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Strategic Global Intelligence Brief for March 12, 2018

Short Items of Interest—U.S. Economy

Mortgage Rates Start to Become Real Headwind
The idea of housing market headwinds has been discussed all year; yet there has not been all that much reaction. The price of homes has been going up. In some parts of the country, this has managed to price a lot of people out of the market (part of what has been driving the expanding market for multi-family construction). The mortgage rates were expected to have a similar dampening impact, but until recently, these rates have remained relatively low. Now, they are accelerating and that worries the market. The higher rates hit the sector in two related ways. The first is that higher rates force first-time buyers out and limit many others that lack the wherewithal to get the mortgages they can handle. The higher rates also make it harder to move—especially for those that had gotten good rates before.

Major Flaw in the Aluminum Tariff Plan
The assertion has been that tariffs on imported aluminum are for the purposes of national security. We don't want to be dependent on foreign sources for the aluminum we consume in everything from airplanes to beer cans. The problem with this logic is that U.S. aluminum producers still need the bauxite that aluminum is derived from. The U.S. has absolutely no bauxite of its own—not one speck. The best and only way to ensure the U.S. has the aluminum it needs is to maintain good relations with those countries that export bauxite and those that export aluminum.

More Fed Officials Sound Rate Warning
The primary threat to the continued growth of the U.S. economy in 2018 will be interest rate hikes. There is more and more consensus around this issue as the Fed looks ahead. It was a foregone conclusion that hawks at the Fed would want to push rates up as a means by which to fight inflation, but it was not clear where the doves and the moderates stood. Now the less aggressive Fed members are growing more supportive of hikes—as many as three or four by the end of the year. That almost guarantees the rates will start to pull the economy down a little.

Short Items of Interest—Global Economy

Making Room for the Young
There is a downside to the fact that older people can remain in the workforce longer. It was once a safe assumption that people in their 60s would be off in retirement, or at least would be reducing their influence as the next generation took their place. Everybody moved up to fill the vacated positions above them. The pattern has changed dramatically as people choose to stay engaged through their sixties, seventies and even eighties. The following generations are bottled up. Those at the start of their career path can't find an opportunity to begin the climb in the first place. This has shoved the unemployment crisis to the younger workers. That affects a whole host of decisions ranging from starting a family to buying a house.

Colombia Splits Between Left and Right
There will not likely be a contest between the center left and the center right in Colombia as these candidates have not fared well in the preliminaries. The hard right and the hard left have fielded the strongest candidates. They will likely emerge from the first round of elections as the runoff choices. The former FARC guerilla is Gustavo Petro. He has over 85% support from the left. His likely opponent is Iván Duque—a far-right senator who has the backing of former President Álvaro Uribe. Their positions could not be more divergent.

President for Life
At the end of his rule, Mao Zedong had become a threat to his own country. Steps were taken in China to ensure that this kind of perpetual rule would not be repeated. There had been terms of office ever since. Xi Jinping has engineered an end to this restriction. He now has the option of staying in power until his death or he decides to resign. China now has a new dictator. Past experience around the world suggests this will not end well.

Let the Games Begin
The steel and aluminum tariff decision has been typical of the way Trump has operated since coming to office. A grand and sweeping announcement starts the process before a series of alterations and shifts. The original idea was a universal tariff of 25% on imported steel and a 10% tariff on imported aluminum, but almost before the idea was floated, there were exemptions granted to both Canada and Mexico (who between them account for almost 30% of imports into the U.S.). At the same time, it was hinted that others could get exemptions as well.

Analysis: The European Union and Japan have stepped up quickly and are employing "good cop/bad cop" techniques. On the one hand, they are threatening trade retaliation with tariffs and non-tariff barriers of their own, but they are also suggesting some compromise on issues that have been problems for the U.S. for years. The EU has erected many barriers to everything from farm goods to high tech and Japan has been highly protective of its farm community as well as its retailers and manufacturers. The U.S. has been working to get better access to these markets for a long time. Now the steel and aluminum tariffs have become part of that negotiation process.

The U.S. is really not in an ideal position to restrict steel and aluminum and these nations will exploit this. There is not enough capacity in the U.S. to meet current demand if imports are restricted. This shortage will drive up prices far more than the 25% and 10% indicated by the tariff. We are now in the middle of a game of "trade chicken." Both sides wait to see who blinks first.

Brazil's War on Drug Gangs
The military has been called out in Brazil in an attempt to break the power of the drug gangs that dominate the favelas (slums) in all of the country's major cities. The effort has been supported by the majority of Brazilians, but gets mixed reviews from those who are in these communities. These are not police—their tactics are military tactics. They tend to shoot first and ask questions later. Those who live in these areas are often more afraid of the military than the drug gangs. Those who support the effort against the gangs are subject to reprisal by these gangs as well.

Analysis: Most analysts assert that calling the military in has been a political move—not one motivated by a real desire to deal with the issue. The drug gangs exploit the desperation of the poor and the attacks by the military rarely affect any of the actual dealers and gang leaders. Most of those who are arrested or killed are users of drugs—not sellers. The country has been deeply concerned with the rise of crime, but they also know that high level corruption is a far bigger threat. The average voter holds that none of the parties competing for leadership are without issues.

Really Good Job Numbers—What Did We Learn?
The expectation was that 200,000 jobs would be created over the last month, so when the numbers were released, there was some immediate concern that something had happened to skew the data. It is not that economists never miss in their assessments, but not usually by this much. The actual number of new jobs came in at over 300,000. That begs for some explanation. One clue was that the overall unemployment rate remained at 4.1% instead of dropping down to 4%. It would have been logical to assume that the rate would fall with that many new jobs, but the fact is that job seekers shifted categories. Those who had been counted as part of the U-6 measurement drifted in fairly large numbers to the U-3 category. This means that some of those discouraged workers decided that now was the time to seek employment. Many were having some success. This had been an ongoing concern—the higher level of U-6 joblessness indicated big holes in terms of hiring opportunity.

Analysis: Beyond the raw numbers, there are several takeaways from this month's data—some good, some bad, and some not quite one or the other. The good news is obvious enough—300,000+ jobs at this point in the economic recovery is nothing to dismiss. Most had expected the pace of hiring to start slacking off given the growth of the economy over the last few quarters. It is apparent that business is still expanding and still hiring. The big news was the shift from the discouraged worker category. The majority of those who are in that group are there for one of three reasons. The majority are in the wrong place at the wrong time. They are ready, willing and able to work, but are someplace in the U.S. where the jobless rate remains high. For some reason or other they are not able to relocate to where the job hunting would be better. The second group is those with limited skills or skills that are no longer appropriate for the workforce. They have to wait for the employers to be willing to invest time and money in retraining them. That means they are competing with everything from robots to outsourced solutions. The third group is made up of those who are making a living off-book. They are working, but not formally. They may be very slow to seek a normal job given what they can make in the informal economy. This is a fast-growing segment of the population and now includes everything from day laborers to those who have made a career of eBay.

The next aspect of the report that bears examination is the kind of job that was created. It is far better for the economy to create secure, high-paying jobs, but the majority of the jobs created this time around would not really fit that description. There was a big gain in retail employment (over 50,000), but these are generally lower-paying jobs, not slated to last all that long. There was also a big jump in construction jobs (over 60,000). These can be well paid, but not all of them. They also tend to be seasonal. That limits the length of time people can expect to hold them. The benign weather in much of the country contributed to the length of the construction season. The other factors that contributed to better hiring patterns included the volatile world of energy production—another example of a boom and bust employment sector.

There was also a disappointing aspect of this report—one that has been vexing economists for a while. The rate of wage growth slowed; it had been expected to increase. It has been odd that these lower rates of unemployment have not resulted in higher wages. All the theories assert that they would, which only makes sense. If there are fewer candidates to hire, it would stand to reason that employers would have to pay more to get the people they want. The last few years have thrown these theories under the bus. It seems that employers are unwilling to pay top dollar for employees that will require extensive retraining. The other issue is that much of the hiring has been taking place in the low-wage sector. That also limits the overall gain in terms of wages. As important as the tax cuts might be to the consumer's mood, the wages they are paid will be far more important. This has not improved at the rate expected.

Reforming Bank Reform
The Dodd-Frank Act has been controversial since the beginning—mostly because of the mood that existed in Congress at the time. It was intended to be punitive and was inspired by real anger. There were many factors that led to the recession that emerged in 2008-2009, but the prevailing opinion was that the banks were most at fault. Their collapse caught the headlines. The rescue attempts by the government put billions of taxpayer dollars at risk through efforts such as TARP. It was a bailout of the largest banks that were too important to the financial sector to be allowed to vanish—the "too big to fail" argument. It was apparent that many of the most venerable institutions had already suffered death blows and many feared that others were right behind them. Could the U.S. tolerate the end of others like Bear Stearns, Lehman Brothers, Merrill Lynch, Washington Mutual and so on? The assertion was that the U.S. could not lose more and the rescues got underway.

Analysis: One of the primary goals of the reform legislation was to ensure "this would never happen again" and by "this," the legislation meant a government rescue that would put billions of taxpayer dollars at risk. The means to that end were a series of rules that would require these banks to have the resources needed to handle any future crisis of this kind. There were also new restrictions on what banks would be allowed to invest in and how they would handle their business. The punitive nature of the reform was opposed by many banks who argued they had done nothing to exacerbate the problem and had never engaged in the kind of high-risk activity that led to the crisis. This was argued most strongly by the smaller community banks that suddenly found themselves engaged in all manner of regulatory activity that hampered their ability to function as effectively as they had before.

Most agreed on the need to relieve the smaller banks. These are the lifeblood of the small towns they serve and are critical to industries like manufacturing and agriculture. It was agreed that these banks had nothing to do with the crisis that led to the recession and they deserved a different system. The complaint by those who oppose the efforts to reform the Bank Reform Act is that modifications are being exploited by the largest banks and these are still "too big to fail." A key part of Dodd-Frank was ensuring that banks had enough cash on hand in an emergency—that they have enough capital to avoid collapse. This quickly becomes a debate one what qualifies as capital and how easily it can be accessed. The changes would allow banks to classify municipal bonds as "high quality liquid assets." Most of the time this is true enough, but one has to question how high quality or liquid bonds issued by Detroit were (and are) and any of the hundreds of other cities that are in financial distress.

There are many changes in the amount of capital required in "custodial banks" and what qualifies as custodial. Some of the very largest banks do some of this, but it is a small part of their overall business. How to handle the definition of capital has been at the heart of the debate as this locks that cash away and limits what the bank can work with and put at risk. There would also be a change in how mid-sized banks would be treated. Right now, those with assets over $50 billion are subject to intense scrutiny, but the changes would make that limit far higher—$250 billion. The Senate will vote on these changes this week. Then it goes to the House where even more concessions might be made to the banking sector.

More Binging
I am not sure if this is a positive or negative, but my current status is as a couch potato. Long term this would be a problem and I am eager to get back to my usual patterns on a weekend. First off, the gardening season starts soon. Then, there will be the end of this cancer stuff. It has made me lazier than I am accustomed to. Hence, I am indulging in some binge watching. The object of my affections this weekend has been Timeless. I didn't watch it when it first appeared, but noted that it had been renewed due to intense fan demand. I noted the first season was available, but access expired this weekend, so I needed to act fast.

Time travel has been endlessly fascinating as a story line. We wonder what might have been if this person had not been born or that person could have been thwarted. This is roughly the premise of the series. It is fun to consider what tiny alterations in history might have created. There has long been a debate over whether it is events or people that shape history. If there had not been Adolf Hitler would there have been a Nazi movement and World War II? Given the movements in Europe at the time, it is likely that somebody like Hitler would have risen to the top, but it might have been different. The show is not historically accurate in every detail, but it doesn't stray as far as it might have. I am now looking forward to the next season.

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Friday, 18 January 2019