Strategic Global Intelligence Brief for June 26, 2018
How Jerome Powell's Comments and GPDI Should Have Us Watching
We use three basic recession indicators. One of them, Gross Private Domestic Investment (GPDI) has predicted 11 of the last 13 recessions dating back to the 1940s. The "Spidey Senses" are warming up, but aren't tingling just yet. Keeping corporate and private investment flowing is critical to keeping us out of recession. The latest report from the Atlanta Fed shows something interesting—and it's probably all tied to trade war fears.
Analysis: We don't have the latest report on Gross Private Domestic Investment, but we can get pieces and components of what goes into it. One of the Industrial Production components of GPDI came in last week. It pulled down the forecast for GPDI in just one month from 10.9% growth to 9.2%. That's still a strong number, but that's how quickly the GPDI figure can reverse course—and it's all sentiment-affected change.
Fed Chair Jerome Powell mentioned in last week's Fed interviews that trade tensions were beginning to change CEO sentiment. He continued that many were beginning to change their outlook, which was starting to impact views on hiring and capital expenditure, moving somewhat back into a conservative holding pattern that was commonplace in the 2016 pre-election period. Although this was anecdotal, we have to watch various reports to see if that sentiment is spreading or gathering momentum.
We still don't believe this is a problem currently. What we are trying to indicate is that the strong investment trend starting in December of 2016 has begun to decelerate. It's still strong at 9.2% growth, but continued pressure on trade could flip sentiment enough that it sends CEOs into hiding.
Redbook Same-Store-Sales Data Strong for Week 16
The Redbook report on retail showed that same-store sales were up 4.7% year-over-year (YOY) in week 16 of the year. This is a little bit deceiving because year-over-year changes in the calendar. How weekends fall, etc. can all skew the data on a weekly basis.
Analysis: We got the second-strongest activity of the year in week 16. That's nothing to really downplay too much. Same-store sales were up 4.7% YOY against expectations for a 4.3% growth rate. Anyone watching the U.S. consumer will see that spending continues to be fairly strong going into the summer months. That's a good sign; rising costs for many consumer products are not deterring spending. Stronger wages, a great job market and some optimism about the road ahead has kept spending steady.
Much has been made of the infighting taking place within the White House over trade policy. There are most definitely at least two sides represented. It has seemed as if neither one has any desire whatsoever to give in to the other. This is not all that unusual in a presidency as trade policy is always immensely complex with lots of potential winners and losers. There has always been tension within the ranks of the Democratic Party as there are those who would describe themselves as "internationalists" and those who veer more naturally to protectionism. They gather their support from the unions that feel threatened by imports and the potential for companies to move overseas or to at least source more from other nations. For years, the Republicans were seen as generally supportive when it comes to global trade as this is the dominant position of the majority of the business community. But today, the GOP is at least half-populist when it comes to their politics. They are as antagonistic towards trade as are some of the Democrats. The White House has that same split with a GOP traditionalist wing and a more aggressive populist wing. At the start of President Trump's term, these wings were split pretty evenly, but now the White House seems to tilt more towards the populist perspective with support for protectionism and outright hostility to both allies and those who would be termed enemies. President Trump waffles back and forth, but has lately been much more comfortable with the populist position.
Analysis: This infighting also takes on a more personal tone as the men who are espousing these points of view are committed to their beliefs and are also trying to stay in the good graces of a president who is notoriously capable of kicking people out of their positions on a whim. The two who are at the center of the current controversy are Treasury Secretary Steve Mnuchin and White House Trade Advisor Peter Navarro. They have clashed many times in the past as Mnuchin is essentially representing the traditional GOP position on trade and Navarro is the iconoclast economist who has made his living blasting China at every opportunity. The two were at odds when they both visited China. Mnuchin sought to mollify the Chinese over the course of the meetings and looked for opportunities for mutual cooperation. Navarro was far less conciliatory and tended to want to lecture the Chinese on their supposed transgressions (which prompted at least one high-level Politburo member to walk out of a meeting).
Now, the two are at odds over the latest move against China based on its interest in U.S. technology and advancements. Much of the U.S. opposition to Chinese investment in the U.S. stems from a report that China produced a year or so ago called "Made in China 2025." This high-level plan calls for China to become a world leader in 10 modern technological arenas—everything from alternative energy to electric cars, robotics, aerospace, civilian aircraft and information technology. These are all areas where the advantage currently lies with the U.S., Europe and Japan. The choice that faces the world in the immediate future is whether China will be left to its own devices or will do this development in cooperation with other countries. There is no doubt that China will be able to make significant strides towards these goals without help. There is also no doubt they could develop faster in some kind of partnership with others. The Chinese have essentially chosen the latter approach, but there is resistance from the nations they want to partner with as they fear China's motivations.
The current Trump plan is to restrict the Chinese in terms of what they can invest in. The goal is to protect U.S. technology, but it also means that the U.S. will not have a piece of what China develops in the years to come. The position of Peter Navarro and others from the populist position is that China is untrustworthy and bent on ruining the U.S. economy. Mnuchin holds the pragmatic position that China will develop these technologies with or without the U.S., so it would be in our best interests to be entwined in that development to ensure we know what they are working on and where it stands.
China Prepared to 'Punch Back'
In the beginning, China reacted to the Trump bellicosity with a certain amount of amusement. They have seen this many times before and they know the drill by now. American politicians pander to their voters with some China bashing. Once the elections are over, the relationship goes on as before. The Chinese are quite familiar with the tactic of saying one thing and doing another. However, as the rants became threats, the Chinese attitude changed. There is now a sense that China thinks there is an attempt to push them around—that is a hyper-sensitive subject.
Analysis: The statements from Xi Jinping are no longer subtle. The terms are aggressive and will involve everything from counter tariffs to stepped-up regulation and an effort to turn Chinese consumers against U.S. goods. It is this last tactic that could be the most damaging as it will be hard to reverse. Once the average Chinese consumer or business person is convinced the U.S. is trying to humiliate China, they will hold on to this negative attitude for a long time—regardless of what the two nations elect to do about tariffs and trade rules.
The Chinese are also far better equipped to deal with the fallout. The U.S. consumer will be hurt by all this; the damage could be quite significant. It is hard to assign numbers accurately, but there are estimates based on what an average U.S. consumer buys. If Chinese goods were to vanish and consumers bought domestically made versions, the annual additional cost would be in the neighborhood of $8,000 per family. This is an amount that will be noticed in anybody's budget. The business community is getting hit even harder. Several have already made the decision to shift production to other countries in order to escape the impact of higher commodity prices.
OPEC Cuts a Deal—Is It Enough?
Last week, it looked somewhat unlikely that OPEC would be boosting production despite the fact the Saudi Arabians wanted to do just that and had the backing of Russia and most of the other Gulf States producers. The holdout was Iran. It had the ability to veto the whole effort and seemed intent on doing so in response to what it termed provocations from the U.S. and Saudi Arabia. In the end, Iran backed down after some promises from the members that it would get some help as far as dealing with the imposition of tariffs and restrictions by the U.S. Does this now mean that the expected decline in oil prices will take effect?
Analysis: At some point, there will be a reaction to the increased production. Prices will fall a bit, but this decline may be delayed by the fact that most of the oil surplus that had existed at the start of the year has either vanished already or is under threat. It would have been expected that additional demand would have pushed additional supply, but with the OPEC restrictions in place, there was no opportunity to boost that supply. That leaves the oil sector vulnerable to disruptions. There have already been several. Libya was once a major contributor, but the eruption of a civil war around the oil fields has reduced their capability by over half. Iran is now facing the re-imposition of sanctions that will reduce their output by over a third. Iraq has also been struggling to keep its numbers up. The utter collapse of Venezuela rounds out the geopolitical threats. This tortured nation is producing less than 10% of what it did 10 years ago and even this meager level is under threat. Add in that the U.S. oil shale producers are running into pipeline capacity issues and the fact is that supply is not going to meet demand for a while yet.
Prices will likely stay about where they are through the heavy consumption summer months. That suggests that prices could begin to sag a little once the weather gets a little colder and Americans travel a little less. The impact on the consumer has been muted thus far despite the increase of around 60 cents a gallon nationwide. It seems that as long as the all important $3 a gallon level is not reached, the consumer feels more or less OK. Those parts of the country that have been seeing $3 for some time don't tend to panic until it hits $4.
Erdogan Wins—Did Turkey Lose?
There was a moment when it looked like the Turks might not put their longtime ruler back in power, but in the end, Recep Tayyip Erdoğan staged a decisive victory with over 52% of the vote. He lost in the urban areas as expected, but not by as much as had been anticipated. His support was in the rural areas within the ranks of the ultra-nationalists who supported his hard-line position against the Kurds and other minorities. The opposition was not as unified as it could have been, but it is unlikely they would have been able to pull off a win in any case. The national currency briefly rallied when it was clear that Erdoğan had won a working majority in parliament, but rapidly tumbled again as people realized that with his victory also came new powers for the executive that give him nearly total control over the country.
Analysis: His approach to the economy has been criticized before as it veers off into extreme populism and often seems to threaten the institutions that have kept the country afloat in previous years. Erdoğan does not want to see interest rates go up even by a small amount and has stated that he is not worried at all about inflation. This is despite the rather sorry past as far as inflation and Turkey are concerned. The global financial community worries that these new powers will allow Erdoğan to subvert the central bank and force it to adhere to his profligate policies. In past years, the Turkish economy has been shattered by the inflation numbers that ravage the banking sector, but this does not seem to concern him.
There will likely be more attacks on the Kurdish population. That pushes the U.S. and Turkey apart as the U.S. has long backed the Kurds. Under President Trump that support has weakened considerably. It may well be the U.S. will turn a blind eye to the Turks as they attack Kurds in Turkey and in Iraq. Trump has expressed admiration for the new presidential powers held by Erdoğan as they make him that much more powerful than the parliament.
It is also expected that more crackdowns will take place directed at "terrorists." That has been a catch-all phrase that mostly includes Kurds and those who protest against Erdoğan. The government is also expected to continue developing better relations with Russia and to distance itself from Europe and even the NATO alliance. As decisive as the win was, the population wants economic growth and change immediately. That will be a very tall order.
I had an opportunity to be a tourist for a few hours in Sarasota as I was able to catch up with an old friend from the Fabricators & Manufacturers Association (FMA). It was her decision to make me the FMA economist years ago that really launched that side of my business. She now enjoys the retired life of Florida and obviously loves the transition from Illinois. We toured the Ringling Art Museum. It was truly impressive. It amazed me that running a circus could have been so lucrative it could finance a life that allowed this kind of legacy. The majority of these works were personally owned by the Ringling family. It reminded me of Kansas City's great art museum—the Nelson. This was created by William Rockhill Nelson of newspaper fame. I was struck by the realization that not too many years ago great wealth accrued to men who ran a circus and published a newspaper. Today, the circus is all but dead and the Kansas City paper is just a shadow of itself.
What will today's moguls look like and what will they contribute to the public good. Right now, it seems those contributions have been less robust than those of the past.