Strategic Global Intelligence Brief for September 14, 2018
Short Items of Interest—U.S. Economy
August Labor Report Highlights
The August labor report was released Sept. 14. Some of you have seen the headlines showing 201,000 jobs created in the month and a rise in wages by 2.9%—which is strong. Those were the highlights, but there's a lot of additional detail to look through.
The highlight was likely the wage inflation piece of the report. With wages inching up to near a 3% annualized growth rate, we are finally starting to see a bit of the wage inflation that everyone has been talking about. Since wage inflation is finally hitting at a macro level, it will give the Fed more ammunition for increasing interest rates.
Forecasters still have two more Fed rate hikes on their radar for the remainder of the year. We don't' believe we will get anything more aggressive than that, but they could increase their views on extra hikes in 2019. That would be bearish for the stock market.
What Can Be Done About Venezuela?
There are all manner of issues that can befall a nation. At any given time, there are governments all over the world that struggle to provide the basics for their population. Most of these states are in this condition only temporarily and can expect to make some kind of recovery when conditions change. They may have been dealing with a civil war or even an invasion from a neighbor. Most often, they have been affected by a natural disaster of some kind—a persistent drought or some catastrophe that overwhelms the country's capacity. The truly "failed state" is the one driven into the depths of despair and poverty by an inept, corrupt and utterly autocratic government. In the past few years, the majority of these failed states have been in Africa—places like Zimbabwe, Democratic Republic of Congo or Sierra Leone. Today, we have a state teetering on the brink of total collapse in Latin America—a rare occurrence. It is not that there has been any shortage of struggling economies and systems in this region, but most of South America has avoided the utter failure that now grips Venezuela. The conversation has now turned to what can be done to avoid a massive humanitarian crisis that spills over into the rest of the region.
Analysis: The economic data that has been coming from Venezuela has been as grim as any seen in any part of the world. It has become almost impossible to even chronicle the depths to which the system has sunk. The hyperinflation that grips the country has all but reduced the system to barter as the value of the bolivar drops by the hour. The estimate is that over 75% of the population now lives in poverty and unemployment is well over 50%. What makes all this more tragic is that there is oil in Venezuela, and a lot of it. The Maduro regime has nearly ruined the oil sector. Production is far less than it should be. This is the only lifeline the nation still has and it has been squandered.
Many of the other nations in the region would be content to let this country wallow in its own incompetence, but there has already been an exodus of some two million people fleeing the privations and violence and another two million will likely flee in the year ahead. This is starting to put pressure on neighboring states such as Colombia, Guyana and Brazil. The new government in Colombia is overtly hostile to the Maduro regime already and has promised retaliation on numerous occasions. There have been several coup attempts launched at Maduro in the last few years, but they have been thwarted with the help of Cuban intelligence agents. It is Cuba that has kept Maduro propped up in exchange for that oil, but there are signs that authorities in Havana are growing weary of the expense. The Maduro government has bankrupted the nation so thoroughly that he can no longer even pay the military regularly. That puts him on very thin ice.
This also leads to the potential for some kind of military intervention. The most likely chain of events would be a coup attempt from within the ranks of the army that would be backed tacitly by the U.S. and perhaps Colombia. Neither of these nations has yet suggested this is a route they would want to go, hpwever. Practically speaking, the U.S. would not do anything until after the November elections, but should there be a real challenge to Maduro, there will be actors that will want to get engaged sooner than later.
European Labor Costs Up
The cost of labor has been going up, but that is not going to show up in the pay checks of the European worker. The 2.2% rise in the cost of labor has been due to an increase in taxes and the general growth of benefits rather than with raises. There is still concern that wage inflation will start to become an issue, but for now the issue has been more of taxation and mandated benefits. The unions are getting restless and have signaled that strikes and other actions will be employed if there is no real progress on actual wages. There is a sense many business concerns are doing better than they have in years. That is true, but certainly not in all cases.
Analysis: There has not been much of an impetus for aggressive reaction by the European Central Bank (ECB). They know inflation is on its way, but it is not feeling imminent at least as far as wages are concerned. The commodities prices are hiking, but not at a record clip. There is fear that tariffs and trade wars will at some point drive metals prices higher. All eyes have been on oil this year. The steady march of storms towards the Gulf of Mexico has many expecting far higher costs for crude. The ECB has just started to get engaged in the higher rate conversation. This will be a major part of the choice of a new head to replace Mario Draghi when he retires. The candidates will be asked if they support the cautious track that Draghi has favored or the more aggressive position taken by the Germans.
Tariff Impact on U.S. Economy Muted Thus Far
Those who have supported the strict tariff policy put forward by the Trump administration have referenced all the good economic news of late to assert that these tariffs and the overall trade policy pursued by the president has been working to build a healthier situation in the U.S. economy. In fact, the majority of the economic analysis points to very moderate impact from the tariffs and trade spats. However, the analysis differs as far as why this is the case.
Supporters of the strict policy assert the U.S. has been able to replace these imports with domestic production and further assert there are many developing markets for U.S. exports that can easily replace those the U.S. has been losing due to the trade disputes. Other analysts are not convinced and assert what is really taking place is a slow roll out of these tariffs and trade barriers. They assert an impact will be felt in the future as more of these barriers are imposed. Thus far, the U.S. has not fully implemented all of the authorized tariffs on steel and aluminum as there are significant exemptions granted to steel and aluminum users that have not been able to find domestic metals to meet their needs or standards. The more important factor as far as the U.S. economy is concerned is many of the nations that have been threatening retaliatory tariffs and other trade restrictions have not fully implemented them as yet. The bottom line is nobody is really all that eager to destroy the existing supply chains. That is especially true when there is an assumption these tariff and trade policies can be reversed in the not distant future.
Analysis: The U.S. has imposed tariffs on about $113 billion worth of imports. This accounts for just 4% of the total imported into the country annually. Retaliatory tariffs have been imposed on roughly $70 billion worth of U.S. exports or 3% of the total. Altogether, this accounts for just 1% of the national GDP. Even if there was to be a concentrated effort to impose the full amount of tariffs and trade barriers authorized, it would still account for a relatively small slice of U.S. global trade. What makes this an issue of such importance to the business community?
The first point is that the pain of this tariff policy is not evenly distributed. This is not like a universal tax that everyone pays, some will be affected by the tariff and many will not. The manufacturer that uses steel will be hit with higher prices for that commodity, while the one that uses some other input such as plastic, ceramics or just another metal will not. The retaliatory tariffs will not be evenly assigned either, as has already been seen. China has chosen to impose the majority of its reactive tariffs on agricultural output from the U.S. as they believe they can replace that output from other nations. They also believe they can impose more pressure on the U.S. through targeting the farm community.
The second point and probably the biggest concern is the potential for escalation to the point these restrictions really do start to hurt. Right now, there is not much incentive to give in on anything critical as there has not been that much damage. The U.S. is not compelled to back away from its demands and the impact on China has been negligible. It can be argued that Mexico and Canada can be compelled to give way more quickly as the U.S. is their primary trading partner, but even Europe can afford to be recalcitrant for a while longer. Part of the issue that complicates these trade talks is the confusing nature of the U.S. demands. There have been very few specifics and the rhetoric has been all about some kind of "balance." The truth is trade between the U.S. and the rest of the world is pretty balanced already. The U.S. runs a trade deficit with most nations when it comes to goods, but runs a surplus with those same companies when it comes to services.
The third point is that trade pacts are rarely just about trade. The U.S. has used these agreements to get political support on a number of issues. Countries that back the U.S. in places like Iraq and Afghanistan get trade considerations. Countries that support the U.S. effort against terrorism in the Middle East get trade advantages. What looks on the surface to be a bad deal for the U.S. may be a deal with far more political import than economic importance.
Disaster Recovery and Tariffs
The impact of the tariffs and trade war may well be felt in the weeks to come as the region being hammered by the hurricane starts the process of recovery. This will be the period when there will be tremendous demand for all manner of building materials. The expectation is that lumber, dry wall, steel, copper and everything else that goes into a structure will be in short supply. These are all areas where the U.S. uses imports. We get a lot of lumber from Canada, while Mexico is a major source of dry wall and cement and other materials. The higher prices that have already appeared will be amplified by the massive and immediate demand created by a storm this size. An even bigger issue will be labor as there were too few construction workers in this region before the storm. Now, there will be a huge demand for many more than before.
Analysis: One of the most difficult tasks during recovery is protecting the population from scams and cheats. The shortage of labor leads people to hire anyone who can fog a mirror. The shortage of material invites people to sell bad lumber, inferior cement and the like. The estimate already that $1.9 billion will be spent on rebuilding and recovery. That amount can easily go up as the flooding risk continues to affect the area. The policies that have restricted migration and that have discriminated against some imports will make this a slow and expensive rebound.
The Waffle House Index
We economists take our clues where we can get them. For years, the most reliable means by which to evaluate the strength or weakness of a given currency has been through the Big Mac index. As the McDonald's Big Mac is the same product the world over, one can translate the costs in any given country and compare them in relation to the dollar. Now, we have the Waffle House indicator as far as storm recovery. It was revealed by a FEMA administrator that they had a three-tier system based on Waffle House business hours. If the local Waffle House is open and serving a full menu, the disaster has passed. Things are getting back to normal—a green light. If the place is open, but only serving a limited menu, they are not working with full power and can't get new supplies—yellow light. If it is closed, you are in the middle of the crisis as these places never close.
For its part, the Waffle House executives have created "jump teams" whose job is to get these places open again as fast as possible so the community has some place to gather.
