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Strategic Global Intelligence Brief for October 24, 2018

Short Items of Interest—U.S. Economy

U.S. Selling Fewer Treasuries
This hardly qualifies as a crisis yet, but it bears watching. The share of foreign investment in U.S. bonds has rarely been this low. It stands at 41%. Even as recently as two years ago, the percentage was 50%. The yields for U.S. treasuries have been generally down—the 10-year bond is down to 3.17%, but just this week, there was a little rally as investors were bailing out of equities and seeking shelter in bonds. The fact is China still holds a trillion dollars of bonds and so does Japan. Most of the investors still have large positions, but the popularity seems to have reached a bit of a plateau. This is related to the overall debt environment and worry that some of the decisions made by the U.S. have not been the wisest. The two most important concerns have been the rising debt and deficit and the ongoing threat from a trade war.

Not Everyone Enjoys Low Unemployment Rates
The national rate of unemployment has been very impressive—staying below 4% for almost a year. The problem is this good news tends to obscure the not so good news. There are many pockets of the U.S. that still confront very high rates of joblessness—often three to four times the overall rate. The most seriously affected have been urban core regions and rural communities that have lost their key industries. The situation in Puerto Rico has been miserable as well. Solving this kind of unemployment is challenging as there are only two options. Either employers have to move in or the job seekers have to move out and go to where the jobs are.

Alaska Starts a Rebound
Among those states with issues of joblessness is Alaska. This is a state nearly 100% dependent on oil revenue. For the last three years, the price per barrel has been very low and Alaskan oil has not been very competitive. The rest of the country has been enjoying jobless rates as low as 3.8%, while the rates in Alaska have been above 7.3%. The recovery of the oil sector has been helping catch up, however, and there has been progress on the issue of royalties. The current governor cut that royalty payment in half so the state could fund itself, but that has been desperately unpopular. Neither of the candidates to replace him plans to extend this policy. The payments are now being made again. Still nobody knows how Alaska plans to finance itself.

Short Items of Interest—Global Economy

Italy's Budget Rejected by EU
There will be a major showdown between the European Union and the populist coalition that currently rules Italy. After weeks of warnings, the EU has rejected the budget plan, which does not curtail spending or address the nation's debt and deficit. The two coalition partners are the Five Star Movement and the Northern Alliance. Both have been promising their constituents buckets of cash. It is a position the cash-strapped Italians can ill afford so the EU has been trying to develop some kind of compromise. The Italians have three weeks to draft a replacement budget, but there seems no desire to do so. If they don't, they will face fines levied by the EU under their excessive deficit rules.

Mexico Demands Long-Term Solutions on Migration
The new president of Mexico is not going to support the position taken by the Trump administration on immigration. This could become a very nasty fight. Mexico has been deporting thousands of migrants who have been coming from Central America. It no longer wants to play that role if there is no change in sight. Andrés Manuel López Obrador is demanding the U.S. and Canada finance economic development projects in Mexico and in Central America so people will not have to move north to survive. He also wants a much more engaged U.S. when it comes to drug interdiction—efforts that stretch into the Central American states that harbor the most violent of gangs. These demands will not be met with enthusiasm from Trump and his supporters, however. That could lead to even larger waves of immigration.

More Fretting in the Global Markets
Yesterday, there was another series of sell-offs in global markets. It started in the Asian perimeter and spread from there. By the end of the day, there were big losses almost everywhere. This kind of roller coaster behavior is getting more and more common as the various worries and concerns continue to mount. The Dow Jones slid by 2%—a drop of almost 500 points and enough to wipe out all the gains made for the year. There was a similar decline in the other indices as Nasdaq fell by 2.6% and is now very close to hitting true correction territory. This was not something that occurred in just the U.S., the markets in Asia were the first to feel the uneasiness. It spread from there through Europe and into the U.S. The trillion-dollar question is whether this is the beginning of a long series of declines that will drag the whole of the global market into correction territory, or perhaps this is just another blip on the radar and doesn't mean much more than the previous declines did.

Analysis: It is useful to review the actual role markets play. Although many try to treat the market as some kind of indicator for the economy as a whole, it has never been very good at playing this role. Investors have a wide range of interests and motivations so they will act accordingly. There are those who take a very long view and invest in solid well-run businesses with extensive track records of success, but these are not stocks that gain and lose value very quickly. They do not interest the investor who wants to gamble on fast-growing stocks that can be bought and sold quickly. There are many investors in the game for the dividends and others that are in and out of a stock in minutes or even seconds. Different things worry these different investors and they react to economic data in differing ways.

The big sell-off yesterday seemed to be motivated by three major concerns. All three are related to what many investors have seen in the global economy of late. At the top of this list of concerns for the Asian markets has been the reaction of China to its latest anemic growth data. The slump to just over 6% growth has taken China back to the bad old days of the recession that gripped the world in 2008-2009. This has prompted the government to start engaging in a series of moves designed to boost growth, but these have been high-risk moves in the past. They tend to overheat the Chinese economy and they tend to promote the development of various bubbles and financial risks. All of this makes the Chinese markets a little nervous. The other nations worry these problems will slop over on to their economies. China is feeling the impact of the trade war with the U.S. far more than the U.S. China is well aware many other nations are seeking to expand their market share at the expense of the Chinese.

The second major worry affecting the global markets is the overall impact of the trade wars on some of the bigger corporate players. The companies that do a great deal of global business worry that these trade conflicts are adding up to some kind of Cold War-like situation. That has contributed to down quarters for the likes of Caterpillar, Boeing and some of the big tech companies. The sense is protectionism is spreading fast and has been underpinned by the growth of populism in the U.S. and Europe. The International Monetary Fund (IMF), World Bank, Organization for Economic Cooperation and Development (OECD) and many others have all ratcheted down their expectations for growth this year and next. The sense is this will become a bigger and bigger issue as countries react and counter-react to each other's trade moves. Part of what worries many is this kind of trade suspicion is usually not an issue when there is solid job growth and a healthy economy. It makes people nervous to think what this looks like when the economy starts to sag a little.

The third major worry stems from the growth of those populist movements that take their inspiration from both left and right. The common ground seems to be antipathy towards anything that smacks of globalization. That creates an inevitable clash. The business that is not global these days is at a distinct disadvantage. It is not just that companies can produce in low-cost environments and take advantage of more limited regulation in many places. The real issue is the development of the global consumer. This has created a truly international supply chain that will not be easily replaced—even if people think they want to. The real threat to blue collar jobs is robots and machines and not cheap labor in other nations. The march towards technology is unlikely to be interrupted.

So Much for That $100 Per Barrel Projection
It seemed that oil prices were on the way up. Many suggested it was likely oil prices would be back at $100 per barrel by the end of the year. It seemed everything was pointing in that direction as there were declarations from several of the largest oil states that they planned to reduce output for a few more months while the demand for oil was continuing to accelerate. That started to change in just the last few days. Now, oil has dropped further in one day than has been the case for the last three months. The price per barrel had been as high as $84 and was headed higher, but after the close of the stock market yesterday, it had dropped back to the high 70s. Does this really mean that $100 a barrel oil is now out of the question? Of course not, there are so many factors that could come into play in the weeks and months ahead that would drive prices higher, but at this point, there are just as many factors that could drive these prices lower.

Analysis: The expectation of $100 a barrel oil was based on some major motivators at the start of the year. The most important has been the growth manifesting in the U.S. as well as in some of the other developed economies in Europe and Asia. This demand was driving many oil states to abandon their plans to cut production as they didn't want to lose market share to each other. The only major oil state still contemplating more cutbacks is Russia. Even it has been active in the spot market of late. The assessment was natural curbs on oil production would be sufficient to keep the price per barrel up. For a while that had been true, but many of these factors were destined to be short lived.

The Saudi Arabian decision to step up production a little was based on the assumption Iranian oil would be pulled off the market sooner than later and would leave a hole in demand. It has been harder to get that output down than was originally assumed as many nations have been reluctant to go along with the U.S. on sanctions against Iran. The No. 1 importer of Iranian oil has been China, but there have been shipments into Europe as well. More oil has been coming from Libya, Iraq and the Gulf States than had been assumed and there has been a step up in production from some of the African producers as well. At the same time this global output was hiking, the U.S. was ramping up and so were Canada and Mexico. In other words, everybody that produced oil was raising their output levels—all except the utter basket-case nations like Venezuela.

The end result was far too much capacity for a global economy that shows distinct signs of slowing down. If these two patterns continue to merge, the oil prices will continue to fall a bit. The threat of $100 a barrel oil will be put off for a while longer, but that is not the unbridled good news that it might have been for the U.S. in previous years. The consumer may appreciate the lower price for fuel, but the U.S. has a substantial oil sector now and stands to make a lot of money when the price of crude heads up.

What Does Pulling Out of the INF Mean?
The statement about the INF (Intermediate-Range Nuclear Forces Treaty of 1987) from President Trump was not entirely unexpected given the position National Security Adviser John Bolton has long advocated. It is a Cold War relic in some respects—a treaty that limits the amount of nuclear weaponry developed and deployed by Russia or the U.S. These are the intermediate range missiles Russia could use to attack and intimidate Europe. The U.S. signed on to this agreement as part of the U.S. commitment to Europe's defense. The fact that Europe is the main beneficiary of this treaty may explain why the U.S. has chosen to pull out. It would have very little impact on the Russian arsenal as the Russians already have a massive level of superiority. The treaty asserted the U.S. would react if these missiles were used, but it is a fairly safe bet the U.S. would react anyway.

Analysis: The subject is supposed to come up when President Trump and Putin meet again in Paris. Right now, the Russian position is the action is not justified by anything Russia has done. The Europeans are furious as this is just another example of the U.S. walking away from Europe or using an agreement like this as a way to squeeze more from the Europeans. For reasons that remain more than murky, the relationship between the U.S. and Europe is very, very bad. The U.S. has been more hostile to those that would seem to be allies than to nations defined as enemies. This may be part of a bigger set of demands regarding what President Trump believes Europe owes the U.S. In return for these kinds of protections, the U.S. wants a more conciliatory position on trade and other economic issues. The Europeans for their part assert they have been the front-line states in the conflict between the Soviets and Americans. The problem now is the USSR is no more. It is hard to determine the relationship between Russia and the U.S. given that Russia's economy is roughly the size of New Jersey.

Steel Makers Look to Be the Chosen Ones
There were always two issues the steel makers wanted addressed by the Trump administration. The first is the one we have been debating for months—the restriction on imported steel into the U.S. market. There has been a sort of "one step forward, two steps back" kind of issue here. The tariffs are imposed and then they are lifted again for select countries. The other important issue for the steel producers is getting an exemption for the things they import to make the steel. No other industry has won as many concessions as steel. Many other industries have lobbied for these exemptions based on the assertion these products are not made in the U.S. or are not available in sufficient quantities. Steel has been far and away the most successful in getting these exemptions.

Analysis: The reason for this favoritism from the Trump administration is complex. There are simple explanations such as the fact Secretary of Commerce Wilbur Ross invests heavily in steel and many of President Trump's advisors came from the steel sector. Then, there is the base of support for President Trump politically as the steel sector plays a somewhat mythic role in blue collar circles. There is also the national security angle as no country wants to be dependent on foreign sources for something as basic as steel. The problem is that what is good for steel producers is often bad for manufacturers.

Has It Always Been Thus?
One of the often repeated complaints about modern society is it has become so coarse and dangerous. The papers are chock full of shootings and other episodes of violence. The invective hurled by social media is stomach turning and leads one to assume we are utterly surrounded by thugs, bullies and boors. An interesting study was conducted by students at a journalism school who looked back at the newspapers of the late 1800s. This was the heyday of the printed word. Nearly every city had several competing for the attention of the public. Just as with today's media, the sensational sells. The papers detailed murders and other crimes—the more heinous the better. The settling of disputes was largely done with a gun or other violence. If one looks at all these accounts and understands how small populations were at that time—it is easy to see violence was everywhere and far more commonplace than it is today.

At another school, a survey was taken to determine how frequently people were directly affected by violence. This would mean you or a close family member had been subject to violence. It turns out fully 90% of the population has never been subject to violent crime—the rate was 30 per 100,000 in the 1700s, 20 per 100,000 in the 1800s and 10 per 100,000 in the 1900s. Today, the rate is less than 5 per 100,000. The vast majority of people will never have an encounter, but we are bombarded with the events every day and begin to think we are all likely to be victims at any point.

The point is not to assert crime is not important or to belittle the experiences of those who have been victims. It is important to note one's risk jumps dramatically according to where one lives and there are many other factors that matter. We need perspective and we need to understand the real risks we face every day—things we can do something about immediately.

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Wednesday, 22 May 2019