Strategic Global Intelligence Brief for June 27, 2018

Short Items of Interest—U.S. Economy

CBO Warning on Interest Rates
The latest report from the Congressional Budget Office is not saying anything that was not known prior, but there is a new sense of urgency as far as the message. The higher interest rates promised by the Federal Reserve will be combining with the running of big deficits to cost the government a lot of money. The last few years have been pretty easy to handle as far as debt is concerned. The U.S. has been running big deficits and adding to its overall debt, which has required the Fed to buy more Treasury bills to finance all of this. The good news was it was being done in a low-interest-rate environment. Now, the debt will have to be paid off when the debt has started to become a lot more expensive. The ideal period to run up debt has come and gone. Things can get very expensive from this point.

Changing Global Supply Chain
The mission of the supply chain manager used to be fairly simple in concept but not so easy to execute. The idea was to find sources for all the needed input that would provide the required quality at the lowest price. Commodities and intermediate parts could come from anywhere. Labor would be less expensive in some places and so on. Regulatory issues, transportation costs and other considerations played a major role. Now, there is yet another challenge to meet. The tariffs that have been imposed along with trade regulations and restrictions combine to push production to new locales and even back to the original host nation. This is all in the name of trying to maintain price stability for the consumer and cost stability for the company that has had to try to transition its production.

Supreme Court Deals Blow to Unions
It is called the free rider dilemma and has been an issue in economics and other contexts for many years. Should people who benefit from the actions of others be allowed to do so without paying their fair share? If people in a given community pay for a park with their tax dollars should non-taxpaying people still be allowed to use that park for free? The unions have long asserted that those who do not join and pay dues should not be granted the same rights as those who do and should not reap the same reward. The Supreme Court ruled that people cannot be forced to join a union or pay dues as a condition of employment. They are entitled to the same pay and benefits as those that have. They saw this as a First Amendment issue.

Short Items of Interest—Global Economy

New Italian PM Fights EU Reforms
Giuseppe Conte, the new Italian Prime Minister, has already sent shock waves through the EU establishment with his pointed criticism of both the economic policy and immigration positions. He has been very aggressive as far as the refugees are concerned and he has the financial markets worried about his cavalier attitude towards adding to Italy's debt issue. As far as immigration is concerned, he has taken a very tough stand against holding any more migrants. This is the Italian interpretation. The sense is that Italy remains intensely divided on whether to tolerate more migrants, but Conte's party is virulently nationalist and has no desire to remain at all accommodating.

Will Trump and AMLO Make a Strange Set of Bedfellows?
On the surface, the two men have nothing to bind them, while Andrés Manuel López Obrador (AMLO) has benefited greatly from all the Mexico bashing by President Trump. Beyond that, they look a lot alike. Both are outsiders who claim to be motivated by cleaning out the old system. Both are nationalists and both have a strong authoritarian orientation which makes them unwilling to listen to others and makes them value loyalty above all else. They will either be at each other's throats or they will see these common traits as an opportunity.

Political Violence in Africa
In just the last three days, there were riots that rocked the capital of Ethiopia and the new leader of Zimbabwe was targeted with a bomb that missed its intended target.

Iran's Hardliners Exploit Crisis
Trying to work out just what the U.S. wants to accomplish in the Middle East has never been easy—this is a notorious part of the world as far as killing off long-term strategies. The alliances are ever fluid and the divisions are deep and overlapping. The enmity between the U.S. and Iran is deep and rooted in decades of being on the wrong side from the other. The U.S. had invested a tremendous amount of energy installing and supporting the Shah of Iran back in the 60s and 70s. He was to be the bulwark for the U.S. and the key ally. When he was overthrown by the Ayatollah Khomeini and the other hard-line clerics, the U.S. swiftly became the "Great Satan." That led directly to the hostage crisis in the 1980s. The U.S. and Iran have been mortal enemies ever since. The U.S. backs Saudi Arabia which is the center of the Sunni branch of Islam, while Iran is the center of the Shiite branch. The Arab states distrust the Persians of Iran as they have been under their yoke in the past. In conflict after conflict, the U.S. has been on one side and Iran on the other.

Analysis: Today, there are three issues that rank as the most important as far as the U.S. and Iran are concerned. The first and arguably the most important is Iran's development of its nuclear weapons capability. This would be the regional game changer as Iran would be able to threaten enemies with these weapons and have a very potent defense. The nuclear pact that was signed last year was considered a very big deal as it limited the ability of Iran to manufacture these weapons. Now that the U.S. has pulled out, the threat has reappeared. The second issue is Iran's support of terrorist groups such as Hezbollah in Lebanon or Hamas in the Palestinian territories. Iran also supports groups loosely affiliated with al-Qaeda as long as these groups are not Sunni (as the ISIS leaders are). Then, the U.S. opposes Iran's support of insurgents in Yemen who are fighting the factions that are supported by Saudi Arabia.

It is very hard to determine what the U.S. thinks can be done about all three of these issues. The thinking of the Obama White House and the Europeans was that these had to be addressed in stages; starting with the nukes made the most sense. The Trump decision to scrap that strategy has emboldened the hardliners in Iran as shown by the riots and demonstrations that have been breaking out all over the country. They are ostensibly over economic issues such as the collapse of the currency and slow growth that leads to higher levels of unemployment. These protests have quickly become anti-American. They have been trying to link President Hassan Rouhani to these ills. He staked his whole government on getting the sanctions lifted and offered the nuclear deal in return. Now that the sanctions are returning, his government teeters on the edge. What the U.S. gets next in Iran is a hard-line leader in the mold of former President Mahmoud Ahmadinejad. If the U.S. has issues in the region now, they will only get far worse with a hard-line regime change. It would seem the best course of action is to keep Rouhani and the moderates in power, but that doesn't seem the strategy at this point.

Will AMLO Remake Mexican Politics?
The elections in Mexico are imminent and that supposed surge by the PAN party has not taken place, nor has the candidacy of AMLO faltered. He will soon be the new president of Mexico. Going by the polls, his political party (Morena) could even end up controlling the legislature. Both the traditional parties (PAN and PRI) are expected to lose almost half of the seats they currently hold. If the AMLO wave is strong enough, it may hold complete power. This would be the most far reaching even in Mexican politics in decades.

Analysis: AMLO has appealed to a wide cross-section of the electorate as he has toned down some of his leftist rhetoric. He has been emulating "Lula" in Brazil by running a slightly more mainstream campaign that has focused on the corruption and failure under the old leadership. Many of those in Morena are brand new to politics and have relatively little in common with one another outside their antagonism towards the corruption of the old parties. They are outsiders determined to change things, but at this point there has been little in the way of a platform articulated. No real plan on how to handle the power of the drug gangs, no plan for the economic growth needed other than trying to tax the rich more. Right now, the mood in Mexico is that AMLO offers something different and that is enough. The biggest boon to his campaign has been Donald Trump and the relentless attacks on Mexico and Mexicans. The issue of separating families has been the latest outrage and AMLO has been quick to capitalize on this. He has already asserted that he will consider Trump an enemy and will refuse to meet him until and unless the U.S. backs off from the harsh rhetoric and assertions that Mexico will pay for a wall. AMLO has been quoted as saying, "Trump says he is good at building walls, well, I am good at breaking walls down."

Some Signs of a Decelerating Economy
This is not a clarion call to panic. After all, the job of the economist is to find the dark cloud behind every silver lining. As has been pointed out, we in the dismal science have predicted 15 of the last three recessions. The latest news on the economy is not so troublesome as to promote deep fear, but there are several indicators suggesting that growth is slowing from the previous pace and may be settling into a more familiar pattern between 2% and 2.5%. This is certainly not awful, but it is not as rosy as things looked at this time last year just before the economy started a three-month run of growth at around 3% (3.1% in Q2, 3.2% in Q3, 2.9% in Q4). It fell back to 2.2% in the first quarter of this year. Most analysts are expecting a nice rebound in the second quarter with the consensus expectation at 3.7%. The issues that are starting to pop up would affect the growth over the next half year and into 2019.

Analysis: One of the key drivers for the economy over the last few years has been the housing market. There has been concern that at some point the "headwinds" would start to have an impact. Thus far, the overall market has been able to resist these problems, but the latest data from the Case Shiller Index suggests these days may be coming to an end. The price of homes has been rising steadily for years. It has been assumed that at some point these hikes would affect the market. They somehow didn't—at least not as much as many had expected. Now, the prices are serving as more of a deterrent to even the well-off buyer. Mortgage rates are still not high by historical standards, but they are certainly higher than they have been. The new home buyer has been pushed out of the market to some degree and even those who are seeking to upgrade are pausing. The costs of homes have been a concern for many as it seems to have locked many into multi-family dwellings even if they want to move. This fact has driven rents far higher than expected. There are still many parts of the country with housing shortages and climbing home values, but there are also many that are saturated. That has slowed the pace of growth to a degree.

A second warning sign, but one that should be taken with a grain of salt, is a decline in consumer confidence. By now, readers of this newsletter know that I am somewhat skeptical of consumer surveys. It is not that those asked are being dishonest, but the fact is the average consumer doesn't have much of a frame of reference and these surveys can be very volatile. In past years, consumers tended to run hot and cold according to the price of gasoline at the pump. If the survey was issued just as gas prices went up a nickel, the consumer was wringing their hands in despair—convinced they would soon have to sell everything they owned and take up residence in a yurt. By the same token, if the price fell by a nickel, people were ecstatic and ready to go buy a new boat. Today's consumer confidence numbers are a bit lower than they have been. It seems that most of the respondents are reacting to some of the threatening headlines concerning trade wars and tariffs, but there have also been higher gas prices to consider. If the levels of confidence fall far enough, there will be a reaction in the retail community. That is the part that worries the most. Consumers were slow to react to the tax cut stimulus, but started to get active over the summer travel months. If that fizzles out, there will be distress at the retail level. All eyes will be on that back-to-school period that starts in just over a month.

The third of these worrying trends to consider has centered for the moment on Harley Davidson, but they are hardly alone. This could be a major issue going forward. If the steel tariffs remain in place and the various other tariff barriers are erected as asserted by the Trump White House, there will be a reaction from those affected by the hikes in raw materials and commodities. The majority will try to raise prices to cover these additional costs, but that is certainly not an option for many companies. They will have to shift production to some other country as Harley has decided to do. It is not the first and will certainly not be the last to do so. However, with every such move, there will be nervousness. Manufacturing has fought its way back in the last decade, but global competition is still fierce. Hiking the price of inputs will do the sector no favors.

Another Climb Down or Just More Negotiating Tactics
It can be hard to discern the master plan coming from the White House when it comes to trade. Like many things with this president, it comes down to how one perceives him and his leadership style. Some see him as basically out of his depth and prone to outbursts that then have to be walked back. Others assert that he is a shrewd negotiator who likes to keep his opponents off balance and guessing as to his next step.

Analysis: The latest issue is the Chinese interest in investing in U.S. technology. It is suspected that often these investments are simply designed to get access to something that China can subsequently acquire and bring home. It isn't stealing as they are purchasing a company or a share of one, but it worries the U.S. nonetheless as the technology involved slips out of the hands of the U.S. exclusively. The initial broadside from President Trump asserted that new and far more draconian rules would be established to keep these technologies in U.S. possession, but now Trump has backed away from this position and asserted that there are existing rules through Committee on Foreign Investment in the United States (CFIUS) that provide all the protection needed. This climb down may also be a tactic to warn the Chinese that further steps can be taken if needed. There is also the sense that this was something of an internal White House fight between Treasury Secretary Mnuchin and the trade advisor Peter Navarro. Mnuchin had been pushing against any new laws and regulations, while Navarro had been advocating a whole new set of restrictions that might have damaged U.S. companies as much as China.

Disillusionment
It is a rather common malady when dealing with politics. I have been watching this for years; it happens on both sides of the ideological divide. There was a surge of wild enthusiasm when Barack Obama was elected president. Many seemed to think this would automatically cure the world of all its ills—no more racism, an economic rebound, help for the poor and an end to terrorism. Of course, none of that happened to the degree desired. Donald Trump was another transformative candidate, the outside businessman that would change everything about how politics worked and would usher in a new era of U.S. influence. This has not worked out as planned either. Just as I heard one-time Obama supporters turn on him, I am now seeing Trump supporters ditching him. In truth, we ask far too much of our leaders. They really can't make the changes we want them to make—at least not alone.

We also have to come to grips with the fact there are over 300 million of us and we don't all want the same things. As a matter of fact, our desires are often in direct competition with someone else's. The leader can't possibly please everyone; most seem to have stopped trying. They have the base that elected them and will keep electing them if they are kept happy. The others are ignored or actively opposed. Our divisions become as stark as they have ever been. If there is to be any kind of progress, we have to shift our own attitudes. Not that we should abandon our beliefs and positions, but we need to work harder at finding the things we have in common as opposed to nurturing and cultivating the grievances that split us into camps. Coupled with that search for common ground is the need to learn to respect the opinions of others—no need to agree with them, just respect the rights of people to disagree with us.