Strategic Global Intelligence Brief for September 24, 2018

Short Items of Interest—U.S. Economy

What Is Magic About 2%?
It has long been a truism that central banks sought to maintain an inflation rate of 2%. It was the Goldilocks number in that it was considered "just right"—not high enough to signal real inflation that threatens to get out of hand and not low enough that it creates concerns about deflation. Not that most central banks have been able to hit that target right on the nose, but it provided a goal and a guidepost for those who wanted to gauge what the banks would be likely to do next. The debate over whether this is the most appropriate goal has intensified of late, but there is far from a consensus regarding what it should be. The estimates have ranged from between 6% and zero. The reality is that 2% is likely to remain the de facto goal for a long while as options continue to get discussed.

Labor Unrest
When it comes to union activity and the possibility of strikes and other actions, it is all about who has the leverage. For most of the years after the recession, the leverage belonged to those who were doing the hiring. The number of people without a job meant should someone be fired there were plenty to take their place. Today, the unemployment rate continues to sit at record lows and there are more jobs than there are people to take them. Skill shortages mean that people with that skill are coveted. The unions now have more leverage than ever. This is bolstered by the fact that most companies can't cede market share to their rivals while battering their own employees. The advantage belongs to the worker for the time being.

Supply and Demand in Gig Economy
In the beginning, the ride share industry was the very exemplar of the gig economy—a way for people to make a decent living without having to go to work for a given employer. It was the independent person's dream. Too much, so it appears. Now that there are tens of thousands of people working the ride share space, it has become intensely competitive and drivers have too many rivals for the limited amount of business. Right now, it is the consumer's dream with ample supply, but the next step will be a drastic reduction in the number of people driving as they will not be able to make the money they need to. There will likely also be attempts to differentiate between drivers so they can pursue an advantage.

Short Items of Interest—Global Economy

French Deficit Worsens
When Emmanuel Macron took power, he promised a lot when it came to growth and expansion of the French economy. He further promised to lower deficits. As has been demonstrated in a lot of nations, this is far easier said than done. The lack of growth has damaged the growth of tax revenue. Further, the reluctance on the part of the National Assembly to cut spending to match the revenue fall has meant the deficit has worsened. It is possible that the reforms suggested by Macron will reset things and allow faster growth in the economy, but most of these efforts have been stalled. It is not clear how Macron gets that momentum back.

U.S. Set to Counter China in Global Investing
As President Trump came to office, his attitude towards foreign aid and assistance was overtly hostile. It was seen as wasting money that could be spent on domestic priorities. Now, that attitude is changing as the Chinese have been using their economic clout to get closer to nations around the world. The U.S. is planning to reinstate a program that made commercial lending possible to emerging market states—a $60 billion effort. The fact is that much of U.S. isolationism and protectionism has been to the benefit of the Chinese. That has caused a rethink for some in the White House.

Meanwhile in the U.K.
Nobody has a clue how Theresa May plans to pull this off, but she has declared that she wants the U.K. to be the world's biggest investor into Africa. In the wake of Brexit defeats, she is looking for any kind of victory she can grab.

Tensions Escalate Between China and U.S.
It seems nothing will halt the imposition of tariffs by the U.S. on China and by China on the U.S. The weekend was supposed to be an opportunity for the two sides to seriously discuss the possibility of compromise and climb-down, but it has become obvious the two nations have far more reasons for animosity than cooperation. The U.S. elected to impose sanctions on a prominent general in the People's Liberation Army (PLA) in response to the Chinese purchase of Russian military equipment. This was deemed a violation of the sanctions that have been imposed on Russia over its role in Ukraine and other provocations. This did not sit at all well with the Chinese; they broke off the trade talks as a result. The reaction from the PLA leadership was furious and the planned talks between the two militaries have been called off. The proposed fifth round of trade talks has been postponed and all but killed for the time being.

Analysis: It now appears the die is cast—the dreaded trade war is at hand. If the current threats are executed, the Chinese will be hitting almost everything the U.S. sells to China with tariffs and other trade restrictions, while the U.S. will hammer over half of the goods it buys from China. There will likely be exemptions from the U.S. side as there are products and resources the U.S. can't obtain from any other nation. The most important are the rare earth metals that are so crucial to the high tech world, but there are also products such as the components for the iPhone. This has deteriorated from some sort of high stakes negotiating exercise to a wholly hostile and belligerent stance. It seems that members of the Trump team simply dislike China and want nothing more to damage their economy by breaking off relations. It is equally obvious the U.S. is disliked intensely by many members of the Chinese political and military elite.

This has gone far beyond the issue of trade. To many longtime observers of China, this is a development that has been anticipated and the only unusual thing about all this has been the length of time it has taken. The U.S. and China have very little in common in terms of their strategic goals. The U.S. seeks to maintain its position in the Pacific. This is precisely where the Chinese assert they have a right to dominance. The trade relationship has long been lopsided as the Chinese have been very reluctant to purchase much from the U.S. The Chinese have backed regimes the U.S. has been opposed to—North Korea, Venezuela, Cuba, etc. and there has been no cooperation with the U.S. on issues in the Middle East. Both are trying to expand their reach in Latin America and Africa. There is also a much closer relationship between the Chinese and Russians than was the case a few years ago. It is probably a little premature to classify the U.S. and China as enemies, but it is far closer to that status than has been the case previously.

The fundamental question now is how far this enmity will extend. There are certainly reasons for the two states to continue cooperating. It would seem to be in nobody's interest for there to be another cold war—much less a hot one. The U.S. seems slightly better positioned to survive a clash with China. The consumer will be hurt by the higher prices in the short term, but it can be assumed that other nations will work to pick up the slack. India is already devoted to doing just that. China needs consumers for its manufactured output. There is no real alternative to the U.S.

There are prominent voices in both China and the U.S. that would like to see this level of hostility get taken down a step or two or three. These are mostly voices from the business community in both countries. It has taken a while for these business leaders to recognize the extent of the threat, but now that they have, they are mobilizing in both the U.S. and China.

Iran Blames U.S. and Israel for Attack on Parade
As Iranian President Hassan Rouhani visits the UN, he will be asserting that the attack on a parade in Iran was the work of U.S. and Israeli forces. He will be asking the UN to condemn both nations for the "atrocity." He indicates that this is a war against not just Iran, but Islam itself. There will be those that take this position in attendance. The reality of the attack is more worrisome for the Iranians.

Analysis: There are not all that many details available at this point. It is clear that Iran will not be publicly exploring the attack beyond the propaganda that has been issued. What is known is that the assailants were Arab separatists, a potentially destabilizing force in Iran. The majority of the country is Persian in origin and not Arabic. The majority of the country is Shiite and not Sunni. The group that has claimed responsibility for this attack is both Arabic and Sunni—loosely affiliated with the ISIS terrorists that have been at war with various regimes in the region. Iran has been directly attacking ISIS and has backed the governments that ISIS has opposed. It was only a matter of time before ISIS followers fought back in their characteristically brutal fashion.

Looking Ahead to the Week's Data
There will be some expected and some unexpected data releases this week—nothing very unusual. Thus far this year, the business of forecasting has been trickier than usual as there have been some tried and true relationships that have simply not responded as they usually do. This has sent analysts searching for rationales to determine whether this is an anomaly or a change that is more permanent in terms of how the economy works. There are also events that have not played out predictably. That creates a new set of challenges. For example, is the Phillips Curve no longer the guiding rule it once was, or will it make a recovery soon? This has been used as an indicator since the 1950s and holds that when the rate of unemployment falls to low levels (such as we have right now), there will be an automatic increase in wage inflation. It makes sense for this to be the case, but that has not been taking place until just recently. The trade wars and the tariff threats have been on again, off again. Nobody quite knows what to expect long term, making prognostications and forecasts tougher all the time. Given that, we have more data to examine this week to see if we can find some clarity.

Analysis: The big announcement will come from the Open Market Committee of the Federal Reserve, although it is also widely expected there will be very little unusual response. The current federal funds rate is in a narrow range between 1.75% and 2%. The Fed has been explicit regarding their next step—hiking that rate by another quarter point so that it will be between 2% and 2.25%. This is still historically low. Given that everybody and their brother expects it, there will be almost no reaction by financial markets unless there is something earth shaking in the commentary provided by Powell. That is not anticipated, but there will be attention paid to the comments on the state of the economy—what is expected as far as growth and inflation. There has been enough movement in both producer and consumer prices to justify more rate hikes. There has also been enough growth for the Fed to be somewhat relaxed about moves that might slow the economy a little. Expect the comments to include a broad hint that another rate hike would be in the offing by December.

This will also be a big week as far as releases from the Commerce Department. There will be a third (and more or less final) version of the second quarter GDP numbers. Most analysts expect there to be no change in the rate. It was revised once from 4.1% to 4.2%, but there has been nothing suggesting it has risen further. In about a year, there will be yet another revision, but these are generally not much different than the one that will be released this week. The slowest data coming in generally concerns consumer behavior and some of the export activity, but both of these factors have already been estimated high and will likely end up about where they were expected to be.

There will be new durable goods data. It is expected this reading will be better than the one last month. The August data fell by 1.7% from July. This month there is a recovery anticipated with a gain of 1.7% over August. Durable goods are those that are designed to last more than three years. The majority of that category is industrial equipment. The consumer gets in the game through the purchase of appliances, but the big dog every month is aerospace activity. If the aircraft makers have a good month, the durable goods numbers end up looking really good. When they have a flat month, these numbers are correspondingly down.

Later in the week, there will be more data on personal income and personal expenditures, which will be watched very carefully. In August, both of these climbed by respectable levels—personal income was up 0.3% and spending up by 0.4%. The expectation for this month is a rise in income of 0.4% and spending up 0.3%. The levels are 2.6% above what they were this time last year. This is not yet the kind of rise that worries when it comes to inflation. It is more or less encouraging as far as the start of the holiday spending season.

The last set of interesting data is not from the Commerce Department but from the University of Michigan's consumer confidence survey. It is expected to reinforce the earlier data from September where confidence levels were as high as they have been since 2004. It is always necessary to issue a caveat or two when looking at the consumer confidence numbers as the consumer tends to be very fickle. These heights can be swiftly turned to lows should something spook the consumer in general.

Another Threat to Agricultural Sector
This has not been a good year for the farm sector in the U.S.—that much is certain. The weather has not been cooperative, tariff politics have messed with prices for months, the consumer is shifting priorities again and nearly every input has been getting more and more expensive. Now, it is becoming obvious that some of the more significant global competitors are ramping up. Russia has been stepping up its production and has emerged as a very serious export threat—in a position to supply the Chinese even as China elects to put prohibitive tariffs on U.S. farm exports.

Analysis: There is always competition from other agricultural states, but the Russians worry the U.S. sector more than most due to the fact that Russia and China are quite deliberately trying to forge closer relations with one another. The big fear in the U.S. farm community is that a market they have worked very hard to develop is going to be lost almost overnight. Once China starts to import heavily from the Russians, they will not likely go back to old patterns. That means the U.S. has lost that foothold on a semi-permanent basis.

Dress Code War
This seems to be a topic that comes up a lot with different age groups. Those of my vintage and older grew up in an environment of "uniforms." One had clothes that were expected at the workplace and clothes one wore for religious services and for special occasions. There was a lot of emphasis placed on one's sartorial choices with more than a few companies mandating certain combinations of suit, tie and shirt. The list of occasions for dressing up was pretty long. Look at the old advertisements for air travel—men in suits and a hat and women in dresses with their pearls. It was a Leave it to Beaver world. I am not sure when that all went by the wayside, but there has certainly been a dramatic pendulum swing with almost no occasion warranting even a modicum of traditional dress.

The collection of outfits on any given airplane can be astonishing and often uncomfortable (for me anyway). I have sat next to burly guys wearing those T-shirts that leave their generous armpits exposed. These seem to be the guys who are unimpressed with deodorant as well. In general, I am no fan of feeling some strangers bare skin resting on my pant leg, but shorts are the dominant feature on the way to some of the sunnier locales.

I invariably wear a suit when giving presentations and am somewhat surprised when I seem to be the only one. I understand these conferences have long days. I can't really blame people for opting for sport shirts and slacks—I have the liberty of doing my thing and leaving. On the other hand, I fly in that same suit and am often the only one dressed that way. When I have conversations with people, it comes down to comfort. That is part of what is odd. I am not really comfortable in public when not dressed up a bit. I am really uncomfortable in casual dress when speaking. At home, it is a different story. People that see me after a day in the garden are almost in shock.