Strategic Global Intelligence Brief for June 21, 2018

Short Items of Interest—US Economy

Supreme Court Reverses Tax Decision
The Supreme Court has overturned a previous decision on whether states can tax internet retailers. The old law said that states would not be able to collect sales taxes on an internet-based company unless that company had a physical presence in that state. Now, the law will allow states to collect from any internet seller that has sold in their state. This has been deeply opposed by the big (and small) internet operations as far too complex and unfair since they would be getting no benefit from the taxes they pay to the state. The states are wildly enthusiastic as it will mean a windfall of revenue, while the traditional brick-and-mortar stores see this as evening out the competitive landscape.

Impact of Higher Borrowing Costs
At some point they will have to. The rate on a mortgage loan is now as high as it has been since 2013—standing at 4.54 for a 30-year fixed. Credit card rates will move up by a point or two and so will car loans and most everything else. It would be assumed this would be enough to damage consumer enthusiasm, but thus far the impact has been minimal. The last time inflation started to make an appearance, the consumer was hit hard and fast, but this time, the average consumer has been less leveraged. That eases the pain somewhat. That said, these interest rates will only be headed up this year and at some point, they will bite.

U.S. Leads in Global Growth
Last year, the global economies were experiencing a rare period of unity. The U.S. was growing and so was Europe, Japan, China and pretty much everybody else. The International Monetary Fund (IMF) and Organization for Economic Cooperation and Development (OECD) were both gushing over the fact that the recession impact had finally started to fade. Now that golden moment seems to have vanished as Europe is back to struggling to get past 1% growth and Japan is starting to sag again. The U.S. has maintained its growth pace, but even here, the days of 3% GDP expansion seem to be in the past. These numbers were last seen in the second and third quarters of 2017. Since then, the pace has been closer to the norm over the last decade—2.5%

Short Items of Interest—Global Economy

U.K. Split by Brexit Still
All of the major and minor parties in the U.K. continue to split over how to deal with the Brexit issue. There are pro-European factions in the Tory and Labor parties, and they are locked in bitter battle with one another. These differences are enough to create issues for the leadership of both. Prime Minister Theresa May is losing her authority as neither faction supports her middle of the road position. Meanwhile, Parliament Member Jeremy Corbyn was handed a significant defeat by the pro-European part of the Labor Party. Even the smaller parties such as the Scottish Nationalists are facing internal fights.

Anger at U.S. Doesn't Necessarily Stop With Trump
Many nations and their leaders are angry and frustrated with President Donald Trump and have not been shy about it. His antipathy towards those the U.S. once called allies is shared by the nations he has attacked. It has been assumed by those who dislike President Trump in the U.S. that the U.S. will be able to rebuild these relationships once he is gone, but it is unlikely to be that easy. Everything the U.S. has done that irritates has been brought forward. These nations are looking to cut deals with each other or even U.S. rivals such as China. The U.S. may never regain the influence it once had—even if there is a concerted effort to regain that status.

NAFTA Prospects Dim
It was not that many months ago that many claimed a deal would be struck soon on the subject of NAFTA —few assume this now. President Trump has taken to launching insults at the Canadian Prime Minister while imposing tariffs right and left. Meanwhile, Mexico is likely to get Andrés Manuel López Obrador (AMLO) as the new president this summer. AMLO has already indicated he thinks the talks need to stop until he is in office next year.

What Is Actually Going on With Immigration?
The issue of immigration—legal and illegal—has become the dominant concern in most of the nations of the world. It has been extremely emotional and divisive in the U.S. and Europe over the last couple of years, but it has been just as disruptive in Australia, South Africa, Middle East, as well as much of Africa, Latin America and South Asia. There is no nation on the planet that has been immune to the challenges of human migration. By all accounts, the problems will become even more severe in the future. There are three major motivations for this migration: people fleeing war and violence, people seeking a better life with more economic opportunity, or people fleeing some kind of natural disaster that has rendered their current home unlivable. There are many other reasons for people to uproot themselves, more personal reasons, but these are generally the most salient.
There are also dominant reasons people oppose this migration. The most often cited is cultural concerns. There is deep resistance to the arrival of people who do not share the cultural norms of the country or the region where they ended up. This triggers deep fear and resentment and often veers towards outright bigotry and racism. A second reason for opposition is driven by economic concerns. These reasons range from fears that domestic jobs will be taken by the new arrivals to fears that government aid will be extensive and cost the taxpayer dearly. A third reason for concern is related to the culture issue. There is fear that the arrivals will upset the current political balance and challenge the power of the incumbents.

Analysis: The issue of immigration is immensely complex as there are compelling concerns on both sides. The people seeking a new life or an escape from war and violence have tragic stories to tell, but nations that have become destination states would not be able to handle the influx of people if there were no border controls at all. In addition to these emotionally laden motivations, there is the business concern. This has been an understated one until fairly recently. The U.S. is now facing a dilemma that has been affecting Europe and Japan for at least a decade. There are far more people leaving the workforce on an annual basis than there are people entering it. Right now, the U.S. loses about 10,000 people a day to retirement and on average the economy only adds about 6,000 people. These are very rough numbers based on population growth. There are other ways that people enter the workforce other than being born here and reaching the age that they can be gainfully employed. Immigration is the primary method by which the U.S. workforce will keep pace with demand for workers.

Obviously, the economic rationale for immigration is different than many of the other motivations; the business community is interested in the immigrant that can fill a need. This is not always a highly trained and educated migrant as there are many jobs that need to be filled in the U.S. that simply do not appeal to domestic U.S. workers. These are often in the farming sector, but there are others in various low-paying sectors. It has been argued that immigrants are taking jobs away from those who are citizens, but the evidence has not supported that assertion. Many of the jobs have been rejected by U.S. workers, while those that are high paying are undesirable for some other reason. They may be in less appealing parts of the country or may be jobs that do not offer the money or advancement opportunities that American workers desire. With the unemployment rate at 3.8%, it is hard to assert that American workers with appropriate skills can't find a job. It has also been argued that immigrants willing to work for less will drag down the pay for everybody. That is likely true, but only because business will always seek to lower labor costs. If it is not a foreign labor pool that accomplishes this, the business community will find other ways to lower these costs. In many cases, that has involved heavier investment in technology and robotics.

A number of years ago the CIA and other global intelligence agencies produced a report detailing what they believed would be the greatest threat in the future. At the top of the list was mass migration triggered by disaster, war or some similar emergency. This would result in millions of desperate people seeking shelter somewhere. This is the population that is least interested in assimilation as they did not seek to leave their home country for some notion of a better life. They are likely to be angry and resentful—even towards their new host nation—if they believe that something could have been done to avoid the situation they are now in. The intelligence community asserts this is fertile ground for radical recruiting as these are people who don't want to be where they have ended up and resent the hostile attitudes they are going to encounter.

Solutions Are Few and Expensive
The assessment of the immigration crisis is complex, but there has been general agreement that coping with these migrants once they have arrived and crossed the border is by far the most expensive and complex. Many states have tried all manner of deterrent to keep the arrivals at bay, but that can be extremely controversial.

Analysis: European nations have been using their navies to keep boats from getting close to shore and there have been denials issued. The Italians refused to allow a refugee ship with over 600 people on it to dock. The U.S. has tried making the detention process as unpleasant as possible—part of the rationale behind separating families. The logic is that people who do not want to lose their kids should not break the law and enter the U.S. Other, more long-lasting strategies assert that steps have to be taken to make it easier to stay where they are—political peace, reduced crime rates, better jobs. That's easy to assert, but extremely hard to execute and immensely costly.

Iranian Economy Headed for Trouble
Prices are already soaring in Iran as the sanctions start to hit once again. The decision by the Trump administration to pull out of the nuclear deal and start the re-imposition of sanctions has had an immediate impact. There is real fear the economy of the country will be in tatters again before the year is out. The rial has been plunging in value and people are desperate to get their cash into any kind of hard asset—everything from gold to cars. The stores are still in good shape as far as variety and supply as the economy had been doing well since the sanctions were lifted. However, as prices soar, the consumer will soon be unable to buy much of what is on offer. A collapsed Iranian economy will reverberate through the region and sets up several ugly scenarios.

Analysis: One of the reactions is already playing out. The OPEC members are meeting this week—there has been pressure from Saudi Arabia to start producing at a higher level. This move has the support of the Russians and most of the other oil states in the region, but there is definite opposition from Iran as well as Venezuela as they need the maximum they can get for their oil. Iran can't afford oil prices back to the $40 to $60 range. They will be overruled as the Saudi Arabians have the clout and support, but that hardly means that Iran will go along quietly. They will do their best to grab as much market share as they are able to as they desperately need that cash flow. China buys much of its oil from Iran already. They will likely be offered even more.

The most worrisome scenario is political. Under President Hassan Rouhani, there has been a slow movement towards reform. He has to move very slowly in order not to trigger major opposition from the conservative clerics. He may be president and an elected leader, but the real seat of power is Ayatollah Khamenei and the clerics that surround him. Every effort at reform has had to make it past the clerics. They are more hostile to the U.S. than ever since the abandoning of the nuclear deal by Trump. This confirmed their suspicion the U.S. could not be trusted and that undercut Rouhani. His promise to the Iranian population was that he would bring economic growth and an end to Iranian isolation. The population is thoroughly disillusioned now as they underwent the humiliation of giving in to the U.S. demands and adhered to all the rules only to be rejected by the U.S. anyway. This will likely mean the end of the reformers and will give hard-line politicians a leg up. The U.S. could well have paved the way for the return of someone like former President Mahmoud Ahmadinejad. His policy stance nearly brought Iran to war with Israel as well as the Saudi Arabians. The conservative leaders will make far more trouble for the U.S. than reformers such as Rouhani.
It remains baffling that Trump has found a way to open up to the North Korean dictatorship but not to Iran. Rouhani was elected in a free contest and committed to a policy of denuclearization that included inspections and verification. Kim Jong-un has agreed to nothing tangible at all. Iran seemed far further down the road to disarming, but has been dismissed by Trump.

Steel Prices Rise Fast
It should not have come as a shock, but it apparently took Commerce Secretary Wilbur Ross by surprise. He now promises an investigation. The average cost of steel purchased in the U.S. jumped by 40% at the time those tariffs were imposed. The expectation was that prices might rise by the 25% of the tariff, but such an assumption is the height of naïve. The fact is that these on again, off again tariff discussions coupled with much banter about trade wars made everybody nervous and triggered many to start hoarding steel and other metals. This manufactured shortage allowed prices to rise fast. Those in the steel sector asserted that it was about time.

Analysis: Now Ross thinks this should be investigated and that these operations are being anti-social. The fact is that this is standard behavior when a market is interfered with by government fiat. The prices were artificially inflated. At the same time, nearly every analyst asserted price gouging tactics would be common. The fact is nobody really knows what is likely to happen next with steel tariffs. That has everybody trying to hedge their bets.

It is unlikely that anything will come of these investigations other than to remind the Commerce Secretary how business works when the government sets out to manipulate the market. The assumption on the part of the steel producers is that the tariffs will be lifted sooner than later as they were during the Bush administration. They are doing their best to make high profits while they can and are taking advantage of the strong economy at the moment.

Favorite Things
With apologies to Julie Andrews—my favorite things do not include raindrops on roses (but they do include whiskers on kittens). I rank many of the audiences I speak to as favorites. I have the pleasure of speaking to lots of small business people—owners that are in everything from manufacturing to construction to retail. These are people who really do inspire me and keep me from going off the deep end over our ridiculously broken politics and the sad situation that has engulfed a lot of big companies. These are people who put their hearts, souls and minds in the business and take great pride in what they do. They are excited, committed and determined. They provide the kind of service and attention that we consumers crave. I just love listening to their stories of how they started all this and what still drives them today.

I spoke with a guy a few weeks ago that I will always remember vividly. He was a college athlete and even briefly played pro football. He was injured in a boat accident and became a paraplegic. He was determined to make something of himself no matter what and became a successful lawyer. Later, he started a business that focused on employing disabled vets. But something was still missing. He was with a friend picking out a puppy when he saw a dog at the back of the kennel that nobody was shown. It turned out he was destined for euthanasia as he had been injured by a car and had lost use of his back legs. He took the dog and promptly turned his attention to making mobility devices for injured animals—finding his passion and his patience. The dogs and cats just needed a little help to be the companion they always wanted to be.