Strategic Global Intelligence Brief for October 12, 2018

Short Items of Interest—U.S. Economy

Where Is the Consumer Inflation?
The latest edition of the Consumer Price Index came in lower than had been expected with a very meager 0.1% rise. It is not that the analysts thought there would be some huge jump in prices, but there has been more than enough evidence to suggest consumers would be feeling the inflation pinch by this time. Part of the decline was due to the reduction in prices for some of the more volatile items consumers purchase (oil, food, entertainment). There is also the sense many are waiting for the other shoe to drop. The tariff and trade war just started to get underway and those higher prices have not yet worked their way down to the consumer. They have started to impact the producer prices, but consumers have been insulated for another month and maybe longer.

Nothing Much Expected From NAFTA Rework
The name may have been changed from NAFTA to the USMCA, but that looks to be about the extent of it. Most of the pact remains intact and as it was before. Even the majority of the auto sector changes had already been in the works. These new rules will not have a big impact on the Big Five (Ford, GM, Fiat-Chrysler, Toyota and Honda). One may be able to thank the renegotiation indirectly as many companies undertook reforms and changes ahead of time since they knew these changes were coming. The fact is there is a highly integrated North American market in place and resetting it is a very difficult task.

Human Capital Index
The World Bank intends the human capital index to be controversial. It always is. The index is intended to spur nations to put money towards developing better health and educational outcomes. The premise is these are the real prerequisites for successful economic growth. When a nation neglects its people, the economy will suffer. The nations at the top of that list include Singapore, South Korea, Japan and Hong Kong. Those at the bottom are generally poor African states like Chad, Mali, Nigeria, Mozambique, etc. The U.S. is one of the lowest ranked of the developed nations at 24. Most of that is due to lack of health care for the young.

Short Items of Interest—Global Economy

Latin Version of 'Throw the Bums Out'
The imminent election of Jair Bolsonaro in Brazil has made it clear many in Latin America have grown frustrated enough to grasp at straws. The issues motivating the population have ranged from crime to corruption to economic stagnation. Andrés Manuel López Obrador (AMLO) in Mexico finally won his chance at the presidency on the assertion he would address income distribution and the drug gangs, but nobody has a clue how he will try to do this. Bolsonaro has likewise stated his intent to deal with crime, but all he has come up with is mass killing along the lines of what Rodrigo Duterte has been doing in the Philippines. The truly tough conclusion is many of these problems may not be politically soluble—no matter who is in office.

Rise of the Green Party in Germany
For the last several years, disgruntled voters had but one real option if they lost faith in the traditional parties. This was the birth of the populist movements, but many of those who expressed dissatisfaction with the status quo were not attracted to the right. Now there has been a counter move from those to the left—including the Bavarian Green Party as led by a very pragmatic young leader—Katharina Schulze—age 33 and set to win big in the coming election.

Germans Worry About U.S. Protectionism
The headlines have belonged to the Chinese and the nations of North America, but the trade partner that has been the most concerned about the "America First" tactic is Germany—a nation that relies on exports for over 50% of its GDP. The U.S. is the biggest export market outside Europe and is one that has been threatened of late by the Trump approach.

Saudi Fallout
It is looking more and more likely that Saudi journalist Jamal Khashoggi was killed by Saudi authorities when he entered the consulate in Istanbul to obtain papers needed to get married to a Turkish woman. There is film of him entering the consulate, but nothing showing him leaving. There is also evidence of a group of Saudi men entering the building after Khashoggi entered. They have been identified as being part of an assassination squad. The Turkish authorities are convinced he was killed, but there has been no evidence obtained to corroborate that story. The Saudi authorities opened the consulate to Turkish inspection, but nothing was reported as evidence of a killing other than an observation that part of the consulate was markedly cleaner than other parts.

Analysis: The longer it takes for Khashoggi to appear, the more likely it is Saudi Arabia either kidnapped him and brought him back to Saudi territory or killed him. Khashoggi has been an ardent critic of Crown Prince Mohammed bin Salman and has labeled his whole reform agenda a sham and a publicity stunt. Khashoggi has been a prolific columnist for the Washington Post and rarely misses an opportunity to point out Salman's shortcomings. Khashoggi has been very vocal about the war in Yemen among other issues. These attacks are certainly annoying, but they are far from the only attacks directed at the Crown Prince. It can be confidently asserted that Khashoggi has far less influence and leverage than do many of these other critics. That leads to rumors about what might really have motivated such an extreme response.

One rumor making the rounds is that Khashoggi had unearthed a great deal of financial information that would reflect badly on Crown Prince bin Salman. These rumors range from assertions of corruption to proof bin Salman had been accepting money from Israel. There have been assertions that bin Salman is in the pocket of the U.S. or U.K. or Russia, and even China. That none of these have been corroborated makes it unlikely this would be enough to murder a journalist. Another set of rumors asserts this hit squad was not sanctioned by the leaders in Saudi Arabia and may be the work of rogue elements. The truth may never be known, but opinions are forming nonetheless.

Several high-profile business deals have been called off and canceled as these leaders do not want to be linked to this kind of political murder. Several governments have expressed condemnation and are demanding that Saudi leaders open everything up to investigation. They have stopped short of accusing the Crown Prince of this attack and probably never will unless there is some tangible evidence provided, but there was frustration with Saudi attacks on Yemen and dissidents before all this took place. Now that opposition has increased. The U.S. has been very circumspect as far as criticism is concerned. That is not sitting well with those who have been suspicious of the Saudi reform efforts.

Populism in Europe
The key issue as far as European elections are concerned will continue to be the impact of populism. The party credited with rallying the populists in the first place was the National Front in France. It seemed poised to emerge as the first winner in this new environment, but Marine Le Pen was thrashed in the second round of presidential elections by the total newcomer Emmanuel Macron. The party subsequently imploded and has gone so far as to try rebranding from National Front to National Rally. However, it still looks to be a shadow of what it once was. Meanwhile the AfD (Alternative fur Deutschland) has unveiled a new campaign that urges children to report on their teachers if they show signs of bias. This strikes many Germans as far too close to the behaviors of the Nazi party in the 1930s.

Analysis: Populism has been struggling to deal with the real issue of governing. Those countries that have put populists in positions of real leadership are discovering there is not much that unites these radicals and much that divides them. They lack any of the instincts for compromise. That has made it all but impossible to craft any sort of platform. They play the role of critic very well, but there has been very little actual governing in places such as Italy, Austria, Sweden, etc. There is a sense voters had no idea what they were voting for—only what they were voting against. The desire to move away from corruption and economic stagnation pushed voters to anyone who claimed not to be part of the establishment.

Global Blip?
The conversation of the day revolves around the stock market sell-off. Is it the beginning of the long unwinding or just a temporary bump in the road that will be essentially forgotten in a few weeks? The issue at the moment is the markets are very jittery and have been for months. There is a sense conditions are right for a major correction that takes the global markets down by thousands of points, but the problem is these conditions have been in place for the better part of the last year. Thus far, nothing dramatic has taken place. While there is considerable worry regarding the future, there are also many optimists who hold that the conditions existing today will remain the dominant factors.

Analysis: There is no universal agreement on exactly what has been driving the success in the markets, but there is consensus agreement these have all been factors driving growth. Interest rates (both at the Fed level and in terms of long-term bond rates) favored investment at a level not seen in years. The election of Trump rallied the business community (at least for a while) and there was enthusiasm regarding the tax cuts. Also, the price of oil rose. This time, it was a good thing for the U.S. as it was no longer a major oil importer but a nation that exports oil. The consumer was buoyed by the growth of jobs and the tax cut promises. It is not easy to single out which of these made the most impact as they have all figured in the growth.

Part of the challenge now is determining which of these factors will continue to be a factor in future growth and which may have started to fade to the point of ineffectiveness. Interest rates are headed up regardless of the opinion held by President Trump and some members of Congress. The Fed continues to worry about inflation while admitting it has not been as big an issue as it was expected to be by now. The other motivations for the rate hike include the impact these rates have had on the markets. There are too many speculative borrower/investors accessing cheap money that is then plowed into the surging markets. The return on these investments allows repayment of that loan, but a collapse of the market like the one this week leaves a significant number of those speculative investors high and dry. Then, there is the concern the Fed has over its ability to handle the next recession when rates are this low. It would mean very little if the Fed cut rates right now as they are already at historical lows.

Other issues the investors seem to be reacting to include the belief those tax cuts have had the impact they are going to have and not much more. It was a shot in the arm, but it came very late—long after the economy had already started to grow. Even without tax cuts, there were two quarters of over 3% growth in 2017. The sense is growth this year would have taken place even without the tax cuts. Now there is more concern regarding the potential for overheating. The consensus view is the tax cuts will not be a factor for the rest of the year and into next. The markets have also been deeply concerned that growth could be dramatically slowed by the trade wars and tariffs. The impact of those tariffs has just started to be felt. In the next few months, the impact on the consumer will be more evident. There has also been concern regarding commodity price inflation. The U.S. now benefits from the higher price for oil, but there are still many who do not. Oil prices have risen by over 24% this year and there is serious conjecture as far as $100 a barrel oil is concerned. Steel and aluminum prices have risen as well due to the tariffs. Now, the other metals are right behind.

The global market situation calmed within a couple of days. It appears this improvement will continue through today and into next week. There is nothing that has convinced the investor these good times must come to an end, but there is also nothing to suggest they will go on forever. Today, the optimists are back in control, but the pessimists have all their issues to continue to worry about—that a major and more permanent correction is coming.

Fed Plans to Stay the Course
The comments from President Trump are not all that unusual although most presidents have been far more circumspect when commenting on Fed policy. The reality is that presidential power over the Federal Reserve is very limited—restricted to making appointments to the Board of Governors that must then be ratified by the Senate. It has always been frustrating to the politician when the Fed elects to start tightening the screws. The political position is always oriented toward growth. Politicians worry very little about issues such as inflation. That knee-jerk response of the politician has to be controlled by the sober impulses of the Fed governors.

Analysis: Trump has been able to appoint six of the seven members of the Board of Governors. That would have been his chance to pack the Fed, but none of the appointments he has made share his opposition to higher rates. Jerome Powell was named Chair and was a strong supporter of Janet Yellen. The other appointments have included Randy Quarles and Richard Clarida—both of whom are currently serving. Marvin Goodfriend, Michelle Bowman and, now, Nellie Liang are waiting for Senate approval. The lone member not chosen by Trump is Lael Brainard. Liang is the latest nominee and is as mainstream as they get. She was an economist for the Fed and is actually a registered Democrat.

Each and every member of the current Board and those who are awaiting approval has publicly backed Powell when he asserts the economy is plenty strong enough to handle a rate hike and still experience substantial growth. There has not even been dissent from the regional Fed presidents. That is an accomplishment given there have been some pretty dovish regimes in place—Charles Evans from Chicago as well as John Williams—who left San Francisco to head the New York Fed.

What Is Really Wrong With Society Today
Hate rules today. There is barely an effort on the part of some of the most prominent "leaders" to disguise their animosity. The latest outrage is the intense criticism that Michelle Obama and George Bush II have come under for their friendship. They like one another. That has become a crime in the eyes of far too many people who have drifted so far to the extreme left and right they have sacrificed everything it means to be a decent human being. The fact that these two are friends does not change one thing regarding their core beliefs and what they advocate—they still come to very different positions. They do not have to hate one another to disagree with one another. The fact they like one another holds out the hope they can find points of agreement and the potential for cooperation—the actions that allow a democratic government to thrive.

Once upon a time, the hero of the conservative community was Ronald Reagan. He accomplished a great many things and, in many ways, embodied what was good about being a conservative in this country. He was able to do what he did because he was not consumed with hate—his weekly meetings with arch-rival Tip O'Neil were legendary as the two men obviously liked one another and respected one another even as they disagreed on many, many issues. They fought and argued, but in the end, they still liked one another. That allowed them to find the common ground required in a system like ours. There is simply no room for hate in a democracy—no room at all.