysis: If there is any method to the Trump approach, it is likely rooted in his business background. The fact is that there is no such thing as a generic business background. The corporate world knows full well that experience in one field doesn't mean much in another. The environment for a health care CEO is vastly different from somebody that runs a railroad. Trump comes from the world of real estate and to some extent from TV. The rules are different in both of these fields. Real estate is non-stop bargaining and negotiating. There is very limited exposure to consumers and managing people—most of the business pressures that other companies face. The statements coming from the administration show a very poor understanding of the realities of the manufacturers' world. Wilbur Ross has stated that he has not seen car prices go up so what difference would a tariff make? Perhaps he should ask the thousands of parts manufacturers that are paying more for steel but have been told in no uncertain terms that the car makers will not be paying them any more for those parts and will in fact likely demand reductions as they always do. These are the companies that will suffer and will be limited in terms of acquiring new machinery, expanding or hiring.
This will not be the only damage inflicted on the U.S. economy. The nations that have become targets are ostensibly U.S. allies and they are feeling betrayed. There will be retaliatory tariffs and trade restrictions. Most will be targeted to sting the U.S. where it would hurt the most. The export sector is responsible for over 15% of the U.S. GDP (a bigger percentage than in Japan). At this point, the most likely to be affected will be the farm sector, heavy machinery, aerospace and entertainment. But that remains to be seen.
It would be a mistake to assume this is the end of it. The pattern has been to force concessions with some combination of threats and cajoling. The U.S. wants to get concessions from Canada and Mexico over NAFTA talks. The tariffs have been dangled as both threat and reward. The Trump team simply dislikes many of the European leaders and resents their intervention on many levels. To be honest, many U.S. presidents have been annoyed by this European habit of "lecturing their little brother." The reality is that Europe accounts for as much as 25% of both exports and imports. That could damage the U.S. economy in significant ways.
The question now is what the U.S. wants from these allies. The Europeans have been threatened with tariffs on exported vehicles and now the steel/aluminum issues have been added again. Traditionally, the U.S. has struggled with Europe's agricultural policies as well as many of the cultural protections. There are many disputes over intellectual property rights and so on. It is not clear that any of these are really the issue. The U.S. may be more interested in global political disputes. The Trump team wants the Europeans on board against Iran and has been angry with the EU over the declared intent to undermine the attacks on Iran. This connection has not been made explicitly, but this has been a pattern with Trump thus far—akin to putting trade pressure on China to get them to pressure North Korea. The biggest issue for the business community is the unpredictable pattern. The fact is that most companies can adjust to any set of rules as long as they know what those rules are actually going to be. The constant waffling over policy makes strategic planning all but impossible Most now assume that these tariffs will be adjusted again as the affected nations seek ways to accommodate the U.S. The sense is that many of the affected states will turn to threats of their own to put pressure on the U.S.
Europe's Many Worries In case you hadn't noticed, the markets throughout the world had a bad day yesterday. They will not see much better news today. The focus has been Europe in one way or the other. The Italians now have a government in place that has the very reluctant support of the president despite his intense antipathy towards both of the populist parties that won the majority of the voter support in the last election. It seems that he assessed the impact of forcing another election and realized that it would only strengthen the hand of the populists. Now, there is a government in place that asserts a deeply skeptical position on the eurozone and the EU as a whole. Some in both the Five Star Movement and the Alliance have openly called for Italy to withdraw from the EU as the British have elected to do.
Analysis: It is not just Italy that has the markets in turmoil. There is also the fact that Spain has just dumped Prime Minister Mariano Rajoy. He will be replaced by the head of the Socialist Party—Pedro Sánchez. This has many worried that Spain may also sink into some kind of populist pattern, but the reality is that there is more worry about Podemos than the Socialists. Many in the mainstream are hoping that Sanchez can hold things together. The other factor that has led to market turmoil has been the sudden shift back to steel and aluminum tariffs by the U.S. The decision seems sudden and perhaps designed to provoke a reaction from the countries facing the taxes, but nobody knows what it is the Trump team really wants at this point.
Consumers Are Starting to Engage The latest data from the Personal Consumption Expenditure (PCE) data shows a nice little bump from last month. It is up by 0.6%, better than the 0.4% registered the month prior. The PCE is the reading the Fed prefers to use when it is assessing the potential for inflation. This rise puts more emphasis on the Fed's decision to hike rates. There has been no hint that there will be an acceleration of the process, but the conversation has started.
Analysis: The most important part of this reading is that it shows the consumer has finally started to seriously engage with the economy. The tax cuts prompted almost immediate business reaction, but the consumer lagged and seemed worried about the future. The consumer confidence numbers have been solid, but there was not that much actual consumer activity. That is finally taking place as the summer travel months have started. The areas that have seen the majority of the new activity include entertainment, lodging, air travel and lawn and landscaping activity. There was also a jump in less exciting spending areas such as gasoline. The spending on food has also started to pick up. If this pace continues through the summer, the impact of the consumer will be felt in somewhat higher growth rates.
Jobs Data Expected to Continue the Story Today The latest edition of the jobs report will not provide much of a surprise, and that is good. At this point, it is hard to conceive of a major upside appearing given the very low rate of joblessness sported over the last year. The more likely change would be a deterioration of the situation that has encouraged employment. There is nothing to suggest that is going to be an issue. Over the last year, the economy has been adding an average of 150,000 jobs per month. This pace will likely be maintained this month as well. If there is anything that might disappoint, it is that summer hiring is expected to be lower than it has been in years. The number of young people seeking jobs has fallen by almost half in just the last two or three years. There has been a similar decline in the number of adults seeking part-time work in the summer months (often teachers and others that have seasonal breaks). It was not that long ago that most of the employment concern revolved around the lack of jobs. Now, the major issue is the lack of job seekers. It is estimated that some nine million jobs are going unfilled right now. The majority of these are well-paid positions where employers simply can't find qualified people.
Analysis: There will be other points of interest as the report is perused. At the top of the list will be pay. The rate of pay has not really kept pace with these low rates of unemployment as the once reliable Phillips curve would indicate. It would seem logical to assume that labor shortages would trigger higher rates of pay as business would need to use money to lure the better candidates and keep their existing workforce from defecting to a new employer. There has been some evidence of this, but for the most part, the applicants have not been qualified enough to command larger starting salaries and wages. The fact is that economists are not all that interested in whether people are getting jobs if these jobs are not paying them a good salary. The reason we like to see people with jobs is that they can then become consumers and drive the growth of an economy that is 80% dependent on consumption. If there is lots of hiring for low-wage jobs and not all that many for the high-paid positions, there is not much overall economic progress. This has been the weakness of the job report for the better part of the last couple of years. It is likely to show up in today's report as well.
Another aspect of the report that will attract a lot of attention will be the rate of labor force participation. For the bulk of the post-recession period, there has been a persistent difference between the U-3 and U-6 readings. There still is, but the gap has been narrowed considerably. The U-6 designation is for those that have been described as "discouraged workers" and those that are involuntarily part time. The growth of the economy has allowed a significant number of these workers to get back in the game and seek jobs. Those that remain in a part-time position are there because this is what they prefer. There has been an expansion of the workforce as many of those that are eligible for retirement have been convinced not to leave. The Boomer generation may go down in history as the least-retirement-oriented generation thus far. In part, this is due to the fact many Boomers are in jobs that are intellectual positions and not as physically taxing as jobs once were. It is one thing for an accountant to work into their 70s or even 80s and quite another to expect a roofer or machinist to do so.
The Disappointments in Life The good news is that my eye surgery went better than expected. I will get my vision back in a few weeks—at least most of it. The bad news is that I expected a patch of some kind—something pirate-like or one that made me look like the Hathaway Man (those under 60 will have to Google that). No such luck. I have a patch to wear at night, but it makes me look like some kind of cyborg or one of the "greys" reputed to be at Roswell. This is such a missed opportunity. It's like when I did the thing that gives you a pirate name. I got "Half-Blind Tad." I am not kidding. My wife got "Black-Hearted Kate" and that is all I am going to say about that.
I am also going to have to give up on my latest entrepreneurial scheme—seeing-eye cats. It would have been great for those wanting to combine adventure with relaxation. One would never know where one was going, but would be able to count on taking naps for 20 out of every 24 hours. I have also been able to closely examine the floors of my home as I can't lift my head for five days. I am astonished at what I have managed to find that I thought was lost. I also have one of those weird mirrors that allow me to watch TV. It makes me feel like I am bootlegging somebody else's cable. Either that or I get the memory of making a periscope when I was a kid so I could look over the neighbor's fence. That session ended when the boyfriend of the girl that lived there yanked it out of my hands and whacked me with it.
Anyway, I am back to some semblance of normal next week. Hopefully, it will not take me five times the usual time to do one of these newsletters.