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Strategic Global Intelligence Brief for June 22, 2018

Short Items of Interest—U.S. Economy

Major Reorganization Proposed At this point, the plan, as developed by the Trump team, is more a series of talking points since it is the mid-term season and few in Congress have the desire to tackle something this complex and controversial. It bears closer examination as it would shift a great deal of current emphasis. One of the bigger changes would be to combine the Labor and Education departments to focus on workforce development. The complaint over the last several years has been a chronic labor shortage, but nothing seems to have developed at a national level to react to the problem. This would focus education on workforce needs and would link welfare and assistance to developing workforce skills so that people would be able to move off the support system.

Who Gets Hit by New Online Tax Rules? When the states began to try determining how to add to their revenue by taxing internet sales on the big players like Amazon and Walmart, the previous interpretation of the internet tax obligation held that companies with a presence in that state would have to pay. The bigger companies soon had facilities in most of the states and paid anyway. The companies that will be hit now are the small ones that had no facilities anywhere other than their home base. Now, they will have to determine their obligations. It is expected that many sellers will decide not to sell in select states at all as the tax burden would be too high, or it is too hard to navigate the tax rules in that location.

Political Targeting Those nations seeking to impose their own tariffs on U.S. goods as retaliation against the U.S. tariff imposition are being very select about what they choose to tax. The major motivation is political—putting pressure on politicians in the U.S. so they will work to end the practice. For example, Mexico is imposing a tariff on bourbon, not because the country consumes so much of it, but because bourbon is a key element of Kentucky's economy and the Senate Majority Leader is Mitch McConnell from Kentucky. Canada is taxing jam as this will impact Smuckers. They are headquartered in Ohio where Senator Sherrod Brown hails. He has been a big supporter of these tariffs on steel and aluminum. Smuckers employs more people in Ohio than do steel operations there.

Short Items of Interest—Global Economy

Merkel Faces Internal Populist Threat Not only has the Alternative for Germany (AfD) become a political nemesis, now Chancellor Merkel is facing an internal threat as well. Markus Soder is the head of the Bavarian Christian Union and nominal partner to Merkel's Christian Democrats. He is far more the populist than Merkel and has taken advantage of the immigration crisis. Germans have turned on Merkel over the issue. Even those who support her have been urging a far tighter control of the refugees and migrants. Soder is intent on replacing Merkel—an alliance with the AfD is not out of the question.

Turkish Elections Too Close to Call When current Prime Minister Recep Tayyip Erdoğan called these elections, he was confident he would win easily over his opposition as he could point to 16 years of accomplishment. The population of Turkey has not been as impressed as he assumed. The opinion polls now suggest the election is too close to call. If the Republican People's Party is able to hold that lead in the real election, they would hold the presidency as well as control over who the next prime minister is. Erdoğan suddenly looks very vulnerable.

China Lures U.S. Business The Chinese are busily rallying their allies in the U.S. by promising the kinds of access to the economy that had been denied previously. The U.S. business community still sees China as a great untapped resource. Now, China is using their lure as a means by which to put pressure on President Trump and the Congress. At the very least, it reduces the effectiveness of the anti-China message.

Lower Oil Prices?—Not So Fast The Russians and Saudi Arabians decided a year or so ago that oil prices had fallen too low and it was time to intervene in the oil markets by reducing their output sufficiently to put pressure on those prices. The tactic worked as planned and the per barrel price started back up—jumping by around $35 at this point. Of course, there have been other factors that contributed to the rise, but most of the change can be attributed to the decisions by OPEC. Now, the desire on the part of Russia and Saudi Arabia is for these prices to stabilize at the current level rather than continue to increase. This is not because the Russians and Saudis are feeling any angst on behalf of the global oil consumers. They know that two things happen when prices climb too high. The first is that some of the consuming nations are forced to cut back on their purchases. That reduces the ability of the oil producers to expand revenues and profits—even with higher prices. The more important factor is that higher oil prices lure other producers back into competition with the OPEC producers (and Russia). The U.S. is now quite capable of producing all the oil it needs—as long as the price per barrel is right. When it gets to the $90 or $100 level, the oil activity in the Dakotas and Texas will ramp up hard. Suddenly, OPEC producers start to experience a decline in market share. This is the logic that Russia and Saudi Arabia have been presenting to the other members of OPEC.

Analysis: If there were no other issues, that argument would likely have carried the day as every oil producer sees the same connections between high prices, demand and overall market share. But there are other issues, and very volatile ones. In the past, the Iranians may have grumbled and protested the plans put forward by Saudi Arabia, but in the end both nations have placed their oil business in the hands of technocrats. Practicality always seemed to prevail. Not so much this time. Iran is furious with the U.S. over the dismissal of the nuclear deal and they are fighting a proxy war with Saudi Arabia in Yemen. The Iranians are interpreting the decision to ramp up production as OPEC giving in to Trump's demands. In fact, Trump has almost nothing to do with the decision. Both Russia and Saudi Arabia have made it abundantly clear they could not care less what Trump wants. His tweets have once again broken protocol as making these demands openly puts countries in a very awkward position. Neither Russia nor Saudi Arabia wishes to look like stooges doing Trump's bidding. Certainly, Iran wants to avoid this assessment.

Iran wants to keep prices going up because this might hurt the U.S. The truth is that such a move helps the U.S. oil producers, but Iran is quite right that higher oil prices will stir up an inflation threat. This would come at a bad time for the U.S. as there are already several other inflation stimulators at work. Driving up the costs of gasoline as well as other petroleum-based products will damage the U.S. Iran seems willing to suffer in order to hurt the U.S. The Iranians have the right to veto the production hikes as they are founding members of OPEC. They also have the support of other anti-American nations such as Venezuela.

What Frustrates the World About the U.S.? There has been some predictable opposition building towards the U.S. under President Trump. He has not been the most diplomatic of U.S. leaders and seems eager to pick fights with traditional U.S. allies while trying to gain points with traditional enemies. The majority of these leaders have alternated between trying to accommodate Trump to publicly opposing him. The polls throughout the world show the U.S. has fallen fast as a country trusted and respected by others. The real question is whether this is all down to Trump and his bellicose behavior. Looking beyond the headlines it would seem not.

Analysis: Opposition to the U.S. has been building for years, and in many nations. Some of the resentment stems from the fact that these nations have not been a priority for the U.S. That has been a steady complaint in Latin America for years. There is the fact that U.S. economic dominance compromises development schemes elsewhere. The political differences have been significant for decades as many nations have opposed the approach the U.S. has taken in combating terrorism. When countries have joined the U.S. in places like Iraq and Afghanistan, they assert they have not been listened to. There are differences over what kind of government the U.S. and others should be fighting for in these states. The nasty confrontations promulgated by Trump have given rise to the willingness to air grievances that pre-date President Trump. It is likely that the future leaders of the U.S. will try to mend these broken relationships, but this will be no easy task. Once divorced, it is hard for couples to set aside their feelings. The split between the U.S. and its former allies is deep and has involved the public. Voters in these countries are not supportive of a rapprochement even without President Trump.

Conference Board Indicators Rise Again This month, the increases in the Conference Board indicators have been a little less robust than had been the case earlier in the year, but all three are still rising. They signal that the economy as a whole continues to improve despite some areas of decline. There are no warning bells of significance—just some sectors to keep an eye on as they tend to be harbingers of things to come. The leading indicators rose by 0.2% in May after a rise of 0.4% in April. Of the 10 components of the index, two were down. Labor markets and residential construction lagged a bit and pulled the index down from where it was in April. This is no immediate cause for alarm as the index still shows growth, but the consensus view is that there is unlikely to be much additional growth this year as the factors that led to drive expansion are in some decline. The coincident index also rose by 0.2%, also slightly down from April. To round out the data, there was expansion in the lagging indicators as well—up 0.5%. This measure has been more volatile than the other two with gains in April, but a decline in March.

Analysis: The data that makes up the leading indicator index is comprehensive and covers a significant swath of the U.S. economy. It is also useful that the Conference Board does this same analysis for a number of other nations. This allows the U.S. to compare its position with states such as Germany, Japan, U.K., France and the like. The 10 components that are measured are: (1) average weekly hours, manufacturing, (2) average weekly initial claims for unemployment insurance, (3) manufacturers' new orders—consumer goods and materials, (4) ISM Index of New Orders, (5) manufacturers' new orders—nondefense capital goods excluding aircraft orders, (6) building permits, new private housing units, (7) stock prices, 500 common stocks, (8) Leading Credit Index, (9) interest rate spread, 10-year Treasury bonds less federal funds, and (10) average consumer expectations for business conditions. These index numbers capture the primary drivers for the economy, but steer clear of the most volatile areas that would result in some wild fluctuations in the data from month to month.
These are certainly not the only numbers that can be used to evaluate and assess the state of the economy, but this set has several advantages over readings based on a single set of data. These are all numbers that have been collected the same way for many years. That allows historical comparisons. It is not a bad thing to update the way that numbers are collected and evaluated from time to time, but substantial revisions interrupt that historical evaluation. The other advantage to the Conference Board system is that these numbers are drawn from a variety of public and private sources reducing the chances that bias enters into the evaluation.

One of the challenges that consistently complicate the process of analysis and assessment is the current environment regarding trust in data and information. There is an incredible amount of data and information now available with a quick internet search, but the vast majority of what comes up is biased to an extreme. The data provided is manipulated to tell a prearranged story. Anything contradicting that established narrative is dismissed. The fact is that all data deserves to be met with a certain amount of skepticism so that it is completely understood. The environment today has gone far beyond healthy skepticism and has deteriorated into polemic broadsides that assert that only information that reinforced a preconceived notion is to be believed.
The facts do indeed speak for themselves. There are presentations of data that can be trusted—whether it comes from the government or a private research outfit of some kind. This doesn't mean that all interpretation of that fact will be identical. Economics is essentially a mix of scientific analysis and political philosophy. There will be agreement on the facts if they are gathered in an appropriate way, but there will be considerable difference of opinion as far as what that fact means to which group of people. Rising corporate pay for C-level officers will be seen as unfair and exploitative by those who are concerned about the gap in pay between the executives and the employees, while others will see the gap as a testament to the strength of the stock market as most of that compensation is tied to the stock price directly and indirectly. The fact is that there is a gap—why there is a gap and what that means is open to interpretation.

The 'Fall' of General Electric It is not really such a big deal in the great scheme of things, but it is somewhat ignominious nonetheless. It is akin to being booted from the country club because your net worth falls below their threshold. GE has been removed from the Dow Jones list, to be replaced by Walgreens. The stock still trades and the company is no worse off than it was before. It is just that after a hundred years, it is no longer a company whose fortunes seem to drive the market. There have been too many years of decline, bad decisions, sell-offs and the like. The bigger signal is that many of the manufacturing stalwarts of past years have slipped out of these lists and have been replaced by service companies and those in health care.

Analysis: General Electric was once the model for how a company thrived and grew. The basic notion was that an organizational approach and strategy could be used to motivate and direct any line of business. The "GE way" would work in aeronautics, appliances, health care, power generation and everything else. It turns out that strategic intent is not enough to offset the environment. A recession makes a mockery of strategic planning; rapid growth periods favor the nimble. Most importantly—selling railroad locomotives is different than selling medical appliances—one-size management strategy does not fit all. That has been motivating the changes that GE has been undergoing of late.

More Learning From the Uber Driver I know that there have been those who have had bad experiences with their Uber driver, but I never have. I like Uber a lot—I gave up on cabs as soon as there was an alternative. Unlike my Uber trips, I have had plenty of miserable and often dangerous taxi rides. Last night, I had another of those unique Uber rides. My driver was a black woman in her 40s (she told me). At first, I was just getting a little tour guide treatment as regards Charleston with advice on what to see and where to eat. She then told me that she was a poet and asked if I wanted to hear her recite some. I indicated that as an economist I was by definition without a shred of cultural sensitivity, but I was willing if she was. They were actually pretty good—especially the one called Stranger in my Home. It was inspired by a friend who moved in for a few days to get on her feet and ended up staying for over a year. The poem was not about the somewhat unwanted guest, but about how little she really knew about herself.

I have had Uber drivers sing original songs for my critique and I have had drivers that wanted to show me their art portfolio (after we stopped). I have heard harrowing stories of how people got to the U.S.—including the Venezuelan catcher who defected in the middle of a game while being chased by armed guards. He escaped when his pitcher intervened and nailed one of the guards with a 94-mile-an-hour fastball. Then there was the Somalian guy in Minneapolis who knew "scarecrow"—the nickname given to a Somalian guy that was picked to be the pirate leader in the Tom Hanks movie Captain Phillips. My driver is still friends with him and proudly listed the 14 other movies where he landed a part. I have learned a lot from my Uber drivers and appreciate the break in the routine they offer.

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