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Strategic Global Intelligence Brief for June 4, 2018

Short Items of Interest—U.S. Economy
Global Indices Fading At the start of the year, the most common question asked of any economist was "what will the year be like?" The general consensus was that everybody needed to enjoy the first six months of the year since the last six months may not be so great. This is starting to pan out—at least according to several of the economic indices that have been released of late. The global Purchase Managers' Index (PMI) is down to 53.1, the lowest level in eight months. The Baltic Dry index is down and so are a variety of metal prices that indicate economic activity. Europe is sinking faster than the U.S., but lately, the numbers for the U.S. are also fading. The peak for the year was in the first quarter. It looks like that this will be the case for the rest of the year.
U.S. PMI Still Strong While the rest of the world has started to see some evidence of decline, the latest Purchasing Managers' Index for the U.S. has rebounded this month. At the start of the year, the PMI hit the 60s and then fell back for two months. This month, the index is back up to 58.3—better than had been expected. The PMI data has continued to reflect the strong performance of the factory sector this year, but there are warning signs that range from the threats of a trade war to the imposition of new tariffs and taxes. The bigger threat may be the slowing of the economies in Europe as well as Japan.
U.S. Shunned by G-7 Members President Trump will meet with the other G-7 nations next week. He is going to get a very cool reception. The imposition of tariffs has infuriated U.S. allies. There will be an unprecedented rejection of a member nation over these issues. Not only are these states reacting with tariffs of their own, but there is now real anger and determination to actually punish the U.S. It is also likely that other nations will start to look to take over the leadership of this group in one way or the other. This cold shoulder will certainly not change any minds in the White House and will likely amplify the tension that now divides the U.S. from what used to be allies.
Short Items of Interest—Global Economy
Italy's Weird New Cabinet Italy now has the strangest of bedfellows running its government. The cabinet that has been cobbled together is comprised of populists, technocrats, moderates, extremists from the right, defenders of the EU and nativists that want an end to Italian engagement with the EU. Analysts have no idea how this diverse and divided group will work together. Many are already predicting that this group will fall apart within the next six months unless they find a way to develop a cohesive strategy.
Russia's China Gamble This is the biggest energy project Russia has undertaken since the end of the USSR. The aim is to connect the massive gas fields in Russia to the Chinese energy market. It is a 3,000-kilometer pipeline through the Siberian region. That creates a major issue and is the strongest signal to date of Putin's shift away from Europe towards China. In past decades, there was reluctance to get that tied to China, but Putin is not enjoying great relations with Europe and is well aware that the EU is actively trying to reduce dependence on Russian gas. The question is whether Russia or China will have the majority of leverage in this relationship.
Major Pay Gap Appears in the U.K. The gap between the old and the young in the U.K. has risen by over 50% in the last couple of decades. The financial crisis has been dumped on the younger and better-educated population. This gap is wide and this generation is unlikely to ever catch up to the income of those in older generation. The bigger issue is that financial conditions are still rugged. That widens the gap with every passing year.
What Realistically Can Be Expected From North Korea? Theoretically, the summit between Trump and Kim Jong-un is back on, although there remains plenty of time for something else to come up. This proposed meeting has been fraught with symbolism—there have been both very high expectations and very low ones. It all depends on the perspective of the analyst that is assessing the potential. The hoopla that has surrounded this "first" meeting between the head of North Korea and the president of the U.S. obscures an important point. The fact that these two nations are in supposed talks designed to eliminate North Korea as a nuclear threat is not at all new. There have been high-level talks between the two nations under Reagan, Bush Sr., Clinton, Bush Jr. and even Obama. In all of these cases, there were all manner of assurances and overtures from North Korea and from three generations of the Kim dynasty. However, the North Koreans failed to live up to their promises and reneged on all the deals they had made. In every case, the U.S., South Korea and even Japan provided what they had promised. There was economic aid, food aid, foreign investment and security reassurances. Sanctions were lifted and postponed until it became obvious the North had no intention of living up to their end of the bargain. The only difference between now and then is that Kim Jong-un has managed to elevate his status in the world by having a face-to-face meeting with the president of the U.S. He has accomplished this without making a single tangible concession.
Analysis: The statements that have been issued suggest this will be a preliminary meeting and nothing all that specific is expected from it. That makes sense from a diplomatic point of view as both sides will need to test the resolve of the other with small measures and concessions. This is why this stage of a negotiation doesn't include the leaders—not yet. The first step is to agree on these concessions and tests. If they are passed, the ultimate meeting is advanced. The aims of the two nations are still very general and vague.
The U.S. wants North Korea to give up its nuclear weapons. That seems simple enough—but isn't. How will this be verified? Will U.S. inspectors be allowed to go anywhere they like in North Korea to determine whether these weapons are gone? This is a nation that does not allow anyone free movement—not its own people, not the Chinese and certainly not the U.S. or South Korea. How will the capability to produce future weapons be handled? The country developed them once and can certainly do so again. What keeps North Korea from hiding weapons in other nations such as China? What about their ballistic missiles? Will these be part of the deal? They can do a lot of damage without a nuclear warhead. How about North Korea's support for insurgent groups the U.S. is currently fighting against? It has been issues like ballistic missiles and support for terrorists that led the U.S. to break the nuclear deal with Iran. What would keep the U.S. from doing the same thing with a North Korean deal?
The bottom line for many analysts is that North Korea has never yet kept its word on a deal of this nature and has never followed through. They have taken what has been offered as an incentive and then refused to do their part—forcing the U.S., South Korea and Japan to be the bad guys that take away food and economic support for a starving and mistreated population.
China's Intentions in South China Sea There has been a great deal of back and forth between the U.S. and China of late. That tends to beg the question—what does the U.S. want from China and what does China want from the U.S. It is likely that negotiations are going far beyond just issues of trade and perhaps North Korea. A strong statement from Secretary of Defense Mattis may indicate that another important geopolitical issue is in play. The Chinese have been aggressively claiming the South China Sea over the last few years. There have been many artificial islands built in the area. They have all been made into military installations. Now, the Chinese Navy is actively patrolling the South China Sea and has come close to challenging the U.S. Navy in the area.
Analysis: The statements from Mattis are about as pointed as they have been thus far. There is no imminent confrontation, but there is plenty of potential flashpoint. It is not out of the question that this has become a part of the discussion between the U.S. and China. The U.S. wants China to treat this region as the international waters they are supposed to be. China wants the region treated as its domestic waters. At some point, this puts it in direct conflict with the other nations in the area. The U.S. will want China to halt their expansion in the South China Sea region.
Will Trump's Policies Cause Massive Job Losses or Not? The latest volley of attacks on trade by President Trump has triggered another round of assessments and warnings from groups as diverse as the U.S. Chamber of Commerce, farm groups, manufacturers groups and those that continue to seek ways to get along with nations that were once considered U.S. allies. At the heart of the critique have been assertions that these policies will compromise growth for the U.S. economy and will cost jobs—millions of them. Those who have supported the president's policies have been just as diverse with steel companies siding with the union they have fought with for decades. It is said that the U.S. has sacrificed too much over the years by engaging in trade deals that allowed foreign companies access to the U.S. market. The assertion is that deficits are by definition bad and they are getting worse every year. There is a lot wrong with this assessment as deficits are not necessarily bad and they do not get worse year after year. The U.S. consistently runs trade surpluses when it comes to service offerings. This is to be expected given the fact the U.S. economy is dominated by the service sector. The fact is that consumers in the U.S. have always benefited from the trade the U.S. engages in as it brings goods to the U.S. that would otherwise be costlier. But these are discussions for another piece. What about the assertion that these trade fights will cost jobs?
Analysis: To be honest, this is a very difficult question to address as there is no way to know for sure what business will do. The imposition of tariffs is not a lot different than the imposition of any tax. There is no enthusiasm for any tax—that goes without saying, but it is generally a fact of business life. Companies generally just add the cost of that tax to their product price and thus pass on the costs to their consumers. This will be the case with these tariffs. Any consumer of steel will add these costs to what they subsequently charge for cars, farm vehicles, construction equipment, etc. It means more expensive construction steel, pipelines and so on. There have been remarks by Commerce Secretary Ross that seem to miss the way that business works. He notes that cars and other products have not gone up, but that is only part of the story. The carmakers do not want to test the patience of the consumer at this point so the pressure was applied to the suppliers of parts. These smaller manufacturers face demands from the companies they sell to and are forced to swallow the costs of that tariff. This is where the job issue develops.
As with any tax or imposed fee, there is that old economic concept that we all remember from our college days—opportunity costs. There was the "guns vs. butter" example. It held that getting one thing may mean getting less of something else. If a company is paying higher taxes, there is less money for other purposes—whether that is buying machines or hiring people or expanding market share. This was the logic that was used at the start of the year when the tax cuts were promulgated. Give companies relief from taxes and they will hire and grow. Therefore, it stands to reason that hiking taxes will mean less growth and less hiring. Companies have very little control over their revenue and profit—these factors are subject to consumer demand, competitive pressure and the like. What are generally under their control to some extent are costs. The two largest cost concerns are labor and material inputs. If there are higher priced inputs to contend with, the most logical place to compensate is in the labor force. That means reducing the workforce. This is where the assumption on job loss comes from. Will it be 23 million jobs lost? Maybe not, but it is certain that jobs will be shed. Most importantly, there will be fewer jobs added.
A second area where job loss will take place involves those businesses engaged in global trade. These will include companies that sell to other nations as well as those that buy from other nations. The tariff decision has provoked a reaction from every nation the U.S. deals with. There are promises of retaliatory tariffs and other trade restrictions. How this impacts the U.S. will depend on how aggressive trade partners elect to be, but the potential for significant damage exists—especially in parts of the U.S. economy that depend on foreign markets such as agriculture, heavy machinery, transportation, electronics and service in general. If exports make up 15% of the U.S. GDP, one can assume that 15% of U.S. jobs are at risk if this export sector is seriously compromised.
Playing by Those Unwritten Rules There have long been rules and traditions that are observed by those in key power positions. Frankly, it has often been frustrating to both the officeholder and the public. We have all heard our share of the noncommittal commentary by some public official as they dance around what looks to the rest of us as perfectly obvious. These rules and traditions play an important role, however, as they keep the playing field fair. Trump managed to break another of these unwritten rules on June 1 when he got a look at the upcoming jobs report and elected to tweet about how he was looking forward to the release. This triggered a surge in the markets as it suggested the news from the data was going to be good.
Analysis: In truth, the good news was hardly a shock as nearly every analyst had been predicting exactly that. There was really no reason to anticipate anything but good news and the president's tweet was not specific regarding the numbers. The point is that this premature announcement rewarded those who happened to be paying attention to those tweets and put others at a disadvantage. There is a reason that news of this kind is embargoed until a specific time. Everybody gets the news and the data at the same time—nobody has an unfair advantage over anybody else. Fed governors do not reveal information early and neither do the legions of data collectors in the government. It is inappropriate for a president to do so. It would have been catastrophic had the tweet been something that expressed concern or disappointment. That would have sent the markets tumbling.
Cats and Health The Internet is full of advice on animals. If you can't trust Facebook—what can you trust? People who have cats will apparently live for well over a century (or maybe it is that people with cats will feel like they are living to 100). This is especially the case when one is having health issues. Earlier in the year, I had to undergo a temporary tracheotomy that I was stuck with for a couple of months. This was a pain to be sure, but the added challenge was that the tip of the trach was bright purple and tended to move when I talked. This was utterly fascinating to Scoot, so I had to be on constant guard against a quick swat at the tube at the most inopportune moments.
Now, I have been dealing with a detached retina and have had to stare at my feet for five straight days. I have this weird looking chair that keeps my face down and utterly confuses Scoot. She wants lap time and I have no lap when I am in that thing. I also have to lie on just one side. Spike has decided to help by plastering himself against my other side so that I can't turn over even if I wanted to (and boy, do I want to turn over!) Sven is the old (new guy) that used to be my late mother's cat. At 18, he is healthy and active and has now decided that he needs to hang with me. All of the feline five have been more than a little distressed by the weird patch I had to wear at night—makes me look like something out of Area 51.
With any luck, this will be the last episode for the cats to adjust to—or me for that matter.

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