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Strategic Global Intelligence Brief for September 12, 2018

Short Items of Interest—U.S. Economy

Better News for Households
The latest census data shows that median household income rose by 1.8% this past year. That brings the total to $61,372. At the same time, the rate of poverty in the U.S. fell by 0.4%. This income level is a record high and is due in large part to the fact that jobless totals are so low. The tax cuts played a smaller but significant role. These are among the many numbers that have reached a 10-year high. That further reinforces the notion that economic expansion has been affecting almost all segments of the economy. The consumer has finally been seeing some hikes in their pay allowing them to both save some money and keep spending. It also helps that most homes have increased in value leaving far fewer people underwater in their mortgages.

Steel Unions Demand Higher Wages
Now that steel prices have risen by an average of 40%, there are demands from the steel workers for higher wages. The tariffs imposed have been only 25%, but as has been demonstrated over and over again, these tariff-driven hikes are always more than expected. This windfall has allowed the steel companies to catch up with their profit and revenue forecasts, but that gain is going to swiftly erode as the other players get in the game. The unions are demanding a wage hike with benefit improvements that are nearly double what they were. The major unions have already authorized a strike at U.S. Steel and ArcelorMittal, but the other companies are likely to follow suit.

United Front on Tariffs Emerging
It has taken a while, but the majority of the business community has finally started to align with one another on the issue of tariffs. In the beginning, there was a sense these tariffs would only hit a few companies and sectors, but it is now clear there will be direct and indirect impact and everybody will be hurt. The White House has been immune to these pleas and threats, but the rest of the GOP can't say that. These politicians are facing the prospect of losing money and support from the business community—politically fatal this time of year.

Short Items of Interest—Global Economy

Lula Protégé in Brazil
Inázio "Lula" da Silva rode the frustrations of the poor to power, but not after laboring in the weeds for years. Lula was not able to get beyond his poor person's support until he shifted tactics and appealed to the centrists who had grown weary of corruption. Lula eventually succumbed to that same temptation and his Worker's Party fell from power after an ill-fated period under Dilma Rousseff. Now Lula has a new successor in Fernando Haddad who makes no secret of his allegiance to Lula.

Assad Plans Last Attack on Rebels
It has come down to this last stronghold. Idlib is the very last place in Syria where the rebels have any presence at all. It is now the target of one last all-out offensive by the Syrian army. The expectation is this will be the bloodiest battle yet as there is no place left to flee and the rebels have vowed to fight to the death. Russia is supporting the Syrians as they have all along, but the rebels are no longer getting any support other than from a few refugee groups. This will be the last battle, but not the end of the war.

U.S. Backs Further Away from Palestinians
The Trump administration has made it clear the U.S. sides with Israel and Prime Minister Benjamin Netanyahu. The first major shift was recognizing the Israeli claim to Jerusalem. Now the U.S. will seek to defund the UN organization that runs the refugee camps for the Palestinians. The oldest of these camps date back over 70 years to the creation of Israel. There are still Palestinians who demand the right to return to villages and homes that have been gone for seven decades. It has been a stalemate waiting for a diplomatic solution, but that seems further away now than ever.

Where Does the EU Go From Here?
The history of the European Union (EU) is full of fits and starts, twists and turns. This was to be expected given the challenge of trying to get over 25 independent nations on the same page. More often than not, there has not been enough unity for the organization to accomplish even some of the minor goals. Most of the EU back story is one of squabbling over who has the power and what they plan to do with it. The crisis that gripped Greece, Spain, Portugal and other southern tier states resulted in an awkward and acrimonious rescue and bailout that Germans still resent. The immigration crisis has been like a wildfire defying containment as it has swept through the region's politics, creating potent nationalist parties that have been upsetting the norm in every election—the latest in Sweden. It would be understandable if the powers that be were shrinking away from any of their grandiose plans and were just focused on survival, but that does not yet appear to be the case.

Analysis: Jean-Claude Juncker, the president of the European Commission, has once again broached the idea of making the euro a global reserve currency that could rival and even replace the dollar. This is not the first time such a plan has been hatched. From the very start of the euro, there were those who pictured it playing this role. Over the years, there has been too much instability in Europe and with the value of the currency. The rest of the world has been reluctant to abandon the dollar. There has been concern that the European Central Bank (ECB) would focus too much on domestic issues and would refuse positions called for by a global role. Some of that thinking may have started to shift. Part of this is due to the way the ECB has managed the euro over the last few years—more attuned to the global value than before. A bigger motivation is eroding faith in the U.S. and the dollar. The policies of the Trump administration have been shocking and baffling to the rest of the world as suddenly the champion of free trade has become isolationist and protectionist and overly hostile to the global institutions the U.S. established in the first place. The world knows full well that Trump will not be in office forever and he may be gone in two years. The bigger issue is that some 30% to 40% of the public still supports the world view that President Trump represents. It may be years before the U.S. returns to its old patterns. It is even possible they will never return at all.

What does a world look like with the euro as a rival reserve currency? It has deep implications for the U.S.—especially as long as those in power in this country insist on pretending that debts and deficits can expand indefinitely. The prime reason the U.S. can get away with its mounting debt burden is the dollar is the world's reserve currency. Every other nation essentially has a built-in limiting factor when it runs deficits and builds debt. It has to finance shortfalls with its reserves. That means having something to sell to accumulate dollars. When there is a financial crisis, the value of their bonds will weaken. It then gets harder and harder to accumulate enough reserves to pay off the profligacy. Not so the U.S.—we can simply print more money. Not literally of course, but the Treasury can always sell U.S. debt and get a good price given the status of the dollar. The U.S. runs a real risk of having far too much debt service, but it doesn't face the limits that others face—as long as the dollar is the undisputed global reserve.

Europe would have some of that advantage should the euro gain status, but there will be those same limitations. The most vexing issue is that a reserve currency trends towards high value. That creates a situation where the European currency is much stronger than it has been at intervals. This is good news for those nations that do a lot of importing, but is not so good for those that rely on exports as most of the EU nations do. Germany has been cool towards the idea of the euro as a reserve currency as their economy is over 50% dependent on exports, but the bulk of that trade is with other EU members so there is some hope Germany would consider supporting the notion.

Removing PM May Turns Out to Be Harder Than It Looks
The conservative Euroskeptics in the British Tory Party thought they had accomplished their long-held goal of ridding Britain of Europe when the country's voters shocked everyone with their Brexit vote. It seemed that at long last their dream of a truly separated U.K. was at hand, but they did not consider the fallout from a concerned business community and a great deal of "buyer's remorse" on the part of the voter. Poll after poll suggests that if another vote were taken today, the idea of Brexit would fail.

Analysis: There are still many conservatives who want a complete break with the EU. They talk endlessly about getting rid of Prime Minister Theresa May, but each time they meet to try to pull off a coup, they can't agree on much of anything and fall well short of that goal.

An Assessment of Where We Are Right Now
This was supposed to be the tale of two years. The first part of 2018 was predicted to be solid—lots of growth and all that comes with that growth (low unemployment, better trade balance, reduced debts and deficits). This was due largely to the tax cuts at the start of the year and the boost they gave to an already growing economy. In 2017, there had already been two quarters of over 3% growth. The downside of this growth was supposed to show up in the second half of the year. The early year boost would serve to overheat the economy and there would be a greater threat of inflation and all that came with it.

As we close out the third quarter, we are just starting to see some of that expected reaction; however, it has been a bit more subdued than originally called for. The core rate of inflation is just now hitting the 2% level the Federal Reserve had targeted. The rise in commodity prices has been about as expected with oil, metals, resins and farm commodities all rising to one degree or another. The laggard was wages as they had been defying the logic of the Phillips curve for months. This was one of those few economic laws that seemed to actually work—until now. It holds that when the jobless rate falls, there will be wage inflation as employers compete to hire the rapidly shrinking base of available workers. This time, the skills gap played a major role as business has not been able to find qualified people so they resist hiring people at higher than minimum levels. This pattern held until this month when the wage increase rate hit 4.9%.

The Purchasing Managers' Index hit new highs and not just in the New Orders category. It has been over 10 years since the index crested above 60. Some of that gain is a bit unique and may not be sustained over the course of the year, but it is fully expected to be in the high 50s throughout. The data from the Credit Managers' Index reinforces the PMI numbers as all of their favorable factors are above 60 and the index as a whole is in the mid-50s. The most impressive part of the favorable data was a big jump in sales and dollar collections.

As has been the case throughout this year, there has been consternation due to the trade controversy and the battle over tariffs. It seems likely that a deal will be struck with Mexico that will not be radically different from what existed under NAFTA as the agricultural sector will remain the same. Most of the change will be in the automotive sector. Canada is not yet slated to join, but the issues that are separating the U.S. and Canada are not insoluble. It is mostly an issue of how much protection Canada will be allowed to offer its farm sector and the degree to which it will give in to U.S. favored dispute resolution. Trade disagreement with Europe also hinges on the farm sector and the extent of EU protection the U.S. will tolerate. The U.S. also does a fair bit of farm sector support so there might be room for give and take. The battle over steel and aluminum tariffs rages on. There are new wrinkles every day—Brazil and Argentina now have exemptions from the tariff. Brazil has been the No. 5 exporter into the U.S.

The short-term threat (fourth quarter) is inflation. It is not expected to become a major issue this year, but there will be enough of it to warrant a more cautious Federal Reserve. The president has been critical of the Fed for wanting to hike rates, but all of his new appointees have been hawks and have long advocated just the policy that is developing. The Fed wants to nip inflation in the bud, but it also wants to have some rate-related ammunition in the event of another recession. If, as many assert, there is a mild recession in 2019, the Fed needs rates at 3.5% to 4% before lowering them again would have any impact.

Analysis: Most of the indicators are very good at the moment, which is part of the concern. Perversely enough this is the time to worry as it realistically can't get much better. There comes a point where there is no way for the jobless rate to fall any further. There comes a point that rapid growth can't be sustained any longer. This hardly means a collapse is then imminent, but it does signal that some aspects of the economy are stalling out. That is a situation that spreads. Less activity means less demand. Certain sectors will feel this first. Transportation will react quickly—as it always does, but so will energy production. Retail might stutter as consumers get more cautious. This is only happening in certain areas at this point, but it is safe to assume there will be more negative news coming in the next few months than positive.

Hurricane Impact
The predictions at the start of the year called for a very active hurricane season, but by mid-summer that forecast had altered due to a consistent pattern of wind shear that tore across the Atlantic and tended to rip the tops off storms. That sheering has stopped and suddenly the dire prediction of several named storms making landfall in the U.S. is back. Florence looks to be the first major storm, but a look at the ocean map shows several more lined up behind it

Analysis: By this time, we know the drill. There will be extensive damage to coastal property and even well inland as the storms drop several feet of rain. The economic impact plays out in stages. The initial issue is short-term damage and the millions it will cost to provide emergency relief. Productivity in the affected region is shattered as people evacuate and then try to return to the mess left behind. The second stage is the longer-term impact of cancelled flights and interrupted supply chains. Companies all over the world will be denied the products that once came from this area. Longer-term impact stems from insurance costs and the expense of rebuilding. The only positive note here is that all this rebuilding means jobs. It means revenue for those entities involved in the process of coming back from the storm.

Information That Gives One Pause
As I scrolled through Facebook the other night, a story caught my eye. I should probably be more skeptical about this but have yet to figure out how to check the veracity. It immediately pulled at my animal-loving heartstrings. I am inclined to believe it although it may only be an opinion. The story was attributed to an anonymous veterinarian from South Africa who was pleading with pet owners to stay with their animals in their last moments rather than walk away and wait for the vet to do their job. Like any longtime pet owner, I have had to put my beloved companions to sleep and the procedure has always been the same. The vet takes my buddy into the treatment room and does what needs to be done as humanely as possible. I never knew there was another option.

This unnamed vet asserts that in their dying moments, the animals start to frantically look around for their owner—they can't figure out why they would be abandoned to strangers in a strange place at the end. I suspect there is too much anthropomorphism in this account, but I am not sure. My cats cling to me when we visit the vet for even routine maintenance. They rely on us for everything as we have protected them from everything. I know they stick close when there are thunderstorms and fireworks, why wouldn't they want that same protection at the end. I don't know they are aware they are facing their final hours, but I do know I am not planning to leave them alone when that time comes. If it is even a tiny bit reassuring to have us there, that is good enough for me.

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Tuesday, 18 June 2019