Strategic Global Intelligence Brief for September 26, 2018
Short Items of Interest—U.S. Economy
Fed Raises Rates Today
For the eighth time since 2015, the Federal Reserve will hike interest rates. Absolutely nobody will be the least surprised. This has been a rate hike trumpeted and planned for all year. It will mean there will be far more interest in the press conference that follows the decision than there is in the action itself. The expectation is that Fed Chief Jerome Powell will reiterate the strategy touted all year—another quarter-point hike in December and perhaps three more in 2019. The inflation threat is a little more pronounced than it was, but the bigger issue for the Fed has been trying to get rates up high enough so a future cut would make a difference. It is not that the Fed is expecting an imminent recession, but should there be one, they don't have much ammunition with which to fight it.
Why Prices and Wages Aren't Rising
In fact, there have been hikes in both prices and wages over the last several months, but analysts agree they have been far less than would have been expected by this time. The Phillips curve asserts that wages go up when the unemployment rate goes as low as it has. There has been talk of imminent inflation for months. The tariffs and trade wars were supposed to have accelerated that process even more. One of the reasons prices and wages have not been as responsive as expected may be the power of big retailers and other business concerns. Wal-Mart demands low prices from its vendors no matter what. Big carmakers (among others) demand low prices for the parts they buy. These businesses also pay as little as they can for their employee base and have the leverage to use that strategy.
An Economic Cold War?
It has been asserted China and the U.S. are headed for what looks like a Cold War based on economics rather than on military prowess or politics (although both of these will play a role). What would the two competing blocs look like? The U.S. would attract allies that need access to the U.S. consumer market and China would attract allies that want to sell commodities to them. It could be a world where oil states line up with China alongside those states that have farm commodities, metal, coal and the like. The U.S. would have those nations that make stuff the U.S. consumer covets—Japan, South Korea, India, parts of Europe. Latin America could end up being the real battle ground region.
Short Items of Interest—Global Economy
Man in the Middle
More than anyone else, one man understands the dilemma facing Italy at the moment. Giovanni Tria is finance minister for the new Italian coalition. One would be hard pressed to find a more awkward set of bedfellows. The Northern Alliance is arch-conservative and almost secessionist in their orientation with an almost unbridled hatred of the Italians in the south and immigrants of any kind. They made common cause with the populists that formed the Five Star Movement. The leaders of the two parties want money spent on their priorities and pay no attention to the size of the deficit the nation runs. The EU pays a lot of attention to that deficit, however. It demands something be done about it. There sits Tria—trying to navigate a path between the two.
Germany Remains Divided
In the years since Germany reunited, there has been a slow realization that true unity remains an illusive target. The situation in what was East Germany remains far less promising than that of the western side. The economic progress has not been as rapid as hoped and the attitudes of the residents remain different. The western Germans now express more frustration and resentment than before—politics plays a big role. The left is still far stronger in the eastern zones. That angers the conservatives in Bavaria and elsewhere. The immigration issue has only made the split worse.
Argentina's Central Bank Head Resigns
Luis Caputo has only been in office for three months, but he has had enough. The peso responded with an immediate slide of 5%, but gained some ground later. This hurts the Macri austerity plan, but Caputo was not willing to deal with the opposition to the effort he deemed necessary.
The United Nations Reaction
Very few international organizations evoke the kind of emotional reaction as the UN. There are those who despise the institution as the very embodiment of anti-American conspiracy and others who insist it remains the world's best hope for peace and tranquility. In truth, there are elements of both assessments in play. It is an awkward combination of idealism and brutal pragmatism and is very often at odds with itself—much less the member nations. It is ostensibly a form that allows the very smallest state the opportunity to be heard, but it also concentrates power in the hands of five nations based on their role in World War II. The Security Council has the final decision-making authority and can overrule anything that comes from the General Assembly. The five permanent members are the victors from World War II. They were once allied against the likes of Nazi Germany and Imperial Japan. Today, the five are divided into two broad camps with the U.S., Great Britain and France on one side and Russia and China on the other. Any of these five can veto anything that comes from the UN. It is very rare that all five are on the same page. The UN has been described as the world's biggest venting organization as it allows the smallest and the largest nations to stand on the same soapbox and air their issues and vexations.
Analysis: Over the years, the U.S. has come in for more than its share of criticism as countries upset with U.S. policy have taken their opportunities, but the U.S. has hardly been alone as Russia, China and many others have been roundly condemned in speeches from all over the world. President Trump was not well received by the assembled multitude, but he is not the first U.S. president to get a critical review. His stance in defense of protectionism and isolationism is not something the UN wants to hear from one of its largest and most influential members. On the other hand, the bulk of the real work done by the UN is carried out by the many agencies and sub-organizations that fall under the UN's authority. Even those in the U.S. who dislike the UN are often favorably inclined towards these groups and are likely unaware they are even part of the UN. These include the International Monetary Fund, the World Bank, UNESCO, World Health Organization, Food and Agriculture Organization and many more.
President Trump touted the policy of "America First" and drew derisive laughter from delegates that do not see this policy as an improvement over the U.S. position in the past. He took special aim at a few targets such as OPEC, Iran and even some of the U.S. allies where there have been struggles. The attack on Saudi Arabia and OPEC was over their refusal to increase production and therefore lower prices. The truth is that higher oil prices have been less about the Saudi production numbers and more about the sanctions the U.S. has imposed on Iran. This is what has limited supply of late. President Trump also went after Iran with accusations and threats just as he has done in the past to North Korea. The assumption is that he is trying the same basic tactic with Iran—intense pressure from sanctions, overt military threats and rounds of personal insults in order to give the Iranians an incentive to get the U.S. to back off. There are many who assert that such a strategy with North Korea has not really worked. There is even less confidence such a move will affect Iran's leaders. All in all, Trump was in a confrontational mood and made no attempt to mollify or cajole.
U.S. Likely to Lose in the Event of a Real Trade War
The European Central Bank has become the latest institution to assess the economic impact of the U.S. trade and tariff policy. Their study is consistent with those done already by other global organizations and various groups within the U.S. The examination makes a couple of assumptions about the execution of the policy and subsequent reaction. The first assumption is there will be an average of a 10% tariff imposed by the U.S. and not the 25% suggested thus far. It is certain some products will be subject to the 25%, but most will not. The second assumption is nations impacted by the U.S. will respond with 10% tariffs of their own.
Analysis: The U.S. has the longest and most detailed of supply chains in the world. That is how the U.S. has been so successful over the years. The production decisions are among the world's most efficient, which has largely benefited the consumer in the U.S. It is true the consumer benefits have been at the expense of U.S. manufacturers on more than a few occasions, but the reality is the U.S. has built an economy that is highly service-sector oriented and highly attuned to the consumer. To drive a service economy, there has to be plenty of disposable income ready for spending on services. That has been made possible by lowering the costs of goods to the consumer who can then support all those service jobs.
Consumer Confidence—What Do These High Levels Really Mean?
The headlines have been impressive enough as consumer confidence levels, measured by the University of Michigan and the Conference Board, have hit levels not seen in nearly two decades. The drivers of this confidence are obvious enough—a combination of solid employment numbers, economic growth and a stock market that continues to be on fire. It has been somewhat baffling to economists that the headwinds discussed thus far this year have not been having an impact, but most assume they will at the point the consumer finally starts to notice. Right now, these are still seen as distant threats. Measuring consumer confidence has long been challenging as the consumer in the U.S. is seen as fickle and easily shifted from one position to another. It has also been hard to determine what kind of behavior can be expected from the consumer—when they are confident and when they aren't.
Analysis: In years past, confidence surveys have been significantly affected by such things as the price of gasoline at the time of the survey. If the pump price was up even a few cents, the surveys were down, while a small decline in the price would send the consumer into a swoon of delight. Other factors which affected the attitude of the consumer included whether there was a natural disaster taking over the headlines, political unrest and the performance of the stock market. Even people who had little or no personal stake in the market would be encouraged by a good run and depressed by a bear market.
What does it mean for the economy for consumer confidence surveys to be positive? It actually depends on the time of the year as much as anything. It is presumed that a confident consumer is one willing to spend more, although that has not always been the case. Coming out of the recession, there was a burst of confidence returning as the steady diet of bad news started to fade, but that did not translate into more spending as consumers were still shocked from the downturn and elected to do more saving. If consumer confidence is up at the start of the year, there is not all that much activity as this is not usually the prime time for consumer activity. The latter part of the year is more likely to see additional spending with higher levels of consumer confidence as this is the holiday spending season. Additional levels of confidence mean that consumers will be able to pay for those purchases down the road.
It is also important to understand what makes the consumer confident in the first place. Generally, it comes down to three factors. The most important is the job market and the security of their employment. There is more confidence when there have been fewer layoffs and new claims for unemployment. There is excitement about the creation of new jobs, but the majority of people are most concerned about their own job security. The second major factor is spending power. If there is a serious threat of inflation that erodes the ability of the consumer to buy what they desire, there will be deterioration in confidence. By now, it was expected that inflation numbers would be high enough to discourage the U.S. consumer. Although inflation is certainly higher than it was even a few months ago, it has not reached a critical level and has not inhibited the consumer. This factor is expected to change in the not very distant future as there have been more indications of additional inflation pressure. The third motivator for a confident consumer is a perception of good growth in the economy as a whole. This can be a tricky one to estimate or calculate as it is not clear what the consumer is using to judge whether the economy is growing or not. Most of the time, the performance of the stock market is used as a proxy, but there will also be reaction to news stories regarding GDP growth and the like. The peril here is that a swift correction in the market reverberates through the consumer sector quickly.
Perhaps the most important aspect of the consumer confidence data is that it is a lagging indicator more often than not. It reflects the consumer's perception of where the economy has been more than where it may go. Even as consumers assert confidence in the future, they are more affected by what has been taking place. The confidence expressed in the future rarely pushes the economy forward.
Home Price Appreciation Slows
For the fourth straight month, the price increases for homes has slowed. The prices are still going up, but just not as fast as they had been. There has been a 5.5% rise in the cost of homes over last year, but in the prior month, there had been a 60% increase. The last month saw an increase of 6.2%. The data from the Case Shiller index has been consistent for the bulk of this year. It suggests some of those long-awaited headwinds are having an impact. The most important change seems to have been the rise in mortgage rates as well as a general increase in the down payments required by the lenders. However, there has not been a return to the frantic loan environment that led to the housing crisis a decade ago.
Analysis: This reduction in the price of homes will have an impact judged to be both positive and negative as far as the greater economy. The good news is this would likely stimulate a little more home buying—not that houses are getting cheaper, but the slowing of the price hikes will allow potential buyers to get their finances in order so they can buy. Prior to this year, it had been very hard to save that down payment as the prices were escalating faster than buyers were able to accumulate more funds. The not so good news is that home values are not appreciating as they have in the past and at some point, this will affect the level of household wealth. The recent report stating that household wealth has been improving was based on the increase in people's investment portfolio as well as the value of their home. It is the latter measure that matters most to the majority of people.
If nothing else, modern travel will teach one to be flexible and be prepared for nearly anything. It has taken me far too long to learn that basic set of lessons given how much traveling I do, but I am slowly assembling the set of survival skills needed. Several months ago, I got caught in a typical set of travel nightmares because I tried to cut things too close. I was trying to get to Louisville for a late afternoon talk and determined I could accomplish this even if I left KC that morning. All I had to do was catch a connecting flight in Chicago and I would be there four hours early. Hah! I missed the presentation and ended up doing a talk over the phone from the Louisville airport—just 20 miles from where I was supposed to be. Never again!
Last night, I arrived in Louisville for a late afternoon talk today. I was supposed to be here at 6:00 and ended up arriving closer to 9:00 as: (1) they had to replace the front tires on the plane, and (2) we got caught by the advancing storm and hung out on the runway for 90 minutes. This time I was more or less ready.
I quickly made a reservation for today in case my flight was cancelled. The absolute best part of Southwest is the ability to change flights at will and at no additional cost. I didn't end up needing today's reservation, so I canceled and will use that money on a future flight with no penalty. I also set up a hotel room in Chicago if needed. I hauled out my laptop and other gear and set about working on the various issues that always seem to await—might as well be productive. I plugged in my noise canceling earphones and drowned out the leather-lunged children behind me. I popped some Advil to offset the impact of an airplane seat and I was good to go. The moral of this story is to travel as if one was wrapped in one's own private cocoon—immune to the world and oblivious to the "slings and arrows of outrageous fortune." Obviously, William Shakespeare was prescient enough to anticipate modern air travel.