Strategic Global Intelligence Brief for March 8, 2018
Short Items of Interest—U.S. Economy
Rise of Nationalists in Trump's Inner Circle
It is a bit early to say anything definitive as we have learned that policy in the Trump era is ever-changing, and often with little warning. A few months ago, it appeared that the power of economic policy rested in the more traditional hands of people like Gary Cohn, but now he has resigned and Peter Navarro is on the rise. Navarro has been a full-on enemy of Chinese policy and has essentially abandoned the academic world to focus on polemics directed at China. His point of view is dominant right now. He seems to be pushing hard to be the man who replaces Cohn. This will be a test as far as the GOP is concerned as Navarro's assertions rankle much of the corporate community. He has not been popular with that base.
Jobs Report Due Tomorrow
By all accounts, the jobs report will be a good one, but there will be areas to watch—especially as it may relate to the emergence of inflation later in the year. There is a possibility that the jobless rate will hit 4%. If that is the case, it will match the low set in 2000. There will likely be an additional 200,000 jobs added, but many will still be expected to be in the lower-wage categories. It is not that there are not good jobs out there—it is more a matter of not enough people with the skills needed to take them. Look for wage growth to ratchet back a little for this reason. The expected gains in wages will only come when the skills match up with the jobs on offer.
Backing Away from Dodd-Frank
One of the areas of stated priority for the Republicans was a partial rollback of the provisions contained in the Bank Reform Act, but without some support from Democrats, this was not going to happen. There now appears to be enough moderate Democrats to create a workable coalition. The primary interest is to reduce the burden on the small and community banks. They fell under the same punitive rules that were aimed at the big-20 banks that were largely behind the high-risk moves that brought the financial sector to its knees in 2008-2009. The plan now is to reduce some of that small-bank burden, but this will be an emotional and ideological debate that will divide both the GOP and Democrats.
Short Items of Interest—Global Economy
Colombia Worries About Rise of the Left
When the Colombian government worked out a cease-fire and truce with the FARC revolutionaries, it was assumed the populace would credit the ruling powers for this breakthrough, but this has not been the case. In the presidential campaign, it is the former guerilla and left-wing ideologue that leads the polls. Gustavo Petro is outlining a plan that looks a great deal like the one that was developed by Hugo Chavez in Venezuela. Somehow, the population has failed to notice what that did to their neighbor's economy. Investment flows are already shrinking fast as the fear is that radical leftism rules sooner than later.
World Bank Critique of EU Policy
As Europe tries to come to grips with the persistence of the populist message, there have been a number of studies launched by the likes of the European Union (EU) and now the World Bank. The conclusions are not exactly shocking. The gaps between those that are doing well and those that are not have been widening–this creates divisions. The fact is that most of those that are struggling no longer think they have a chance to get ahead and escape the current situation. That is a stark contrast to even 20 years ago. They want a different system entirely even as they have no idea what difference that would make.
Alexa Laughing at You?
It may be time to run, now. It seems that Alexa and even Siri have started to learn to communicate independently. It has been reported that these devices are laughing spontaneously and at certain commands. If you are not grammatically correct, you are likely to evoke a giggle of derision. Be afraid—be very afraid.
The TPP Lives On
The Trans-Pacific Partnership (TPP) was killed off even before Trump came into office, but that didn't stop him from taking credit for its demise. It is useful to review the origins of this agreement and why it roused such ire in the halls of Congress. The basic idea was to cobble together a large group of Pacific nations in a way that would limit the influence of China in both economic and political terms. China has obviously become a major world actor, but it has been near dominant in its own sphere of influence. The nations of Asia and the Pacific have seen their economies tilt further and further towards China as their exports have been moving in that direction as well as their imports. These nations have wanted alternatives to Chinese dependence and the U.S. certainly wanted to loosen the grip of the Chinese as well. That was what prompted the TPP—a group that would strive to open up markets to one another for both economic and political reasons.
Analysis: The opposition from within the U.S. stems from the fact the U.S. is the only nation that could come close to offering the kind of market opportunity China could. Every nation slated to become a member of the TPP was expecting better access to each other's markets and that generally meant the U.S. was going to allow more imports and more competition. This angered various sectors of the U.S. as they didn't see much benefit to their business. The farm sector was going to get far better access to these nations than before and there would have been gains for the service sector as well—especially the financial community. In the end, the TPP was rejected by Congress. Most thought this would be the end of the effort.
Now, it has been reformed as a partnership that still excludes China and is without U.S. engagement, but is open to more participation from other nations in the future. The core members will be Japan, Canada, Mexico, Australia, Brunei, Malaysia, New Zealand, Chile, Singapore, Peru and Vietnam. The countries that have been targeted as future members include Thailand, Taiwan, Philippines, South Korea, Sri Lanka as well as the United Kingdom and of course the U.S. The plan is to continue to exclude the Chinese, but under certain circumstances they may be allowed observer status of some kind.
The political emphasis has faded under the current membership. It has been made far more trade centered. The U.S. involvement would be crucial as far as pulling these states away from the Chinese orbit. There has been some urgency expressed as the Chinese are certainly not standing idle. They have created their own version of the TPP and have been active in supporting all manner of business development and investment efforts to ensure these states remain connected to them. The U.S. decision to impose tariffs on nations like Japan, South Korea, Canada, Mexico and even Australia has further bolstered the Chinese argument that they are the more reliable trade partner.
ECB Continues to Back Away From Stimulus
The European Central Bank (ECB) is apparently growing more confident with every meeting. The latest one marks the clearest departure from the old stimulus efforts. The ECB has removed the reference to "easing bias" from its statements. This was the explicit promise to keep buying government bonds should there be a period of inadequate growth. This has been at the core of their quantitative easing (QE) strategy for some years now. The decision to back away from an explicit recognition suggests a significant jump in the confidence level at the bank.
Analysis: This decision comes on top of the scaling down of the various QE measures—from purchasing 80 billion euros to 60 billion to 30 billion now. There is certainly concern about how robust the growth prospects are for the rest of the year, but most signals have been positive this year. The most consistent worry now is political. The breather that came with the victory of Emmanuel Macron has faded as it has become clear that populism and anti-EU sentiment remains strong. The elections in Italy seemed to pain Mario Draghi more than a little as he has been allied with the centrists for years. Now the two most anti-EU parties in Italy are in the driver's seat. Relations between the ECB and the Five Star Movement and Northern Alliance have never been cordial.
Draghi also had sharp words for Trump and his protectionist agenda. He wondered what it means when allies are punished as enemies and predicted that these measures will start some form of a trade war that will ultimately damage the eurozone nations and the U.S., as trade figures so prominently in their respective economies.
The Likely Winners and Losers
At this writing, there are still mysteries surrounding the specifics of the tariffs to be applied to imported steel and aluminum. The latest rumors are that Canada and Mexico will get a better deal than the other nations that send steel to the U.S. There have been rumors that certain grades and types of steel will also be handled differently. The decision has caused a major split within the Trump White House with Gary Cohn resigning in protest. Rumors (again, these rumors) hold that both National Security Advisor H.R. McMaster and Defense Secretary Mattis are considering resignation as well. By the beginning of next week, there could be more changes and revelations. For the time being, it has to be assumed the tariffs will go into effect as stated. There will be some sectors of the economy that will be damaged quickly and perhaps permanently.
Analysis: Generally speaking, the negative impact will be felt by those companies in the U.S. that consume steel and aluminum. Obviously, these companies will be seeing higher prices and, in many cases, far higher than the 25% tariff would suggest. The fact is that U.S. steel producers are nowhere near able to meet current demand for steel should imports be sharply reduced. The estimates vary, but the sense is that domestic producers can only meet around 40% of demand. This capacity issue will drive prices even further as shortages will promote what amounts to bidding wars. The companies that will be most at risk are those that lack the flexibility to adjust to these higher prices quickly. That includes the bulk of the businesses that are classified as fabricators and small-scale manufacturers. There are around 30,000 companies that do something with steel (bend it, weld it, etc.) and collectively, they employ 900,000 people. The steel-producing companies number around 916 and employ around 80,000 people. It is pretty easy to see which of these two sectors contribute to the economy more, but in truth, they are both important and both deserve attention that is far better thought out than this ham-fisted response.
Those who seek to downplay the impact of the tariff, state the additional costs will be easily absorbed and price hikes will not have a major impact on the consumer of products made of steel and aluminum, but this misses two key points. Take auto manufacturing for example. The fact is that more expensive steel may not be a major issue as far as the total price of the vehicle and consumers may not react all that strongly, but there are several steps that car companies will take that will affect the parts manufacturers directly. The car companies will be able to reduce the impact of the price hike by demanding that these smaller companies absorb that hit—this has been their pattern for years anyway. The second step will be to eliminate that much more steel from the car. There has been a reduction in steel and aluminum use anyway as the industry has been mandated to reduce fuel consumption. Now there is another reason to reduce and use alternatives like plastics, ceramics and composites. Then, there is perhaps the biggest threat of all. The countries that are subject to the tariffs will seek ways to get around the restrictions. In many cases, that means they will concentrate on shipping in parts and assemblies made in their countries as opposed to shipping steel and aluminum to the U.S. so that local companies can make these parts.
There are some sectors that are far more price sensitive. Construction is one of these. This is the sector that currently consumes the largest percentage of steel. The most aggressive construction market is public sector. Steel is used widely for roads, bridges, airports, seaports and so on. These are projects with inflexible budgets. When the price of commodities goes up, the scale of these projects will be reduced, and in some cases the whole project will be shelved. Consumers of cars may be able to tolerate higher-priced vehicles, but the farmer is not going to be able to tolerate the higher costs of farm machinery. They will buy far less than would have been the case.
The advocates for the tariffs have made some glib statements regarding the potential loss of jobs—stating that perhaps 200,000 will be lost and asserting that this is no big deal, just one month of typical job loss and gain. The part that is missed here is that these 200,000 lost jobs are high-paid jobs belonging to skilled workers in manufacturing, while the majority of the job growth over the last year has been in low-level service and retail. Does it advance economic growth to lose a job paying $25 to $35 an hour and replace it with one that pays slightly over minimum wage?
Dissent Within the Ranks
The traditional GOP is not happy with the steel and aluminum tariff plan. This has created the most substantial rift thus far between the Trump White House and the GOP. Over 100 legislators signed a letter of protest urging Trump to back away from the plan, but this has fallen on deaf ears.
Analysis: The way that this plan seems to be coming together is as a series of carrots and sticks. Right from the start, Mexico and Canada will be exempt providing they agree to changes in NAFTA. The other nations that are affected will be given an opportunity to see the tariffs removed or reduced in exchange for some other concession to the U.S. The long-term goal may be to whittle down the number of affected countries to the original targets of U.S. ire—China and perhaps Russia. The problem is that many of the affected states deeply resent this kind of economic blackmail and will be more likely to use their own threats to get the U.S. to change its mind on tariffs. This will especially be the case with the Europeans who play a major role in terms of U.S. export markets and could do some real damage in a trade war.
Road Warrior—At Least Temporarily
I didn't want to miss the opportunity to interact with the folks from the Fabricators and Manufacturers (FMA) this week in Phoenix, so I convinced the physicians I could play hooky for a couple of days. My FMA friends have been taking good care of me by supplying me with plenty of Boost to drink. That has become my diet of late! Getting back on the road—even if for just one little trip—has reminded me of what is both good and bad about the travel industry. In other words, I can ditch my complaints about health and go back to my more usual subjects.
I have been able to be complimentary and annoyed—more or less par for the course. I was relying on good ol' Southwest more than I should have, but circumstances demanded a high level of confidence. I was slated to arrive in Phoenix at 11:30 and had a talk at 1:00. Leaving only 90 minutes leeway is foolish in the extreme, but the flight ended up landing 20 minutes early and all was as it should be. When I was standing in line the gate agent noticed the trach tube and asked if I needed to board early. I declined as I was standing at A-16, but it was a nice gesture—kind of like having the Boy Scout offer to walk you across the street.
The resort was not quite as accommodating. I find it interesting that casino hotels are not all that eager to show hospitality. Check in was at 4:00 which is on the late side. I tried to plead that I really needed to get some rest and asked if there were any rooms ready anywhere. Not a one. That is when I succumbed to playing the cancer card and suddenly there was a room. Really? I have to have a malady before I am treated like a paying guest? In contrast, I was once at a Marriott really early in the day (around 11:00) and was not surprised there were no rooms, but I must have looked tired as the manager came out and asked me to follow him. He went to a room that was being cleaned and asked another member of the staff to help and the three of them put it all together in about 10 minutes. I had a room and further reason to really like Marriott properties.