Strategic Global Intelligence Brief for March 15, 2019
Short Items of Interest—U.S. Economy
Housing Sector Off to Weak Start
The expectation for this year was not especially high given all the accumulated issues affecting the housing sector, but the latest data in new home starts has been weaker than expected. The decline was 6.9%, when the majority thought there would be a small increase. In January, the decline in sales was 4.3% on an annual basis, so there has been a slowdown manifesting for some time. There are extenuating circumstances to be considered; however, this data is often revised later as details emerge. One of the more salient factors was the weather. It has been utterly impossible to get in a construction mode with a winter this brutal and extended. The big inhibitions have been the higher price of homes, and to some degree, the financial anxiety of new home buyers.
Jobless Claims Up Last Week
This is causing no heartburn as these readings are volatile from week to week. There have been no signs of a big layoff in any industry sector at this point, but there are some concerns starting to develop given the data on sectors like construction and retail. The construction employment data is always volatile, but the bad weather this year has slowed progress in almost all parts of the country. That has spiked layoffs in both construction companies and in those companies that supply the sector. There are also worries that poor retail numbers may start to cause employees to be laid off due to reduced activity. This month's data is likely more reliable than those of the last few as there is not the impact from the government shutdown to contend with.
PPI Not Causing Much Concern Yet
There was very little movement in the Producer Price Index (PPI) this month—only a slight gain of 0.1%. That small increase was mostly due to a rise in the cost of energy as the OPEC/Russia decision to reduce output has started to have an impact on the per barrel price. Nothing else is really affecting the PPI—not even metal prices which had been a major factor last year when the steel and aluminum tariffs were being imposed. This would suggest that an imminent inflation threat can be dismissed—at least for now. The potential remains for higher commodity prices and even higher prices for energy.
Short Items of Interest—Global Economy
Another Atrocity and in a Very Unlikely Place
Unfortunately, the world has become accustomed to mass killings in the U.S. and often in Europe, but there have been countries that seemed immune to this kind of brutal madness. At the top of that list was New Zealand. The news is still developing, but what is known is that a mass killing was carried out at two mosques in Christchurch. Four people have been detained and one has been accused of murder. They made their right-wing agenda very clear with a series of manifestos and ranting screeds over the course of the last few years. The fact is hatred and bigotry are not unique to any one place. Stopping this kind of terrorism is extremely difficult.
The contest over the future of the Christian Democratic Union (CDU) party was intense. In the end, the winner was Annegret Kramp-Karrenbauer (AKK). After holding off the challenge from Friedrich Merz—who positioned himself as the more conservative of the two—AKK has made it a point to establish her independence from Merkel without losing the support of Merkel and her backers. She has challenged those in the CDU who seem to take offense at everything and remarked that "Germans are the most uptight people in the world and need to lighten up."
World Bank Critic Likely to Get Job as Its New Head
David Malpass is on his way to becoming the next head of the World Bank despite having been a major critic over the years. There was opposition from some member countries, but it has faded.
Britain Will Ask EU for Delay
This seemed an inevitable outcome given all the wrangling that has come very close to toppling the government of Prime Minister Theresa May. Yet it was never seen as inevitable as there have been many in the U.K. Parliament as well as in the EU that rejected the whole idea of extending this ongoing crisis. It is now a partially done deal in that Britain will formally request an extension of the Brexit past the end of March. It is not guaranteed that Europe will go along with this, but the betting is that they will, but not after asking some very pointed questions. The most important of which will be "how long." The second most important question will be what the plan might be to break the stalemate that has locked the U.K. and the EU into this fight. At this stage, it is not clear that anybody in the U.K. has an answer to either one of these questions.
Analysis: In theory, this is what happens next. The automatic extension on technical grounds will be until June. If PM May is not able to get a deal her party can agree to, she will ask the EU for a much longer delay—perhaps of a year or more. This would presumably give her time to find ways to pressure the hardliners. They seemed to waver a little in the last few votes as they started to realize that any new deal proposed will be worse than the deal on the table. There is now renewed talk about the "Norway" option which leaves the U.K. connected to the single market, but free of most of the political entanglements. This would presumably satisfy those mostly concerned about the immigration situation, but leaves the U.K. economy subject to many of the EU rules and regulations of the single market. The argument against the Norway option has always been that a nation is subject to the rules and regulations, but will have no voice in setting them. Norway was essentially powerless regardless of their status, but the U.K. had a position that was at least as influential as that of Germany, France or Italy.
There remains a possibility that the U.K. would return to the polls for a second referendum, but that rankles many on both sides of the debate. It seems to say to voters that they will be given opportunities to vote until they get it right. The sense is that voters made their preference known and now it is up to the politicians to figure it out. On the other hand, the polls suggest that the population as a whole has changed its mind on the issue and a substantial number want another chance at the decision.
Given the turmoil within both the Conservative Party and the Labor Party, it is very hard to predict what happens from here. This may be the point that cooler heads start to prevail, but it may also simply be an extension of the crisis as members of Parliament continue to focus on their ideological positions and their specific constituents.
Is the Economy Slowing Down? If so, Why?
The latest poll of economists surveyed by The Wall Street Journal is not a very encouraging one. The consensus view is that economic growth is stalling this quarter and the pace will be far lower than it was at any time in 2018. The view is that growth will be no more than 1.3%. That would mean the U.S. was sinking to levels that have been vexing the Europeans and Japanese. The slump is not unexpected given all the turmoil in other global markets, but the U.S. had seemed somewhat immune to that chaos—at least for a while. There are always questions regarding the economists who are surveyed by the WSJ or any other group. The group surveyed by WSJ are all private-sector economists (no government or academic economists). These are all people working for large corporations, banks, investment houses and the like. They are generally not particularly ideological and take a very pragmatic view. There are two questions that beg to be answered. The first is how accurate this assessment might be. The second is what might have caused the U.S. economy to stall out this quarter.
Analysis: It was only a few weeks ago that these same economists predicted a growth rate of around 2% and that was considered pretty anemic as compared to the nearly 3% rate that dominated 2018. This assessment comes in sharp contrast to the predictions coming from the White House and from elements of Congress as they look ahead at the 2019 budget. They are predicting continued growth at between 3% and 3.5%. Even with that rate, there would have been a significant increase in the deficit and debt, but if there is only growth of 1.3%, that deficit and debt jump would be greater than anything seen in the last 30 years. This predicted rate of growth would be as slow as anything seen since 2015.
Over 80% of the economists pointed to the same issues. The number one concern was trade policy. The fight with China has already cost the U.S. economy billions and a further tightening will hurt even more as the affected goods will be those that consumers buy in the U.S. The reports of an imminent deal have not cheered the assemblage much as the offer seems loaded with potential landmines that would continue to impact trade. As described, the plan would have a review every 90 days and the U.S. would be able to impose tariffs unilaterally if they find China in noncompliance. Given the lack of presidential predictability and the politization of this issue, there is no confidence that a trade war can really be averted for long. It is not just China that is of concern to economists. The future of the U.S.-Mexico-Canada Agreement is in serious doubt as it faces stiff opposition in Congress and lukewarm support from Trump. The talks with Europe have all but fizzled out, while the U.S. has managed to alienate most of its traditional trade partners. The U.S. depends on exports for 15% of the GDP—around three trillion dollars. The sense is that all of this business is at risk. That makes analysts nervous as well as investors and executives. The latest survey of the Business Roundtable execs is also down, and for much the same reason.
There are other factors that have worried the economists. The extent to which these issues will impact the economy vary with the analyst, but the issues mentioned include the lingering impact of the government shutdown on those companies that do business with the government. Those 22,000 companies were not compensated for that lost month of business. There is worry about the weak job numbers reported in the last month even as many acknowledge that there were plenty of extenuating circumstances. Other issues brought up include the weak retail sales numbers, drooping levels of consumer confidence, the threat of higher commodity prices and the potential for higher wages and wage inflation. Most of these worries are still tentative, however. There is a chance this data will reverse later, but for now, the estimate is that these have been enough to put a drag on the first quarter economy. This pessimism has not extended to the rest of the year as most are still asserting growth will be in the 2.5% range. Should this poor start to the year extend into the second quarter, that outlook will be revised downward as well.
The Costs of Business Interruption
Anyone relying on the airline industry to get them where they need to go, when they need to get there knows all too well the fragility of that arrangement. Delays and cancellations are just part of the experience. There are so many factors that play a role—weather is the main issue, but then there are the mechanical issues and disputes with unions and the actions of government. The decision to ground the Boeing 737 Max may or may not be justified—time will tell. The assumption is that cancellations and delays are the problem of the airline—that they will lose money, but passengers will simply adjust and alter their schedule. This is not how it works. It is hard to estimate exactly, but quick computations show that business is affected by these moves as many aspects of business are time sensitive. Each canceled flight is thought to cost the passengers in the neighborhood of $150,000.
Analysis: These are clearly "back of the envelope" numbers as every flight is very different in terms of who is flying and for what reason, but speaking just for myself, the costs can be dramatic. If a flight I am on is cancelled, I will likely miss the presentation I was scheduled to make. On a flight a few months ago, I was in the waiting area with two other speakers on the way to the same conference—they were the keynotes. None of us could make it. That meant they both lost a $10,000 speaking fee. The conference was suddenly without its program and was forced to refund much of the money that attendees paid—total of $300,000. The cancellation was obviously significant. When multiplied by the thousands of events like this one, it is obvious what a drain this can be on more than just the affected airlines.
White House Budget—Politics Over Economics
The budgets that come from any president are only remotely connected to economic priorities and growth. They are all essentially political statements as the decisions on what to put in and leave out of a budget will be up to the members of Congress. When there is a split in leadership, as there is now, that political dimension is even more obvious as the president knows there will be pushback from the other political party. Trump knows full well he will be fighting the Democrats in the House of Representatives over most of his plan.
Analysis: The budget does demonstrate the priorities of the Trump administration. Few of the ideas come as any shock—they reflect the issues that have been at the top of his agenda since he took office. To the surprise of nobody, he has a big chunk of cash earmarked for his border wall. There is a massive increase in the military budget at the same time he has been ordering the withdrawal of U.S. troops from bases all over the world. Much of the military spending seems to be geared towards new weapons rather than personnel. There is a call for a major infrastructure effort—perhaps as much as $500 billion over the next couple of years.
The proposed cuts are also instructive. Nearly all domestic programs would be subject to deep reductions—everything from welfare to research and development. Almost all foreign aid is cut. There are plans to reduce funding for the State Department as well as the intelligence services. The budget is very optimistic as far as expected growth is concerned—expecting rates at between 3.5% and 4%. However, economists in general are not that confident and assert that growth of 2% would be about the upper limit. The plan also preserves all of the tax cuts from 2018—even those that were supposed to have expired this coming year. The budget as it has been presented would drastically increase the deficit and debt burden.
Corruption and Bribery
There is nothing quite as corrosive and destructive as corruption—especially at high levels. It sends a very destructive message as it tells people that nothing they do will matter as far as pursuing their goals and dreams. You can work hard, get the skills and education you need, get experience and all of that. But if you watch someone get what you have worked so hard for by bribing or cheating, your motivation to keep working hard vanishes.
I spent many years as a student of the Soviet Union—majoring in Soviet and East European studies. There were many things that brought that system to an end, but from what I observed, the most destructive aspect of that system was corruption. Who you knew was far more important than what you knew. In short, people simply stopped trying. Nobody cared about their job as they knew the only thing that mattered was the ability to bribe.
The sad fact is that corruption has been a reality in colleges and universities for many years. This latest episode is the more outrageous because these people had all the legitimate resources they or their progeny would ever need. They could hire dozens of tutors and pay for dozens of prep classes. They could have had their children actually learn how to participate in a sport and get good enough to earn their entry. Today, their ability to engage in that activity is compromised—not only by the legal system, but by the fact that most of them are now losing their jobs and their kids are getting expelled. The real tragedy is that, once again, we have been smacked in the face with the fact that we do not begin to compete on a level playing field.