Strategic Global Intelligence Brief for June 28, 2018

Short Items of Interest—U.S. Economy

Growth Not as Robust as Thought
The third iteration of the U.S. GDP numbers shows less progress than was originally thought; it seems to have been the fault of the consumer. The last estimate of Q1 growth had been 2.2%, somewhat lower than the first estimate. Now the assertion is that growth in the quarter was only 2%, slower than the last decade's norm of 2.5%. The culprit appears to be subdued consumer spending, which is not a huge shock. This is a consumer-driven economy. What happens with the average person's wallet makes a lot of difference. It seems that the tax cuts didn't really make much of a dent, but that is also not a big surprise as the consumer would not have started to see much difference in their take-home pay until later in the quarter. There is not much that drives the consumer at the start of the year.

Will Second Quarter Data Be Better?
The second quarter is nearly at an end. Some estimates for this GDP are pretty impressive—as much as 5% growth. That would be more than double the pace set in Q1 and the fastest pace since 2003. As with the first quarter data, there are likely to be some anomalies that explain much of the number. The first quarter was down due to the bad weather affecting the most populated part of the U.S. This quarter has been boosted by a big jump in exports and a more subdued increase in imports. There is evidence that exporters are trying to get a jump on the tariff increases and are stuffing the pipeline as full as they can. The GDP data is always somewhat volatile, but this may be an exceptional period if there is that wide a range between the two quarters. Now, all eyes will be on third quarter as this is often the strongest of the four.

Fed Preparing for the Next Recession?
Even those Fed members with a reputation for being doves are starting to get serious about the threat of recession and what preparations the Fed has to make. The new line of thinking is really an old line of thinking. The Fed needs to build up capacity to stimulate with its traditional tools—interest rates. At this point, the Fed has very little in the way of ammunition should the economy sink back into recession as many economists assert could happen as soon as 2019 or 2020. The interest rates are still low and cutting them would not have much impact. The Fed would need to have rates high enough for a reduction to have meaning. That means rates at 4% to 5% at the lowest. Many at the Fed would prefer rates be even higher than this.

Short Items of Interest—Global Economy

Summit Between Putin and Trump
This meeting has been suggested since the start of the Trump term, and even before, but the circumstances have changed radically. It was once thought that Trump would make rapprochement with Putin a key to his foreign policy, but that was before the investigation into Russian meddling in the 2016 election and the subsequent clashes between the two nations on issues like Syria, Ukraine, terrorism and the price of oil. Now, all of this is supposed to be on the table for discussion, but there are few expectations.

Trade War Casualties
The trade war brewing between the U.S. and China would be expected to have an impact on the Chinese and the U.S., but it appears that the countries at greater risk are nations like India—now expected to be collateral damage. The Indian rupee has fallen to record lows as the restrictions applied to China and Europe will also be applied to them. They will suffer loss of opportunity in both the U.S. and China. Further damage will be done if the trade disputes affect growth in Europe since that remains their largest export market.

Mexican Anger
Andrés Manuel López Obrador (AMLO) is riding a wave of real frustration and anger that crosses all classes in the country. The majority of the population indicates that two things are driving their vote this year. Economics is not one of them. It is corruption and drug violence. To many, these are linked.

Unlikely Hero for Merkel
If one had offered the opinion a few years ago that Germany's Chancellor Angela Merkel would be rescued from a dire political crisis by Greek Prime Minister Alexis Tsipras, one would have been laughed out of the room. It was Merkel who fought so hard against the efforts of Tsipras and the SYRIZA Party in Greece as they tried to wiggle out of the monstrous debt crisis engulfing Greece. The Germans were making it abundantly clear they considered the crisis a creature of Greece's making—years of profligate spending financed by wave after wave of debt. Now that Greece was falling apart, the Germans and the EU were supposed to ride to the rescue. It was as if Greece was the irresponsible teenager that lands in jail and calls Mommy and Daddy to bail them out. There was real enmity between Merkel and Tsipras. How things change in the world of politics.

Analysis: Merkel is now facing her most serious political crisis. It stems from the immigration issue that she has been unable to resolve or distance herself from. Her ruling coalition is on the verge of total collapse as the Bavarian Christian Union is furious with the policy she put in place. There has been an astounding array of miscues and bad assumptions since the crisis began. Merkel has been trapped by them all. It is hard to even understand the original idea even though it was only brought forward a few years ago.

At the time that Merkel opened the German door to refugees from Syria, there were three key assumptions that have since proved inaccurate. The first was that the civil war in Syria would end relatively quickly and that Bashar al-Assad would be removed from power. The Syrians would not be staying very long in Germany as most would simply go home to rebuild their nation. Today, Assad is stronger than ever and there will be no returning for the vast majority of those who fled. The second assumption was there would be a limited number of refugees arriving from an essentially middle-class society. Instead, the whole of North Africa and the Middle East as well as South Asia seemed suddenly determined to come to Germany. Most of these migrants wanted to stay and were fleeing poverty and deprivation as opposed to war. The third assumption was that the Germans would embrace the role of humanitarian and all of the EU would band together to help the Germans with this effort. German patience wore thin very quickly and the rest of Europe wanted nothing to do with this.

To make matters worse, the exodus of refugees and migrants quickly became overwhelming. The brunt of the impact was felt by the poor states of Southern Europe. The fleets of rickety boats landed in Greece, Italy and Spain, while the overland treks took people into the less-than-welcoming states of Eastern Europe. These counties alternately tried to get these refugees to stay home or they tried to expedite their move to Germany. This became the crisis for Merkel. The numbers are in the tens of thousands now. The Germans want them to leave, but those southern states have adamantly refused to take them back. Italy, in particular, has become bitterly hard line on this issue under the new populist leadership of the Northern Alliance and the Five Star Movement.

Suddenly, there is Tsipras from Greece agreeing to take thousands of these refugees and migrants back to Greece for further processing. Some may eventually be allowed to stay, but many others will be deported. In the meantime, the Greeks will have to find some way to pay for all this. That is likely what Tsipras got from Merkel—along with some degree of flexibility on how Greece will be expected to deal with its longer-term debt issues.

No Chinese Climb Down on South China Sea
It is going to take more than vague threats, or so it would appear. The comments by Defense Secretary James Mattis were intended to get China to back away from its ambitions in the South China Sea, but the response from Xi Jinping could not be clearer. He stated quite publicly that China would not yield an inch of that territory and hinted strongly that more expansion is to come. The Chinese consider this body of water to be theirs, but much of the rest of the world considers it international water, including the U.S.

Analysis: The Chinese have been building artificial islands in the region for years. Over the last few years, they have been steadily militarizing them with missile placements and troops. They now have the capability to attack any ships that pass through the region. That has prompted the U.S. to sail naval vessels through this disputed territory at random intervals as a means by which to dissent against the Chinese claims. The fear is that trigger-happy Chinese troops will try to scare off these U.S. ships. That runs the risk of escalating exchanges and the potential for open conflict.

Does the Business Community Have a Stake in the Supreme Court Battle?
Of course it does. However, at the same time it should be noted that there is rarely anything like a united business position on much of anything as there are hundreds of issues that will find business interests on both sides. The Supreme Court gets a great deal of attention for the decisions that affect social issues and legal precedents. That tends to obscure the fact that almost 65% of the decisions are directed at business issues and many are more technical than controversial. With the resignation of Anthony Kennedy, the expectation is that the selection of the next Supreme Court Justice will dominate much of the political news this summer and will figure prominently in the various mid-term elections. This is always going to be the case when a new appointment is made to the high court. This time, however, the stakes are considered higher as Kennedy has been the swing vote that often decides close cases. He is considered a conservative justice, but has come down on a more liberal interpretation on many social issues, such as abortion, gay rights, capital punishment and voting rights. In these decisions, there have very often been hard-line positions staked out by the other more ideologically "pure" judges with the four conservatives (Samuel Alito, John Roberts, Clarence Thomas and Neil Gorsuch) taking one approach and the four liberals (Sonia Sotomayor, Ruth Bader Ginsburg, Elena Kagan and Stephen Breyer) taking the other. Kennedy was the tie breaker. The question for many in the business community is whether a new justice will be good or bad news for them.

Analysis: At this point, it is hard to tell what direction Trump will go with his choice although there some hints that can be gleaned from the process that surrounded the selection of Neil Gorsuch. Trump essentially threw the selection procedure into the laps of groups like the Heritage Foundation and the Federalist Society. These are thoroughly mainstream Republican think tanks that have advocated for justices that are conservative interpreters of the constitution and generally do not gravitate to the more extreme populist positions promulgated by some in the Trump White House. If that pattern is repeated, the nominees will likely look a little like Gorsuch and will be seen as less interventionist on a variety of issues.

For the business community as a whole, it is not expected to be as controversial as it will be for other sectors. Kennedy was often at odds with other conservatives on social issues, but was quite consistent on business and economic issues. His political orientation was often described as closer to classic libertarian than conservatism. He was an advocate of small government and a minimum of government intervention on issues of business and held that interference in personal decisions should not be part of government either. The person selected to replace him will not likely hold these views and will be more traditionally conservative. This would mean business as usual for businesses, but likely changes as far as social policy is concerned. This is all speculation at this point as there have been literally dozens of names floated as potential nominees and there are considerable differences between them. It is striking that none of the names thrown out thus far would be described as populist in the modern sense. In other words, there do not seem to be any who have adopted the anti-business positions that often accompany these political orientations.

The next issue of interest will be whether there will emerge another swing vote justice as there always seems to be a need for that tie breaker. Prior to Kennedy, that role was filled by Sandra Day O'Connor. Now that Kennedy is leaving, the thinking is that the next swing voter would be either Chief Justice Roberts, as he has broken with conservative orthodoxy on occasion, or perhaps Breyer who has not always been a reliable liberal voice. There are four who are as rock-ribbed as they can get and never stray from their stated core positions—liberal judges Sotomayor and Ginzburg along with conservative judges Thomas and Gorsuch. Breyer and Kagan have taken a pro-business position on occasion and broken with liberal orthodoxy, but Gorsuch has not always been on the business side and is new enough to the Court that he is still getting established.

This is going to a very nasty and intense battle as both Democrats and Republicans have a lot at stake here. The process will affect the mid-term races. It may even serve to unite the GOP after a spring and summer full of splits and divisions. It may also galvanize Democrats if it appears the Court will be turning hard right.

Women and the High Court
It has been a long time since the ground-breaking appointment of Sandra Day O'Connor to be the first woman on the Supreme Court; she was nominated by Ronald Reagan in 1981 and served until 2006. Since then, all the women who have been appointed to the Court have been placed there by Democratic presidents and have been decisively liberal (Ginsburg by Clinton, Sotomayor and Kagan by Obama). There is a very strong push now for Trump to appoint a conservative woman to the position—a number of names have been floated already.

Analysis: Amy Coney Barrett currently serves as a circuit judge for the seventh circuit and was a professor at Notre Dame Law School. Allison Eid was a Colorado Supreme Court judge and is on the tenth circuit court. She is a graduate of the University of Chicago Law School. Britt Grant is on the Georgia Supreme Court and a graduate from Stanford Law School. Joan Larsen is a justice on the sixth circuit and was a member of the Michigan Supreme Court. She is a graduate of Northwestern University School of Law. Margaret Ryan is a judge on the Court of Appeals for the Armed Forces, a former Marine and graduate of Notre Dame Law School. Diane Sykes is a justice on the sixth circuit and a former justice on the Wisconsin Supreme Court. She is a graduate of Marquette University Law School. It is, of course, highly possible that none of these women get the nod, but all have strong judicial backgrounds and are considered more conservative in their judicial outlook.

They Are Still Out There
It would be easy to get awfully disillusioned regarding the state of the human race right now. I understand that much of this is attributable to the choices made by the media as the adage still holds—"if it bleeds, it leads." The worst of our behavior is considered noteworthy and we are bombarded every day with a deluge of shameful activity (or at least it should be considered shameful). The good stuff is not catching our attention unless we are lucky enough to see it.

On the flight home from Washington DC, I noticed a young man who was quite overweight and obviously struggling with other issues. He was too loud, too pushy and his mom was working hard to manage him. He was essentially a five-year-old in the body of a young man. As one would expect, everybody gave the two a wide berth and did their best to avoid eye contact even as he tried to wave and say hello. He was always crestfallen when people looked away. We played a waving game for about five minutes as the plane boarded. He and his mom were at the end of the boarding process and separated by about three rows as he plopped down in the front row between a black guy nursing an injured knee and an older woman.

He sat there scowling at first, but the injured guy immediately started a conversation with him. The woman joined in and they got him all excited talking about what he had seen in Washington. He would turn back to his mom every so often and point at the two and proclaimed loudly—"these are my friends." I saw mom crying more than once. The guy scored him a pair of the wings the flight attendant wears. By the end of the flight, they were high fiving and hugging. Even as they left the plane they stayed together as they headed for baggage claim—new "besties." I heard the mom tell the two that she had not seen her son smile and laugh this much on the whole trip. It had become the highlight of their time in Washington.