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Strategic Global Intelligence Brief for November 5, 2018

Short Items of Interest—U.S. Economy

Hiring Is Up and so Are Wages
The latest jobs report showed some movement as far as wages are concerned. This has been long overdue. It is not the rocket speed some had feared and there is still relatively little pressure on wage inflation, but a least there are gains considered near normal. The fact is there are far more jobs available than there are people to take them. It is high time politicians quite nattering on about creating jobs and spent more energy on creating people qualified to take the jobs on offer now. The problem is that addressing the lack of workers is far harder and more expensive than simply calling for business to create more jobs.

Diversifying Economics
Janet Yellen has become the latest to call for different ways to do economic research. The trend over the last few decades has been for economics research to focus on issues that can be dealt with through mathematics. It has been the era of the econometrician and has focused on being a "hard" science as opposed to fields like sociology and political science. This has meant too few analysts focus on the issues of the day. Yellen pointed out that nearly all of the modeling economists completely missed the financial sector meltdown as nobody was really studying it. There is need to spend more energy on case study analysis and on paying attention to anecdotal evidence that can lead to more real-world applications.

U.S. Backs Off on Some Iranian Oil Sanctions
The U.S. had plans to impose sanctions on nations that buy Iranian oil, but days before the policy was to come into effect, the U.S. has exempted several nations from these sanctions for six months. The list of those that have been exempted is more than a little peculiar. There are allies such as Japan, South Korea and Taiwan as well as important nations with which the U.S. has some prickly relations—India, Turkey and Greece. The big surprise is China was granted an exemption as well. It seems the U.S. is offering a little bit of a peace offering to China, but this also benefits the Iranians as China is one of their biggest customers. At this point, some 20 nations have already halted imports of oil from Iran, but some may now be rethinking that stance.

Short Items of Interest—Global Economy

Iran Claims Sanctions Victory
At the same time several European states have received exemptions from U.S. sanctions on Iranian oil, the government of Hassan Rouhani is touting the fact that Europe is fighting the U.S. on the issue of these sanctions and the whole idea of the nuclear pact where the U.S. backed out. The machinations of all this has become murky. It is not clear what the U.S. wants as far as Iran is concerned as the exemptions have taken a good bit of pressure off Iran for the time being. Most assert the U.S. may not be motivated by keeping oil prices south of $100. This has introduced flexibility where there was not much before.

Agriculture Tariffs and the Vote
It has been a tough and complicated dilemma for many in the rural communities. On the one hand, this has been solidly Trump country for several years—areas Trump won handily two years ago and where he has maintained popularity. That popularity has been challenged by pocketbook issues. The trade war with China has slammed the farmer very hard and sent many close to outright bankruptcy. The Trump team has been less than responsive which has allowed disillusionment to set it. Unfortunately for the farmer, there has not been much help offered by Democrats either.

France Hangs on to Its Island Paradise
The people of New Caledonia are unwilling to cut ties with their colonial power. The referendum that would have given the colony its independence from France failed and it will remain a dutiful subject.

Expectations Dim for G-20 Breakthrough
There are messages flying around that will provide support for almost any position on the U.S.-China trade dispute. The optimist can look at the comments by President Trump after his "very good" phone conversation with Xi Jinping, while the pessimists can point to the fact that no similar declaration came from Xi. Instead, the Chinese leader raked the U.S. over the coals with assertions that the U.S. was employing the "laws of the jungle." The global markets had rallied last week on the assumption President Trump was engaged in his usual "head fake" style of negotiating as he sounds hard line at the same time he gives concessions. Now it is not clear what kind of concessions might be offered and whether any of them will be accepted by the Chinese. After months of bombast and blather, the reality of the tariff and trade policy has started to manifest. Many think it has gone too far for the two nations to back away.

Analysis: There are several facts that have emerged, which should have an impact on the course of the future conversation. The first is China is in far worse shape economically than the U.S. at this point. This has placed limits on the leverage the Chinese can enjoy. Their growth rate has sagged to just over 6%. In China, that is tantamount to recession. The country has to grow fast enough to create at least 1.2 million jobs a month—just to keep pace with population growth, while the U.S. has to create 250,000. The Chinese require growth of at least 6% to achieve this. The U.S. can meet its goals with 2.7% growth. The bottom line is China is not in a position to tolerate much more slowdown. The Chinese government has been engaged in a lot of stimulation of late, but in the past, this has led to higher rates of inflation as well as various financial bubbles. They remain wary of this developing again. The Chinese essentially have two choices when it comes to furthering growth at this stage. The first is they will need to dramatically expand their own internal market so Chinese consumers can support the Chinese economy. The other option is that Chinese companies will have to find other places where to sell. Neither of these options will be easy given the realities of a trade war with the U.S. If the Chinese are not exporting, they are not making money. That limits what the Chinese consumer can contribute. The fact is no place in the world consumes like the U.S. does. The U.S. will be hurt by these tariffs as well, but it is likely to be a shorter-term issue as the U.S. will be seeking other sources of supply—a much easier challenge than that facing China.

If there were to be a breakthrough at the G-20 meeting when Xi and Trump are supposed to be talking, what might it look like? Realistically it would either be a shift in Trump's position (which has happened many times before) or it would involve some kind of capitulation by the Chinese —not all that likely at this point. Analysts have asserted all along that something important has been missing from President Trump's set of tactics. His approach has been all stick and no carrot. If the U.S. wants to close that deficit gap, it has to sell more to China as opposed to simply trying to buy less. Importing less from China will not mean U.S. manufacturers will replace these goods—the U.S. will simply import them from some other nation, although the prices will likely be higher. The U.S. should be urging greater engagement in the U.S. economy and not less. That is a far more nuanced strategy than the blunt instrument of a tariff war. It is not something President Trump has shown skill at developing however.

Should Europe Embrace Trumpism?
There are many aspects of Trump policy that match well with the European right. The attitudes towards immigration are similar. There is also the same frustration over the erosion of "national values" whatever that means from one country to another. The Italian government is a populist one now and similarly oriented groups have emerged in Germany, France, Sweden, Greece, and so on. They are conservative parties, but deviate significantly from traditional conservative positions when it comes to debts and deficits. Trump has presided over one of the largest boosts to the U.S. debt and deficit, and at a time when many thought the U.S. was in a good position to retire some of that.

Analysis: Now the populists in Italy (as well as others) are calling for that same kind of budget busting activity—sharply higher levels of spending along with sharp reductions in taxes. Italy's populist coalition is in deep trouble with the EU for their budget. They are now calling for the rest of Europe to emulate them with the argument that spending and reducing taxes will stimulate the economy to the point its success will mean more revenue for the government. The problem is it never really works out that way as growth has not been high enough or sustained enough to provide that kind of boost. The conservative mantra was once rooted in fiscal conservatism, but those days appear to be long gone.

Trade Gap Widens
The trade gap is wider than it has ever been and the U.S. is running a higher deficit than it has in many years. This seems counterintuitive given all the energy devoted to reducing the U.S. dependence on China and other nations. The level of imported goods hit $218 billion in September—a record high. The deficit climbed to $54 billion. The effort to address the trade imbalance has centered on imposing tariffs as opposed to getting China and other nations to buy more from the U.S. That kind of strategy often backfires—at least in the beginning.

Analysis: The most logical reaction from any given business is to reduce or escape taxes when possible, and a tariff is a tax. The company which fears that something it needs will soon carry a higher tax will do what it can to obtain the product or service before the tax takes effect. The importers in the U.S. have been buying aggressively as they do not know what will be added to the list of products subject to a tariff. This sets up another issue down the road. That buying means a bigger inventory. If it not sold soon, it becomes a drag on the company. Most of what has been purchased will likely be consumed, but not all. That inventory will hang over many companies into the coming year.

Are the Rules Really Different Now?
"Nothing Lasts Forever." "What comes up must come down." "All business cycles have an end." Choose your aphorism or saying; there are many to choose from and they all essentially say the same thing. The economy of any given nation will have its ups and downs. The majority of the time, one can see that cycle developing well in advance. That is what tends to anchor any kid of prognostication on the part of economic analysts. The current economic growth period is one of the longest on record. That longevity has given rise to all manner of interpretation and speculation. Some have asserted it has lasted this long because it was anemic for so many years. Others assert some fundamental rules are no longer in effect. One who has been asserting that it is now a whole new world is Fed Chair Jerome Powell. He is not alone and has some support from within the ranks of the Fed, but there are skeptics as well. This opinion has implications as far as what the Fed plans to do with interest rates in the immediate future as well as in the longer term.

Analysis: There are many reasons the Fed will provide proof to justify any change in the Federal Funds Rate. Remember, this is the rate that banks essentially charge each other for those very short-term loans needed to conduct business. A change in the Fed rate does not automatically mean a change in all other rates although there has always been a close connection. The banks will usually determine their prime lending rate based on the rate set by the Fed. Mortgage rates are not only affected by the Fed rate, but also by the rates on long-term bonds. All the other rates are connected, but not at the hip—car loans, credit card rates and all the others are certainly influenced by the Fed rate, but there is always variability between issuers of that credit.

It is also important to understand why this kind of indirect influence matters. The Fed is not equipped to turn the economy on a dime. It takes many months for Fed policy to have an impact. To stimulate an economy, the central bank needs the lending community to react to their lower rates and to start loaning more. The reality is some will and some will wait. As the rates come down, there will be more and more lenders willing to lend. The Fed seeks the trigger point by lowering the rates in small increments. By the same token, the Fed needs time to control an overheating economy. It is not as if banks will suddenly stop loaning and companies will stop borrowing simply because rates went up by 25 basis points. To make the economy react to Fed decisions may take the better part of a year. This is why the Fed has to forecast and prognosticate. If the impact of its decisions will not be felt for the better part of a year, it will have to make assumptions about what the situation will be in a year.

This is why there has been so much interest in cycles and rules. There has been a lot of conversation regarding the efficacy of the Philips Curve and why it has failed to be the predictive tool it once was. It seemed logical enough, and most importantly, it actually worked as a predictor. It stated that when the rate of unemployment falls, there will be a greater chance for inflation as wages will start to come up as employers have to pay more to get the people they want and need. This has not been the case this time. It has been pointed out that it was not the case a decade or so ago either. The assumption behind the assertion is that employers will pay the wages demanded by the workers, but for the last 10 to 15 years that has not been automatic. The unqualified or undereducated worker has little leverage and is not going to command a higher wage. The sectors that used to be most sensitive to lack of labor have now discovered an alternative in technology and robots. The low-wage manufacturing jobs have been lost to automation. So have many of the low-wage service jobs. The fast food place dumps counter help and replaces them with machines. Consumers are made to do more and more of the work at a store as they check themselves out.

Right now, the Fed has not indicated it will be changing its plan as far as hiking rates once more this year and again next year, but there has also been no hint it plans to speed things up either. The inflation motivation is not as strong as it once was, but there are other reasons the Fed would hike rates. It wants to make sure rates are high enough so it will have some ammunition when the next recession arrives (some assert that could be as soon as late 2019 or early 2020). There is also the desire to end some of the speculative borrowing fueling the surge in the stock market.

What Comes Next?
The elections are nearly here. We can safely watch TV again. This has been a bitter year to say the least. There will be some very, very angry people regardless of the outcome. This has been a year when the center has all but vanished in a war between the "bases"—one extreme left and the other extreme right. Most of us remain in the center according to the majority of polls, but we will end up picking a side if we want to cast a vote. For many, this will be the end of it and life will supposedly return to some semblance of normal; however, this should only be the start. After tomorrow, we will have our latest collection of "representatives." That should mean we now start communicating with them.

We will have another shot at voting for most of them in another two to four to six years. If one assumes they want to remain in office, they will need to pay heed to those who would vote to either keep them or get rid of them. We now need to really get engaged with the system so that these politicians know what matters to us and why. They will certainly hear from plenty of lobbyists, but will they hear from the rest of us? If the past is any indication, they will not. We mostly abandon the process after the election. That is really not how it should be.

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Tuesday, 11 December 2018

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