Monday, June 26, 2017

Strategic Global Intelligence Brief for June 26, 2017



Short Items of Interest—U.S. Economy

The Volatile World of Durable Goods
The latest durable goods numbers are presenting analysts with the same dilemma they always do. The expectation was that there would be a modest decrease in the level of durable goods orders—maybe a reduction of 0.4%. Instead there was a much steeper decline of 1.1%, but as is often the case, the issue has been aircraft sales. These dipped for the second straight month; the decline here was steep. Last month, there was a drop of over 31% in orders for military aircraft and an 11% drop in orders for civilian aircraft. That decline is in evidence this month as well. If one strips out the aerospace orders, the overall data doesn’t look all that bad, but neither is it improving. The impression is that manufacturing has stalled to some degree, but not in every sector.

Massive Tax Change Proposed
Part of the House Republican proposal for tax change has not gotten as much public attention as one would have expected, but it is clear there has been considerable behind the scenes activity. The plan would eliminate the deduction that businesses can take on interest paid on debt. This has been the key to finance at almost every level of business. Big companies leverage debt as it is cheaper than relying on equity financing; farmers use it to get through until harvest. The fact is the U.S. system is weighted towards debt and a big part of this strategy is the ability to write off some or all of the interest paid. Changing this could be a $1.5 trillion-dollar change.

Banks Pass Stress Tests
The stress tests that have been mandated by the government and the Federal Reserve were designed to identify issues far enough in advance that they can be dealt with before reaching a crisis level. In the wake of the financial collapse, many banks did not pass these tests as they lacked sufficient capital to back their obligations. Since those bad old days, the banks have changed enough to comply. None of the major banks had any trouble passing the tests this time around. By this measure, the financial sector is in better shape than it has been in years.

Short Items of Interest—Global Economy

Italy Bank Rescue Under Attack
The banking system in Italy has been teetering on the edge of crisis for years and was reaching the point of no return. The Italian plan to bail out two of the largest banks in the country has evoked a lot of antagonism in the European Union (EU). The plan breaks the pattern that had been set by the European Central Bank (ECB) and EU and weakens the effort to avoid future taxpayer bailouts. The state will provide 17 billion euro to wind up these banks—that is a taxpayer bailout. The ECB argued against the move, but the options were just not acceptable to the Italians. Now the EU is more or less back to where it was when it first started to try to deal with Greece. Other nations will certainly look at this as permission to do much the same as Italy just did.

Labor Shortages in Eastern Europe
Economic expansion has been compromised in much of eastern Europe as there are simply too few people to build these economies. There are at least three important factors. The first is that these are older populations and demography is catching up. The second is that too few have the appropriate education and training. Third, the people who would be the next generation have been leaving in droves to work elsewhere in Europe while few people make the trip in the opposite direction.

Canadian Rate Hike Less Likely
There had been an assumption that the Bank of Canada (BoC) would hike rates, but the latest inflation data has made that less likely. The subdued numbers take the pressure off the BoC. That will give the doves a bit more ammunition to make the case that in the wake of low commodity prices, the Canadian economy still needs help.

Why Protectionism is Not Such a Good Idea?
The Bank for International Settlements has become the latest global financial player to add its opinion to the conversation regarding trade and protectionism. The comments by the chief economist are as strong as any that have been released thus far by the likes of the OECD, IMF, WTO, World Bank and so on. Claudio Borio was quoted as stating that “rolling back globalization would be as foolhardy as rolling back technological change.” This is a very interesting and telling comparison as both globalization and technological change would be at the top of the list as far as economic disruptions responsible for costing millions of people to lose their jobs. There is often fierce opposition to both of these developments and there are many who would forcefully advocate slowing or stopping both the process of globalization and the advance of technology. The fundamental question is whether this would be good for the overall economy of the countries involved as well as the world in general—the old argument of “the greater good.”

Analysis: The standard argument for increased attention paid to globalization as well as technological innovation is that consumers benefit greatly from both of these advances. The consumer is given access to imported (and usually cheaper) goods from all over the world through trade, and technology is always pointed towards making their lives easier and more efficient (at least that is the theory). It is quite evident that both trade and technological advances have a downside for some and in many cases a very serious downside. The person who sees their employer fail because they can’t compete with the foreign import will lose their job and so will the person whose job is now being done by a robot.

Is the consumer advantage large enough to offset the damage from job loss? At a macro scale, the answer is yes. The consumer is the anchor for most every economy and certainly for the major industrial states. The consumption of goods and services accounts for more than 80% of the U.S. economy and this activity accounts for a like percentage of the jobs. It is simple math to note that if people have more money to spend on these goods and services, there will be more economic opportunity. This can be accomplished as people make more money, but the price of those desired goods and services matters as much or more. If the price rises, the consumer will be able to consume less—this is the threat that has always been posed by inflation. The connection between inflationary pressure and trade has always been close. It has been the same story with technology. The availability of less expensive imported goods and the advances in technology are largely responsible for the lack of inflation. If there was to be a dramatic reduction in imports and technology was to be restricted, the price of goods would shoot up and the impact on the consumer would be severe.

In the great scheme of things, an inflation threat is far more dangerous than a recession. It has been a long time since the U.S. really suffered a severe inflation—many have forgotten (or never knew) what it feels like. Everybody is affected as everyone tries to catch up with the higher prices. The average person watches their whole lifestyle erode as they can’t afford the prices. Those with the least leverage are hurt most as they can’t do anything to improve their income. The average recession hits some parts of the economy really hard, but others are essentially unaffected and may even benefit as prices are falling in response to the reduced demand.

The bottom line is that restricting trade is a bad idea as it has very negative impact on the economy as a whole. It is also very apparent that expanded trade and the expansion of technology cost many people their livelihood. That is a not an insignificant problem. At the moment, it would seem there is a solution just waiting for the powers that be to take action. For over a decade, the manufacturing community (as well as construction, transportation and many others) has complained bitterly that they do not have the workers they need. They assert that in a few years, the crisis will be acute as their older workers retire. Millions of jobs remain unfilled and there are millions who have been laid off. Is it that hard to determine that the solution is to train those who don’t have jobs to do the jobs that are available? Not that this is an easy problem to solve, but if ever there was a good use of government money, this would be it.

Is India Ready for This Reform?
Narendra Modi has been nothing if not bold and aggressive when it comes to long-awaited reforms. His determination has been lauded by some, while others simply assert that he is being bull-headed and unrealistic. His massive currency reform was expected to be an unmitigated disaster, but it turned out better than even the supporters had hoped. The next round of serious reform is the imposition of a nationwide goods and services tax designed to get the whole country on the same page. The opposition has come from a variety of quarters—the various states resent being excluded from the tax process and business has objected to the demands and the amount of paperwork involved. They will need to provide information three times a month and do all of this digitally despite the fact that even big companies are far from ready.

Analysis: There is general agreement that most of these reforms are necessary (although the states refuse to accept this as they have been milking the system for years). The issue for most is speed. They are afraid the system will devolve into chaos because there are too many parts that have been untested and companies have not been able to react in time. The Modi team responds by saying that this is always the excuse and there will always be demands for more time. This is considered stalling and the Modi deadline has been unchanged. The chaos will be dealt with as it appears. If India is able to pull this off, the power of the central government will be dramatically expanded. Doing business with and in India will be simpler as today there can be dozens of jurisdictions to contend with, which has made business expansion very hard.

The Economic Diplomat
The major critique of the Trump administration from the perspective of the U.S. allies is that it has been very hard to get a sense of what the policy is on any given issue. Trump has been incoherent at times and mercurial at other junctures. His campaign positions have been consistently altered as the realities of governing have become more apparent. The ferocious threats directed towards China have faded as the U.S. is taught once again what China can use as leverage. The promises to pull out of NAFTA have been replaced with assertions that some part of the pact will be changed and altered. The border adjustment tax proposal is facing significant opposition in Congress and so on. The alternating threats and promises have left allies with a sense of unease and confusion. That makes the most recent appointment to the Trump team all the more important—provided that he will be given the attention needed by them. Indications are that he will have a voice and the allies and enemies of the U.S. are expecting him to provide some clarity.

Analysis: The man that is being referred to as the economic diplomat is David Malpass. If confirmed, he will be Treasury’s new under-secretary for international. He is a former Bear Stearns economist and was part of the Trump transition team. He is not an economic nationalist and will side with Steve Mnuchin and Gary Cohn more often than not. His views are basically traditional Republican orthodoxy on trade and various alliances. He will be the point person for the rest of the world, but that hardly means that he will be able to set policy on his own. The important role he will play is as “chief explainer.” The allies (and enemies) have trouble figuring out what Trump wants from one day to the next as he contradicts himself often in those stream of consciousness tweets. It is obvious by now that Trump likes to vent and much of what is expressed is a reflection of what he is thinking at that precise moment and may not reflect the ultimate policy or decision. Malpass will be expected to put these comments in some kind of perspective so that the rest of the world can react appropriately.

At the top of the list of issues to address will be trade. The U.S. pulled out of the Trans-Pacific Partnership even before Trump took office, but since that decision, there have been many elements of the pact that have re-surfaced. Some of the other nations intend to go forward with a version of it. The U.S. has long been critical of some elements of NAFTA, but enjoys benefits due to other provisions. That new position will have to be developed and communicated. The U.S. will be building a new relationship with a post-Brexit U.K., but there is also a need to stay close to the EU and not be seen as taking sides in the coming set of negotiations. The U.S. needs to find ways to work with the Chinese and thwart some of their aims. India is a new opportunity and a challenge. There will also be delicate relationships with Japan and especially with South Korea under its new and more anti-U.S. leader. Malpass will likely be less public and more the advisor in Trump’s ear.

How is Trump Doing? Depends on Age, Gender and Other Factors
As always, there are profound differences between members of the voting public. People have differing attitudes according to their age and gender and where they live and how much money they make—among other things. The Trump administration is no exception as it has both supporters and detractors. The challenge for analysts has long been that people don’t have a real sense of who is responsible for either success or failure. Is their issue the president or Congress or the state they live in. Much of what transpires in the economy is out of the hands of a president and is more the purview of the Supreme Court or the Federal Reserve or any of the hundreds of bureaucracies in the government.

Analysis: Support for Trump breaks down by both age and gender with his best supporters coming from men over 50. Over half think the economy has improved and give him credit for it. Only around 43% of men under the age of 50 give him that credit. Among women, his support is weak with only around 15% of women under 50 asserting the economy has improved and that he should be given credit for this. Among women over 50, the percentage that thinks the economy has improved due to Trump is only slightly better at 40%. Of course, there are many other reasons for a voter to favor a given president other than economic attitudes, but as the 2018 elections near, there will be a lot of politicians remembering that “it’s the economy that matters” and these attitudes will play a big role in what transpires in the coming campaigns.

One Man’s Vacation is Another Man’s Work Environment
The next time I get on an airplane to fly to some exotic locale to deliver some words of (ahem) wisdom will be July 19. That is nearly THREE weeks of being able to sleep in my own bed, reintroduce myself to my wife and indulge in the attention of cats. To me, this is a vacation although I will be working and writing every day. I will be doing this at my desk and not in a hotel or an airport—glorious indeed. As I was completing the odyssey last week, I was growing more irritated and impatient with every passing day. It didn’t help that I was in Louisville on Tuesday, Albuquerque on Wednesday, Chicago on Thursday and Greensboro on Friday. It especially didn’t help that I arrived in Raleigh at 2:00am Friday morning and had to barrel out to drive an hour to Greensboro at 6:00am.

I do love what I do when I get there. I have an insatiable desire to pontificate and am always in need of strangers to afflict as my friends. My family just puts their hands over their ears and starts humming. It is the getting there that can make one question one’s choices. There are the tender ministrations of the TSA, the weather delays and those mysterious “mechanicals” that suddenly make connections a form of gambling. Hotels are generally decent, but they aren’t home (most suffer from a major shortage of cats). The biggest problem is that so much time is wasted in the process of moving about and I fall behind in all the other duties as assigned. Now, I have almost a month to get my act together and I am looking forward to that. I also have to confess that I will be enjoying more than a few evenings sitting on my deck and sipping wine at the end of the day!!! Now THAT is what I call a vacation.