Strategic Global Intelligence Brief for June 20, 2018
Short Items of Interest—U.S. Economy
Recovery in Housing Starts
For the last few months, there has been a steady drumbeat of concern as regards the state of the housing sector. It has been assumed that past patterns would start to manifest at some point—the headwinds that everybody seems to talk about. Higher home prices and higher mortgage rates would have an impact at some point—surely they would. The month before last it appeared that this point had been reached, but now we have last month's data and the news is better than it has been since 2007. The best news was that there was more activity in parts of the country that have not seen all that much this year. There was also a surge in apartment construction again. Even with all the activity of the past year, it is estimated there remains a shortage of 20% to 30% in terms of available housing in the hotter markets.
Markets Worry About Trade Tensions
Up to this point, there has been relatively little reaction to the trade tensions as far as the markets are concerned. There has been a persistent belief that most of this has been for show and Trump would not actually follow through with the more draconian threats. Now that it looks like there is not going to be the expected level of restraint, the implications of an all-out trade war are sinking in. It worries the markets to the point there has been some serious decline. Granted there are those who have asserted the markets are overvalued and due for a correction, but that may also mean this decline will be more serious and long lasting.
Senate Rebukes ZTE Deal
One of the more perplexing moves made by Trump as regards China was his decision to reverse the restrictions imposed on ZTE—the Chinese telecom company. ZTE was in flagrant violation of the sanctions that had been imposed on North Korea and Iran. President Trump declared he would help save these Chinese jobs, but the Senate was not so inclined and has rejected the deal. However, the House version of the legislation this was attached to did not kill the deal. Now, there will be a battle over which version prevails.
Short Items of Interest—Global Economy
Migration Crisis in Europe
The group that has been charged with developing a solution to the migration crisis is unlikely to meet that challenge and will instead be an opportunity to vent on all sides. Nothing has divided the EU this thoroughly in decades. The states that oppose more accommodation for the migrants are deeply opposed by those that want severe crackdowns. There appears to be very little room for compromise. Behind the immediate fear is that any sort of accommodation will encourage even larger flows. The Europeans are simply not prepared to host any more.
Plummeting Faith in U.S. as Far as Australians Are Concerned
Australia has long been faced with a dilemma of sorts. They are isolated in a number of ways. Physically, they are distant from most, but there are also deep cultural differences with their neighbors. It has long been a choice as to which nations they should be closest to—Asian states like China and Japan or the U.S. and the U.K. For years, the preference was for the U.S., but that support has nearly collapsed since President Trump came to office. Now, the majority want more emphasis on China and Asia and far less on the suddenly unreliable U.S.
BRICs and Corruption
Once upon a time, the nations that made up the BRIC states were united by their potential to grow. Brazil, Russia, India and China were the future. That seems a long time ago now that all four are struggling to one degree or another. They still have something in common though—they are among the top-10 most corrupt nations in the world. Since they have been more engaged in the global economy, corruption has steadily worsened.
Who Has the Edge in Trade War—U.S. or China?
It needs to be asserted that the majority of economic analysts assert that nobody "wins" a trade war. The fact is that companies and consumers become the unwilling warriors in such a conflict. They are the ones who suffer and occasionally gain. If there are exports and imports between nations, it automatically means there is demand for the products and services that are being sold. The consumers of a country are getting products they want at a cheaper price, manufacturers are getting the commodities and parts they need. Many companies make a lot of money selling to the world market, but many companies find they can't compete against that foreign supply and they go out of business. There are winners and losers no matter what—no nation wins or loses entirely.
Analysis: China has been a vexing and tantalizing trade partner for many decades. It has allowed many U.S. companies to make millions and it has put many U.S. companies out of business. The nations that have lost the most to Chinese competition are those that are most like China—other low-cost producers. It was not that many years ago that a trip through a U.S. consumer's house would reveal a lot of supplier nations. When I was a professor in the 1990s, I had students make a list to determine how many countries were represented in their possessions. The average was 36 with China accounting for perhaps 20%. By the end of that decade, the average number was less than a third of that and China accounted for almost 75% of all the imported goods they owned.
In the early days of Chinese exports development, this was looked on very favorably as it meant that the isolationist policies of Mao Zedong were giving way. The western states were confident that more economic interaction with the rest of the world would speed reform politically. At the time, there were few who anticipated the arrival of Chinese-style capitalism—a system that combined the freedoms of the market system with the tight control of community autocracy. During those early years, the Chinese market was the ultimate lure—"If each person in China bought just one item—we would be rich beyond the dreams of avarice." In the beginning, the western states had the advantage and China was exploited in the same way all developing states have traditionally been exploited. China learned fast, however, and soon realized it also had leverage and could use it.
Today, China is an enigma in many respects. It is simultaneously a developing nation with a very large and very poor population, but it is also a modern, middle-class nation that can produce at the same level as the modern states. The middle-class population is as large as the entire population of the U.S. (around 350 million) but that leaves a billion people who are still poor. It is the world's second-largest economy, but is almost totally dependent on exports for its growth and survival. Over the years of its development, it behaved like most other poor nations with extensive protection for the domestic economy and plenty of incentives to build an export juggernaut. There is no question that China has far more in the way of trade barriers than the U.S. ever had. The domestic economy in China is well protected and insulated from the modern world if the Chinese want it to be. The U.S. and the rest of the world have a point when it comes to assessing Chinese trade policy—it is not a level playing field and it never has been.
During previous periods of negotiation, there have been assumptions regarding how these talks were to be conducted. There was an assumption that one must never cause the Chinese to "lose face." This would only intensify their resistance to the direction one wanted them to go. This led to lots of what appeared to be fruitless talks. It long seemed that China was getting the best of the U.S. and the world. In fact, the Chinese gave up things as well—perhaps more subtle things. China remains an autocracy, but years of being driven in part by the market have changed the country with more assertive business people and consumers. It is not quite the transformation picture at the start of Deng Xiaoping's reforms, but total control of China is no longer in the hands of the communist party.
President Trump's position is that the U.S. can win this war—that the edge belongs to the U.S. because China needs a market to sell its exports to. This is true, but China can sell to other countries as well. More importantly, it has been the goal of the Xi Jinping regime to see a more active Chinese domestic consumer so that exports are not as crucial as they have been. This trade war plays into the hands of the Chinese as they can now make buying domestically an issue of patriotism. That is exactly what has started to happen. The U.S.-made product once had lots of cache, but those days are over as the average Chinese consumer is now very angry with the U.S. and its perceived bias against them.
Oil Wars Fought in Earnest
If there was any doubt as to the state of tension within the ranks of OPEC, these latest meetings put an end to the speculation. The organization is as divided and contentious as it has ever been. Even those states that are not part of OPEC have been profoundly affected by the state of interaction. There have always been built-in tensions that stem from the diversity of the membership. There is nothing these nations have in common other than that they are all oil producers. There are very rich oil states that have quite ostentatious lifestyles fueled by oil and there are very poor states who have their entire budget tied to the per barrel price. There are states that despise one another forced to cooperate in the context of oil policy. There are nations that are very close to the U.S. and Europe and those that have very deep enmity towards the places that buy the majority of the oil they produce. Then, there are the states that are not members of OPEC, but who sell oil and are deeply affected by the decisions made by the cartel. Right now, every single division within the ranks is on full display.
Analysis: Perhaps the most intense confrontation is between Iran and Saudi Arabia. The divisions between these countries are as deep as any could possibly be. The Iranians are Persians and the Saudi ethnicity is Arabic. Over the centuries, the Persian Empire oppressed the Arabs, which only compounds the differences caused by religion. The Saudi Kingdom is the seat of influence for Sunni Isla while Iran is the heart of Shiite belief. They are apostates to one another and conflict between them has lasted centuries. The two nations are fighting proxy wars in Yemen as well as Syria and there have been terrorist attacks launched on each other. The split between states like Venezuela and the Gulf Oil producers like Kuwait and Abu Dhabi and others are stark as well. The one thing that can unite these disparate communities has been the price per barrel of oil. It was universally held to be too low a couple of years ago when it was languishing in the 40 to 50 dollar range. All agreed to reduce output as a means by which to get these prices up. Russia threw its support behind this strategy as well—even though it has never been an OPEC member.
Now that oil prices have nearly doubled to $80, the Saudi position has been that production should start up again and keep that price from going any further. It is not that they are averse to making more money on their oil and it is not because they have become a stooge for the U.S. as the Iranians have been asserting. The Saudi Arabian Oil Ministry is well aware of the fact the U.S. has become the world's largest oil producer (when they want to be). At around $90 to $100 a barrel, the U.S. shale oil producers kick into high gear and start taking a large share of the market for oil away from Saudi Arabia and other OPEC states. They do not want to invite that competition by allowing prices to rise too far and too fast. Iran doesn't see it this way as they think demand will hold steady enough to support the higher prices. They also have no desire to cut the U.S. a break on anything—especially the price of crude oil.
Russia will be the dealmaker here. Right now, they are siding with the Saudi position and are preparing to increase their production to levels last seen two years ago. They have much the same motivation—a desire to keep the U.S. oil producers on the sideline to some degree.
Global Immigration Crisis
It was roughly 20 years ago that the intelligence agencies around the world began to sound an early warning. Report after report stated that migration would be the preeminent security threat for the future, and for the simplest of reasons. The economic pressure on the poor populations of the world was getting more intense with every year. There would be less food, fewer job opportunities, more wars and civil conflicts. At the same time, there would be majority populations under the age of 30. These deprived people would become desperate enough to risk everything to move to a richer nation (Europe, U.S. and others). The warning was not heeded and that time has arrived.
Analysis: At the time of the reports, it was made abundantly clear that no nation would be able to keep its borders secure from migration pressure unless extremely draconian and expensive steps were taken. Even these would fall short given the pressure to leave. The reports made it clear there was only one real solution—give people a reason to stay where they are. The strategy would be to help these nations develop economies that could support their own populations. This would be coupled with efforts to build security that allowed people to feel safe in their own lands. Very little of that strategic effort has ever taken place.
Consumers in U.S. Start to Feel Impact of Tariffs
The first round of tariffs were aimed at products that would only impact the U.S. consumer indirectly. These are the goods that are mostly sold to U.S. businesses—parts, assemblies, commodities and the like. This is nearly always the strategy employed when the U.S. imposes tariffs and other trade barriers as there is a strong desire not to upset the consumer enough to apply political pressure. The second round of tariffs is going to hit the U.S. consumer far harder as the majority of what is imported from China is consumer goods. That means that price hikes will be swift and obvious.
Analysis: Several areas will be hit the hardest. These are likely to provoke some consumer response. At the top of the list will be electronics of all kinds. The price of phones, computers, TVs and the like will rise almost immediately. The clothing sector will likewise feel an immediate pinch and so will toys. Furniture will see a major price jump as well as smaller gift items. The threat to the retail sector in the U.S. stems from the fact that many of these items are anything but necessities and consumers will abruptly stop buying them in the quantity they once did. That stresses an already low-profit-margin sector to the point of failure.
Drat! Missed Another One
I really do take my responsibilities seriously and know that I have loyal readers who look forward to the newsletter each day—if only to line their parrot cages. It pains me when my schedule conspires against that regularity. It is almost always a travel problem when I miss an issue. For example, the missing June 19 edition was due to another high-risk move. I had a program to do in Minneapolis at 2:30 and my flight left at around 10:00 from Kansas City (KC). Amazingly enough, I made it. But that was as long as luck would hold. I had to be in Indianapolis that evening. That meant a flight out at 6:30 and a plane change in KC so that I arrived at 11:45. That was bad enough, but I calculated I could write a bit on Monday and still finish up on Tuesday morning.
That was before the two and a half hour delay in KC and threats to cancel the flight. Now I arrive at 1:45am and still had to be in Bloomington by 8:00am. That morning window to write slammed shut as I tried to grab three or four hours of sleep. So it goes in the travel world these days. Those weather-related delays are impossible to predict.
On the other hand, these events give one an opportunity to see people at their best (as well as at their worst). Normally the KC airport is basically shut down by 10:00pm or so. Not many flights scheduled past that hour. But here we were—a planeload of sleepy people unable to depart until close to midnight. All the eateries and snack bars shut down except for the Starbucks next to the gate. The manager sent the staff home and prepped the place to close, but elected to keep the coffee coming as long as we were all there. He stuck it out for two extra hours and scored some points for Starbucks in the minds of the weary traveler.
