Business Intelilgence Brief: July 3, 2017

Short Items of Interest – US Economy


  • Forecasts Show Drop in Enthusiasm – The sense is that all those earlier expectations are now fading fast. Some of this is to be expected as it is rare that a new leader is able to sustain momentum for all that long. This is the origin of the first hundred days assertion. It is thought that the honeymoon for a new President is about 100 days and if there is not a lot of activity by that time the inertia of politics takes over. The forecast community has lowered expectations for the US economy due to the fact that little was accomplished in that 100 days and now the divisions in Congress have made it clear that nothing is going to be easy. The chances are now dimming as far as meaningful tax reform, infrastructure spend and deregulation.


  • Tiny Rise in Producer Prices – A gain of 0.1% as far as producer prices is concerned is certainly no signal of impending inflation but the rise – nominal as it was – was not expected. Most analysts held that the PPI would be flat this month as most of the commodity prices have been lower and there has been little evidence of increased intermediate part prices. For the year the PPI has risen by 1.9% and that is anemic, far less than the Fed would prefer. Their other measures have also seen some modest hikes but not enough to provoke any concerns at the Fed level. The inflation threat remains very subdued and is still not a factor.


  • Yellen’s Last Trip Before Congress? – Janet Yellen is before Congress again today as part of her annual duties. The law requires that she brief the good men and women of Congress and she dutifully does so. Is this her last trip? Her term expires in January of next year and there have been rumblings that Trump wants to replace her. She has not spoken about her future directly but has suggested that she would be open to another term. It should come down to what the overall financial community favors as has been the case in the past and they seem happy with her tenure. Removing her would be a purely political move and thus far there have only been the vague hints as far as who might become the next Fed head.


Short Items of Interest – Global Economy


  • Macron and the Trump Visit – The statements from Emmanuel Macron thus far have made it abundantly clear that he and Trump disagree on most things. They differ on issues such as climate change, refugees, trade and the importance of Nato. They do agree on Syria at least. A few months ago, Trump commented that “Paris was no longer Paris” due to the threat of militant Islamists. The French took exception to the remark and Macron has stated that he wants to show that “Paris is Paris” and plans an almost purely tourist agenda. The other focus of Macron’s interaction is to build some bridges with the populists in France. He cannot very well cozy up to Le Pen as she remains a virulent opponent – making nice with Trump could win him some points.


  • Five Elections in Africa – In the next few months there will be five important elections held in Africa and collectively they illustrate the challenges of democracy on this continent. Joseph Kabila in the DRC is refusing to even hold the one scheduled and shows no intent to leave. The elections in Kenya and Liberia will be hard fought and relatively honest – the winner will actually have to get the most votes and the polling should be mostly honest. The elections in Rwanda and Angola will be shams – show pieces for the current leaders who will claim support from 90% of the voters.


  • South Korea Worries About Trade Pact – Trump has been describing the current trade pact with South Korea as a job killer and wants it changed. That seems more and more likely given the enmity that has developed between Trump and the new Korean president – Moon Jae-in. Trump has been angry with his position on North Korea and is in no mood to offer concessions. It is thought this pact has no more than a 45% chance to survive.




Report from the Trenches

The latest edition of the Beige Book has been released. This periodic study from the Federal Reserve is derived from reports from the twelve Fed districts and is designed to provide something of a snapshot for the overall economy. These are generally put together with input from the Board each district has – local bankers and business people who can comment on what they are seeing. It is not necessarily a well-developed statistical analysis but the work of the staff at each bank works its way into the report. As one would expect there are specific issues and developments in each district but there are always common themes that provide some insight into what is happening throughout the country and this edition is no exception.


Analysis: The question that most want an answer to is whether the economy is growing and this report suggests that the answer is basically yes. It is not the kind of rapid and robust growth that had been hoped for and predicted at the start of the year but it is growth and it seems steady enough. The pace is about as it has been for the last several years – regional rates between 1.5% and 2.3%. There are pockets of the country that are seeing faster growth but by the same token there are parts that are not growing much at all. The factors that have been leading to faster growth include a predictable surge in tourism and travel in various parts of the country and an improvement in export numbers. The dollar has lost a bit of its strength and that has allowed better overseas sales – especially to those parts of the world that have been experiencing growth of their own. The nascent European economy has been giving the US a boost and that will continue to provide opportunities for regions of the US that have traditionally relied on that market.

A second theme that emerges in the report is that most of the country is trying to contend with labor shortages and in a wide variety of sectors. We have harped on the issue as far as the manufacturing sector is concerned and we have likewise detailed the labor issue in construction and transportation. The data from the Beige Book makes it clear that there are labor shortages in a host of other sectors such as health care, IT and some of the professions such as finance, law and accounting. It would seem that there is a major gap between those who have education and training and those who don’t. The unemployment rate for those with college education is less than 2% and for those without a high school diploma the rate is 7.4%. Those who remain unemployed now are those who lack skills and training and education and this is one of the reasons that the very low rate of unemployment has not yet pushed wages up faster. The people who would normally be demanding higher wages are not out there. Business usually uses higher wages to recruit the people they need but when the people they need are simply not out there is no reason to offer higher wages. No business is going to overpay for somebody who lacks the skills needed to do the job.

A third theme that emerges in the examination of the Beige Book is an overall lack of inflation. There is very little price pressure showing up anywhere. The usual motivation for inflation is commodity pricing and wage hikes and thus far there has been little evidence of either. Oil prices may be staying in the $40 to $50 range for months and perhaps years. This used to be the factor that drive inflation fast. The farm commodity prices are down and so are metal prices. The bottom line is that commodity prices are low and likely to stay that way. The wage hikes aren’t happening either as discussed above. Without inflation pressure there is little or no reason for the Fed to be in a hurry as far as hiking rates. The latest testimony before Congress by Janet Yellen said as much. Unless and until the rate of inflation rises there is no pressure on the Fed to hike and the rate increases will be moderate.


Gamers Stay Out of the Workforce

This is one study that will doubtless be challenged in the months to come. It is either going to confirm the suspicions of those who are fed up with millennials or it will provoke a spirited set of denials. The basic assertion of the study from academics from Princeton, Univ. of Rochester and the University of Chicago is that video games are drawing off a substantial portion of the male population and keeping them out of the workforce. The study purports to show that these young men are indeed living in their parent’s basements and spending nearly all their lives immersed in some kind of video universe. They are not getting jobs and they are not getting additional training or education.


Analysis: There is some disturbing data in all this. It seems that 15% of young men who are not classified as students are not holding a job and in 2000 the percentage was just 8%. Of men between the ages of 21 and 30 the number of hours worked fell by 12% between the years of 2000 and 2015 as compared to a reduction of 8% for men between ages of 31 and 55. The researchers have concluded that video games and on-line activity has accounted for between 26% and 46% of that decline. This is indeed a bit of a leap as there may well be other factors related to the slow growth of the economy but there is certainly reason to be curious.

The basic scenario is that young men (far more than young women) are drawn more deeply into these virtual worlds and end up sacrificing everything else to the experience. The social psychologists have been commenting for years that these on-line experiences are replacing real world interactions and creating a generation of people with minimal social skills and communication skills. They have been isolated from the world for so long they have not learned how to interact with anyone else. The study opens up a lot of possibilities and poses questions that will take a long time to puzzle through. It has always been a concern and now there is some evidence that this is having a significant impact on the economy as a whole.


Has China Ended its Deleveraging?

The powers that be in China were deeply worried about the state of the financial system at the start of the year and in April the banks tightened their credit considerably – trying to dry up that liquidity, At the same time the government installed a new and far more aggressive regulator who went after the banks hard with a flood of new rules and interpretations. The effort was a major success – almost too much so. The Chinese have elected to reverse course and move towards boosting the financial sector and by extension the economy. The central bank has injected some $53 billion into the system in the last few days and the regulators have indicated that they will relax somewhat. The lenders in China have been in a real quandary for months as they have been short of cash and have no idea what they were supposed to be doing. There is still a great deal of confusion within the banking sector as nobody knows when the leadership might want to reverse course again. The goal is some kind of happy medium but that has proven to be very hard to achieve as the tendency is to overshoot in one direction or another.


Analysis: Analysts who had been trying to determine what the Chinese were after assert that the deleveraging effort was not well enough understood and that Chinese authorities were shocked at what the policies triggered. It was assumed that the deleveraging effort would play out slowly and deliberately but that is not what happened. The effort to back away from the debt crisis was so dramatic that it nearly triggered the outcome the policies had been trying to avert. The regulatory part of this was far more influential than had been anticipated as banks really did not understand what they could and could not do. They essentially froze and that just about shut down the whole economy. This is what has prompted the retreat and the sudden flow of stimulus but now there are worries that this might be too much and that it will cause problems akin to the ones that existed a few months ago. Fine tuning an economy the size of China’s is anything but simple.

In the immediate aftermath of the efforts to deleverage, the banks started dumping short term bonds at an accelerated rate – causing the government’s short term bond yield curve to invert. The impact was more dramatic and severe than had been expected. Most analysts think the current strategy will be short lived as they assert that China remains most concerned about financial stability and deleveraging. Some of those measures to control the debt crisis will likely reappear but in a far more controlled manner. For now, the idea is to get the banks to some semblance of normal but with an eye towards keeping them from getting carried away. The crux of the ongoing crisis is that regional banks have a very hard time turning down the requests from local and regional governments and these entities are focused on projects that create jobs and they are far less worried about whether these projects are profitable or financially secure.


What Did Russia Expect to Get From a Trump Win?

The “Russia thing” has preoccupied the press and political Washington for months and for all kinds of reasons. There are certainly real issues of national security involved but the motivations of many of the actors are considerably less exalted. The Democrats see a weakness they can exploit and the media sees a story line that attracts viewers. One of the questions that has not been explored in any detail is what the Russians sought to gain. If they favored a Trump win – why? What did they hope to gain? Is it working out as they had hoped?


Analysis: The focus for Russia has been the sanctions imposed by the US and Europe after Russia intervened in Ukraine and essentially backed the division of the country. The war in Ukraine may have dropped out of the media headlines but it is still raging in many parts of Ukraine. Russia’s economy is not in good shape – it has been in recession for the last three years and there are few that see a recovery any time soon. This is a commodity based economy trying to cope with a collapse of prices in all the sectors they rely on. These sanctions have hurt the economy and Putin wants them to go away.

During the campaign last year, it was obvious that Clinton was going to emphasize her experience as Secretary of State until she became endlessly reactive to everything that Trump threw at her. Russia knew full well that she would be an aggressive adversary and that she backed these sanctions fully. Her advisors were all essentially former Cold Warriors and hostile to Putin. Of the options Russia favored almost anyone over Clinton and as they have done since the 1920s they did what they could to push people away from the candidate that was least helpful to them. It has been standard strategy for Russia and the USSR before it.



The Black Owl Report – An Executive Intelligence Brief

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I was doing a presentation last night to a group of business people and in conversation with an old friend I learned a bit about the way he named his latest venture. It is called Mustard Seed and it is in the business of helping companies grow and develop new markets. He put an immense amount of thought into this name and it ties back to his religious faith and the notion of growth and so on. Very impressive – especially when compared to what transpired with the creation of Armada.

The idea was essentially hatched in a bar after a few beers. We (Keith and I) really had our doubts as to how successful this would be and we were a little cavalier about what we would start with. We had visions of a suite of companies under one umbrella and we were going to name these sub-units after clipper ships (Sea Cloud, Endeavour, the Hoogly). This was prompted by the fact there was a big picture of a ship over the bar. Armada seemed appropriate for a fleet. The logo still looks like something out of Harry Potter with the owl representing my wisdom and the falcon testifying to Keith’s aggressive approach (or something like that). We had our doubts as to how long we would last and if we had known we would be around 17 years later we might have given this more thought!

This is the point I suppose – we never really know what a decision will lead to. Most of the time it is far different than we intended – we just have to learn to roll with it.


These are parts of the commentary that appeared in a recent Black Owl Report.  We invite you to start a one month trial subscription so that you can see the variety we offer in this publication.

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What Might China Want? – The crisis that has been created in North Korea is much more complex than has been assumed. The bottom line is that North Korea moved a step closer to being a real threat to the US but is not there yet. The missile tested can hit the US but they lack the ability to put a nuclear warhead on it. The reality is that there is time to react and that means engaging China. They can stop Kim in an instant if they want to. The question is what will make them want to. The Trump approach thus far is to threaten and that doesn’t seem to be working. What would China want to engage in stopping Kim?


It is possible to overestimate the influence of China. Realistically they are not in a position to simply wade in and remove Kim from his position. He has loyalists and has built a solid base of people that follow him blindly and would not support such a Chinese invasion. The Chinese would have to squeeze him and be somewhat subtle about it. It will take time but the fact is the North Korean economy is wholly dependent on China and even Kim knows that.


There are likely four things the Chinese would want from the US and the other engaged states if they were to get involved with forcing real change in Pyongyang. The first and most obvious is reduction in economic pressure from the US. They do not want to hear any more about currency manipulation and unfair trade practices. They want an end to the US effort against China being named a market economy by the WTO and they want an end to threats to impose tariffs such as the one being discussed over steel. China wants the US to back off of these and other economic issues.


The second demand would be an end to US engagement in what China considers to be sovereign territorial issues. This is mostly in reference to the South China Sea but would also include the dispute with Japan over the Senkaku/Diayou islands. The Chinese are bent no claiming control over the South China Sea and the US has opposed this


The third demand is a little less urgent but can be a bargaining chip nonetheless. China is engaged with nations all over the world and many of these are not popular with the US. They would like less pressure on states such as the Sudan and Venezuela and other places where China has invested to get hold of raw materials and oil.


Finally, China wants to do more direct investment in the US but is sometimes thwarted when the acquisition is considered sensitive. China wants these restrictions eased if not eliminated. It is not that China expects to get all of this but they see little reason to risk anything in North Korea without getting something in return. What is certain is that China will not respond to bellicose threats and intimidation as they know full well that they have all the leverage.


Giving in on the first two would be very high profile and it is unlikely the US would be willing to stage such a climbdown but the latter two adjustments could be made with very little fanfare and would allow both nations to save face as they moved closer to containing the North Koreans.


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