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Strategic Global Intelligence Brief for May 8, 2018

Short Items of Interest—U.S. Economy
Is Secular Stagnation Dead? The notion behind the concept of secular stagnation is that the U.S. economy and that of the European states and others will be prone to periods of very slow growth unless there are extraordinary steps taken to stimulate the economy beyond what it seems to be capable of. The last few years have seen many of these efforts—from aggressive intervention by the central banks through very low interest rates, bond buying and manipulating the interest that banks receive for their deposits. Then, there were the big tax cuts at the start of the year as the fiscal side of the equation got engaged. While all this was happening at the government level, the private sector was borrowing extensively to keep growth rates high. The fact is that without all this, the growth in the U.S. and the world would have been very anemic indeed.
Housing Hotspots One of the issues that will affect housing is that popularity begets higher rents and higher prices. Some refer to this as gentrification, but it takes place even in neighborhoods that are not in transition. When a city or community becomes a popular place to live because it offers job opportunities or because it has become the "cool" place to live, the costs of living there go up. The rents rise and the home prices rise. Now, many who had lived there before are priced out and have to find a new location. The community likes the growth and expanded tax base, but worries about what happens with those who can't keep pace. The biggest change now relates to where the job opportunities are—hot labor markets are also seeing far higher costs of living. That has been especially true when it comes to housing.
Credit Boom Underway There is both good news and bad as far as this development is concerned. The growth of demand for corporate bonds has resurrected the junk bond market. Suddenly, there are many investors loading up on lower-rated bonds as they can't get their hands on the higher-rated bonds at a price they want. This has been a boon for those companies who have lower-rated bonds, but this risk appetite is starting to look like it did prior to the credit crisis that precipitated the Great Recession. Not all of these bond bets pay off—especially when and if the economy starts to slip a bit.
Short Items of Interest—Global Economy
Italians Go Back to the Polls Even in a country that has a notorious reputation for governmental instability, this is unusual. The elections of just a few weeks ago have been utterly inconclusive as the parties that took the majority of the votes did not get enough to form a government without a coalition. The problem is that none of the parties want anything to do with each other and a government has been unable to form. This leaves the voter with another chance to vote. The fear is they will simply repeat what they did before and fail to give any one party enough support to form a working government.
Paramilitary Leader Bid for Iraqi Leadership The militia under the command of Hadi al-Amiri has been credited with driving ISIS forces out of Baghdad and scoring many other victories against the Sunni radicals. Now, he wants to parlay that acclaim into a position as Iraq's new strongman leader. What worries the U.S. is that he gets a lot of support from the Shiites and Iran. It is feared that he may be working intimately with the Iranians in setting Iraqi strategy.
Unrealistic Demands The U.S. is demanding changes in the way that China conducts business, but the demands are far too unrealistic. Not even a weak power would give in to these. It is assumed that these demands are simply for domestic consumption in the U.S. as they would show Trump to be tough. The next step would be more realistic demands, but nobody knows for sure when trying to puzzle out the approach that Trump has taken.
Aluminum Prices Fluctuate Wildly The tariffs that have been suggested by the Trump administration have been the topic of intense conversation among both producers and consumers, with most of the attention focused on steel. The fact that aluminum was added to the mix felt almost like an afterthought as there had never been the same pressure to rescue that sector as there had been for steel. The most fundamental difference is the U.S. will always be dependent to a significant degree on foreign imports as the U.S. lacks the raw material for aluminum smelting—bauxite. The metal produced in the U.S. is entirely from scrap or from imported bauxite. The impact of the steel tariff has been discussed at some length. It has been made clear that manufacturers and those in construction have been badly damaged by the higher steel prices that have resulted from even the threat of tariffs. Much less attention has been paid to the impact of higher aluminum prices, but it is becoming clear the impact has been even more profound as the market has been roiled by this developing set of restrictions. The tariff imposition has become entangled with the expansion of sanctions on Russia. That has put even more pressure on this sector.
Analysis: Over the last three months, the price of aluminum has hit a six-year high. The volatility has been unlike anything seen since the late 1990s. Those companies that use aluminum are nearly at a standstill as they try to predict the prices they will be paying. This has affected large companies such as Boeing and Ford, but also many smaller operations that make everything from cans to small aluminum parts. The companies have tried to hold pricing levels down, but that has already started to change dramatically as it is obvious that there will be more volatility and not less in the weeks and months to come. Not only is the sector affected by the imposition of the 10% tariff on imported aluminum, it has been even more profoundly affected by the sanctions that have been imposed on the Russian company—Rusal. They are one of the world's largest producers. Now, they can no longer sell to the U.S. This has created a supply crisis for U.S. aluminum users. Many are trying to figure out what the next steps will be. The same exemptions on imports from key nations are in place as has been the strategy with steel, but just like the steel tariffs, these exemptions are contingent and could reappear at any time. The sanctions against Rusal are an entirely different matter and will depend on how cooperative the Russians choose to be regarding some of the investors in Rusal. The sanctions on that company are really aimed at some of these investors. The restrictions might be lifted if these individuals agree to divest their interests in the company. It seems there has been no willingness on their part to take this step and no signs that Putin is ready to force the issue.
Oleg Deripaska has agreed to sell his stake in the company, but the details of that divestiture are murky. It could be weeks or months before the U.S. completes its examination of the deal. The price of aluminum spiked to $2700 a ton when the sanctions were announced. That was 35% higher than had been the case prior to the sanctions. The prices have eased a little since then, but remain far higher than they had been—roughly around 17% higher than before the sanctions started. The Russians supply 12% of the aluminum used in the U.S.; the majority of that coming from Rusal.
The consumer has not felt the impact at this point, but that day is not far off. The prices of planes and vehicles have remained steady in part due to competitive pressures. Boeing can't automatically hike prices while competing with Airbus, as these sanctions do not apply to Airbus manufacturing. Meanwhile, Ford has been pushing the aluminum truck. It simply can't jack prices too high and still maintain a competitive position against the other truck makers but, at some point, the rise in material costs will force an adjustment. The consumer will likely see the first set of price hikes in other aluminum products ranging from beverage cans to parts in all manner of appliances and machines. These costs are a little easier to hide—competitive pressures are slightly less intense. Analysts are more worried about the inflationary impact of higher aluminum prices than steel and suggest the Fed has been tracking this issue very closely.
Cuba's Balancing Act Say hello to the new boss—same as the old boss. If anybody expected Cuba's Castro regime to turn over power to some wild-eyed reformer, they simply do not understand the situation in Cuba very well. Miguel Díaz-Canel is best described as an apparatchik (Communist party member) and a Castro loyalist. He has been carefully groomed to take the position and keep the power of the Cuban Communist Party intact. That will be his No. 1 priority. His actions show that he knows that role very well. Cuba is not about to undergo some radical transformation like the nations of Eastern Europe did when the Soviet Union fell. But stability is not the only assignment as far as the new leader is concerned. Cuba is in an economic crisis; one that worsens every day. The traditional patrons for Cuba are gone or have lost interest. There was once plenty of cash coming from the USSR and later from Russia, but they have problems of their own. When Hugo Chavez was riding high on oil revenue in Venezuela, he shared that windfall with his Cuban brothers. Those days are long gone as Nicolás Maduro has turned Venezuela into a failed state with poverty levels at 65% of the population. In order for Cuba to get out of its economic mess, it needs investment from elsewhere in the world. That means opening up parts of the economy to western nations.
Analysis: The challenge is immense as navigating the ossified Soviet-style bureaucracy drives would-be investors to distraction and the economy is weak. Trying to appeal to the domestic consumer in Cuba is not a money maker as the majority of the population is poor and not in a position to spend. This means that Cuba has to focus on exports and on tourism. The export sector is almost entirely agricultural. That places the country into competition with every other nation in Central America and the Caribbean. Most of these countries are able to sell their output broadly, while Cuba still must navigate the barriers that exist to trade with the U.S. The biggest trade partner now is Mexico. This has been one way to partially circumvent the U.S. restrictions.
The majority of the investment interest has come from Europe and to a lesser degree from Asia. The Chinese have just started to look at Cuba, but it has not been a big priority thus far. The French have long had an interest in developing the oil reserves in Cuba, although they are small compared to what the other oil states in the region have to work with. The most complex sector for development is tourism. On the one hand, there is demand as Cuba is still largely unspoiled and has some of the best beaches in the region. The problem is that tourism is a service sector endeavor and harkens back to the days of pre-Castro Cuba. There is no desire to go back to the exploitative days of the old regime and there is worry that more such exposure will reveal deep social problems the regime would rather not confront.
There has been a concerted attempt to deny that Cuba has problems such as drug use and prostitution, but observers have noted that both are major issues. The drug culture is certainly not as pervasive as in places like Jamaica and other Caribbean states, but it has been getting worse. Prostitution has been common as well. The concern is that more tourism makes the problem worse. The country's leadership would like to be very picky about what kind of development takes place in Cuba, but that is far easier said than done, as those who choose to invest are not doing so for any reason other than opportunity to make profits.
Energy Development Holds Africa Back There is considerable room for optimism as far as African development is concerned, but there are also many barriers to that successful process. Perhaps the biggest modern need is for reliable energy infrastructure. It is estimated that over 600 million people are without any access to electricity. This is out of a population expected to hit two billion by the year 2050. The cities have grown rapidly and have stressed their own infrastructure to the breaking point with brown-outs. These are more and more common in even the most modern of urban areas. The challenge is that Africa remains torn between the immediate needs of a growing population and the ideal. The fastest way to get the energy needed would be to build new, coal-fired plants and nuclear facilities, but there has been active and deep opposition to both options.
Analysis: The advocates for renewable energy are active and want to see commitment to solar and wind and others, but these will not be sufficient to supply the needs of the continent for many years. The investor interest in traditional power plants is limited as there is no assurance these projects will be supported into the future. The alternatives are tempting, but they have been small scale leaving the African energy deficit far too large to support the kind of economic growth that is needed. A short- vs. long-term choice has to be made, but few have a desire to engage.
Is 3.9% Unemployment a Good Thing? The fact is that unemployment levels this low can be good and bad. On the positive side, this is the lowest rate of joblessness since 2000 and there has been an average of 200,000 new jobs created every month this year. This is robust growth indeed for an economy that is in the eighth or ninth year of growth. It had been expected that a slowdown would have manifested by now. The part that is not good and frustrates the analysts is that job growth has not been combined with wage growth as would be expected. The numbers this month were lower than last month—2.6% vs. 2.9%. There was some hope that growth rates were turning a corner last month. Now this seems more unlikely.
Analysis: The crux of the problem is that many of the newly added jobs are not the kind that pay all that well. The bulk has been in low-paid service sector occupations. There is still no reaction to the near-record low levels of unemployment. The labor and skill shortage hangs over the employment numbers—the fact is that companies are not finding the people they need and want to pay more. There have been, however, some signs that this pattern may be altering somewhat. It is not that there are many more qualified people showing up, but companies are getting far more aggressive as far as poaching the workers from other companies. That means higher wages are being used as a lure. It also means companies will be paying their existing staff more in order to protect against that poaching.
You Don't Miss Those Little Things Until They Are Gone I get engaged in some of the oddest conversations these days. I call it the brotherhood of maladies. Once somebody knows that you are going through some kind of trial, there is an instant kinship as it seems to allow conversation about that malady. People know that most do not want to hear of our problems. I am always reminded of the quote from Tommy Lasorda—"I never tell people my problems—70% don't care and 30% are glad I have problems." That rule is somehow set aside when we can complain to and with another who suffers some sort of indignity.
A man was watching me eat lunch at a conference the other day and noticed that I swigged water with every single bite of food. I have to as my salivary glands were scorched and savaged by chemo and radiation. I never gave my saliva much thought before, but I sure miss it now. Dry mouth is a constant drag and makes eating much more complicated. He related that this was his life a year or two ago, and for the same reason. It was reassuring to know that some of this ability returns in a year or so. This prompted a woman sitting at the table to relate her story, as she had cancer treatment that caused neuropathy in her fingers (something my wife also experiences). She pointed out that she once did a lot of crafts, but can't now as she just can't feel the knitting needles or crochet hooks very well. These are small sacrifices to be sure as the important thing is that we all are cancer free, but there was a price to pay and an altering of what was once our chosen lifestyle.

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