Strategic Global Intelligence Brief for October 2, 2018
Short Items of Interest—U.S. Economy
Next Up?—China
Now that the U.S. has moved to a new version of NAFTA, the attention of the trade deal has shifted to China. It is expected the same techniques will be applied—a mixture of dire threat and a way to salvage the relationship. The U.S. has started to run out of ways to punish China as there have been tariffs planned for almost everything we buy from the country. Any further attack on exports may do the U.S. more harm than it does China, so now there are other issues at stake. There has been a threat to cut off student visa applications to the U.S., but this has caused great alarm among schools across the U.S. The estimate is that China is getting hit harder than the U.S. right now, but there is still no guarantee the Chinese will elect to give in.
Food Glut
The sector that has been most adversely affected by the trade war with China has been the farm sector. It needs help badly and immediately. This has not been a good year in any case as weather has been adverse and global prices have been down. The two programs that were set up to help the farmer get through this have created issues of their own. The agreement to pay farmers for the crops they can't sell to China has added considerably to an already bloated deficit and debt. The governments at the state and national level have also been buying a lot of food directly and distributing it to food banks and the like. They are now glutted with food and don't know what to do with the majority of it. This program has also been a budget buster.
Tax Cuts Not Showing Up in Higher Wages
Now that there have been a few months to observe the behavior of the corporate community, it is possible to determine what the majority of these companies did with that tax cut windfall. It turns out that very few used the money to increase their worker's pay. In the beginning, there were several companies that made a big deal of their decision to raise pay, but they have been the exception to the rule. Most of the tax cut saving has gone to things like stock buybacks, investment in robotics and machinery, and investment in training current and future workforce members. What's more, there is no sense that more pay hikes may be coming later.
Short Items of Interest—Global Economy
Japanese Government Shuffle
In the wake of Shinzo Abe's recent victory, there has been a cabinet reshuffle. He was elected to another term as the head of the Liberal Democratic Party (LDP). Since they have the majority of the seats in the Diet, he is the prime minister. His cuts included one of the two women left in his Cabinet, a far cry from the campaign promise a few years ago asserting women would be well represented. The largest number serving was five; it has been dwindling ever since. Most of those in the new Cabinet are the same as they were in the old Cabinet despite calls from the other leaders of the LDP to get some new blood.
Male Rage
All over the world, there has been a series of confrontations that seem rooted in the relationship between genders. There has been a surge of activism around sexual harassment in almost every country. Now, there is a sign of intense backlash from men who seem to be losing the authority to which they feel entitled. The U.S. has been grappling with this issue for some time now. There has also been conflict in Europe, but now there are societies where male dominance was normal seeing a surge of opposition from women.
Paris in the Lead
With the advance of Brexit, the British will have to say goodbye to the dominance of London as a financial trading center. Many firms have already started to move, but the question has been to where. The three competitors for that influx have been Berlin, New York and Paris. Lately, it appears France has the best position to offer. Firms are pulling out of London to move to Paris and make this the new trading capital.
What Does a Europe (or Germany) Look Like Without Angela Merkel?
There have been few political leaders who have dominated over the last 10 years quite like Germany's Chancellor Angela Merkel. None of them have been leading a democratic state. It is relatively easy for a Vladimir Putin or Xi Jinping to twist a government to suit their purposes as there is no counterbalance to their power. In a democracy, there will always be rivals ready to exploit weakness or convince voters to oust the incumbent and try somebody new. Traditionally, the most long-serving politicians are those who stick closely to domestic issues that seem to matter most to the constituents. However, Merkel has always been at the forefront of both European and global issues even when the actions she has taken could not be seen as in Germany's best interests. The era of Merkel is now starting to come to an end. Assuming she serves out her current term, she has indicated this will certainly be her last and she will leave office in 2021. The question now is whether she will stick it out that long. Will her power and influence wane so quickly that Germany, Europe and the world suffer for the lack?
Analysis: Europe is increasingly divided into four camps. Germany has been as well. The old system featured two rival approaches to government—one from the center right and one from the center left. They were profoundly divergent from one another on a wide range of issues, but they also tended to agree on some basic premises as far as the process of government. From time to time, they found ways to work together. Germany was the most advanced when it came to that cooperation as Merkel kept cobbling together a "grand coalition" that included her Christian Democrats with the Social Democrats. There was never universal harmony, but the two parties put their differences aside to accomplish mutual goals. To a lesser extent, one saw this kind of "coalition of the center" in many other European states. This system is now in real peril as there are four sets of policies now competing. Two of the four have no interest in cooperation with the others for any reason at all.
Europe now has the populist left and the populist right. They are extremists in the political sense of the word. They have turned their backs on the traditional ideas of both the left and right and have demanded radical solutions to the problems they place as priorities. These populists do not represent the majority of Europeans—not by a long shot. They are far too weak to win power for themselves in a general election, but their numbers are large enough to deny leadership to the traditional parties. Germany is an example of this situation. It is why Merkel is weaker now than she has ever been. That she would be challenged now is violating every "rule" of politics as she is presiding over an economy that is as good as Germany has seen in over a decade. The national debt is shrinking fast and the government has a surplus to work with. Unemployment is close to record lows and business expansion has been robust. By all accounts, she should be facing a clamor for her to stay on as leader, but instead her own party is chipping away at her power and the support of the voter has dwindled. Just as with the U.S., the economy is not the issue. Merkel has been felled by issues that are far more emotional and cultural.
The party that has changed the face of Germany is the AfD (Alternative fur Deutschland). They are the German version of the right-wing populism that has been transforming all of European politics (as well as politics in the U.S.). They are rooted in the same traditions as the National Front in France or the Sweden Democrats. The focus for the populists is nearly identical in every country where they are active. The top of the list is virulent opposition to immigration, but right behind this issue is general opposition to the business community and its priorities. The demands create a situation where the left-leaning populists and right-leaning populists are nearly the same as far as policy. There is deep distrust of the traditional center and assertions that corruption is rampant. Immigration remains the critical issue. This has been the most challenging one for Merkel. The decision to allow some Syrian refugees entry was her most serious miscalculation as her government was not prepared for the numbers and the fact that tens of thousands of people from all over North Africa, the Middle East and South Asia would come streaming in. The German government was quickly overwhelmed. The public grew resentful—blaming all social ills on the newcomers.
Without Merkel as the steady center of European politics, it is hard to imagine who or what fills the void. Emmanuel Macron is fighting for his political life in France, the U.K. is no longer connected and Italy is a messy coalition. Europe without Merkel is essentially rudderless. That makes many in the business community very uneasy.
Culture of Corruption in Brazil
The election in Brazil is set to bring a right-wing populist to power that terrifies many in the country as well as many of Brazil's neighbors. Jair Bolsonaro has exploited the population's fury over crime and corruption—both issues are affecting voter attitude more than the economy. This is significant given the fact Brazil has been fighting recession now for almost three years. It has fallen quite a way from the days when it was one of the leading BRIC (Brazil, Russia, India, China) states.
Analysis: Unfortunately, corruption is so well-rooted in the country that even those who decry it are engaged in it. There simply seems no way to survive without resorting to bribes and patronage. It has become a nation with no faith at all in its core institutions. The conclusion is that anything you want done will have to be done with the help of some "grease." The culture is pervasive so it feels almost normal to be engaged in some form of graft.
The majority of the population remains even more concerned about crime. Here is the other area where Bolsonaro scores points with his very aggressive position. He has even been compared to the president of the Philippines—Rodrigo Duterte. Only recently Duterte admitted to ordering extrajudicial killings. Estimates are that over 6,000 people in the Philippines have been murdered by government forces because they were suspected of being involved with the drug trade.
The Impact of USMCA on the Auto Sector
Most of the conversation regarding the future of NAFTA revolved around what had developed in the auto manufacturing world over the last 20 to 30 years. It seemed simple enough for the politicians to just cut off access to the U.S. market for foreign carmakers and make demands regarding local content, but these utterly simplistic notions exposed the ignorance of those asserting there was an easy fix. Few industries have worked so hard to build a complex and integrated supply chain. It is nearly impossible to identify a car as "domestic" or "foreign" given the intricate set of decisions that deliver parts for assembly all over the world. The new USMCA was intended to change the nature of the North American car business. To some degree it will, but not necessarily in the way political leaders expected.
Analysis: There are three parts to the new agreement that will likely matter most. The first is the demand for more "local" content in vehicles sold in the U.S. The percentage will go from 62.5% to 75% of the parts coming from the U.S., Canada and Mexico. This is not likely to cause any disruptions for the Big Five automakers in the region as they have all worked hard to procure locally over the years. There was some political motivation to do this, but there was also an element of control involved as companies wanted to be closer to the source of their inputs. The U.S. vehicle market is dominated by Ford, GM, Fiat-Chrysler, Toyota and Honda. Toyota has already reached a point where almost nothing comes from Japan or any other country to North America. Honda is right behind. The companies most affected will be the Germans as Mercedes, BMW and Volkswagen import most of their engines from Germany.
The second aspect of the new agreement that will affect auto making is the provision that demands workers be paid more. It is now required that 40% to 45% of workers in a given operation earn at least $16 an hour. This is likely to push many companies to expand the use of robotics as there will be an unwillingness to pay very high wages for simple assembly work. This will ultimately mean fewer people working in the sector, but those that do end up working side-by-side with the robots will be well paid. The aim of this rule is to blunt the appeal of moving to Mexico to get cheaper labor, but now there will be as much incentive to move because it will be easier to fully automate a plant—something the U.S. and Canadian unions have resisted.
The third factor worrying the auto sector is tangentially related to the new pact. The fact is all these new provisions and demands will create higher costs. This is coming at the same time that steel and aluminum tariffs are creating higher prices for these key raw materials. The price of steel has jumped by over 40% despite the fact the tariff imposed is only 25%. The car market has started to slow down anyway. The fear is that even slightly higher prices will put people out of the mood for a new vehicle. Higher steel prices have already cost Ford and GM an additional billion dollars each. There are even reasons to think the consumer is getting fatigued. Sales have been falling and consumers may soon be faced with decisions based on fuel costs. There are signs oil prices may be back to the $100 level before the end of the year. That translates into a pump price well above three dollars. Will this send the buyer back to the small car which doesn't make the auto company much money?
Peaking for U.S. Economy
The data is not bad, but it isn't all that good either—not like it was just a few weeks ago. It appears that the U.S. economy may have reached its peak. The only place to go from here is down. The growth in Q2 was a stunning 4.2%. This quarter will likely be above 3%, but Q4 may not hit that high. Most analysts are now predicting growth next year of perhaps 2.5%—closer to the average that has been in place the last 10 to 15 years.
Analysis: There is not much consensus as to why this may be the trend, but three suggestions have been made more than once. The first is the tax cuts are far in the past now and no longer have the impact they did at the start of the year. It was always assumed they would be short-lived stimulators. The second issue is the mounting trade war tensions. Even if there are winners in all this, there will be losers as well. That dampens enthusiasm. Finally, there is the fact the housing market has softened considerably.
I REALLY Do Not Want to Know This!
I know my charming and loving wife means well—she really does. I was urged to come to the living room just a moment ago to watch a portion of a news show. The subject was cleanliness at airports. Those of a weaker constitution should quit reading now. The team of intrepid reporters went to an airport and started swabbing everything they could think of. The meter they used registered all manner of bacteria and the swabs were sent in for analysis. The stuff they found was capable of making people very sick and many were even life threatening. The most common finds were all related in one way or another to fecal matter. These excrement-related bacteria were all over the trays one places your stuff in at the TSA checkpoint—readings of over 600 when the maximum should be less than 100. It gets worse. The seat belt registered over 800, the tray table was at 1,600. The cleanest place at the airport was the toilet itself, which registered just 32.
FOR PETE'S SAKE—WASH YOUR HANDS! I really do not understand why this is such a hard concept, but apparently it is. Each and every time I visit a men's room, I note that more than half do not bother to wash their hands. I have seen dirty diapers left on the floor and in the sink. I can only imagine what the ladies room looks like. I am no germophobe, but I am not as young as I used to be. These things hit me harder than before. I fly a lot and have tried to be conscious of the opportunity to clean, but now I will be one of those using wipes to sanitize my seat. I once sat next to a guy who wrapped himself in a black plastic bag as soon as he sat down. I thought he was a real weirdo, but today I am thinking he might be a pioneer when it comes to air travel.
