Strategic Global Intelligence Brief for May 7, 2018

Short Items of Interest—U.S. Economy
NAFTA Plans
The latest proposal from the Trump team as regards NAFTA is pulling together some interesting bedfellows. The objection that some have had regarding Mexico's role in U.S. manufacturing is that pay scales are far too low for U.S. manufacturers to compete. This is obviously part of what attracted many companies to shift operations south of the border. Now, Trump's plan is to urge Mexico to raise these wages to at least $16 an hour so that this wage advantage is blunted. The interesting response as far as Mexico is concerned is coming from Mexican presidential candidate Andrés Manuel López Obrador. He is all for the change and supports the idea. The fact is there are other cost advantages to doing business in Mexico that would likely keep interest high. He can then claim that he is working to help get better pay for the workers in the country.
Texas Rides the Energy Roller Coaster
In truth, the Texas economy is not all that diverse. It is one of the largest states in the country, but it has an outsized interest and dependence on the energy sector that dwarfs all the other contributions from sectors such as finance and health care and construction. Even the manufacturing community is dependent on demand from the oil sector and construction has long followed the lead of energy. When the price of oil is up, Texas does very well. When the price per barrel falls, the Texas economy suffers. The recent rise of the per barrel cost of oil has reawakened the Texas energy sector. The state is booming again. As many in the U.S. start to worry about the increased cost of gas and other fuels, the Texas economy is welcoming that change. In the bad old days, a price hike in oil and gas was bad news for the U.S., but now it can also be good news for some parts of the country.
States Getting Healthier Revenue News
For the last few years, the news from the states and many cities has been unrelentingly bad. The simple fact is that states and cities rely very heavily on the tax revenue generated by the businesses and people that reside in that state. The recession took a very serious toll. Many people are now more aware of what kind of services and activities are handled by these more local jurisdictions and many felt the loss. Now that economic recovery has been underway for a while, the fiscal outlook for the states is as good as it has been in years. Many will be able to return to some of the efforts that had been planned before the downturn.
Short Items of Interest—Global Economy
Hezbollah Wins Seats in Lebanon
The conflict between Iran and Saudi Arabia plays out in many ways in the Middle East. The war in Yemen is a proxy war between the two states. They are clearly on opposite sides in Syria. The other nation that has become a place of conflict is Lebanon. It had been hoped that Lebanon's Prime Minister Saad Al-Harir would gain support in parliamentary elections, but that was not to be the case. He has lost ground to Hezbollah which now has close to half the seats in the governing body. This deeply concerns the Saudi government as well as Israel.
Macri Still Popular
It is amazing what soccer can do for one's political career. Argentina President Mauricio Macri has been able to maintain his popularity despite the precipitous fall in the value of the peso. Much of that popularity stems from his previous role as head of the national football club that brought Lionel Messi to the Argentinian fan.
Migration as Defining Issue
The western states are nearly all facing the same vexing issue—the one that seems to be driving the growth of anti-establishment populism. The Europeans and the U.S. are very concerned over immigration and migration and all the demographic trends suggest this will be a bigger and bigger issue in the years to come. The undeveloped world is young and unemployed while the developed world is rapidly aging—a recipe for ongoing crisis.
Why Did We Miss This Oil Rally?
It has been asserted that economists and weather forecasters have the same issue. The definition of an economic forecaster is someone who explains tomorrow why the predictions they made yesterday did not come true today. There are not many sectors better at making fools of the economic forecaster than oil. The reasons are similar to those that baffle the meteorologist. It all comes down to the fundamental challenge of interpreting highly variable data. For the economist, the price for a barrel of oil is far more than an issue of supply and demand, although that can be hard enough to get a handle on. There are issues of geopolitics and the actions of a fickle consumer. The decisions made by governments can throw the most carefully considered predictions into chaos.
Analysis: The price per barrel has gained by 12% this year, and this is only the fifth month. This is the highest level reached since 2014, far higher than had been anticipated even a month or so ago. That was when most analysts held that oil would linger in the range between $50 and $60 at most. Nobody seemed to see $75 a barrel oil coming. It could even go far higher than that. It was once a sure bet that $100 a barrel oil was no longer in the cards, but now that may not be such a far-fetched idea. What happened to those confident forecasts?
There are usually three factors that can upset the most careful prediction and assessment. One factor is weather. There have been many times when a hurricane has blown through oil sectors in the Gulf of Mexico. Even smaller storms can affect local oil regions—limiting production and transportation. The second factor that can impact oil forecasts is economic growth, or the lack of it. The recession of 2008-2009 dropped oil prices like a rock as the demand for that oil collapsed. Then, there is the most common disrupting factor—geopolitics. Unrest and confusion in an oil-producing region and country can cause the markets to panic and assume that oil output will fall in the affected areas. Right at the moment, there is considerable geopolitical turmoil and oil prices are responding accordingly.
The most important factor has been the somewhat surprising cooperation between the Saudi Arabians and Russia. These are not nations that generally agree on much. They are on opposite sides of conflicts in Syria and Yemen as well as having far different opinions on Iraq and Iran. But when it comes to the price per barrel for oil, they find some common ground as both nations are very dependent on the money they can earn from that oil. Several months ago, the two states cut a deal to limit production. Many assumed they would soon go their separate ways. However, they have not ended that cooperation and have instead asserted they will continue limiting output for many months. This decision took a lot of oil off the market at the very time consumption started to spike.
The next big worry for the market has been Iran. The nuclear weapons deal that Iran struck with the U.S. and Europe meant that many of the sanctions that had been imposed on Iran were lifted or are on their way to being lifted. This meant a steady flow of oil from a nation that was once the No. 3 producer in the world. The Trump assertion that the deal was "the worst ever" has shaken the markets as they now fear those sanctions could be imposed again and take that oil off the market just as demand is requiring more. Another regime in play is that of Venezuela. The thinking is that the Maduro government is a "dead man walking." Its collapse will throw more oil production into doubt. The country is a shadow of its former self as an oil producer, but this can get even worse if a full-on civil war breaks out.
There is not the same deep concern regarding many of the other oil producers, but nobody is expressing a lot of confidence in the output from places like Iraq, Nigeria and other North African states. The overall impression is that instability rules. When this happens, the markets start to build in higher prices. There is one factor that can and will reduce prices sooner than later. That is the U.S. and its oil production. The boom in the oil shale areas ended with the recession, but there are many signs of a renewed interest. These operations can be brought to life far faster than the conventional oil operations. The U.S. producers are moving back to the market. Within a year or less, they will be affecting the prices as they push more of their crude.
The bottom line is that oil prices are likely to keep rising through the summer months as this is driving season in the U.S. Even with higher pump prices, the motorist will be traveling—putting pressure on supply. By summer's end, the prices are likely to start stabilizing and slowly receding.
Chinese Development Bank Expands
The Asian Infrastructure Investment Bank (AIIB) was created by the Chinese to rival the World Bank as a development tool. At the time of its creation, there were many who assumed it would only have very limited influence. It was really more of a symbol than a serious competitor for the other global lenders such as the World Bank or the International Monetary Fund (IMF) for that matter. China had been at odds with World Bank policies over the years and resented the fact these institutions were heavily weighted towards the U.S. and Europe. Those who attack these banks as somehow giving taxpayer money to various foreign governments fail to understand the role this money plays in the economies of the donor nations. This cash does not come without strings. The development projects are generally taken on by western firms that use western companies for nearly every phase of the effort. These projects have been money makers for the big engineering firms as well as companies such as Caterpillar. There are dozens and dozens of companies from the U.S. engaged in every phase of the effort. That means the bulk of the money that is provided to any given nation finds its way back to the donor nations such as the U.S.
Analysis: For years, the Chinese have tried to crack the system and get its companies involved in this lucrative business, but given the reduced role played by the Chinese in funding the World Bank and others (Asian Development Bank and the European development banks), their role was always minor. The AIIB was their way of countering the western influence of the existing development efforts. At first, the majority of the effort was focused on Asian projects; usually on countries that meant something to Chinese strategy or the Chinese economy. Lots of cash has found its way to Malaysia, Indonesia and the Philippines, but precious little was assigned to Vietnam.
Recently, the AIIB has signed agreements with the development banks that are active in Africa and Latin America. This dramatically expands the reach of the Chinese effort. The agreements have been with the African Development Bank and the Inter American Development Bank. The Chinese are asserting that non-Asia lending will remain limited and tied to projects that relate to the Chinese economy, but there is considerable room for interpretation as to what this really means.
The agreements take on new meaning in the context of trade wars and tariff wars. The U.S. under Trump has elected to target China aggressively and has been pushing other nations to do the same. The Canadians and Mexicans have been warned that their continued exemption from the steel and aluminum tariffs will depend on how they handle NAFTA talks and whether they join the U.S. to pressure the Chinese. That same threat has been issued to Brazil, Argentina, Turkey and others that have been shipping these metals to the U.S. China now has a means by which to retaliate. If nations want to defy the U.S. pressure, the Chinese have a nice little reward for them. They can access money from the AIIB. That gives them some independence from the U.S. on this issue as well as others that come up down the road. This also provides a boost to the Chinese companies that compete with U.S. and European companies as they will get the opportunity to work on those big projects that are in the pipeline in places like Brazil, Nigeria and the like. China is especially interested in nations that are involved in the oil business as well as those that are extracting all manner of precious metals.
Iran Deal—Who Has What at Stake?
It would be tempting to look at the nuclear deal with Iran as just something between the U.S. and Iran, but of course there is far more to this. The European states have a much larger economic stake in this deal than does the U.S.—especially France. The Iranians have been selling a great deal of oil to the French company Total S.A. since the sanctions were lifted. That is a relationship the French want to continue. Iran has stated that they can make up for losing the French contact with sales to the Chinese, but the Chinese have long exploited the Iranian situation by paying them less than the world price.
Analysis: Trump has opposed the deal for what it does not include. He has not asserted that Iran is breaking any of the rules as they clearly have been complying. The deal was narrowly written to deal just with the nuclear ambitions of the Iranians. There has been no attention focused on either the missile development in Iran or their support for groups like Hamas, Hezbollah and other Shiite insurgencies in the region. The country that has the most to fear from these Iranian efforts has been Israel. Prime Minister Benjamin Netanyahu has been on a tirade for weeks asserting that Iran remains an imminent threat to Israel—a claim that is reinforced by the Iranian refusal to end their anti-Israel rhetoric. There is also deep opposition to Iranian activity on the part of Saudi Arabia. It would appear that Trump's position on Iran has more to do with the attitudes of these allies than with any sort of direct threat that Iran could pose to the U.S. and/or Europe.
Record Level for Unemployment Numbers
The level of unemployment has fallen to 3.9%, the lowest level seen since the end of WWII. This is good news, but with plenty of qualifiers. The expected rise in wages that would be expected to accompany a jobless rate this low has not taken place. That worries the analysts and business community. To be blunt, the people who are being hired lack the skills needed and thus do not command higher wages. The new hires are speculative—people being hired on the basis of attitude rather than aptitude. The hope is that they can be trained, but many will not make the grade. Others will simply take the training and go work for somebody else.
Analysis: The labor shortage has been acute for years and has continued to expand to more sectors. There are few parts of the employer community that are not struggling with manpower. This has meant lots more investment in machines and technology. Many companies are actively considering a move out of the U.S. so they can find the employees they need. There are no simple or quick solutions to this long-standing concern.
An Open Letter to Southwest
Let me start by saying I love you guys. You know that. I have been singing your praises in this column for years. Long ago, I took the Southwest pledge that has me flying as far as you will take me and driving the rest of the way so that I can stay off the other carriers. I do this because you are good at what you do, but sometimes I think you get carried away with your self assessment. Yesterday was a horrible flight primarily due to your over optimistic assumptions. My goal was to fly from Ft. Lauderdale to San Diego with a stop to change planes in Austin. This is a brutal flight no matter what—six plus hours. The part that made it a nightmare is that you scheduled my departure from Austin at 8:10 when my flight from Florida was supposed to arrive at 7:30. This means that boarding for that San Diego leg was to take place at 7:40. That is cutting things close when all is well, but all was not well yesterday.
The flight from Ft. Lauderdale was 15 minutes late taking off, so now I am going to be late to board. This got lots worse in Austin when the plane was forced to wait 20 minutes for a gate to clear. As I finally got off the plane, I had exactly one minute to get to the next gate and was certainly no longer A-16 to board—now I was C-178 and the very last person to get on a totally jammed flight. Just love that center seat between two valley girls who talked across me for two hours while obsessively playing with their hair. I checked my bag (or was rather forced to). That meant a wait at the end of an already very long day. The bag is now missing part of a zipper, but still functions.
My plea then is simple—I really do love you guys. I just want you to be a bit more realistic about the vagaries of air travel and avoid putting passengers into heart failure with connections that are nearly impossible to make.