Strategic Global Intelligence Brief for June 13, 2018

Short Items of Interest—U.S. Economy

Producer Prices on the Rise
Yesterday, the news from the consumer side of things indicated that there was reason for concern about the rise of inflation. Now, there is support for that notion from the producer price index as well. The rise was by 0.5% over levels seen in May, above the estimate of a 0.3% hike. On an annual basis, the inflation rate is 3.1% higher than it was last year at this time and is higher than it has been since 2012. This data comes as the Fed is meeting to consider a rate hike. There is nothing to dissuade them at this point. There are even those who think the Fed could surprise with a half-point hike, although that opinion is in the minority among economists and other analysts of Fed activity.
Borrowing Costs Are Rising
This should certainly come as no shock to anyone, but as the Federal funds rate rises, so do the rates on everything else. There is never a direct connection in that a quarter-point hike by the Fed causes an immediate quarter-point hike for the prime rate or for mortgages. There are other factors that affect mortgages, car loans, credit cards and the like. The Fed moves usually trigger a lot of other reactions—that has been evident all year. All debt has become steadily more expensive. The main concern now is whether this will slow the economy in the near future. It almost has to as higher-priced debt will crowd some out of the market.
Merger Mania Returns
This has been a busy year as far as mergers and acquisitions are concerned. That will likely be the case for the remainder of the year. Part of the impetus has been the tax cuts and the windfall that landed in the corporate pocket. The second motivator has been the desire to make up for the slow years, leading companies to want to expand their market share. The quickest way to that end is to buy up competition or at least a corresponding business. The atmosphere is not quite as crazed as during the last boom, but the activity has already exceeded the pace of the years since the recession.
Short Items of Interest—Global Economy
Asian States Move Quickly on North Korea
The other Asian nations are not wasting any time in making their own overtures to Kim Jong-un and the North Koreans. The South Korean leadership is center left and was placed in power in part because it advocated an open relationship with the North. Japan has suddenly jumped on the bandwagon and may try to arrange a summit of its own. China has been wildly enthusiastic—especially regarding the potential lifting of sanctions. The truth is that rapprochement with North Korea will do the U.S. very little good economically, but Asian states will stand to sell a great deal to the North Koreans as the Kim regime will have plenty of U.S. aid money to do that buying. The country that stands to benefit the most will be China.
What Is in a Name?
It seems that quite a bit rides on the name of the country that sits just north of Greece. The decision by the new state to change its name from Macedonia to the Republic of North Macedonia ends a great deal of tension between it and Greece, and opens the way to joining both NATO and the EU. The northern province of Greece is Macedonia. The Greeks have refused to recognize the country to the north as Macedonia despite the fact it held that name when it was part of Yugoslavia. The historical significance of "Macedonia" is huge as far as Greece is concerned. Now everybody seems to be happy enough.
A NAFTA World Cup?
United 2026 has won the right to host the 2026 World Cup. That means the U.S., Canada and Mexico will co-host the event. It has not been worked out who gets what—that will come later. For now, the mission of these three states will be to ensure their national teams get into the competition with a reasonable expectation of doing well.
Breakthrough or Height of Being Naïve?
To be fair, the world of diplomacy and politics is full of hyperbole and grand statements. This is the world as defined by sound bites after all. Even so, the statements made regarding North Korea strain credulity. President Trump's declaration that there was no longer a nuclear threat from North Korea may go down as the most naïve statement since the fabled "mission accomplished" declaration by Bush during the early days of Iraqi involvement. The North Koreans have done absolutely nothing to this point. There has been no inspection of their nuclear facilities and not even a promise to allow such an inspection. It is unknown how many missiles the North Koreans have. Nobody knows if they already have nuclear capability with those missiles, although it has been assumed they do. Kim Jong-un has made no pledge, made no promise and has not outlined anything approaching a verification system. The contrast between Iran and North Korea is stark on this point. Iran has complied with every aspect of their nuclear deal and has allowed unfettered access to everything connected to these weapons. Still Trump elected to call off the deal. Kim has agreed to nothing and has the deal of the century.
Analysis: The Kim regime has all that it wanted and more. The dictator who was a global pariah just a few months ago now rates a personal summit with the U.S. president. The U.S. has called off any military exercises with the South Koreans indefinitely. This seems to ignore the fact that North Korea's conventional army is massive and threatening. The exercises have been directed at the fact that North Korea has an air force of over 458 fighter planes, 516 attack aircraft, 5,000 tanks, 9,335 armored attack vehicles, 4,330 artillery pieces and over six million people in the armed services. Nothing at all has even been hinted at as regards reducing this capability. These assets dwarf those of South Korea. That nation would be overrun in a matter of hours if the U.S. was not present as an ally. Now, we are an ally with no experience of supporting the South Koreans.
The North Koreans have stated the U.S. is going to lift sanctions, but thus far, the U.S. has only hinted at this. Should this be the case, the North Korean leader got the grand prize without offering a thing in return. The U.S. has not extracted a promise as to who North Korea sells to either. In the past (all of five months ago), the North Korean government was accused of selling arms and technology to elements of both al-Qaeda and ISIS. They have consistently been willing to sell weapons and technology to any who request them. There has also been ample evidence of their engagement in cyber warfare.
It is a mistake to look at the travails of the North Korean economy and conclude that this is a wholly backward state. As the USSR was once described—it is a third-world economy with a first-world military. All the emphasis goes into the military with a budget of $7.5 billion. The country carries a $5 billion external debt. The armed forces account over half of the national budget. The latest weapon of choice has been the cyber-attack. There have been many high-profile assaults on South Korea as well as the U.S. There is even evidence of collusion between North Korea and criminal operations that are seeking financial data.
It is quite right to assert that talking and promising more talks is better than threatening one another with nuclear annihilation, but there has been nothing to reduce the threat thus far. Perhaps Kim really has had a change of heart and wants to be a world citizen, but it is also very likely that he got all that he wanted and now plans to keep developing his offensive capabilities in secret so that he maintains even more leverage.
Why AMLO and Why Now?
It has been asserted the third time is the charm. That certainly seems to be the case for Andrés Manuel López Obrador (AMLO). He has run for the presidency in Mexico twice before this effort and lost as the bulk of the population did not seem ready for a firebrand leftist. This time around, he has toned down that radical rhetoric, but the country he now appeals to is different. The fact is that Mexicans are fed up with drug violence, corruption and have lost faith in the old political elites. The base of AMLO's support is the poor rural areas as has long been the case, but now he has been able to appeal to the young in a nation where the median age of the population is 27.
Analysis: His rhetoric is less radical, but the basics have not changed. That is what worries many in the business community as well as the analytical community. It is a populist agenda along the lines of what has been developed in Europe. There is lots of social spending and loading up on debt to do that spending. It means heavier taxes on the business community, which could trigger some dramatic reactions when one combines that pressure with U.S. tariff threats. It is possible that companies elect to leave Mexico.
Death and Taxes
It has been asserted that nothing is certain in this world other than death and taxes—a comment first attributed to the venerable Benjamin Franklin. Although great strides have been taken to delay that inevitable demise, there has not been a registered case of immortality. Taxes, however, are not always quite so certain—they occasionally disappear. At least some of them do. The city of Seattle had this great idea as to how to combat the problem. They planned to extract a higher tax from the big companies such as Amazon, Starbucks, Microsoft and others. The logic was that these growing companies had been attracting a lot of people to Seattle and that had strained the ability of the city to keep pace with needed infrastructure such as housing. Therefore, these companies should be forced to pay a high tax. Consider the implications of this move. As a reward (punishment) for bringing jobs and economic growth and revenue to the city, the companies responsible for this expansion get to pay even more in taxes. It somehow never occurred to the leaders in this city that these companies would take this move as hostile and would find ways to move away from Seattle at their earliest opportunity. This is what the affected companies made clear to the Seattle authorities. Suddenly, that tax plan was voided.
Analysis: This brings up the bigger issue as far as taxation is concerned. What, really, is the purpose behind taxation and to what degree should the system be asked to do more than what it is designed to do? The function of a tax is simple enough, while the execution is immensely complex. It is simply the means by which governments raise the money needed to carry out the functions demanded by the public. If there are many demands for government services, the tax take will have to be commensurately large. If the public would rather not pay much in the way of taxes, they will have to be content with less service. The fact is that there are wide gulfs between those who want low taxes and limited service and those who want lots of service and are prepared to pay for it. There are also two basic approaches to budgeting and taxing. One starts with the level of taxing tolerated by the public and then decides what can be done with that amount of money. This is most familiar to the average person as that is how most of us do our own budgeting. The other alternative is to figure out all the things that one's government wants to do and then figure out how to get that money from the taxpayers.
Where tax issues get really convoluted is when taxation is used for some kind of social engineering. We tax things that have been deemed bad for people at a very high rate so that people will be discouraged from engaging in that behavior. Cigarettes are bad for you and carry a major tax as does alcohol and recreational drugs where they are permitted. Other tax schemes are designed to encourage good behavior—tax breaks for going solar or for contributions to worthy causes. Still other tax ideas are designed to balance economic realities so that poor people pay less and rich people pay more—a means to balance out incomes and economic status. Needless to say, there is intense controversy over any of these attempts. Taxing cigarettes makes perfect sense to those who don't smoke, but critics point out that many smokers are poor and thus this tax burden falls heaviest on them. The income distribution argument raises even more hackles as it seems that those who work hardest are the most penalized.
The Seattle challenge is typical of many cities. The idea of rapid growth is very appealing. Every city is doing its best to be good at this development. Most business has been attracted to a given city by incentives and deals. Amazon is busily "auditioning" cities all over the country as it decides where to put new facilities. The expectation when a company sets up shop in the city is that their contribution to the city or region will be largely indirect. They certainly expect to pay something in terms of property tax, sales tax and the like, but they will seek ways to reduce that burden. The real significance is the contribution made by their employees as they buy houses, food, furniture, restaurant meals and so on. They also pay income taxes and all the other fees that a given city manages to come up with. That Seattle wanted to go beyond this and assess the big companies for their contribution to growth was taking things to an extreme and presented the city with unpleasant options.
Development is a double-edged sword. Many communities seem to forget this inherent truth. It is certainly positive that growing companies bring jobs and activity, but there are also the demands for support. There will need to be more roads, sewers, schools and more police and fire protection services among many others. The city may not be ready for this success, but that is hardly the fault of the business community that was asked to invest and grow.
Speaking of Taxes and Government
The budget deficit is 66% wider than it was a year ago at this time. We can thank the tax cuts for this development. This is not to say that the cuts were a bad idea as one can also attribute a certain amount of the growth in the U.S. to those corporate cuts. The critique offered at the time was that these cuts would make the debt and deficit issues worse, and they have. The main reason for the increase in the deficit by 23% has been a reduction in revenue for the government. It is presumed that at some point overall economic growth will become so robust that this revenue shortfall will be reduced, but that is asking a lot from an economy that traditionally grows at around 2.5% per year.
Analysis: The estimates vary a little, but it is asserted that in order for the U.S. to organically grow its way out of these high levels of debt and deficit, the economy must be charging along at a rate of 4.5% to 6% per quarter for an extended period of time. There are many who assert that it would take growth at more than 7%. The U.S. has not been anywhere near that for many decades.
Back by Popular Demand—Cat Stories!
I am not kidding—there was actually demand. Granted, this demand came from only a few of the loyal readers, but these are people of substance. Who am I to deny that request? In truth, this will be a story of other people's cats as much as mine. One of the bonuses of traveling to where people have read this publication is that many share their cat stories and pictures—always a delight.
There is the guy who had made gentle fun of me for years as he was a devoted dog guy. He always asserted that the canine was far more suitable than the feline. That was before his daughter returned from college with a recently rescued kitten that she promptly dumped on mom and dad. He originally declared the cat would soon find a new home unless the daughter kept him. That pledge lasted less than a week. I saw the pictures of this white fluff ball as snuggled as only an animal can—wrapped around his neck. He stated that he could never really get his dogs to be that loyal to him—they would always jump fences, ignore him when he called and basically behave like slightly bored roommates. Not so the cat. It's a constant companion, 24-7. Runs to greet him at the door, comes when she is called. Loves to ride on the motorcycle in her own little bag on his chest. That little fluff ball is growing fast and will soon be a 20 pounder with long white fur.
Not to be outdone, another recent convert told of his new cat. It's a stray that just showed up last December—cold and sick. After nursing him back to health, the guy who never wanted any kind of pet now belongs to a very handsome ginger cat. He always thought about getting a guard dog, but never bothered. Now he has a guard cat. The guy's brother decided to show up unannounced one evening and thought he would quietly enter and crash on the couch. The ferocious growling and hissing ended that quiet part. When the cat's person arrived on the scene, he saw his brother standing on the coffee table in mortal fear of the angry and protective collection of teeth and claws. The minute he assured his cat that the brother was OK he switched to purr and play mode.