Strategic Global Intelligence Brief for June 5, 2018
Short Items of Interest—U.S. Economy
Beating Trade Restrictions
It is a little misleading to refer to trade wars between nations. The fact is that countries do not buy or sell anything to another country. It is not like the U.S. government is purchasing from China to fill the shelves at Walmart. Trade takes place because companies in the U.S. want to buy something from companies in another country and vice versa. The reason these companies want to buy from some other nation is about as obvious as any concept in business. The item sold by a Chinese, Indian or Mexican company is cheaper than the same product made in the U.S. (or Germany or Australia, etc.). Every business looks at total landed cost—the actual cost of that product once everything from transportation to regulation and taxes are determined. A business must always seek ways to reduce costs. If a tariff is imposed that adds to that total landed cost, it will force a recalculation. Maybe the product is still cheaper to import or maybe the product gets sold through another country not being hit by the tariff. The point is every company will do all it can to keep that low-cost alternative.
Fed Urged to Relax
The central banks in the emerging market nations are now pleading with the Fed to avoid too much tightening. The fear is that U.S. financial policy is putting immense pressure on these emerging markets at a time when European issues are adding to the crisis atmosphere. Fed interest rates hikes draw more investment away from these markets. At the same time, the U.S. is hitting the debt markets hard again as the tax cuts have contributed to much higher debt and deficit. The countries that are having the hardest time at the moment are Turkey and Mexico, but others are on the brink.
Watch for JOLTS Today
The Job Opportunity and Labor Turnover Survey (JOLTS) is released today. As usual, the majority of the interest will be focused on the quit rate. This is the number of people willing to just up and leave their current job in search of something better. This is different from the people who already have a post waiting for them. It takes a lot of confidence in the job market to throw caution to the wind and strike out for new territory. The higher the quit rate, the more likely there will be wage inflation as people rarely want a new job that pays less.
Short Items of Interest—Global Economy
Italy's Government to Clash with EU Right Away
It is not clear that the new leaders of Italy have been able to find the bathrooms yet, but they are already on a major collision course with Europe as a whole on two key areas. They are taking aim at the immigration issue with a promise of mass deportations and aggressive rejection of more refugees. This may actually involve attacking and sinking ships trying to land in Italy. The other issue is a rejection of pension reform. This will most certainly bust the budget and put Italian deficits well above the 3% of GDP limit set by the EU. That would trigger fines and other punishments. The new government asserts it will not pay them.
China Rethinks African Investment
It would be safe to say that China has not had the experience it wanted in Africa. This investment was intended to bring a reliable supply of key raw materials to China. The expectation was that China would be welcomed with open arms. The reality is that China has been labeled the "new colonialists" by many African leaders and the welcome has been cool. Furthermore, the infrastructure challenges have been far worse than expected. China is reversing course quickly.
New U.S. Ambassador to Germany in Hot Water
Richard Grenell has only been in the post for a month, but he is making few friends in Germany other than those engaged with the right-wing populists Alternative for Germany (AFD). He has stated that he wants to "empower" groups like this. That breaks the cardinal rule for a diplomat—do NOT interfere with domestic politics. The Merkel government is furious—another low point in this relationship.
Some Worrisome Trends Start to Emerge
If one looked just at the economic data that has emerged from the U.S. the last few weeks, it would be easy to conclude the good times will continue to run through the year. The jobs data was good, better than many had expected. There was a very promising Purchasing Managers' Index (PMI) that showed renewed growth after faltering for the last few months. There have been improvements in the rate of capacity utilization and an increase in the levels of capital investment. All seems to be going as planned, but off in the distance, there are unmistakable sounds of distress that will at some point affect the U.S. as well. What has the global markets a little worried and concerned about how the year will end?
Analysis: The primary cause for concern has been the almost coordinated collapse of many indicators that have been riding some very impressive highs for the last year or so. Not that these have all fallen to the point of no return, but the absence of growth is worrying as there does not seem to be a new source of economic stimulus around the corner. In fact, one of the factors weighing on the markets has been the increasing tension between the largest trading nations. The trade wars that have been fast developing between the U.S. and Europe will inevitably take a toll. If there are other weaknesses manifesting, there is a fear that issues will accelerate faster than anticipated.
The Purchasing Managers' Index from Markit has fallen back to 53.1, the lowest level it has seen in eight months. Not that 53.1 is a cause for panic as anything above 50 still indicates growth. The services index also fell to an eight-month low. That can be a bigger deal for service-dependent economies like those in Europe and the U.S. European growth has slowed substantially—a big worry. Last year, it looked as if Europe was starting to get a head of steam and had started to shake off the impact of the Brexit debacle. France dodged a bullet with the defeat of Marine Le Pen, but Emmanuel Macron has struggled to remain popular. His reform ideas have triggered major strikes and considerable political resistance. The Germans are worried again as Merkel barely squeaked back to power and has to contend with the rise of the populist right. We all know what a mess Italy is facing as their insurgent populists have now formed a government. Those confident assertions regarding European growth have been replaced by expectations of decline.
There have been other issues to note as far as index readings are concerned. A much-studied indicator is the Baltic Dry Index as this looks at shipping tonnage around the world. The index has fallen by 22% in the last six months. This indicates that global demand is off from previous peaks. There has been less demand for a variety of industrial metals such as copper and nickel. Part of the decline in demand for steel and aluminum stems from the fact that consumers of these metals bought heavily when the tariffs were first discussed earlier in the year. They were trying to beat the inevitable price hikes. Now these users are back in the market and the metals are more expensive. This has reduced consumption to a degree.
The emerging consensus among economists watching for the next recession is that it will likely appear in late 2019 or sometime in 2020. The expectation is that it will be a mild recession triggered to an extent by the actions of the central banks as they shift their emphasis to fighting inflation. Rising interest rates will slow the economies of the U.S., Europe and Asia. This will take the wind out of current economic growth patterns for a while. The markets seem to be getting ready for that development sooner than later.
The Era of the Strongman
There has long been something of a fatal flaw as far as democracy is concerned. In order for it to work, the governed have to care about how that governing is done. The voter must trust the institutions that have been set up to reflect their collective will. That means they should trust legislatures more than the executive leaders and they should trust the legislatures that are closest to them. The problem is that far too many people are uninterested and are content to be led. This propels the strongman leader to the forefront and reduces the role of those democratic institutions.
Analysis: It has been asserted by some analysts that the world is in the grip of the strongman and democracy has been severely weakened. The dominant figures in the world have accrued considerable independent power and routinely ignore the institutions whose focus has been exerting control over that executive power. Vladimir Putin has more power in Russia than any leader of that nation since Josef Stalin. Xi Jinping is now China's head for life and even Donald Trump has made a habit of weakening Congress.
Why Trade Wars and Tariff Battles Hurt the U.S. Economy
For reasons that are murky at best, the Trump administration is committed to a set of trade policies that challenge allies and enemies alike. It is not that trade spats are unusual—in fact they are quite common. It was the mission of the General Agreement on Tariffs and Trade (later morphed into the World Trade Organization (WTO)) to end the kind of trade protectionism that had been a contributing factor to the Great Depression and World War II. The majority of nations engaged in what was referred to as "beggar thy neighbor." It meant that every tactic possible was employed to export and avoid importing. Currencies were devalued, barriers were set up to protect every domestic industry, domestic producers were subsidized and so on. The flaw in this approach is that if everybody focuses on exports and prohibits imports, there is nobody doing any buying—everyone can't be a seller all the time. The U.S. has been a champion of free trade for decades and has reaped a lot of rewards for that open attitude. This is a diverse economy with a lot to sell and needs as many markets as it can get. It is also a consumer-oriented economy that is healthy when the consumer is healthy and has access to goods from all over the world. Money saved by buying a less costly pair of shoes is money that can be spent on something else.
Analysis: It is not clear what motivates President Trump's trade policy. There are perhaps three theories. The first is that Trump is trying to leverage the relationship the U.S. has with the rest of the world as far as trade is concerned. The U.S. is the dominant market for most of the world—everybody wants access to the U.S. consumer. The talks that have been taking place between the U.S. and its trading partners may be focused on getting something from these nations in return for that access. Maybe that is more buying from the U.S. as has been demanded from China. It may be political as in getting China to put pressure on North Korea or forcing the Europeans to support the U.S. position on Iran. Thus far, the U.S. has not been all that explicit as far as what is wanted (except in the case of China). Generally speaking, those who surround Trump have the attitude that other nations have taken advantage of the U.S. over the years. Though this may have been the case on occasion, the evidence shows that the U.S. position has been adopted the majority of the time by the WTO and other organizations. It is also worth reminding critics of past trade policies that deals were often made that gave nations preferred access in exchange for political and military concessions. During the Cold War years, a country could get about anything it desired by promising to be on the U.S. side against the USSR.
A second motivation is rooted in purely domestic considerations. The Trump campaign aimed at a very specific section of the electorate and that focus has not changed. There never was a drift to the middle or an accommodation to those who disagreed with him. The political base of support is everything. There is some diversity in that base, but many are part of a sector that has suffered from the overall process of globalization. It can be argued that taking care of the consumer is the best way to advance the U.S. and its growth, but that doesn't matter much to the person whose job has vanished. The easiest way to exploit the politics of this situation is to find someone or something to blame. The reality is that millions of blue collar jobs have been lost to blue collar robots and technology, but it is easier to blame the Chinese and others that are exporting to the U.S. The U.S. is far from the only nation that has been confronting this set of challenges—the populist message has resonated in the U.K. with Brexit, in France with the rise of the National Front, in Italy with the success of the Five Star Movement and in Germany with Alternative for Germany. This group of workers has a right to feel abandoned and maligned.
A third theory is that banning and taxing imports will force U.S. companies to fill the gap. It would seem logical to assume that U.S. producers would rush to provide the output that is no longer coming from imports and there will certainly be some of these adjustments. The problem is that companies will be very reluctant to commit to big investments in a volatile environment. The only reason they would have a market in the U.S. was because imports were banned or taxed. If that policy changes, that investment is wasted. Few companies will risk much. There will also be lots of lost business for U.S. companies as other nations retaliate against the U.S. moves. It is very unlikely that expansion opportunities will offset the loss of business that comes from a trade and tariff war.
Employment Trends Index Is Down a Little
After five months of steady gains, the Conference Board's Employment Trends Index was down this month and last month's reading was downgraded a little. This is not really cause for panic as the index had been tracking unusually high since the start of the year. These latest readings are basically settling back to the normal trend. Of the eight components in the analysis, six of them are trending negative. Of these, the biggest drop is in the category of firms unable to fill available positions. The others that fell include: (1) percentage of those that assert that a job is hard to find; (2) job openings; (3) number of temp employees hired; (4) initial claims for unemployment insurance; and (5) ratio of involuntarily part-time workers to all part-time workers. The two categories that trended positive include real manufacturing and trade sales and industrial production.
Analysis: There is nothing in this latest report that would cause alarm other than the indication of an end to the unusually strong job creation period. The growth in the jobs sector has been extremely robust as many companies have been trying to make up for lost time. The sense is that some unusual attributes have started to fade. The growth in jobs has been tied to some degree to the fact that so many have been retiring and they have to be replaced in many cases. The expectation is that continued growth will mark the rest of the year, but perhaps not at the accustomed pace.
Every Crisis Is an Opportunity
As I have mentioned before, I have an unusual opportunity to listen to any number of speakers on a wide variety of topics as they are part of the same program I am. The "motivational" speakers come in a wide variety of flavors. Some of these are pretty fluffy. It is apparent they are really there for their entertainment value. But others have some important gems to share. I remember a man who gave a talk that focused on making "lemonade from lemons," as it were. He was confined to a wheelchair as he had lost both legs to an IED in Iraq. His left hand was missing as well. He further revealed that he still carried dozens of shrapnel pieces in his body, suffered from PTSD and had fought through everything from pneumonia to shingles. That was before he learned he had cancer and would need over a year of chemotherapy. If ever there was a person who had the right to rail against an unfair world—he was it.
He was as funny a speaker as I had ever heard—all self-deprecating humor to prove a point. He took each of these setbacks as an opportunity to learn something about himself or the world around him. He learned that having to sit all the time put him at the same level as kids and started to talk to them differently—listening and treating them seriously. He taught himself to do one handed card tricks. He became highly sensitive to anxiety in others because of his PTSD and used that to learn how to work with dogs that had been abused so they would become adoptable. He makes the most of every second of his day and points out that when he was physically healthy, he was mentally and intellectually stunted. He was a self-described "jock and grunt" who basically sat around, drank beer and watched sports. He hastened to point out that he still drinks beer, but now he likes those craft brews and he still watches sports. The point is that limitations forced him to broaden his life. That is a lesson for all of us.