Strategic Global Intelligence Brief for October 3, 2018
Short Items of Interest—U.S. Economy
ISM Reports Record Numbers for Service Sector
The latest numbers for the manufacturing side have been down a little, but they are up quite dramatically in the service sector with a reading of 61.6. That is higher than the index has been since 2008, but it is not likely this will be repeated in the next month's data as there seemed to be some unique aspects of the service data this time. A lot of the activity has been attributed to companies trying to prepare for the onslaught of tariffs and trade restrictions. The fact is most companies were building contingencies and inventories as they feared the worse when it comes to trade with China, or any other nation for that matter. The expectation is the service sector will cool a little and be more like the manufacturing reading.
Fed Doesn't See Labor Market Inflation Just Yet
According to the data provided by looking at the supposed behavior of the Phillips Curve, the threat of wage-driven inflation should be right around the corner, but it has yet to manifest. The latest statement from the Fed indicates they are not seeing this kind of labor market overheating. For the moment, they do not see substantial inflationary pressure from this source. There is speculation as to why this is the case, but the bottom line is employers are simply not overpaying for their new workers as they lack the experience and training to command higher wages. This serves to reduce some of the pressure on the Fed to hike rates any faster than already seems to have been indicated.
Reducing Restrictions on Some Big Banks
As the financial sector imploded and ushered in the Great Recession, there was much ire heaped on the whole sector. That culminated with the Dodd-Frank law that imposed a whole new regime to make certain these big banks would not be bailed out by the taxpayer. The plans backfired to a degree as the small banks ended up being hit as well. The process of dismantling elements of Dodd-Frank is still under way. The latest move comes from the Fed as they plan to reduce some of the liquidity demands placed on small banks. So far, these restrictions will remain in place for large foreign banks.
Short Items of Interest—Global Economy
Italy Attacks Budget Deficit
Italy's economy minister has said the country will reduce its budget deficit by 2020—a concession to Brussels before Rome sends its formal spending plan to the European Commission for approval this month. Giovanni Tria, Italian economy minister, said the country would reduce its budget deficit as a percentage of gross domestic product after next year, a shift from a plan unveiled last week to keep it at 2.4% for three years.
Mexico Welcomes New Deal to Replace NAFTA
Relief surged through Mexican boardrooms and government offices this week after Canada and the U.S. overcame their differences to agree the U.S. Mexico Canada Agreement, preserving a regime that has contributed $1.2 trillion in annual trade between the three North American partners. Business leaders hailed the revamped North American free-trade pact and said Mexico could look forward to a stronger currency, higher growth, lower interest rates and a rise of as much as 50% in exports over the next decade.
Iraq May Get a Government Yet
After months of deadlock, it looks like Iraq has found a leadership duo that might work. Neither man is part of the entrenched political parties. That could be good news or bad. They will not have the internal fights, but they will also have few allies unless they start cultivating them now. Adel Abdul-Mahdi is the prime minister designate and Barham Salih is to be the new president. They have few outside ties at the moment, but will have to develop them soon.
Turkish Economy Stuttering
The series of economic crisis situations in Turkey have been escalating and the issues are becoming more and more destabilizing. The inflation rate has soared to over 25%. Many assert it can continue to worsen as the country tries to regain control of the value of the currency. It has lost almost 40% against the dollar this year already. This has made imports very expensive. Given that Turkey imports food, fuel and other basic goods, the impact has been swift and dangerous for those in the country that lack the ability to adjust their own incomes to match these price hikes. The crisis started when the government of Reccip Tayyip Erdogan got into a major dispute with the U.S. over how to handle the status of a radical cleric living in the U.S. and a U.S. religious leader who had ties to him. President Trump demanded the release of the American. Erdogan refused unless the U.S. was willing to turn over the cleric that Erdogan has asserted was behind the coup attempt of a few years ago. The U.S. then took steps to impose tariffs on steel produced by Turkey. The subsequent trade war escalated. It has not helped Turkey's cause that Erdogan has been putting pressure on Israel and siding with Bashar al-Assad of Syria.
Analysis: The Erdogan government is sounding more desperate by the day with alternating blasts of collusion and attempts to blame the public for the damage done. The finance minister has tried to assert the inflation is due to hoarders and those who are reacting in panic, but it is plain this has not been the issue. Turkey has been busy alienating all those who would once have been counted as allies due to the increased paranoia manifested by Erdogan. Transportation costs are up 38% in September alone due to the higher prices paid for oil, food costs are up by 28% and overall producer prices are up by a whopping 46.2%. This large jump will soon start to impact consumer prices as well.
Where this goes from here will depend a great deal on the outcome of the hearing for Andrew Brunson. If the Turkish courts simply decide to expel him and leave the issue behind, the markets will assume economic issues will start to return to normal and the lire will regain some of its strength. If Erdogan puts more pressure on the U.S. over the Gulenists, the situation will worsen very quickly and hyper inflation becomes a real possibility. Erdogan has been trying to create some kind of anti-Trump alliance between Turkey, Russia, Europe and China, but nobody has been taking the bait despite all having issues with President Trump.
Beyond the issue of Brunson and his connection to Fethullah Gulen, there is the Turkish opposition to what the U.S. has been doing with the Kurds. The U.S. has essentially approved the formation of a Kurdish stronghold in northern Syria that has linked up to some degree with the Kurds in Iraq. That leaves the Turkish Kurds as the one group left out. Erdogan still considers this ethnic war his chief priority. His willingness to bend and cooperate with the U.S. has been severely limited by his defiance, but it seems Turkey lacks any kind of leverage that would budge the U.S.
Not a Done Deal Yet
For all the bombast and attention focused on Trump's style of negotiation, the fact is that trade agreements are ultimately the purview of Congress. The original agreement is established by the leaders of the countries involved, but in the case of the new U.S. Mexico Canada Agreement, that is only the start and, in some ways, it might be the easiest part. Now President Trump needs to see the pact ratified by Congress while Andrés Manuel López Obrador (AMLO) needs to get the approval of Mexico's Congress. Justin Trudeau needs the approval of the Canadian Parliament. There is good reason to think the agreement will eventually be approved, but it will not be a simple process by any stretch. The way negotiations have been conducted to this point will have an impact on how it goes from here. There are already many in Canada who are attacking Trudeau for giving in to President Trump and demanding that a better deal needs to be worked out. The antagonism that exists toward Trump in Canada is extreme. Even the more conservative members of Parliament are angry at how Canada has been treated. Meanwhile AMLO is trying to establish a whole new kind of leadership in Mexico that rests on challenging the way the nation has been treated by the U.S. Then, there is the U.S. Congress itself with its usual divisions. There is still support within the GOP for trade deals, but there are also many in that party who have adopted the anti-trade positions of the populist. There are also certainly anti-trade forces within the Democratic Party. The pro-trade Democrats may be needed to offset the anti-trade Republicans; however they will not easily support President Trump in a crucial election year.
Analysis: The agreement will be handled in the U.S. through the Trade Promotion Authority which is also known as fast-track authority. This will mean there will be a specified date by which the agreement must be voted on and there will be restrictions placed on amending it. It will essentially be a matter of saying yes or no with little wiggle room. The current opposition to the plan is coming from left-leaning Democrats who have been deeply opposed to the level of outsourcing that has taken place over the years. They do not think the provisions contained in the deal regarding domestic content and wages are sufficient. The problem with their stance at this point is that outsourcing is no longer the threat to U.S. jobs it once was. The real issue now is robotics and automation. The shift of production to Mexico took place a long time ago and is unlikely to be reversed. So there is a sense that many of these politicians are busy fighting yesterday's battle. The Republicans who oppose the deal are from the populist wing of the party and have a similar view as to where production should take place. It doesn't appear these hardliners have enough votes to stop the deal, but if they get even a handful of others to join them, the deal would be in trouble.
If one assumes the Democrats win control of the House of Representatives (polls now say this is the most likely option), there will be a block of votes against the deal and there will be incentive for the moderate Democrats to oppose the deal so they can deny Trump a win. He has threatened to pull out of NAFTA altogether without a replacement. That would remain his "nuclear" option as he would be able to pin the turmoil on the Democrats.
The supporters of the trade deal will have to rely on three basic arguments. The first is that relations between these three nations are so completely intertwined that breaking them would severely damage all three economies, costing jobs and slowing growth to the point of recession. The majority of U.S. companies would instantly be placed at a disadvantage against global competitors. That lost market share would be very hard to recover. The consumer would be hard hit by this breakdown as well. Prices for food would surge given the amount that is purchased every year from both Mexico and Canada. The costs of manufacturing would rise. That would also add to the price hikes. Estimates vary according to what products would be affected by the end of the pact, but they range between $5,000 and $9,000 a year for the consumer in extra costs for what they currently buy. Finally, there is more delicate issue of immigration. If the U.S. really wants to slow the migration of people from Mexico and elsewhere into the U.S., there has to be an incentive for them to stay where they are. That means having job opportunities at home.
We Do Not Need Any More Jobs
This is probably a little extreme, but the point is that the U.S. has more of an issue with labor shortage than unemployment. It is the mantra of the politician to demand more and more job creation. It is assumed there are legions of workers standing idle waiting for an opportunity to work. The reality is there is a legion of jobs available and nobody to take them. At this time, there are over a million more open jobs than there are people seeking work.
Analysis: Those people who want a job and are unable to get one are either without a skill or training that makes them hireable, or they are in the wrong place at the wrong time. The real need for the economy is more workers, especially those who have required skills and education. The U.S. has done a very poor job of identifying what is needed from the workforce, which limits the ability to get employee and employer matched up. Too many high schools have abandoned their "industrial arts" curricula, too few community colleges and trade schools exist to meet demand and too many of those in college are spending a fortune to get an education that has little relevance to the real world of gainful employment. If ever there were a point at which to utterly revamp the education system, this would be the moment. Many other nations combine a free advanced education with an exchange for directing the student into the job or career the country needs.
Women Emerging in World of Economics
The "dismal science" has long been a male-dominated profession with women rarely seen in high leadership positions in either government or the private sector. That has started to change as there are now more women heading up major institutions and serving as important academic leaders. They are still quite diverse with some staking out fairly liberal positions and other drifting more towards conservative positions.
Analysis: One of the most prominent is not actually an economist by training. Cristine Lagarde is the head of the International Monetary Fund (IMF) and is extremely influential as far as developing global economic strategy. The new head economist for the IMF is Gita Gopinath, currently a professor of economics at Harvard. Laurence Boone is the incoming head economist for the Organization for Economic Cooperation and Development (OECD) where she replaces another woman (Catherine Mann). Boone has worked for the French government and in the private sector. Kristalina Georgieva is the CEO of the World Bank, a new position. She has been with a number of international agencies and in government positions in Bulgaria. Pinelopi Goldberg is the new chief economist for the World Bank. She hails from the world of academia as well. Clare Lombardelli is the chief economic advisor to the U.K. Treasury. That puts her at the very top of that heap.
Janet Yellen was the first woman to head the U.S. Federal Reserve and one of the few women to be on the Board of Governors. Now the group includes Lael Brainard who was with the U.S. Treasury. It will soon include Michelle Bowman who has been nominated, but waits to get through the Senate. She is from a banking family in Kansas and was on the Kansas Banking Commission.
How Far We Have Come
At dinner last night, the conversation somehow got around to where we grew up and what we were like in high school, and even before. One very accomplished woman was relating how she had grown up in a tiny Alabama town of 500 where she was the "shy nerd" who had her heart broken by the handsome, long-haired high school dreamboat. She attended a reunion after having missed most of the others and discovered her former heartthrob had apparently never missed a meal and was now as broad as he was tall. The big men on campus were stuck in the same place they were before, while she was now a partner in a major global accounting firm. This provoked a lot of similar stories.
I remember a kid who was almost universally shunned—overweight, plagued by acne, socially inept. If he wasn't exactly friendless in high school, it was close. I was a freshman when he was a senior, so I only knew him tangentially, but I often wondered if his life ever improved as I never saw him at the reunions I attended. One year, he showed up at one of those multi-class events. I walked over to see if he remembered me. "Sure! You were one of the few who didn't stuff me in a locker." So I asked what he had been doing. He replied very simply, "I have been working as an astrophysicist for NASA." I don't think I talked to anybody else that whole evening!
