Tuesday, December 12, 2017

Strategic Global Intelligence Brief for December 12, 2017



Short Items of Interest—U.S. Economy

Unexpected Impact of Comparison Shopping
It has always been highly recommended that a shopper engage in as much price comparison as possible if they want to save money and get the best deal. This once meant an exhaustive search; usually going to several different stores. It was nearly impossible to seek out deals outside of where one lived. The internet changed all that. Now we can get prices from anywhere in the world with a mouse click. This has not only saved consumers a lot of cash, but it has altered the direction of overall inflation. Even if a given store wants to hike prices locally, it really can’t as the consumer can get the item from anywhere. This has been a surprising factor as far as keeping the lid on inflation.

Loopholes Galore
Remember when the tax cut plan was first being discussed? One of the express aims was to lure U.S. companies back to the U.S. and keep others from locating their operations in other nations. As the bill reads right now, there are actually new incentives to take manufacturing overseas. There are also other provisions that will encourage wealthy individuals to turn themselves into companies as a way to reduce their tax obligations. As currently written, there are more loopholes than there were before. The rush to get this bill passed by the end of the year is resulting in a chaotic process that will inevitably yield a whole host of unintended consequences.

Producer Prices Gain by 0.4%
There has been a rise in the price per barrel for oil—not a huge one, but far more than has been the case through the bulk of this year. It was enough to create some inflationary pressure as the Producer Price Index is concerned. That led to the 0.4% gain. This is not serious inflationary pressure yet, but the trend has been clear enough with hikes taking place in a number of industrial commodities as well as with wages.

Short Items of Interest—Global Economy

Iran Nuclear Deal Looms Again
Two months ago, Trump elected to dump the Iran nuclear deal and its extension back in the lap of Congress. If the deal was to be extended, the decision would have to be made by Congress. They have—predictably—missed their deadline. It will now be back on Trump’s desk in January. He continues to assert that it is the “worst deal ever” and that he doesn’t like it. He has not said he will refuse to extend it, but he has shown no desire to do so. The impasse is driving Europe nuts. Analysts are afraid a failure of the deal will embolden the hard liners in Iran.

Is Russia Really Pulling Out of Syria?
Vladimir Putin made a surprise visit to the air base that Russia uses in Syria. He declared that the war against ISIS had been won and Russia would soon remove most of the troops currently in that country. The problem is that he said the very same thing a year ago and Russian troop strength increased. The majority of analysts agree that ISIS has been defeated in terms of being able to establish a caliphate, but the battle against the ideology is far from over. What is more likely is ISIS returning to classic terror tactics. Meanwhile, it seems that Bashar al-Assad is in the most secure position he has been in since the conflicts started.

Rare Moment of Trade Cooperation
It seems that the U.S. is not the only nation upset with the trade policies of China. In an unusual moment of cooperation, the U.S., Europe and Japan are planning to gang up on China to address issues like overcapacity in their steel industry, technology transfers, illegal subsidies, state financing and the like. This comes at a time when Australia is fighting Chinese political meddling. The mood has shifted in the last few months—it appears that China may have miscalculated. Their assumption has been that other states were more upset with Trump and his protectionist impulses and therefore willing to give China a pass.

Will Manufacturing and Exports Lead Europe’s Recovery?
To a significant extent, it has already been the case that Europe’s recent rebound has been taking place at the same time that manufacturers throughout the eurozone have been finding new export markets or have seen their old ones start to recover. It is not a big shock that Germany has seen the industrial community showing improvement, but it isn’t just the German economy that has been responding. France has seen resurgence in confidence since the election of Emmanuel Macron, but the rebound goes deeper than that. French companies have been expanding their contacts into Asia as well as Latin America. There has been renewed attention to those traditional markets in Africa and the Middle East as well. Italian manufacturers are expanding rapidly and the northern regions of Italy are reclaiming their status as the manufacturing and exporting centers of the country. There has been more expansion into the U.S. as well as other parts of Europe. Italy has been very busy working its way into the fast-growing eastern regions. Spain has likewise watched its fortunes improve through manufacturing and exporting to countries in Latin America as well as to the U.S. and other parts of Europe.

Analysis: In some respects, this is not shocking as manufacturing and exporting are nearly always part and parcel of general economic growth, but what makes this European growth remarkable is that Europe still has all the barriers it has long had as far as expansion of manufacturing and exports. This is not a low cost or low wage part of the world. The European companies are not going to be able to compete on price with India or China or any of the dozens of other states that can routinely undercut. The wages in Europe are too high, regulations too strict or requirements too onerous. This has been the story for decades and has been cited as the reason that European companies can’t adequately compete in the global market. Until now that is.

The single, most important reason for the newfound competitiveness is innovation. This is a very broad and not very descriptive term, however. Basically, it means that European manufacturers are counting on their ability to develop new products and their ability to maximize efficiency. European manufacturers have embraced technology, robotics and automation. That reduces the advantage that low-production-cost states have. The European companies have become far better at listening to their customers as opposed to simply waiting for somebody to order something.

Not that this is universal. There are still plenty of companies that are uncompetitive, but those leading the effort have been transforming expectations. It also changes the dialogue politically as the assumption had been that Europe would only become competitive again if it found a way to reduce the costs of production in Europe. That meant lower wages and reduced benefits for workers and lighter regulations. These were not popular measures; many a government has faltered as they tried to impose these changes. Now it seems that the real solution to competitiveness is to advance innovation. The governments of Europe can play a role here as well. Feeding innovation means creating a pipeline of trained and qualified workers, which translates into more focus on education than ever.

Chinese Influence in Australia
There has long been some concern in Australia as far as the Chinese are concerned. After all, the Australians refer to China and the other Asian states as the “Near North.” The importance of China as a trade partner can’t be overlooked as they are the primary buyer of Australia’s commodities such as coal, iron ore and grain. There has been considerable investment into Australian business by China as they have sought a platform for everything from real estate to manufacturing and the service sectors. For the most part, the Australians have welcomed this interest, but the concern occurs when it becomes obvious that China is trying to influence the politics of the country.

Analysis: The Chinese do not want to see anything that would interfere with the supplies they covet and have therefore tried to influence the way Australia’s mining companies are handled. They have done overt lobbying, but the more troublesome engagement ranges from outright espionage to influence peddling and trying to get crucial politicians under their sway. The resignation of a prominent Labor Party MP illustrates how pervasive their tactics have been. Sam Dastyari was accused of collusion with the Chinese. He elected to resign his seat so as not to be expelled. There are several other MPs who are suspected of similar ties. Dastyari’s resignation may not be the last. It has been a delicate balance at best as China remains crucial to growth in Australia, but there is intense nationalism in play as well—Australians do not want to be tools of the Chinese.

Treasury Offers Weak Rationale
As the debate over the tax cut plan goes on, there are all manner of interpretations as to how it might impact the economy. There will never be a definitive interpretation as all of these assessments will be based on assumptions. There is no other alternative as there is never any certainty to anything in economics. The stated purpose of the tax plan is to promote economic growth, although there are obviously many other motivations at work as various group strive to improve their tax situation in one way or another. The assertion by the Treasury and the White House has been that the economy will grow fast enough to eliminate the over $1 trillion deficit created by the reduction in federal revenue. This is not the assumption that has been made by the Congressional Budget Office and the many groups that examine tax policy. This is not to say there is consensus among these groups either, as some are closer to the Treasury position and some are extremely pessimistic.

Analysis: There are a number of key assumptions made, but none as important as the expected rate of growth. The faster the rate of GDP growth, the less the deficit would likely be (assuming that spending levels stay roughly where they are). The Treasury/White House assumption assumes a consistent rate of 2.9% growth from the point of the president’s budget out to around five or six years. How realistic is this assertion? The past performance of the GDP is not all that encouraging. Looking at the last two years, there has been a great deal of variability—in 2015 it was Q1 at 2%, Q2 at 3.2%, Q3 at 2.7% and Q4 at 1.6%. In 2016 it was Q1 at 0.5%, Q2 at 0.6%, Q3 at 2.2%, and Q4 at 2.7%. This year started weak again with a GDP number of 1.6% and then improved to 3.1% in Q2 and 3.3% in the third quarter. This is not averaging even close to 2.9%.

There are many analysts who predict that a recession or at least a downturn will come in the next year or two—if only because this current recovery has been one of the longest in recent history and will probably have to come to an end. On the other hand, it has been pointed out that this has been a very weak and prolonged recovery and hasn’t provoked the Fed to engage in the rate hikes and other restrictions that are usually employed to head off inflation—at least not yet.

The pessimistic analysis of the tax plan and the deficit was presented by the Congressional Budget Office in a fairly lengthy report that tried to examine all the potential reactions to the tax cut. Assumptions were based on past behavior and projections were tied to the actual performance of the U.S. economy. It has been asserted by Secretary Mnuchin that Treasury developed a comprehensive analysis of its own, but it has not been released. The only thing that has emerged of late has been a one-page document that makes the same assertions that have been made so far, but with no additional backup.

The bottom line is there is considerable skepticism regarding growth and the ability of the U.S. to pay off an additional $1 trillion deficit. It should not need pointing out that this is on top of the already existing deficit. In 2017, that deficit is 3.5% of the U.S. GDP, higher than in 2016, 2015 or 2014. Granted, the deficit as share of GDP was over 10% in 2009 due to the impact of the recession, but the point is that the deficit is already high. The U.S. debt is also higher than it has been—over 100% of GDP. It is debatable that the tax plan will create enough growth to handle the additional deficit, but nobody sees a point at which the U.S. starts to address the existing issues. It would take growth at more than 10% annually to move towards a balanced budget.

One of the pressing questions at this point is whether growth would improve if the budget was brought into balance. The U.S. economy is arguably in good shape right now with low unemployment, confident consumers and business people and good quarterly growth. It doesn’t really appear to need a stimulus like the tax cut. It can be argued that now is the time to focus on reducing that debt and deficit by raising taxes and reducing spending, but Congress has never been good at either one in the past.

Some Vexing Aspects of Unemployment
There are some confusing pieces of data as regards the employment situation. We know that unemployment rates are at a 17-year low—whether one is looking at the U-3 or U-6 rates. We know that the quit rate as measured by the Job Opportunity and Labor Turnover Survey is back to levels seen prior to the recession. We know there have been far fewer people being laid off and the majority of those who have lost jobs find new ones in less than two months. The confusing part is that the pace of hiring has not picked up much in the last three to four years. Companies are not doing much more hiring than they did when the unemployment rate was at 6% and higher. We know that close to six million people are without work. This doesn’t take into account the people who have essentially dropped out of the formal economy.

Analysis: This is a different issue than just job creation. If there are job openings numbering close to nine million and six million people who seem to need work, why isn’t there more hiring? The fear is that we are facing a growing population of unemployable people. They may lack the skills needed, they may lack the motivation needed or they may be in the wrong place at the wrong time. They may have family commitments that keep them out of the workforce. Whatever the reason, they are not working at a time of record employment and that doesn’t bode well for them or the economy. The society as a whole has a choice—either to find ways to get them back to work with training or other programs or accept their status as permanently unemployed and likely dependent on some form of government assistance for an extended period of time.

Civic Duty
I need to be careful with this commentary as I really do not want to give the wrong impression. I was called for jury duty yesterday. Like 90% of the people there, I would rather have been somewhere else. I fully understand the need for us to make this contribution to our legal system and I really did intend to do my best if I was seated. As it turned out, I was not picked. I was indeed more than a little relieved given the things on my agenda this week.

The distressing part to me was the commentary and exchange that was taking place during the process of deciding who would and would not sit on the jury. With almost no details of the case revealed, there were several people who had already decided that the guy who pulled a knife on his employer was innocent because he had probably been threatened. There were those who decided that it was not a “real” assault as nobody was hurt. There was a woman who declared that only the Lord could make this decision. I was shocked and appalled by the attitude of many. I assume that these people were not chosen, but I can’t be sure. My wife was involved in a trial a year or so ago. The jury couldn’t reach a decision as one woman refused to find the defendant guilty despite the fact the victim caught him and witnesses backed him up. I understand that no system is perfect and there are all manner of cases where judges have erred. I just wish that people could take this duty seriously and find a way to perform as expected. Faint hope I suppose.