Friday, October 20, 2017

Strategic Global Intelligence Brief for October 20, 2017



Short Items of Interest—U.S. Economy

Jobless Claims
Remember the advice we gave at the time of the storms? We warned that much of the economic data we will be looking at for the bulk of the rest of the year will be skewed by the disasters. We saw an unusual dip in the rate of new home starts and we have seen a big surge in the rate of new car buying as people try to replace the four million vehicles that have been damaged by flood and fire. Now we have the lowest number of jobless claims in 40 years occurring at the same time that many millions have been thrown out work. How is this possible? It seems that storms destroyed much of the electronic infrastructure, and that has drastically slowed the process. The people who are applying for jobless claims have been delayed—the real numbers may not be known for weeks to come.

Hurricanes and Housing
The storms continue to have an impact on housing as starts are down again. Not only have some of the hottest markets been disrupted, but there have been severe shortages that are affecting the housing market throughout the U.S. The already severe shortage of construction labor has become acute as nearly every person with an appropriate skill has decamped for Texas, Florida or to the California regions affected by fire. This has meant a dramatic slowdown for the rest of the country. There have also been shortages of material as the bulk of this output has been sent to the storm-damaged regions. These shortages are expected to factor into housing well into 2018.

In Spite of It All
The latest edition of the Beige Book is pretty encouraging despite the damage done by the storms. There has been some slowdown in the regions affected by the hurricanes and the fires, but all 12 districts are reporting progress at some level. The fast-growing areas are where one would expect—the Northwest and Northeast as well as part of the middle. The slower regions have been in the southern states and in the regions of the west that have seen some declines in mining and extraction. The overall picture is a positive one. Now all eyes are on the consumer and what they are prepared to do with the holiday season.

Short Items of Interest—Global Economy

U.K. Tries to Budge EU Opinion
Prime Minister Theresa May has implored European leaders not to back her into a corner on Brexit, saying there was a “clear and urgent” need to move exit talks to the next phase as her Eurosceptic critics began to mobilize. The attempt has been made to move the needle with Angela Merkel, but it hasn’t paid off. The sense in Europe seems to be that Britain made its choice and now has to live with it. The business community in the U.K. as well as Europe would like the enmity to cool and for practicality to emerge, but that seems to be a faint hope.

South Korean Setback
South Korea is expected to resume the stalled construction of two nuclear reactors after a state commission recommended doing so following months of heated discussion and despite President Moon Jae-in’s campaign promise to scrap the projects. The recommendation could deal a blow to Moon’s pledges to overhaul the country’s energy policy by scrapping all existing plans for new nuclear power plants and canceling lifetime extensions for aged reactors.

Taxes and Foreign Companies
Foreign companies operating in the U.S. could face major changes in their tax bills under an overhaul being planned by Republicans. Those could include new surtaxes or limits on how much companies can deduct on certain expenses such as rent, royalties and interest on debt. The changes would be addressing a supposed imbalance. Because U.S. corporate tax rates are higher than they are in many other countries, foreign companies have an incentive to book big expenses in the U.S. so that more of their global profits get taxed at low rates back home. 

Global Reaction to U.S.
The Chinese are having their celebration and Xi Jinping is basking in the glory and attention while he contemplates his next five years. The Chinese leader is now hailed as the most powerful man in the world, a term that was once the exclusive province of the U.S. President. The world leaders are frustrated with the U.S. under Trump. That frustration is now turning to vocal opposition. Under the Trump approach, the global trigger points have proliferated. War with North Korea remains unlikely, but the chances for such a conflict go up with every angry exchange between Trump and Kim Jong-un. The U.S. is now threatening to walk away from the Iran nuclear deal. That puts that region into more serious play. Trade deals have been called into question and even the closest allies now question their future with the U.S. The surge towards protectionism and isolationism is not unheard of in the U.S., but in the past, that path was a destructive one. It promises to be so again.

Analysis: The Trump approach alienates allies and seems to embolden rivals. The Chinese are taking full advantage of what they see is a void in global leadership. The heart of the GOP’s national security community has been more than distressed by the wholesale shift from the neo-conservative patterns practiced under George W. Bush. Not that the plans put in place by people like Dick Cheney, Donald Rumsfeld and Paul Wolfowitz were spectacular success stories, but it can be argued the U.S. position was far stronger in the world when these were the more important principles. Trump has presided over a void. Now it is a matter of who will fill it. The global economy will hinge on this. If the U.S. is not at the center—will China assume that position?

Monetary Policy Fight
The current set of candidates to lead the Fed for the next term could not be more diverse. Two of them have been integral to the current Fed policy and two have been ardent critics with a fifth somewhat in the middle. It is more than unusual for a president to have such diverse candidates in mind at this late stage and this has been upsetting the financial community to some degree. The banks want stability and predictability above all—the current situation provides neither. This division of opinion from the White House reflects the division that exists within the ranks of the GOP as a whole and perhaps in the wider financial community. The choice is really pretty stark as choosing either Yellen or Powell would be an endorsement of the policy which has been in place for the last eight years or so, while the choice of Warsh or Taylor would be a move to reverse course and alter the function of the Fed.

Analysis: The debate is over a few critical issues. The most dominant is whether the Federal Reserve should be pursuing a loose or tight monetary policy. For the last eight years—since the start of the recession—the policy has been very loose as the Fed was left with the task of stimulating the U.S. economy on its own. In past years, the real stimulus was the responsibility of Congress or the overall government itself. The decision was generally made to spend heavily on programs that would boost jobs and give the consumer more money to spend. The plans involved big infrastructure projects, more generous aid and support, and lower taxes. There was a little of this at the start of the recession, but it was woefully inadequate as the government was already saddled with debt and the deficit that was out of control. The $900 billion attempt was just not enough to shake a GDP of over $16 trillion (It is now about $18.5 trillion). The lack of engagement on the part of Congress meant most of the burden fell to the Fed, but at best, the central bank can only encourage growth. It is often referred to as “pushing a string” as the Fed can make borrowing and lending easier and more appealing, but can hardly force any particular course of action.

This is the motivation for loose monetary policy. The usual tools include setting interest rates very low so that banks have the freedom to lend to borrowers attracted to the low rates. There will also be a lowering of the reserve ratio so banks are not required to keep as much of their money at the Fed. This time around, the Fed also deployed unusual and unique tactics such as three rounds of quantitative easing. The first round was designed to take the mortgage-backed securities off the bank’s books and thus free them to do more lending. Many argue that this was the most useful of the three rounds. The next two involved the Fed buying billions and billions of dollars worth of treasuries as a way to push even more cash into the system. This was indirect stimulus since it relied on banks to loan and borrowers to borrow. That has not always been the case.

The critics of the loose monetary approach have three major concerns. The first is that this effort can trigger major inflation by flooding the system with far too much money. The inflation surge has not yet manifested at this point—in fact the Fed has been trying to get that core inflation rate up for the last few years. The inflation hawks point out that inflation can and does build very quickly. Taming it once it breaks out is very hard to do. The second problem the hawks have with the loose approach is that it seems to encourage reckless behavior among investors, which increases the potential for bubbles. Many of those who have been upset with the current policy point to the stock market surge as an example and worry that too much of the recent growth is froth. Froth occurs when investors are borrowing money to make purchases over and over again with the assumption they will make what they need to cover those cheap loans and make profits as well. This leads to the third critique. That centers on the efforts of the Fed to micromanage the economy. Since the legislature has essentially given up any semblance of economic management, the Fed has been left with only its tools. That has led to trying to boost and nudge with cajoling and by indirect means. The critics want a far more constrained and formula-driven Fed that leaves these economic decisions to the private sector and the market. They want the Fed to force the legislators out of their lethargy and into the role they have been assigned.

Age Difference as Far as Confidence Is Concerned
The consumer is not a general term although it gets used that way. The consumer is old and young, male and female. There are differences according to ethnicity and where the consumer lives—urban dwellers differ from those in the suburbs and the rural areas. One of the more important differences is according to age with the senior consumers a lot more confident in the polls than the younger consumers. Regardless of the survey, the older consumer expressed more confidence than the young, but the problem has been that this confidence has yet to translate into actual spending.

Analysis: The index for the older consumer improved by 44% over the last year. It is as high as it has been in 10 years, but actual spending has yet to show that surge. The older consumer continues to drive the majority of the big-ticket purchases, however. This includes cars and electronics as well as housing and leisure travel. The Millennial is the penny pincher, but one would be hard pressed to realize this by the way that advertisers react. The goal still seems to be appealing to the young despite the fact the young aren’t spending that much and ultimately have less to spend anyway. The Boomer is still the Boomer, and still has the belief that those with the most stuff when they die are the winners. The problem for retail is that older consumers already have most of what they desire or need. That forces retailers to seek new ways to motivate their engagement.

Movement as Far as Tax Reform?
The core of the debate over tax reform has hardly been overcome, but there has been some progress that might lead to reform by the end of the year or early next. The Senate narrowly passed a measure that allows the tax plan to emerge from its first phase. The system used is the same one the GOP tried with the revision of the health care law, but this time they got enough votes to pass. The next step will be to reconcile the Senate version with the one passed by the House—that will not be simple. The issue is the deficit. The fact is that few in the GOP are against tax cuts—the opponents to the plan objected to the expanded deficit and debt. They wanted to be sure that spending cuts were equal to the loss of revenue that would come from the tax cuts. The original idea would have added a $3 trillion deficit. The one that has emerged sees a $1.5 trillion cut. The threat that is hanging over all of this is the size of the national debt as the Congressional Budget Office asserts this debt will be up to $27 trillion from the current $15 trillion by 2027. This means a debt that is 91% of the national GDP. This is a level that has not been seen since the 1940s.

Analysis: There are far more deficit and debt hawks in the House than the Senate. These are the legislators who arrived as part of the Tea Party movement. They are still as concerned over debt and deficit as ever. They are not opposed to tax cuts, but they want this plan to be revenue neutral. That means that tax cuts have to be twinned to spending cuts. This is when it gets politically tricky as taking that kind of money out of the budget will mean going after some sacred cows like Social Security, Medicare, Medicaid and defense spending. These are the largest parts of the budget; accounting for almost three quarters of what the government spends.

The Democrats will try to halt cuts to the programs they support and there will be members of the GOP who will support some of these as well. Farm state legislators will oppose cuts to agricultural aid, those who are in export-oriented states will want to see their subsidies remain, while most are all in favor of some additional infrastructure activity to boost jobs in their states and districts. You get the idea. Cuts will be hard fought. If they are not deep enough, the revenue neutral crowd will not go along with the plan.

It has been asserted that the tax cuts will be stimulative—that they will help the middle class, but these are assumptions. The reduction in the corporate tax may well result in additional hiring and investment, but there is no guarantee. That tax cut could be siphoned off into stock buybacks, expanded compensation to owners and stockholders, mergers and acquisitions that aim at rivals so as to reduce competition. It can also find its way to international investment. Not that these moves are at all bad for the company getting the tax break, but if the purpose of the break was to punch up the economy, these moves are inhibiting to some degree.

This issue will likely play a big role in the coming election—especially at the primary level. Those legislators who support the plan will face opposition from deficit hawks that focus on debt. The Tea Party advocates are not as strong as they once were, but they have hardly vanished from the ranks of the GOP.

Animal Emotions
I suppose this is quite controversial. There are many who assert that animals lack the capability to express real emotions the way humans do. We are just engaging in anthropomorphism and ascribing our own emotions to them. I have never agreed with that position as I have seen some very real emotions from the animals that have been part of my world. I see them get angry and frustrated and I have seen them grieve. They show love and happiness, and they can get their feelings hurt.

There is a video making the rounds that will break your heart. It is of an older chimpanzee nearing the end of her long life. She is obviously fading and has withdrawn. Then she looks up and sees the man that once cared for her many years ago. He had long since retired from the zoo, but came back to say his last good-bye. She transformed as soon as she recognized him. She held on to him and patted his face and head. She even allowed him to feed her after having rejected food for days. If the look in her eyes was not love, I have no idea what else you would call it. She died a few days later, but was reported to be more at peace now that she had seen her old friend one last time.

I know I am a total sap when it comes to animals, but I have seen a lot of emotion from my cats over the years—enough to know they feel a lot and are very complex and caring creatures.