Strategic Global Intelligence Brief for June 12, 2018
Short Items of Interest—U.S. Economy
Inflation Starts to Show Its Ugly Face For the better part of the last two years there has been a steady drumbeat of concern among economists that inflationary pressure was about due, but it never seemed to quite manifest as expected. Most of the blame for this slow reaction has fallen on the job market as there has not been the rise in wages that would be expected with an unemployment rate this low. The latest data from the consumer price data shows that there has finally been a surge in prices and that inflation has gone from threat to reality. The annual rate is now 2.9%, the highest in six years. The Consumer Price Index (CPI) is not the favored data as far as the Fed is concerned as they tend to like the Personal Consumption Expenditure reading, but the CPI is a closely watched indicator for many and the Producer Price Index is moving in the same direction.
Fed Nominees May Face Opposition in Senate The Senate Banking Committee has approved the nominations of Richard Clarida and Michelle Bowman to the Fed, but there was opposition from the Democrats on the committee, although this seems to be more of a ploy than real opposition. Neither of the two is remotely controversial and both are well qualified, but there has been an issue of voting on new members of the Export-Import Bank board. These have been held up by GOP members who do not like the Ex-Im Bank. The hold on Clarida and Bowman may be to pressure a vote on the Ex-Im bank nominees.
Small Banks and Deregulation The not so funny joke that goes around the banking community these days is that the good news is that banks are hiring, but the bad news is that they are only hiring compliance officers. The Dodd-Frank Bank Reform Act was supposed to make sure there would never be another banking debacle like the one in 2008, but it became highly punitive and far broader than it needed to be. The small banks have been pushing for deregulation and they have seen some. Michelle Bowman would be the small bank advocate if she is actually confirmed as a Fed Board member.
Short Items of Interest—Global Economy
Mexico Likely to Reduce Investment in Oil Sector As it looks certain that Andrés Manuel López Obrador will become the next president of Mexico, he has started to pull a team together. Their policy statements are already instructive. The most likely appointment to the position of finance minister is Carlos Urzúa—an economist with his doctorate from the University of Wisconsin at Madison. He has made it clear that he will welcome foreign investment in every part of the Mexican economy except oil. It was a highly controversial decision by the current president (Enrique Peña Nieto) to open foreign investment in Mexican oil. It now seems this door will once again be closing although hundreds of tenders have already been made.
Migrants Denied Entry Into Italy The new government in Italy is further to the right than before and very hostile to the notion of any more immigration. A rescue ship with 629 refugees had been denied access to Italian ports and looked to be out of options before the Spanish leader agreed to allow them to dock. Italy has now put Europe on notice that no more migrants will be allowed unless and until there is a Europe-wide agreement on how to handle the influx. The issue has galvanized the populist right throughout Europe and nobody really has a plan.
Trying to Walk Back G-7 Comments Perhaps the most unexpected and controversial part of the G-7 blowup was the vitriol aimed at Canada's Prime Minister Trudeau. President Trump was insulting and dismissive. Now an attempt is underway to walk these comments back and move on. Trudeau will be gracious and accept the apologies, but the Canadians are angry. The U.S. is going to see a far less cooperative Canada going forward.
Where Does the G-7 Go From Here? There are, in fact, a lot of "Gs" out there. There is the G-7—once the G-8. Then there is the G-20 and on occasion even the G-50. These are not really all that formal as far as organizations go although they all have their staff and support. The G-7 is considered to be the "rich nation's club" as it contains the dominant economic players in the world, or at least it used to. It is made up of the U.S., Canada, U.K., Germany, France, Italy and Japan. Many wonder why Italy is still in the club given the collapse of that economy and wonder why nations like South Korea or Australia are not. Russia was once part of the group; it was called the G-8. But adding Russia was an acknowledgement of their political standing and not their economic contribution, so why not China, India and Brazil as well. In short, there is a lot about the G-7 that is arbitrary. Over the last few years, the more diverse G-20 has taken on more significance as it includes the G-7 plus Argentina, Australia, Brazil, China, India, Indonesia, Mexico, Russia, Saudi Arabia, South Africa, South Korea, Turkey and the EU as a whole. For the most part, meetings of the G-7 attracted the attention of policy wonks and the press, but few others even noticed. The statements were pretty bland. There was rarely any real debate or division—quite unlike the spirited and often angry exchanges at the G-20.
Analysis: What does the G-7 do post Trump? It is not that the U.S. is planning to pull out, although with President Trump that could happen. The comity that marked these meetings has been shattered. Those who attended are reported to be alternately stunned, confused and truly angry. Does this mean the end of business as usual for the group? In some ways it does and in others not really. In the aftermath of the showdown, there was immediate talk of becoming the G-6. That could be a possibility although without the two largest economies in the world, it would be hard to assert it had anything close to the clout it once had. Three scenarios are developing at this early stage.
Scenario one holds that Germany seizes the moment to assert itself further in the world. It arguably has an economy that is large enough to play an expanded global role, but it is not clear the Germans want to. It has balked at playing that role within Europe itself as it chafed at rescuing the Greeks and the other states on Europe's southern periphery. It would be hard to imagine Germany playing the global role the U.S. played, but as the U.S. seems determined to withdraw from all that into isolationism, there may be an opportunity for limited German expansion—especially if the French back them. Right now, Germany has the support of Emmanuel Macron. How long this cooperation lasts is anybody's guess, as at some point, these leaders step down and could be replaced by those who question the cooperation between the two.
Scenario two is a bit radical but has come up. As the U.S. seems bent on alienating its allies and striding away from Europe, there is a gaping hole in terms of global leadership. It is one that China is eager to fill. It is highly unlikely that China would be invited to join the G-7 (or G-6), but it is not out of the question if the conflicts with Trump continue. The U.S. would have to quit the group as it takes a unanimous vote to bring a country in, but that is not out of the question either. This would drastically change the makeup of the group, but if the U.S. moves too far from its former allies, the desire might be too strong to resist.
Scenario three is the most likely of the three, although it is pretty murky. It basically consists of the members trying to accommodate and mollify the U.S. They are all well aware that Trump is not the only player as far as economic and trade policy is concerned. They know they have allies in Congress. They also know that no president is forever. At some point, the U.S. will have a different one. It is not in their interest to cut off their nose to spite their face. They will do what has to be done to work with what they have. It will not be the first time there has been an awkward moment. The relationship between G-7 members has been strained before—Silvio Berlusconi of Italy, Jacques Chirac of France, Stephen Harper of Canada and several Japanese prime ministers have had their disagreements. No moments quite as blunt as this one, but in some ways more serious.
Central Bank Divergence There have been many remarkable developments as far as central bank policy is concerned over the last decade. The most remarkable has been how closely the world's dominant banks have been following the same script. They raised rates at the same time and lowered them dramatically at the same time as well. The economic conditions favored this kind of cooperation, but there has been considerable divergence since—especially between the U.S. and Europe. This has already affected the pace of interest rate adjustment and will continue to do so.
Analysis: The U.S. Federal Reserve will hike rates by another quarter-point today. They will very likely signal that another hike will be forthcoming in September and maybe even another one by the end of the year. The European Central Bank (ECB) has been suggesting the time has come to slow down on stimulating, but there are no plans to start hiking rates right away as they will start with reducing the bond buying and other measures. The rates will be quite far apart for a good while to come. That will have an impact on the markets as investors will have that much more interest in the U.S. due to the higher rates. The divergence is expected as the economic growth in the eurozone has not been as robust as the growth in the U.S. and there are many countries that need the kind of economic boost provided by the ECB of late.
Should We Get Excited or Hopeful? I am compelled to remind people of a couple of things before I proceed to offer my assessment of the summit between President Trump and Chairman Kim Jong-un. I am a creature of the Cold War as I started my graduate school career with a major in Soviet and East European Studies. To me, the USSR was really and truly the Evil Empire and my distrust of similar communist regimes was intense. Life was simple then—we had clear enemies and clear allies. You were either in the communist bloc or you were in ours. North Korea was and is firmly in that communist bloc and has been for decades. The other issue to bring up is the vicious nature of that regime. The Kim family is ruthless to an extreme. This is not a "reform communist" on the order of Gorbachev or a Deng Xiaoping. He has been a tinpot dictator his entire life. The bottom line is that President Trump may trust him, but I don't. In the grand scheme of things it matters not at all what I think as this four-hour summit was judged to be a moderate success by analysts.
Analysis: The best-case scenario was to have Kim arrive with a plan in hand to give up his nuclear ambitions. This was not really expected by anybody, but it would have been a bold move and would have shoved the ball into the U.S. court. We would be reacting to that plan and would be criticized if we judged it too harshly. As it turned out, there was no plan and not even much conversation over what the future plan might look like or when it would arrive.
The worst-case scenario would have been for Kim to have set a trap for the U.S. He could have called the meeting off at the last minute or he could have spent the entire meeting railing and ranting against the U.S., but that did not happen. By all accounts, he behaved like any world leader and traded platitudes and vague assurances. There was much mutual gushing as Trump referenced how talented Kim was and Trump was hailed as heroic by Kim.
Now we have a start, but nobody is really sure for what. Trump made no demands and Kim offered nothing concrete, so the next step is more talking. It appears the U.S. will make the first gestures by lifting sanctions and putting together aid packages while declaring an end to joint military exercises with the South Koreans. This gives Kim an immediate victory without having to make any concessions of his own. The majority of the analysts with a history of assessing the North Koreans were very disappointed as there was none of the tough talk President Trump promised. All Kim promised was a vague goal of denuclearization with no timetable and no specifics. A far cry from the "trust but verify" mantra of the Reagan talks with the USSR. I am not inclined to believe that Kim has changed and I fully expect North Korea to wiggle its way out of any real commitment while milking his newfound friends for all that he can get.
The Cost of Violence Brazil has been beset by violence over the last few decades—something it unfortunately shares with many nations in Latin America and the world for that matter. This has been enough of a concern that the government commissioned a study to determine just what these crimes have been costing the country. It is always awkward to try to break down the impact of murder to dollar terms as the tragedies are far more intense than these costs would indicate. However, the goal of the government is to get the business community to engage and commit to fighting the violence. It is also a motivation for those that are more concerned about the economic progress of the country.
Analysis: The report suggests that murder alone has cost over $120 billion in lost productivity. To put this in context, this is more than was spent rebuilding Europe through the Marshall Plan at the end of the war. This is over 4.3% of the country's total GDP and a massive drain on the urban areas. This does not count the cost of increased police and military presence to try to deal with the scourge. The government would like to take more aggressive steps to end the killing—everything from more police to more use of conflict resolution techniques. Over half the murders are committed by people who know one another and are very often in the same family. The rest of the killings are dominated by drug wars and conflicts between gangs. The money required is significant, but the loss from the crime is more expensive yet.
Conversations I might have mentioned once or twice that I am always delighted to get into conversations with the people who attend the meetings I address. I confess that I often steer the topics to areas that I want to know more about—the industry scoop as it were. Either that or I am gathering ammo for this publication. Yesterday, I visited with an old friend who avidly reads this newsletter (Yes, there ARE such people). He often shares comments by email, but it is not as satisfying as being able to have lunch with him. There was the added bonus of meeting his wife and talking with her as well.
One topic stood out and seems appropriate to discuss. He and his wife share a trait with me and my wife. We really genuinely respect anyone who puts in a good day's work and believe that every job is an important one. I recalled a book by one of my favorite economists (Dave Colander) entitled Why Aren't Economists as Important as Garbagemen? Frankly, you would miss the guys that pick up your trash far sooner than you would miss me. I get lots and lots of attention for what I do. I definitely appreciate it, but I doubt that anybody has a kind word for the trash guys or the people who are trying to keep the airports clean. I suspected that Dave was the kind of guy that acknowledges everyone and I was right. The amazing part is that it is so rare and yet so simple to do. A kind or supportive word takes seconds and may make a person's entire day. At the end of the day, we need more people like Dave and not just because he reads this publication a lot.