Strategic Global Intelligence Brief for September 11, 2018
Short Items of Interest—U.S. Economy
A Fed Without Ammunition
There are many reasons the central bank chooses to hike rates. Controlling inflation is at the top of that list, but it isn't always the most important. The critics of the Federal Reserve (including Trump) have tended to focus on the short-term impact of these higher rates as they will signal the end of the low-cost loan party to some degree, but long term, the Fed needs to have rates high enough so that lowering them again will have an impact. The Fed needs rates to be somewhere north of 4% if it wants to have an impact on the next recession. The prime weapon the Fed has to combat recession is the ability to stimulate bank activity through loans. Dropping rates by a point or two will not be all that stimulative. It limits the power of the Fed during that kind of crisis.
Correction From White House
On Monday, President Trump tweeted a rather amazing statistic—asserting that it had been 100 years since the GDP rate was higher than the unemployment rate. In Q2 the growth rate was 4.2% and the current rate of unemployment is 3.9%. It certainly would have been amazing if it was true, but it isn't. The statement was "corrected" by members of the economic council at the White House. The last time this occurred was in 2006—a little closer to a decade than a century. The puzzling thing is where this assertion came from. It seems that a piece of fantasy from some website filtered through and was picked up before he checked with his team. It is impressive enough that growth is high and jobless rates are low—fanciful statements are not needed.
Agriculture and Trade
It seems that most of the current trade controversies revolve to some degree around the farm sector in several nations and the U.S. The fact is most countries are sensitive to the agricultural community to some degree or another. There is the deep-seated fear of being dependent on some other nation for food. There is also the issue of maintaining a viable rural community. The Canadians are unwilling to open up their dairy sector, the EU is still protecting the small holder in Europe, the Japanese refuse to import rice and China worries about food leaving for other markets. The U.S. farm sector has its own set of supports and regulatory protections. These all make trade agreements hard to hammer out.
Short Items of Interest—Global Economy
Rapid Rapprochement Between Russia and China
After years of acrimony and mutual suspicion, what do Russia and China have in common these days? At the moment, a key common element is President Trump and the U.S. attitude generally. The two states are facing all manner of restrictions and attacks from the U.S. on almost every element of their economy. They are now fighting back by getting closer to one another. Russian gas is set to flow to China at a much improved rate, the two are selling more and more food to one another and Russia has never been so open to Chinese imports. The Chinese are promising to be the reliable market for Russian commodity sales as well. The latest summit between Xi Jinping and Vladimir Putin was a not very thinly disguised swipe at President Trump and his trade policies.
Another Summit With North Korea?
Kim Jong-un wants another high-level meeting with President Trump. The problem is that North Korea has done very little of what was originally promised. It is unclear what the U.S. gains from giving this little tyrant another moment in the spotlight. Most would demand that something definitive take place first, but that may not be Trump's approach.
Bolsonaro Gains in Brazilian Polls
The right-wing candidate for the presidency in Brazil, Jair Bolsonaro, was ahead before he became the victim of a stabbing, but that support has swelled since. He is expected to make a full recovery, but remains in intensive care with severe stomach wounds. His anti-crime message has only been strengthened by this assassination attempt.
Immigration Issue Grips Sweden
As expected, the weekend's elections in Sweden left the country with a very uncomfortable political reality. Neither of the two major parties was able to win enough seats in the parliament to govern. Both the center-left coalition (Social Democrats, Greens and Left Party) and the center-right coalition (Moderates, Center, Christian Democrats and Liberals) held 40% of the seats with the center left maintaining a very slight edge. Neither party can govern without adding to their coalition. The third largest party is anathema to both dominant coalitions. The Sweden Democrats had their best results ever and now hold around 17% of parliament. They have gone from being a fringe party with roots in a neo-Nazi past to the party that could spell the difference between ruling and being in the opposition. At this point, the two major coalitions are declaring they will never ally with this group, but in this election, the Sweden Democrats softened their image a little and focused almost exclusively on the issues of crime and immigration—concerns that are twinned in the minds of many Swedes.
Analysis: There are really only three scenarios for Sweden at this stage. The first is there are defections from one or the other of the coalitions to the other side so that the new formation will have the requisite number of seats in parliament. The most likely loser would be the center-right group as it is conceivable one or two of the smaller centrist parties would be persuaded to join the center left provided they can get some of their policies adopted. If the Center Party (8.6%) and the Liberals (5.5%) defected to the center left, they would have a ruling block. For the center right to gain, they would need either the Greens or the Left party to move to their side—not all that realistic.
The second scenario is that a deal is made with the Sweden Democrats to support a government. Nobody is going to formally include them in one of the coalitions, but it is possible that an agreement will be worked out that allows the Sweden Democrats to support the center right on most issues. In order for that to happen, the center right will have to adopt most of the anti-immigration policies of the Sweden Democrats, which may be too much for the centrists. The demands thus far have included a total halt to further migration and widespread expulsion of immigrants who are suspected of engagement in any kind of criminal behavior. There have been even more draconian steps suggested that would include mass expulsion regardless of criminal threat.
The third scenario is a long-lasting government crisis during which no combination can be made to work and the country will be forced to go back to the polls. This prospect terrifies the two dominant coalitions as voters are likely to behave more radically than before as they get tired of the political wrangling and lack of action on their concerns. Right now, the betting is on current Prime Minister Stefan Lofven to cobble together another weak government with some defections, but these relationships are anything but stable. That makes progress on much of anything very hard.
Wages on Their Way Up—Good and Bad Implications
There was finally a breakthrough of sorts in the latest jobs data as there was a significant gain in wages—a 2.9% increase on an annual basis. This is the fastest growth since 2009, the formal end of the recession. This also marks the 95th consecutive month of job growth with another 201,000 jobs added. This is by any measure a robust job market and still there are major issues of job shortage. The first thing to react to is the wage gains that have been very long overdue and baffling in their absence. It is probably not necessary to go into detail about what has been happening with wages as we have been harping on this for months, but now that the situation looks to have normalized a little, it may be useful to review.
Generally speaking, there is a pattern to job gains and wages. As the unemployment rate falls, there is an expected reaction from the job market as employers face more competition for the people they seek to hire. The people who are available for work start to demand more for their services. Most of the time, they get what they want. This time the pattern didn't emerge as expected. The jobless rate fell to the lowest level seen in years, but the wage gains were anemic. It was an issue of qualification and to some degree mobility. The people who were looking for work lacked the skills that were in demand by employers. That kept them from commanding large pay packets. There were also many people stuck in areas where there was little in the way of job opportunity, but for a variety of reasons, they could not move to where the jobs are. That is still an issue, but employers are choosing to hire people without the experience they would have preferred and are paying a premium for "attitude." It is also important to understand some bigger shifts—such as the willingness to hire older workers and the trend towards more gig economy jobs.
Analysis: There are silver linings and dark clouds with numbers like this. Obviously, it is a great thing that so many people are still getting hired this deep into the recovery and with a much smaller base of unemployed people to work with. But this enthusiasm is tempered somewhat by the fact that many of these new jobs are in the lower-paid service sectors such as food service, retail and maintenance. There is still a major job shortage to contend with. That has meant many of the new hires are people who will need training before they can start making top dollar in their chosen field. There are still more jobs available than there are people available to take those jobs.
The bigger issue as far as the overall economy is concerned is the impact of these higher wages on inflation. This is what the Fed has been focused on. The usual motivation for higher interest rate moves is the threat of inflation. There are generally two components of that inflation spike. There has already been movement as far as commodity prices are concerned. Oil and, therefore, gasoline prices have gone up substantially since last year, and even from earlier this year. The price of industrial metals surged due to the steel and aluminum tariffs imposed on the various nations which had been exporting to the U.S. There have been hikes in some farm commodities as well, although most of that activity is likely to come next year due to the limited production that has taken place this year.
That leaves the other half of the inflation due—wages. This is generally the more impactful of the two. As costs go up, there is a greater demand on the part of employees for pay hikes that allow them to handle those hikes. Obviously, some workers have far more leverage than others and can make those demands. When the rate of unemployment is low, the skilled or experienced workers will have many more options. If their current employer is unwilling to meet new wage demands, these employees can easily depart and get that raise from some other employer. Once this chase starts, it is very hard to stop. Prices go up, wages go up to match the price hike and that encourages the producers to once again hike their prices. The speed with which this takes place is one of the reasons the central banks and other economic authorities want to act fast to nip the rise in the bud.
Speaking of Commodity Inflation
The oil business has never been for the faint of heart—more akin to making a living at the poker tables of Vegas than to running a more normal and predictable business. The crux of the issue is that oil is the ultimate non-elastic good. People may complain bitterly when the price of gas goes up and may cheer when it goes down, but their buying habits don't change. We have to drive where we have to drive and buy the gas we need to do so. Two things affect the price of oil—demand and supply. There are those who see conspiracy and collusion in every price move, but the reality is that oil is traded in a very competitive market.
Analysis: During the oil boom earlier this decade, the price per barrel fell rapidly as there was a major increase in supply driven by the high prices one could get for a barrel of crude. Then the recession and slack demand arrived. The booming oil sectors sagged and prices fell. Now that there is economic growth again, the price per barrel is coming back up. That acceleration has been amplified by the fact that oil producers have been trying to restrict the amount of oil coming to the market. If the past is any indication, we will soon see the beginnings of a glut as the higher prices will convince producers to get in the game again. They will soon produce more than demand can sustain. If there is a recessionary blip somewhere along the way, the price per barrel will likely fall even further and the whole cycle will begin again.
Memories of 9/11
The anniversary of the 9/11 attacks has once more arrived. It is more than apparent that few really know what to do with this event now. There are those who will use the tragedy to whip up renewed anger at whatever target they favor. There will be others who seek to assign blame for the attacks on U.S. policies that stirred up such anger towards the U.S. Some will simply take time to remember the thousands of innocent lives taken in a vicious assault aimed squarely at the innocent. Frankly, polls suggest that many will not do much of anything and are now unsure what actually happened.
Analysis: Tragedies of this kind fade from public view—replaced by new tragedies. The fact that 9/11 altered the conduct of the U.S. as a whole has been largely forgotten. The TSA came into being due to this attack. The security concerns and monitoring we take for granted now were not in place prior to this. The 9/11 attacks brought the U.S. to the same place that many other nations had been in for years. We knew of bombings and attacks in places like Ireland, the Middle East, Africa and elsewhere, but nothing like that had happened in the U.S. and hasn't happened since. Was it the stepped up-security that has kept this atrocity from being repeated? Was it the fact we jailed many of those responsible for planning this attack? Was it because the terror groups shifted their strategies and tactics from this kind of brazen assault to trying to create a Caliphate in the Middle East? The answer is yes to all of these. The U.S. was stunned but recovered. It is almost reassuring that so many can basically ignore what happened on 9/11—it means their lives went back to normal. That is a tribute of sorts to our resiliency.
Stuff to Worry About
As I was talking with various people at the annual meeting of the North Carolina Society of CPAs, I was struck by some of the activity these people were engaged in. In one sense, I am not surprised as I have seen more and more reliance on accounting professionals by the business community as well as the public sector. The biggest part of an accountant's job now seems to be consulting and on issues that go far beyond the traditional realm of accounting.
One guy has been engaged in developing a future plan for his western North Carolina county—a plan that goes decades into the future. They have connected with futurists to assess trends they need to be aware of if they want to survive and even prosper. Life can be tough for that part of the state and they have to consider their options very carefully. Another conversation revolved around what to do about the aging of the business leaders in their communities. They know they will retire at some point, but lately they have seen far fewer planned departures as people have continued to work into their 70s and 80s. Now, they are not retiring at a specified point, but leave due to death or illness and the company is wholly unprepared for what happens next. This guy was essentially forced to become interim CEO until a replacement was found and installed—a process that took over a year.
There were lots of questions focusing on the rapid impact of change—everything from the impact of robotics and automation to the change in demographics and the whipsaw of political decisions on trade. The lack of certainty on much of anything is a major worry.
