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Strategic Global Intelligence Brief for October 2, 2019

By Chris Kuehl, Ph.D., NACM Economist

Short Items of Interest—U.S. Economy

Manufacturing Matters
One of the adages in economic analysis is that we are what we measure. The "knock" on manufacturing as an influence in the overall economy is there are not that many people employed in the sector compared to other professions and compared to the past. It is asserted that manufacturing accounts for just 8.5% of jobs in the U.S. compared to 25% in 1970. This can be a misleading statistic. One is classified as being employed in manufacturing by what one does; not by who the employer is. If you work for Ford Motor Company and are on the assembly line, you are considered a manufacturing worker. If you are a designer or work in accounts receivable or as a supervisor, you are not classified as being in manufacturing. It would come as quite a shock to the person employed by Ford to learn they are not in manufacturing. If people were classified by who they worked for, the manufacturing sector accounts for close to 40% of jobs in the U.S.

Economic Confidence at the Fed
The specter of a recession by the end of next year seems to hang over the economy at the moment—even as the majority of the data seems to remain pretty solid. There is always the risk of talking ourselves into a recession as consumers and business people start to let their concerns affect their decisions to consume and expand. The latest statements from various Fed officials indicate the ingredients for a recession are just not in place at the moment. They therefore expect the economy to continue to grow at a reasonable pace—around 2% to 2.25%.

Trade and Pressure
There has been a consistent narrative when it comes to the trade war between the U.S. and China. The assumption has been that both Presidents Trump and Xi have been engaged in a war of tactics and have just been waiting for the "right" moment. The assertion is Trump will suddenly make a deal with China at a pivotal point in the election campaign so as to deliver a burst of economic growth. That may well have been the intent, but it now seems other issues may complicate that move. The Ukraine mess may preoccupy the White House for months and staying close to his base will matter more than ever. This will make any concession to China harder. Meanwhile Xi is riding the wave of the 70th anniversary of the Communist Party of China and has little room for maneuver. Both may want a deal, but it has become that much harder to execute.

Short Items of Interest—Global Economy

North Korea and Its Missiles
The North Koreans want more talks with Trump and want more concessions from the U.S., so naturally, they are expressing this desire by firing missiles that have splashed down in Japanese waters. An interesting negotiating technique to be sure—akin to punching one's counterpart in the mouth before asking for a favor. Trump has indicated he wants more talks, but thus far, the meetings have yielded absolutely nothing other than an opportunity for Kim to lie and renege on his various vague promises.

Israel Headed for Third Election?
The latest set of talks between Prime Minister Benjamin Netanyahu and Benny Gantz have broken down. This has made the possibility of a third election more likely. The votes were a clear defeat for the Likud coalition, but not clear enough to propel the new Blue and White coalition to power. There has been an effort to create a unity party, but the animosity between Netanyahu and Gantz is intense. Neither is willing to see the other as prime minister. If the deadlock continues, the voters will get another opportunity, but polls suggest that the outcome would be the same.

U.K. Construction Sector Feels Brexit
There are sectors of the British economy that have yet to feel the brunt of the Brexit debacle although most assume their time is coming. The construction sector has been feeling it for several months already with six straight declines. The desire to expand and build commercially is non-existent; even residential is dramatically off. This has started to hit the job market hard.

Global Manufacturing Takes a Hit
There is nothing in the latest set of readings that comes from various Purchasing Managers' Indices (PMIs) that should come as a shock. If there is anything shocking about this latest data, it is how long it has taken for the trade wars to have this kind of influence. In country after country, the PMI has been declining. In many cases, the decline has been precipitous. Even before the latest down numbers, it had been noted that of the 15-largest export markets for the U.S. all but three had been sporting readings that were under the 50 line that separates expansion from contraction. In every case, the slowdown in manufacturing has been attributed to trade issues. This is not just the tariff war between the U.S. and China, although that has arguably been the most significant contributor. The Brexit mess has been affecting Europe and the ongoing battle between Japan and South Korea has profoundly affected Asian trade. There are other rifts as well—between Latin American states, between nations in the Middle East and South Asia and Africa. In general, there has been a global move against further globalization and towards nationalism and various degrees of isolationism.

Analysis: The PMI numbers for the U.S. declined for the second straight month. The combined reading now sits at 47.8 after being at 49.1 in August. The U.S. is anything but alone in this new misery. Most of the nations in the EU have seen numbers slip deeper into contraction territory with both Germany and France looking at numbers as bad as they have been in several years. China saw decline and so did Japan along with South Korea and India. No major nation escaped the decline. The data from the CPB Netherlands Bureau for Economic Policy Research showed that global trade flows fell by 0.8% in the second quarter and are down by 0.3% for the year. The forecasts for global growth have been reduced twice already this year by the International Monetary Fund (IMF), World Bank, Organization for Economic Cooperation and Development (OECD) and others. The message is about as loud and clear as it gets. The global economy is in distress and trade is on the decline.

Many simplistic suggestions have been made as to what has been causing this and even more simplistic and ineffective solutions. Trump has asserted it is all due to the Fed policy of holding interest rates at too high a level. A Federal Funds rate of 2% is not high in any sense and there is no evidence suggesting companies are unable to get access to capital should they need it. Trump claims the dollar is too strong because of these rates. The reason for the dollar's strength is that the U.S. economy remains healthier than those in Asia and Europe and that is stimulating investors. The interest rate is no factor at all in this market demand. Furthermore, the lack of exports from the U.S. has had little to do with the value of the dollar as evidenced by the fact that no nation has been watching its exports grow. If currency value was the key, it would be expected the U.K. would be surging in the export market, but it isn't. Exports are down because nations are feeling the economic pinch from the trade wars and nobody is in a position to do much buying.

The U.S. has been imposing tariffs on China and they have been experiencing slower growth—down to around 6%. That means China is buying less from the many nations relying on that activity to bolster their own economic growth. These nations, in turn, are buying less from the U.S. The global trade system is just that—a system. If one aspect of it is altered or disturbed, there is a ripple effect on the rest of the world. The fight between the U.S. and China has been one very large ripple. As mentioned, the issue between the U.S. and China is not the only one. Brexit has been more of an issue in Europe and there have been other trade disputes.

There is a political undercurrent that is making global business very, very tough. In nation after nation, there has been a shift away from free trade and globalization despite the ample benefits the trade patterns have brought consumers around the world. The problem is these benefits are diffuse. Consumers are dimly aware their products come from around the world and that this distribution of production means they will be cheaper. The people who have lost their jobs to foreign competition are affected immediately and profoundly and make their case more effectively than the consumer who notes that being denied foreign goods will cost a few dollars more. The fact is that losing access to foreign production will cost the average consumer in the U.S. around $8,000 a year. One would have to ask how upset people would be with an extra tax of $8,000 annually.

Tariff Exclusions
To this point, there have been over 2500 U.S. companies seeking relief from the tariff war. They have collectively asked for exclusions on 31,000 products. The assertion is the products in question are not available from anywhere else or that getting these items from somewhere else would be exceedingly expensive. The U.S. Trade Representative's office has ruled on less than 1% of the requests and has granted a whopping 31% of them. The majority of these requests are coming from companies that supply parts to other U.S. manufacturers and to retailers that are selling to consumers.

Analysis: It has been hard to determine what impact this has had on the overall U.S. business community, but it has been clear that many companies in the U.S. have been forced to reduce the size of their workforce. Some companies have even gone out of business. It has been difficult to determine how many of these products are now being made in the U.S. Anecdotal evidence suggests that companies have not elected to buy in the U.S., but have been importing from other nations such as Vietnam, India, Mexico and many others. The reality is the U.S. consumer is not willing to pay the price that would be required for a long list of goods if they were made in the U.S. The costs of production are simply too high.

The State of the Economy
Are you among the millions who are confused as to what to believe about the state of the economy? You have tried to listen to the experts and are now more convinced than ever that an expert is a former drip under pressure. How can you get five economists in a room and get five different answers? There are reasons for this confusion.

To begin with, it is important to note that at its heart economics is a philosophy and a social science. This has two major implications. As a philosophy there will be differences of opinion among economists over what is a good thing and what is a bad thing. A more liberal-leaning economist will observe the fact that 10% of the population controls around 80% of the nation's wealth, while the bottom 50% controls about 1% and conclude this is a state of affairs that must be changed through some form of income redistribution. The more conservative economist will look at the same numbers and conclude that those who start and run businesses and engage in investment are the ones that drive the economy and therefore get a bigger share. They observe that the upper 1% pay 40% of all the income tax collected by the government. The numbers are the numbers, but what they mean is open to interpretation.

Beyond the philosophical differences, there is the fact that economics is a social science. That means it is trying to study the always-fickle consumer/worker. The human being is ever-changing and that goes for their role in the economy. The average person reacts to a whole host of economic motivations—the security of their job, what they are paid, how much things cost, what they can get by saving, what they need at different stages of life—when they have kids in school as opposed to saving for their own retirement. It can be hard to keep up—especially when there are big differences between Baby Boomers, Gen-Xers, Millennials, and the latest cohort—the Gen-Z.

Analysis: Having said all that—what shape is the economy in at the end of 2019 and what does this say about the prospects for 2020? In truth there is a little for everyone. For the sake of simplicity, we can look at three issues that come up most often in economic discussions: unemployment and the job market as a whole; the potential for a recession in the relatively near future; and, the impact of the trade war with China.

The unemployment rate has been at or near record lows for the last few years and that is a good thing. There are a couple of caveats to be aware of though. The first is that a significant reason for the low rate of joblessness has been the large number of retiring Baby Boomers. They are leaving the workforce at a rate of 10,000 per day—a quick look at the math reveals that this translates into 3.6 million people a year. Not all of them will be replaced, but many will. It is also important to note that the majority of the new jobs have been in the relatively lower-paid service sector. It is indeed good that the jobless rate is around 3.8%, but not everything about the job market is healthy. There are severe shortages of people with needed skills for sectors as diverse as manufacturing, transportation, construction, health care and even the professions. The manufacturing sector alone is expected to face a shortage of 2.5 million workers by 2025.

The next issue is recession. There are indicators that convince people it is imminent, such as the inverted yield curve. It is important to note that an inversion doesn't cause a recession—it is an indicator of conditions that might lead to one. The yield curve inverts when investors start to assume the central banks will slash rates to deal with an impending recession. That reduces the demand for those long-term rates. It has also been pointed out that the Purchasing Managers' Index has fallen very close to contraction territory (anything below 50) after having been close to 60 less than a year ago. But at the same time, there has been an uptick in the durable goods orders and factory orders have been essentially stable. The capacity utilization numbers are not quite in the ideal range (between 80% and 85%), but have been consistently in the range between 75% and 78%. In other words, there are some signs of a slowdown for sure, but it would be very premature to assert that a recession was looming. It is reasonable to expect growth to slow to between 1.8% and 2.1% yet this year and into next.

The third area is trade and tariffs. The effort has been decidedly unpredictable with many threats of tariffs that are subsequently negotiated away. At this writing, the U.S. had imposed new tariffs on China that would hit U.S. consumers harder than the previous ones. China retaliated with tariffs that will hit the U.S. farmer and manufacturer harder than had been the case. The current tariff on goods from China will cost the average American an additional $1,000 a year. Is that enough to affect the economy negatively? Maybe and maybe not. At the same time as China tariffs are hitting consumer goods, the price of gasoline has been hitting new lows. The average per gallon price has been around $2.60. It was only a few years ago when the average was $4.14. Assuming that a person fills their 12-gallon tank once a week, they are now paying $31.20. They were paying $49.68—a difference of $18.48. Multiply that by 52 weeks and you saved $960.

No Grass Growing Under Their Feet
I had an opportunity to do some socializing with some of my wife's old school chums last weekend. These women get together every now and then and do some trips down memory lane while catching up on what has been going on since those halcyon days. Some of the women are fast friends and some are basically acquaintances, but all have a good time. I was struck by some contrasts. My wife's best friend is Barb and I have become good friends with her husband Jerry. These two are nonstop. He is a retired dentist who taught at the dental school for years along with his practice. He is a Renaissance Man if ever I met one. He is a skilled woodworker, avid bicyclist, fixes machinery, reads history voraciously. His days are packed. She is a singer and tends to her extended family through every means available. Both are funny and fascinating. They are 10 to 15 years older than I am with more energy than I can dream of.

Then there were some of the others. One group of men never said a word to anyone at the party—just plopped in front of the TV to watch a football game between two teams that have absolutely no connection to this area or to them. They remained inert for the duration of the evening. When they did move, it was a monumental effort as they were very overweight and likely had other ailments. Watching Barb and Jerry, it was obvious they loved life and experienced it to the hilt. Just like my own blushing bride. I just try to keep up and enjoy the world half as much as they do.

Top Foreign Owners of U.S. National Debt
The U.S. debt is now at around 110% of the $20 trillion GDP. Analysts assert this percentage should never be more than 60% of that GDP. The deficit is closing in on a trillion dollars and is 4.6% of the GDP—never should be more than 3%. The U.S. adds to the debt and finances the deficit through the sale of bonds. There is always a market for the Treasury bill. With yields as low as they are, it makes some sense to borrow, but perhaps not this much. The real issue is debt service. The buyers of these bonds expect a return. That debt service is 8.7% of the Federal budget ($393 billion). That makes it the fifth-largest part of the total budget behind Social Security, Medicare, Medicaid and the military. By year 2026, it will be 13% of the total budget and $762 billion. In 2020, the total military budget was $718 billion. In economics there is a concept called "opportunity cost." You doubtless remember that old Economics 101 lesson about guns and butter. If the government is spending $762 billion on debt service, that is $762 billion it can't spend on anything else. Therein lies the problem.

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Thursday, 09 July 2020