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Strategic Global Intelligence Brief for October 8, 2018

Short Items of Interest—U.S. Economy

Concern Grows as Regards Inflation
The rate of unemployment is as low as it has been since 1969. That has the bond markets worried that at some point the inflation issue is going to become real. The threat has yet to manifest as expected, but that certainly doesn't mean it will not in the months ahead. The sense is sooner or later the hiring boom will force companies to pay more to get the people they need. The evidence that wages have started to rise remains a little spotty, but it is apparent almost every company is now actively engaged in poaching the employees of other companies. To accomplish this, they will need to pay more. That triggers the company that might get poached to offer existing employees more money to stay and hence wage inflation starts to heat up.

China Warnings
The dispute between the U.S. and China is taking on a level of seriousness that goes far beyond trade and tariffs. The U.S. seems bent on creating a true Cold War atmosphere. There have now been warnings from within the White House that business should reconsider its engagement with China. The latest warning came from Kevin Hassett—chair of the Council of Economic Advisers. The point they are making is that an early settlement of trade differences will not be likely. The U.S. has far more at issue with China than just exports and imports. There has long been concern about the protection of intellectual property. Also, China has not played by the majority of global trade and business rules. The U.S. may be developing a strongly anti-China position on everything from trade to business to the military and diplomacy.

WTO Panel Near Collapse
Since the moment President Trump took office, the World Trade Organization (WTO) has been a target. One of the ways it has been affected is by total non-cooperation. The panel of judges that are supposed to rule on trade disputes has not met for two years because no one has been appointed to take up this job. That leaves the panel without authority to meet—much less act. The impasse has convinced some in Europe that a reform effort has to be undertaken as far as the WTO is concerned or it will simply cease to exist as any kind of trade authority.

Short Items of Interest—Global Economy

Dire Warning From UN on Climate Change
The latest report on climate change from the UN will not change a single mind. Those who think climate change is the critical issue of the time will have another report to add to their supply. Those who believe all this evidence is bogus or manipulated will go on believing just that. The one thing that emerges from the latest set of reports is a focus on what to do rather than on some vague notion of stopping the factors that lead to the issue of climate change. This is a shift away from prohibitions and prevention to coping mechanisms. This may mean everything from technological remedies to finding ways to remove people and business from future harm's way. The UN report has been dubbed prescient or hysterical—depending on which side of this debate one sits.

Nigeria and Oil Crisis
There is certainly money to be made by selling crude oil and of late the profits have been a little better. The reality is much more can be made from selling refined products than can be made from crude. That puts nations like Nigeria at a severe disadvantage. They have plenty of crude, but very limited refining capacity. That means two problems for the government. For one, they don't make as much money. Then, they also have to pay high prices for the refined product needed to run the country.

Crime in Latin America
There is no shortage of issues affecting the nations of Latin America, but more than anything else the issue of crime has risen to the surface. Much of that crime is related to economics and poverty, but addressing that core cause seems an insurmountable task, so many are choosing what looks easier to deal with—hard crackdowns. The problem is this rarely works when the motivation for crime is economic desperation.

Push for Global Infrastructure
This may be one of the most confusing of issues to come before the various world governments. There is scarcely a politician anywhere who does not extol the virtues of infrastructure development. It is even rarer to find one who doesn't regularly point out what is wrong with the current system. In almost every sense, the state of the global infrastructure is perilous. Scarcely a day goes by that one doesn't see a story about a bridge collapse or some similar failure such as a train derailment. The lack of solid infrastructure investment over the last few years extends to everything from broadband access to reliable power generation and even water access. The vexing part is that everybody agrees this is very important activity, but government after government has failed to put their money where their mouth is. This is despite the fact it has been proven time and again that developing infrastructure is a way to stimulate an economy both directly and indirectly. The construction or repair of that infrastructure means jobs and business for the companies carrying out this activity in the short term, but long term, there is the development that follows the infrastructure improvements. This has especially been the case with the expansion of broadband services.

Analysis: The fact is public sector investment is constrained by budgets that are pulled in a variety of directions. As important as the development of this infrastructure may be, the reality is the constituents are divided and diffuse. Everybody benefits from a road or power or broadband, but it is hard to get a rally going to influence the powers that be. The squeaky wheels are found in many other areas; infrastructure projects struggle to get their fair share. For years, there has been a promise on the part of the private sector to get engaged, but it never seems to play out. That may have started to change as there has not been this much private equity money going toward infrastructure before—everything from telecoms to broadband, pipelines to railroads, seaports to airports. This year, there has been an investment of over $68 billion already and there is still a quarter to go. This is already up by 18% over what was invested last year.

This kind of private sector engagement can change the nature of infrastructure development as there has to be a direct return to the private sector. The government can build a road and not worry about being paid back. The goal of the government is to provide for the common good after all. The private sector wants a return on that investment. This is leading to more "pay as you go" projects such as toll roads and toll bridges, but it has also become a matter of using fees and assessments in the same way that governments do through the use of taxes. There has also been a lot of investment in sectors like energy as most of that infrastructure is not government owned.

Much of the motivation is that investments in other instruments has not been getting the returns and aren't nearly as steady as these projects can become. The major concern these days is that good opportunities are getting harder to come by. There is fear that investors will start dumping cash into dubious ventures that will ultimately not yield what was expected or needed. Governments will not walk away from an infrastructure investment even if it consistently loses money, but a private investor most certainly will.

Brazil About to Get New Leader
The polls have closed on the Brazilian election and the votes are being counted. By all accounts, the next president will be Jair Bolsonaro. It has been a long time since Brazil has had a leader like this. The same electorate that put the leftist leader of the Worker's Party, Inazio "Lula" da Silva, in power over a decade ago now has switched to the far right. Bolsonaro has emerged from what has been considered the far-right fringe. His comments have been extremely divisive.

Analysis: He has been a legislator for 28 years, but has managed to pass just two pieces of legislation. He also had a military background and was very supportive of the junta members that once governed the country. He has been especially critical of women and makes comments regarding them that alienate most of the urban voters. He has also been accused of falsifying most of his resume and of hiding the support he has received from many on the right of Brazilian politics. His appeal has been based on his social media image. He focused on the two issues that resonate most in Brazil at the moment—crime and corruption. He has the same approach that Rodrigo Duterte has advocated in the Philippines—kill all those that are suspected of criminal activity. He has also been very harsh when it comes to politicians and graft, but there is abundant evidence that he has been eating at that same trough for years. The rural community that once backed the left now seems to be backing the right.

A Good Week to Gauge Inflation
The economists of the world have been somewhat akin to Chicken Little these days. For the better part of the last year, we have been warning about impending inflation. Every month, the dreaded development fails to make its expected appearance. Depending on the version of this fable one adheres to, the lesson learned is either that hysterics should be dismissed or that disaster may befall one even if the original threat is discounted. Thus, it may be with inflation. The motivator missing thus far is wage inflation. That is generally the most important factor in terms of mounting inflationary pressure. The latest jobs data from Oct. 5 showed that jobless numbers fell further, but the hike in wages was meager—far less than one would expect. This will be a good week to look at some data that could point to a bigger issue with inflation as well as the possible timing.

Analysis: On Oct. 10, the Commerce Department will release its latest Producer Price Index (PPI). This is the measure that tracks the costs of those industrial inputs ranging from commodities to those intermediate goods that get assembled into a final product. There has been expectation of a serious jump in this data for a few months now as there have been some pretty obvious price hikes for some of the industrial metals due to the impact of the steel and aluminum tariffs. However, these hikes have not manifested as has been expected. Last month the PPI only expanded by 0.1%; this month the expectation is for a 0.2% gain. The price of steel and aluminum has indeed risen (by an average of 40% for steel and around 25% for aluminum), but the other metals and inputs have not. Oil prices have been fluctuating and have generally gone up by around 24% for the year, but there has been a lot of volatility that shows up month to month. Other producer prices seem to have been going down rather than consistently up.

On Oct. 11, the Consumer Price Index (CPI) will be released. There is an expectation of further gain, but at a slower pace than was the case earlier in the year. The CPI has been gaining every month for the last five, but the speed of that increase has slowed. Last month, prices were rising by 2.7%; the two months prior the rate was 2.9%. This month the expectation is the rate will fall even further to 2.4%. This is not exactly what one would really anticipate given all the "sturm und drang" over trade wars and tariffs. The sense was that import prices would start to manifest and make these numbers far worse. If the data this week shows a faster rise than currently expected, the sense will be that these import prices are indeed manifesting. Most analysts note there has been a pattern when it comes to these import costs. As the intent to impose tariffs becomes known, there is a period of anticipation. Many importers and exporters rush to get their orders filled and their shipments accepted. The desire is to unload as much of the stuff as they can before the tariffs and restrictions kick in. Once the taxes are being levied, the frantic pace slows down and prices go up. The majority of the tariffs and restrictions have yet to be implemented and thus they are not yet showing up in the data.

On Oct. 12, there will be additional data on what is going on with imports. The Labor Department will issue its latest import price data. The expectation is there will be a slight gain of 0.2%. The fact that oil prices have fallen globally will figure in this number, but not to the degree that would have been common in the past. The U.S. now imports very little of its crude oil and has, in fact, become an exporter of crude. The only reason the U.S. is not entirely independent of foreign oil imports is that it remains cheaper to bring oil by ship to the east coast refineries than from the U.S. oil fields due to the lack of pipeline infrastructure. There is also the fact that some grades of crude are not available in the U.S. The price drop in oil has been enough to offset the rising costs of other imports. That's at least for the time being.

The last data set of interest as far as inflation is concerned will be the University of Michigan consumer confidence report. Generally speaking, the consumer reacts poorly to inflation—higher prices instantly make the consumer feel less confident about their financial status. The index rose to 100.1 from 96.2 in the last version due primarily to an improvement in the confidence level for those in the bottom third of households. This group is especially sensitive to the job market and has been encouraged by the fact that jobless rates are so low.

Nobel Prize Winners Emphasize Technology and Growth
The Nobel Prize in economics has always been a little controversial as it is not exactly an award given by a wide cross section of the world's economists. In fact, it is not even awarded by the usual group that assigns Nobel awards, it is provided by a committee of Swedish bankers along with the Swedish Academy. In past years, it has been criticized for being far too politically motivated, but that is the same critique that has been leveled at the other Nobel prizes (awarded by the Swedish legislature).

Analysis: This year's recipients are not theorists as many have been in the past. Both have been at the center of many political debates over the years. Paul Romer has been chief economist at the World Bank and is at the Stern School of Business at NY University. He is the son of former Colorado governor—Ed Romer. His co-winner is often called the father of climate change economics—William Nordhaus. Both men have been advocates for the use of technology to impact economic growth and both have been instrumental in providing the link between public policy decisions and economic progress. Specifically, they have been critics of the short-term thinking that permeates politics as most solutions demand much longer-term thinking. The lack of education in technology throughout the U.S. hampers growth at all levels and makes it nearly impossible to deal with issues like climate change.

It was a casual conversation on the plane between two tired guys eager to get home to our much-loved and charming wives. It was quite nice to listen to somebody else who was still very much in love with someone they had been with for many years. I just celebrated my 34th wedding anniversary and he had reached 29. We talked a lot about the little things that made us feel appreciated. My wife always prepares me for travel with little packets of vitamins complete with messages urging me to come home soon. In his case, she packs him a lunch every day and writes a little poem for every day he is on the road. This is when things got interesting. He showed me the poem she wrote for that day and it was a total scrawl—looked like what a right-handed person would write with their left. I assumed that perhaps she had injured her writing hand and was making the best of it.

Then, we left the plane and there she was—waiting for him with the biggest smile. She was dressed up as well—very nice dress, lovely necklace and well-coiffed hair. It took a minute to realize that she was also a woman with cerebral palsy. She walked to him as fast as she could, but needed to be steadied by the driver she had employed to bring her to the airport so she could take her sweetheart home. Her movements were jerky and she obviously moved with some pain, but none of that showed in her face. I already knew they had met in a language class where they were both trying to master conversational Japanese. She had always wanted to visit and they had finally been able to a few years ago. It was beyond obvious that he loves her deeply and she loves him. No physical barrier was going to keep them apart. It reminded me once again that I am absolutely the luckiest man in the world to have a love just like his.

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Wednesday, 17 October 2018