Strategic Global Intelligence Brief for September 20, 2018
Short Items of Interest—U.S. Economy
The End of the Automotive Run?
For the past couple of years, there has been a consistent assertion that the end of the automobile bull market was nigh. The consumer would surely stop buying these vehicles as the headwinds became more intense. This prediction has been proven inaccurate several times now. The latest challenge to the market is developing fast, however, and this may finally do the trick. The tariffs slapped on China by the U.S. will affect the shipment of auto parts to the U.S. The reality is these are parts that are not made anywhere else. The Chinese companies that produce these parts know this. That means they will very likely pass the cost of the tariff on to the U.S. buyers of these parts, which will mean higher-priced vehicles for the U.S. market. Of all the industries in the world, there are few so global as automotive. We are about to see what that really means.
Current Account Deficit Narrows
The measure of the nation's trade and financial flows narrowed by quite a bit in the last quarter. In a weird way this was due to the trade war threats as well as the looming tariff barriers. The U.S. exported a great deal of goods and services in the second quarter as nearly every company scrambled to sell to China and other trade partners before the tariffs and restrictions set in. For example, the sales of soybeans to China hit a record in Q2, but have since fallen off to almost nothing as the tariffs were put in place. The upshot is that second quarter numbers will look really good and third quarter numbers are likely to look really bad if the trade threats are actually carried out.
The Polish government is a populist-led coalition under the control of Andrzej Duda. It has been staking out a position not unfamiliar to the Poles who equally uncomfortable with both Europe and Russia. Now there is serious talk of a permanent U.S. military base in Poland that would aim straight at Russia. Needless to say, that will not be popular with the Putin regime, and the Europeans are not happy about it either. Then, there is the matter of expense and where the U.S. would find the cash to do this long term.
Short Items of Interest—Global Economy
Turkish Austerity Plan
The policy outlined by the Turkish finance minister may be the riskiest one yet as far as the current government is concerned. The country has been in the grips of a major currency crisis; inflation threatens to run rampant. The solution on the table is to slash public spending by at least $10 billion and impose some very strict currency controls while also trying to hike rates by the central bank. This is going to impose a major hardship on the population. Those who have been big supporters of Erdogan will likely be the hardest hit. It is not clear yet whether this will cost him that popularity.
Perils of Turning Inward
There is the idea that the U.S. is turning inward under President Trump, but that this shift may be inevitable as far as the U.S. and the world is concerned. There are many who are deeply opposed to that strategic direction change. Bill Gates has added his voice to that chorus with particular reference to Africa. This is the next frontier in many respects—a region with a very young population and a region that is better educated and has higher hopes than before, but only if it continues to get help.
U.S. and Canada Still at Impasse
The two main issues remain. The U.S. wants access to the Canadian dairy sector and Canada wants the arbitration system to stay intact. Both nations have very strong domestic lobbies pushing for these. It is not clear that either set of negotiators will be able to hammer out a compromise any time soon.
OECD Worries About Impact of Trade Disputes
There has been a common thread running through most of the analysis of the trade wars. It has been something like "there has not been much damage thus far but just wait—it will get worse." The Organization for Economic Cooperation and Development (OECD) has issued its mid-year analysis. It has concluded these threats have started to impact export levels, but not to the point that GDP growth has been affected. The overall rate of growth for the global economy this year has been estimated at 3.7%, better than it has been in the last few years. The bulk of that new growth has been attributed to the expansion of the U.S. economy. That is a little different as well. Through most of the last few decades, the Chinese have been the growth engine and the U.S. has lagged a little. Now, it is the opposite. The concern voiced by the OECD is that export levels are falling below overall growth levels. This decline in export activity has been across the board as well—not just affecting China and the U.S. There has been a slowdown in European trade due to the uncertainty over Brexit, while the slowing of the Chinese economy has affected many of the Asian export nations. The concern has led the OCDD to peel a little off their growth estimates for the world economy next year and into 2020.
Analysis: There are three basic reasons the OECD and other organizations have been worried and expressing trepidation regarding the future of global growth. The most common point made is that nobody is sure what will come of all these trade wars. The U.S. approach has been disjointed and nobody really has a sense of what the ultimate goal is. There have been many episodes of "one step forward and two steps back." The steel tariffs were originally universal. Then everybody but China and Russia got exemptions, after which, they became universal again. Now exemptions are granted to Brazil, South Korea and Mexico if the latest trade pact gets signed. The talks with China look fruitful one minute and hopeless the next. It is simply not a coherent strategy that anybody can figure out. That makes predicting its impact very tricky.
The second major issue is that nobody quite knows how these tariffs will play out should they actually be imposed. These are no bans on imports—the tariff is a tax and companies deal with taxes all the time. They have a choice as far as how to react. They can decide the consumer will be able to handle the price hike and will just pass along the tax. Many of the products the U.S. plans to levy tariffs on are not available anywhere else so consumers will simply have to pay the price. The company hit with these tariffs may decide to simply absorb the cost of the tax and maintain their market share position. A society such as China's has more of that capability than most as the government is far more engaged in these businesses. The third option is to find ways to cut costs so it offsets the tax. In the case of China that likely means more use of robotics. Ironically, that tends to kick China into trying to produce at a higher quality level where they will have more price control. The very thing the U.S. would rather not see.
The third issue for the OECD is to what extent other nations are willing and able to fill the void if China is somehow excluded from this supply chain. The rest of the world would love to find ways to gain entry into the U.S. market. There are certainly domestic producers in the U.S. that would like to take some of that available business, but this means they have to ramp up and develop that capacity. It is not clear they can do this fast enough. The impact of their new entry may be delayed by a year or more. That will affect growth potential while that transition is underway.
Is the U.S. Trying to Become a 'Normal' Nation?
There is a somewhat provocative theory starting to make the rounds. By no means does this have the overwhelming support of those who consider the place of the U.S. in the world today, but there are many who have started to examine the policies of the U.S. in a different light. The Trump administration has upended a great many aspects of traditional U.S. foreign policy and has come under withering attack as a result. The president ignores allies that have stood by the U.S. for decades while trying to be cozy with nations that have been and still are hostile to the U.S. Protectionism and isolationism have replaced the principles of liberal free trade and open economies. The very institutions the U.S. created to promote global trade and progress are under attack from their creator. Domestic issues take precedence over everything international—even if that comes at the expense of other domestic consideration.
The devotion to the creative destruction of capitalism is being replaced by extensive government intervention that has its mission in picking winners and losers. The steel industry is protected from global competition at the expense of the manufacturer. U.S. exporters are damaged in an attempt to reduce imports. Is this all a deliberate strategy worked out by the Trump team? Most are unwilling to give that much credit to a well-thought-out master plan. It seems more logical to assume the president and his supporters are reacting to some larger forces and changes that are pushing the U.S. in this direction. If this is the case, it means it really wouldn't matter if Trump was in office or someone else—the patterns might well be the same.
Analysis: The basic assertion is that the U.S. can no longer be the country it has asserted itself to be for nearly the last century and certainly since the Second World War. As one critic puts it: "the restoration of the U.S. is as a selfish state among selfish states, not an over-worked governess with the entire free world as her mewling wards." The U.S. has been trying to make the world in its image—economically, politically, socially and in every other respect. The other nations are not "different and entitled to their own patterns"—they are flat wrong and in need of correction. Every nation should have our brand of capitalism, our brand of democracy, our approach to religion and civil rights and so on. In many respects this is a noble goal as one can be pretty confident the rest of the world's population would prefer not to be impoverished and exploited by tyrants. But for the U.S. to continue to play that role requires a massive commitment of energy and money. It can be argued the U.S. now has neither.
The assertion is that the U.S. is entering a period of realpolitik based on two inexorable realities. The first is that Americans have become much more selfish and focused on internal issues. That makes the U.S. population more like the rest of the world than they might have been in the past. The average Chinese citizen wants only what is good for China, the average Russian cares not at all about the lives outside its own country. More Americans have that position than ever before. It is perhaps because of the immense sacrifices that have been made with only paltry rewards. The U.S. has been at war in Afghanistan for 17 years. There have been over 1700 deaths; another 4500 have died in Iraq. Those injured amount to triple that count. The U.S. population doesn't see what the U.S. has gotten for this sacrifice. Trump has challenged allies all over the world and demands to know what is in this for the U.S. In truth, the U.S. has received quite a bit, but there are clear indications of imbalance which leads to the second motivation for this round of realpolitik.
The U.S. can't afford this traditional approach as easily as it once did. The U.S. was once very generous with aid and assistance and essentially backed the majority of the development projects that took place in the world. These were certainly not all motivated by pure altruism. There was always a lot of benefit to the U.S. from the programs, but the U.S. was the major backer regardless. The U.S. now has a budget crisis that is persistent and shows no signs of abating. There is no will on the part of the political leaders to tackle debt and deficit through higher taxes or by cutting spending to the biggest domestic programs such as Social Security, Medicare and Medicaid. That leaves only one big area to extract funds from— the military. If the U.S. elects to withdraw from the world and leave nations to their own devices, it means an opportunity to pull U.S. troops away from dozens of conflicts and nations—adopting a position that is purely defensive. The U.S. leaves you alone unless you attack the U.S. Then there is massive and indiscriminate retaliation with no further engagement.
A Very Traditional Federal Reserve Board
When Trump took office, there was an opportunity for him to immediately put his stamp on one of the most important institutions in the U.S. On occasion, it appeared he was thinking about it. In the end, he opted not to upset the ways of the financial community with his choices for the Federal Reserve Board. He faced six vacancies in a seven-member board. Of his nominees, three have been approved by the Senate—Jerome Powell as chair, Richard Clarida as vice-chair and Randall Quarles. All three are mainstream and experienced technocrats to one degree or another.
Analysis: Marvin Goodfriend from Carnegie Mellon and Michelle Bowman from the small bank sector in Kansas are awaiting approval from the Senate. They are seen as traditional as well, although Goodfriend is very hawkish, which gives some in the Senate pause. The last nominee was announced this week. Nellie Liang is a former Fed economist and the person charged with creating the first financial stability board for the Fed. This is a very mainstream Fed board with deep ties to the institution and nary a controversial position in sight.
Business Community United but Ignored
It is relatively rare for the business community to be united on anything. In the majority of situations, what is good for one sector is probably not good for another. Right at the moment, there is more common cause than not when it comes to opposition to President Trump's trade strategy. It is not that these companies have failed to appreciate the level of Chinese duplicity in terms of trade. There has long been a desire to get the Chinese to play by global rules. The objection to the current approach is that it takes a sledgehammer to a problem that requires a far more delicate touch.
Analysis: The bottom-line argument is that these aggressive tariffs may or may not force China to make the concessions the U.S. would prefer, but it is certain they will negatively affect U.S. business, and right away. The farm sector is already in shock and many are expecting widespread farm failures. Manufacturers are also pointing out the shortage of parts and commodities already.
No Accounting for Taste
I have confessed on more than one occasion that I take guilty pleasure from the America's Got Talent show every year. I enjoy the wide variety of spectacles and marvel at the ability of people to make utter fools of themselves. I also like trying to figure out what other people find talented and entertaining. I usually guess wrong. I know it has much to do with my own taste in things like music and performance. I have a very hard time appreciating certain genres of music. My preference in dance runs towards Fred Astaire or the creations of Bob Fosse.
As this season drew to a close, I was shocked to discover that I pretty much agreed with the breakdown of the competition. I had my favorites in the top 10 and was surprised to see most of them reach the final five. In the end, the winner was a magician with amazing sleight of hand ability. I was mildly disappointed as I was a big fan of the troupe called Zurcaroh. I always try to look at these things from the standpoint of the prize—a show in Las Vegas. Would I pay those Vegas prices for this or that performer? Of all those that made it to the end, I think only this troupe would be able to pry that money out of me.
The bigger point here is the diversity of taste. I have passionate discussions over what is and what is not talent with friends. I never cease to be amazed at the differences. Perhaps more than anything else we show to others—it is what entertains us that gives others insight into our real personalities. All one needs to know of my father is that a Pink Panther movie would leave him laughing so hard he could hardly catch his breath!