Strategic Global Intelligence Brief for June 29, 2018

Short Items of Interest—US Economy

That Was Fast!
For the last few years, there has been a steady drumbeat of expectation as regards the rate of inflation. The Fed stated often that it had a goal of 2% inflation at the core rate (the rate that excludes fuel and food). The signs all started to point to an outbreak as there was so much money getting pumped into the economy by the Fed. That surge never happened—until there was some of that good old-fashioned pump-priming cash dumped into the economy via the tax cut at the start of the year. There were assertions that inflation would be right behind the cuts as the economy was already starting to grow, and sure enough—here it is. The rate of inflation hit a six-year high in May. This is not likely to continue at this pace, but even it is steadily above 4%, there will be plenty of justification for more interest rate hikes.

May Consumer Spending Moderates
As is often the case, the consumer is not putting their wallets where their mouth is. The level of consumer confidence has been up according to both the Conference Board and the University of Michigan, but it appears to be all talk and little action. The retailers are not seeing the evidence of that supposed confidence. The latest numbers for consumer spending in May are down from April when they were supposed to be up. Part of the reduction in spending may be related to seeing inflation at the gas pump and in areas like air travel and restaurant meals. This trend could cause some revisions in the very optimistic assessments of the second quarter's growth.

Close to Panic in the Farm Sector
This is not turning out to be a banner year for the farm sector as a whole, and for the most predictable of reasons. The weather has been anything but cooperative in the parts of the country that produce the most. Winter was slow to leave, which inhibited planting. Then, there were rapid periods of growth that affected yield. The price of inputs rose with the rise in the price of oil. Now, there are the trade war threats. This may be enough to put many in the farm sector in real crisis. The farmers can't afford to lose the China market, especially not this year. The Chinese know full well the vulnerability and they have targeted the farm sector for their own response. The prospects are not good at all.

Short Items of Interest—Global Economy

How Might AMLO Govern?
By the end of this weekend, the new president of Mexico will be Andrés Manuel López Obrador (AMLO). He might even have effective control over the Mexican Congress. He has a reputation as a left-wing populist and has been running for the post for decades. Does this mean that Mexico is about to get its own version of Hugo Chavez of Venezuela? Some still assert that this is likely, but others are pointing to the people he has already indicated he will bring to the Cabinet and will have as advisors. They are nearly all U.S.-trained economists and specialists who have reputations as free traders and business savvy. It seems as likely that AMLO will be emulating the path taken by Inácio "Lula" da Silva in Brazil, only hopefully without the rampant corruption and cronyism that felled Lula and his successor—Dilma Rousseff.

China Tries to Open Further
Even as the U.S. and China circle each other like kick boxers, there are efforts underway in Beijing to make progress. It has been agreed that several new industrial sectors will be opened to outside investment. Most of these are sectors the U.S. has wanted access to. Even as the two nations bluster and threaten, there are concessions and plans to keep this from spiraling out of control. The U.S. has backed off its threat to interfere with Chinese investment in the U.S. at the same time.

Austria Takes Hard-Line Position on African Migrants
Not that the dominant party in Austria is in favor of any migration into the country, but special efforts have been underway to stop the migration from Africa. The focus on Africa has many accusing the current regime of outright racism. Several in the Freedom Party have not contested that assessment.

Migration Compromise in Europe
It was a classic set of negotiations. It was tense and exhausting as the leaders of the EU met and worked through the night to figure out what to do about the migrants who have been pouring into Europe for the last few years. The result was that nobody was really happy about the outcome. The most extreme positions were generally abandoned, but that didn't mean those holding these views were satisfied and willing to support the plan fully. The migrant response will still be voluntary. That was a position that France and Germany fought hard against. They still fear the burden of dealing with the migrants will fall on them and the few other nations willing to share some of the burden in the past. It is not clear this will be enough to mollify the opponents to Angela Merkel and Emmanuel Macron within their own parties.

Analysis: Critics have been pointed. They assert that this is nothing more than a stopgap measure that doesn't do anything to address the bigger issue. The conversation barely even touched on some of the more vexing problems. The assessment of the issue holds that there are three related but separate areas of crisis. The one that was dealt with in this meeting was what to do with the millions of refugees and migrants who are already in Europe. Right now, they are scattered throughout the EU and are in very different circumstances. There are camps that are well-run and well-structured. They are working to assimilate the migrants through everything from language training to job placement. Other facilities are little more than vast holding pens and have been compared to prisoner of war camps. The bulk of the migrants are either stuck in the southern-tier nations where they originally arrived or they made it to Germany or France where they have been generally better handled. One of the key issues for Germany was the issue of "cross migration." Countries like Italy, Greece and Spain as well as the nations in East Europe have been trying to get the migrants to keep moving on and to seek refuge in Germany and elsewhere. This is unacceptable to the conservatives in Merkel's coalition. She seemed to get some of what she wanted with a promise to stop the practice as long as the EU funds these settlement centers and doesn't expect the "front-line states" to absorb them all.

The bigger issue, and one not dealt with in this meeting, is how to stop further migration. The pace has slowed a little, but there are still thousands of migrants making it to the borders of Europe by ship and overland through Eastern Europe. The reaction has ranged from imploring African and Arab states to stop the flow to using the navies of Europe to interdict the boats before they reach land. Still, there are daily rescues of those that are trying under desperate circumstances. Once they have arrived, they will be in these centers, but there is not unlimited capacity.

This leads to the biggest issue of all. The motivation for risking all this to come to a world overtly hostile to them must be extremely strong, and it is. If they stay in the countries they are fleeing, they have no hope of a better life. They are trying to escape grinding and perpetual poverty, war, famine and worse. The story is made clear enough through the comments of one woman who survived the voyage on a fishing boat with 80 people on board. "My cousin is in Belgium and she works as a cleaner in a building. Can you imagine a place that would pay me to make things clean? It must be beautiful and generous there."

Crumpet Shortage
There are many things that should cause alarm to the person trying to keep pace with the daily news. There is fire and famine, volcanic eruptions, migrant issues and war. But now the list of crisis situations has gone too far. There is a tragic shortage of carbon dioxide gas in Europe due to some supplier issues (maintenance and ill-timed accidents). The upshot is that there is a mounting shortage of crumpets. Life may no longer be worth living for some who value their afternoon tea and crumpets. Scones are a poor substitute and bagels are completely out of the question.

Analysis: Not only have major British bakers been forced to shut down their operations until the gas is available again, but other users are feeling the pinch. The makers of fizzy drinks are worried that they will have to try to sell the flat version. The gas producers expect to be back to normal production by the end of the summer, but that is a long time to be "crumpetless." What is this world coming to when there are threats of a chocolate shortage, and now this? Beyond the drinks and crumpets, the gas is used in meat production and a host of other foods. There is no ready replacement. It is also expected that prices will rise through the next few weeks as the production of the gas proceeds.

Why Weakness in First Quarter Economic Numbers?
There is now something for every economic persuasion in the GDP data. If one leans towards pessimism and looks for the dark cloud behind every silver lining, there is the fact that first quarter GDP data has been revised downward to just 2%, much lower than the pace set through most of last year and far lower than the original assessment of that Q1 data. On the other hand, there is also something for the optimists among us as the preliminary assessments of the second quarter indicate that growth might hit 4% or even 5%. What was that about Harry Truman's search for the one-armed economist that would not be able to say, "on the other hand?" So, which is the right attitude—pessimism or optimism? In looking at the data for both quarters, there is a case to be made for both interpretations.

Analysis: Three factors tended to stand out as far as the first quarter was concerned. The initial assessment showed more growth than the final version. That means that the data collected towards the end was not as impressive as had been hoped. The early information generally includes exports and imports, but one doesn't really have a handle on consumer and business spending until the quarter is completely at an end. There was less activity in the consumer sector than had been expected. The consumer was buying goods at about the same pace but their purchase of services fell off that quarter. Some of that decline has been attributed to the bad weather that affected many of the largest cities in the country. This weather kept people from eating out, flying and generally engaging in much of anything as they waited for the snow to stop. There was also less purchasing of health care and financial services by the business community in this period.

A second factor was the housing sector as it has been drifting towards being a drain on the economy rather than an accelerant. There has been less in the way of new housing than in previous months. The average person is finding it harder and harder to buy a home as mortgage rates rise at the same time that the price of homes has risen. There is thus far no hint of the kind of housing sector collapse that triggered the 2008-2009 recession as there has not been the madness of subprime loans and frantic dreams of house flipping one's way to great wealth. It is just not the driver it was even a few months ago.

The third factor is a vexing one and stems from the way the data is collected and adjusted for seasonality. The first quarter numbers always seem weaker than they should be. More often than not, there is a further revision around the corner that shows things were not quite as bad as they seemed for the quarter. This also accounts for some of the enthusiasm for the second quarter performance as the rebound from the first interpretation of Q1 shows up pretty quickly.

There are reasons for the enthusiasm about Q2 (which ends formally tomorrow). The top of the list is that it appears that consumers started to shake off their winter blahs and began to spend on services again. This is also related to the fact this is the travel and vacation time of year—that always boosts activity in the hospitality sphere. The consumer had not really reacted to the tax cuts this year—at least at the pace of the business community. There is some evidence this pattern started to alter towards the end of the quarter. Another factor that bolstered the business side of the data has been reaction to the tariffs and trade wars. The most immediate response from both exporters and importers has been to load up on needed inventory as fast as possible in order to beat any future price hikes or shortages that might develop. Machines that might have been acquired later in the year are being snapped up now. This accelerated second quarter activity may serve to dampen growth numbers in the third quarter if those anticipated price hikes take place.

Thinking About Poverty
The way that a country reacts to poverty will determine the way that assistance is offered to the poor. The dominant attitude in the U.S. is that being poor is largely the fault of the poor. They made bad choices, such as dropping out of school, having children too early, engaging in drug use and so on. They should get help, but that help should come with a requirement to change the error of their ways. The alternate interpretation is that many people are poor through no fault of their own. They may have been born in a region with few opportunities, they may have dysfunctional families, they may have health problems and they may have had no alternatives when they made those bad choices. The help they need is beyond asking them to act differently.

Analysis: One of the assumptions is that poverty is rare in the U.S.—that it only affects a small percentage of the population. The reality is that almost 60% of the U.S. population has been poor at some point in their lives. The vast majority of those in poverty are there for a period of time and then claw their way back out. The two leading causes of poverty in the U.S. are a health issue and divorce. The person with a health challenge soon loses their job and faces mountains of debt that wipes out what they might have saved. The majority of those with children who are divorced struggle financially for years before recovering. The third leading cause of poverty is living too long. Many people now exhaust their retirement savings before they die and spend the last years of their life in financial distress. People did not make a bad choice to get sick or age. The majority of those who are divorced did not want the marriage to end, but were dumped and left to deal with the kids on their own. It would seem that a rethink of poverty and its origins would be in order.

Knowledge Is Spelled With a 'K'
It is not clear how reliable the little poll was, but it purported to ask several hundred college students from all over the country if they could match up these leaders with their country. The vast majority (71%) could only connect two of them to the correct nation. If that is really the case, we have some big issues to face down in the not distant future. Let's see how my faithful readers do.

Emmanuel Macron—Iran

Shinzo Abe —Argentina

Angela Merkel—Saudi Arabia

Narendra Modi—Great Britain

Theresa May—Canada

Vladimir Putin—Greece

Alexis Tsipras—Mexico

Bashar al-Assad—China

Justin Trudeau—France

Mohammed bin-Salman—Syria

Andres Manuel Lopez Obrador —Turkey

Hossan Rouhani—Japan

Xi Jinping—Germany

Reccip Tayyip Erdogan—India