Business Intelligencec Brief: July 10, 2017
Short Items of Interest – US Economy
• Yellen Resists Congressional Calls for Reform – It seems like such a good idea until it doesn’t. There have been those in Congress who believe that the Fed needs the wise guidance of our elected officials. The same people who have run up both a record debt and deficit and are preparing to shut down government in September as they can’t work out a budget. Specifically, the call is for the Fed to set arbitrary mathematical goals and limits and be required to explain to Congress when and if they plan to deviate. The problem is that mathematical formulas can be concocted for a wide variety of economic and financial situations and they always fail at some juncture when the assumptions they are based on change. It is not that the Fed has not made mistakes but no other system will be foolproof and those that are being suggested are far less flexible when a correction needs to be made.
• Jobs in a Slow Growth Economy – The jobs data was better than expected but this is not to say that all is well. This kind of low unemployment rate should have triggered sharp wage hikes and inflation by this time but it hasn’t and analysts point to two prime factors. The first is that employers can’t find the people they need with the skills required and so they are not hiring at all. Even if they are willing to pay more there is nobody they want to pay. The second and related issue is that business is not seeing the kind of growth that allows speculative hiring. Most companies have the staff they need now and would only start hiring if they anticipated more activity in the near term.
• Governors Lead Fight to Preserve Medicaid – At the heart of the debate over what to do with reforming health care is Medicaid. To advocates this is the lifeline for the poor and they wanted to see the expansion under the ACA preserved. To those who do not like Medicaid it is emblematic of all that is wrong with welfare in the US. It is a system that discourages people from working and preserves dependency. The battle is both economic and ideological. The real opposition to the GOP plan now seems to be coming from the GOP governors who are facing the real brunt of the issue. Thus far 16 Republican governors decided to expand Medicaid under the ACA and they are fighting the repeal and changes.
Short Items of Interest – Global Economy
• French Tax Cuts for the Wealthy – The Macron administration advertised itself as pro-business and most of the plans for French growth rely on greater expansion of investment and entrepreneurial activity. To that end the government is discussing tax cuts as soon as 2018 but the challenge is getting that money into something that bolsters the economy. The wealthy tend to be passive about their cash and they do little additional spending and they do not necessarily invest in growing their business. To get that money to work will require some tricks to direct behavior and these are hard to predict.
• Shinzo Abe Drops in Popularity Polls – The future of the Japanese Prime Minister is now in doubt. His ratings have plummeted to levels not seen since 2012 with only 36% approving of his rule and 58% against it. His government has been hit by scandals and his economic gains have been elusive. The electorate seems ready to make a change and there are those in his own party who have their own ambitions. The most likely challenger would be Yuriko Koike. She is the governor of the Tokyo region and has been essentially the opposition leader. She is a populist in many ways and has a no-nonsense reputation.
• Germans Attacked Again for Fiscal Rectitude – The world wants the Germans to spend wildly and run their debt up to record levels. This would be good stimulus for the struggling economies of Europe. This is a bit like looking at one’s frugal neighbor and demanding that they run themselves into crippling debt to buy you a new pool. The Germans would rather not cripple their economy so that spendthrift states can spend more money and this becomes the bone of contention for the IMF and many in the EU.
Did We Learn Much from the Latest Jobs Report?
This is really a pretty silly question as we always learn something. Even if there is no real change to the data we learn that the economy is stable as compared the previous month and if there are gains or losses we get a sense of what is trending in the overall economy. A better question is whether the data is a surprise or not. This month there were expectations of a mediocre number of new jobs – somewhere near the numbers that we have been seeing since the start of the year. Instead the gains were more robust – the best month of the year so far. What does this mean? With unemployment as low as 4.3% where did all these additional jobs come from?
Analysis: There are three important takeaways from this month’s data. The first is that 222,000 jobs were added when the expected rise was nearer 140,000. The second major change is that the unemployment rate moved up slightly to 4.4% from last month’s 4.3% and the third important piece of data is that wages have not been going up as much as would be anticipated with jobless numbers like these.
The first two observations are somewhat linked. When one sees the number of jobs increasing at the same time the rate of unemployment is going down there is a shift taking place within the ranks of the unemployed. Those who had been categorized as “discouraged workers” are starting to find job opportunities. This is more than a little important as these are people who have been unsuccessful looking for work sometime in the last twelve months. Many have been without work for over a year. When this group starts to find employment, it is a signal that companies are starting to get more desperate. The people who have been unable to find work are “employment flawed” in some way. They may lack relevant skills, they may have a less than desirable work history, they may be older than would be preferred by the business community and so on. The list of reasons to be essentially frozen out of the system can be long. Right now, the business community seems more amenable to hiring people who will need training and people who may not turn out to be the most reliable people they could hire. This has meant that the U-3 unemployment rate has been climbing a little and the U-6 rate has been falling – people are shifting out of that discouraged worker category.
This pattern may also be a factor as far as wage growth is concerned. Those who are being hired out of the discouraged worker category are not likely to command top wages and salaries. Their entry into the workforce is offsetting the pay hikes that have been offered to those who have the needed skills. The lack of wage growth has been a growing concern for many. To be blunt the economist really doesn’t care all that much about how many people are employed if these are jobs that don’t pay all that well. The interest is in how people function as consumers. This is what drives the economy after all. The consumer sector accounts for some 70% of the national GDP and provides the majority of jobs. If the consumer is denied a significant level of disposable income the whole economy starts to get sluggish. Low paying jobs produce limited consumers.
There are several trends emerging that could make this issue even worse. As companies struggle to find the workers they need they begin to find alternatives. The manufacturers look towards robotics to handle the work that people did in the past. Fast food restaurants turn to self-service options for the patrons in order to reduce the size of the staff. Then there are those promises of self-driving cars. We have been pumping our own gas for years and the on-line shopping option is reducing the need to hire clerks at the retail outlets. This steadily eliminates jobs and that tends to lower the pay available for those who lack the skills needed.
One other factor as far as hiring is the number of people that are opting for retirement. Given that almost 4 million Baby Boomers leave the workforce every year there is a need to replace them but the new hires are not going to be making the money these workers once did and they may never get to that level given the way the work world has changed.
How Isolated is the US?
The G-20 meetings were every bit as fractious and tense as expected as the majority of those in attendance were doing their best to shift Trump’s position on trade. The tactics ranged from cajoling and pleading to threatening. It all came down to the position these countries have tried to maintain with the US. It should also be noted there was more than a little hypocrisy given the position many of these states have adopted in the past as regards access to their own markets. China is busy promoting itself as a free trade model despite many years of protectionism, dumping, subsidizing and manipulating. There has long been criticism of Japan when it comes to regulatory barriers and Europe has consistently blocked US farm exports with the Common Agriculture Policy. The truth is that every country has engaged in some level of protectionism at one time or the other.
Analysis: The real worry is that the US may be abdicating its role as the world leader on trade issues. This has been something that has been taken for granted for years and not always for the most altruistic of reasons. The US has been an open market to the world for years and that has been good for the nations that seek opportunities in the US. It has come at the expense of domestic industry in many cases but the policy has also been very good for the consumer in the US as it has allowed access to cheaper goods.
The US has also used trade and access to the US market for a wide variety of other purposes other than economic growth. In many cases trade deals were developed in order to cement strategic alliances or to bolster allies in certain parts of the world. Access to the US market was not granted out of the goodness of anyone’s heart – the US got something in return.
Who Leads if the US Chooses Not To?
The issue was not what the US has done or intends to do. This has long been the focus for meeting like that of the G-20 or G-7 or Nato or any of the other high-level sessions involving the US. The issue now is what the US will not do. The sense of the meeting is that the US under Trump is pulling back into an isolationist and protectionist posture but even that assessment is flawed to some degree. The US has adopted an anti-globalization posture and that has affected trade relations but at the same time there is far more bellicose rhetoric coming from the White House as regards North Korea and the issue of terrorism. There are more troops moving into places like Afghanistan, Iraq and Syria and new locations for US engagement keep popping up. It is simply not clear what the US intends and that became a topic of intense debate among the other attendees at the G-20 meeting.
Analysis: Analysts are deeply divided as far as which nation assumes the mantle of leadership should the US continue down its current path. None of the other contenders have anything close to what the US has in terms of resources but they may try to act collectively. Germany has been emerging as the champion of the traditional policies towards trade and economics as well as the defender of the global approach to issues such as climate change. They have been joined by the major economies in Europe (France, Italy and others) and have garnered support from other major trading states like Japan and China. What this really means is anybody’s guess as Germany is unlikely to throw open its doors to imports in the way the US did. Those that would replace the US in terms of leadership are all export centered states and simply don’t have the capacity to absorb the influx as the US has over the years. Remember a few years back when the emerging market states were asserting that they could trade with one another and would no longer need the US market? That lasted less than a year before it became obvious that Brazil, Russia, India and China (the original BRIC states) couldn’t generate nearly enough demand as compared to what the US could offer.
The US has abdicated its role in issues such as climate change and a number of other global concerns. In truth, the US has long been somewhat reluctant to get out in front of these issues as it has always had more to lose and has always been concerned about the fact India and China were not being asked to make the adjustments the US and Europe had. Still, the US stayed engaged and now is pulling back. China appears ready to take a leading role but they have massive internal issues to overcome first. Europe has been on the forefront as far as laws and technology and could play a bigger role as well. It is also important to note that the US may have pulled away at a national level but remains very active at the local and state levels. Corporate contributions are as robust as ever given that many think this remains good for their business.
That leaves the issue of global security and the US has not indicated a withdrawal at this stage. If anything, the US is more engaged than ever with threats aimed at the North Koreans and promises to get more active against the terrorist groups. The problem at the moment remains a lack of an overall strategy and the reluctance to work with allies that share a common purpose.
Steep Slide in Manufacturing Jobs
The boost that came with the expansion of the auto industry has come to a screeching halt and that is affecting the entire manufacturing sector. According to a new study from the Brookings Institution 39 of the 100 largest urban areas in the US lost manufacturing jobs since 2015. It further points out that 45 of these cities specifically lost auto manufacturing jobs. The pattern is not unusual and the culprits are the same as they have been.
Analysis: The first issue is demand and it is off in the automotive sector. All that rapid growth of the last two or three years has slowed although it has not really reversed. The issue is that carmakers are scaling back from the expansion they underwent when demand was peaking and that means reducing third shifts and other moves. The more consistent problem is that robotics keep advancing and replacing the workers that used to do these jobs. There has been little capacity change as far as auto production in the US – even as Mexico has gained more jobs. The capacity has been draining from Canada more than it has from the US but in the US the plants are shifting to the southern states and the modern ones use far more technology and new systems than in past year and so do all the companies that have been supplying the auto sector. The decline in these jobs tends to hide the fact that manufacturers need more skilled workers and now struggle to find them.
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We are finally getting a taste of what much of the rest of the country has been coping with. Thus far this year my region has been somewhat wetter and cooler than usual. Not that it has been San Diego weather but it had not really hit the mid to upper 90s yet and by the fourth of July one used to be able to count on that heat. This week we will flirt with the century mark.
I am not a big fan of heat – tried to tackle a monster of a weed patch over the weekend and soon felt like a wet dish rag. This was once supposed to be a patch of boysenberry plants and became an overgrown mess. I am not yet done but at least I can see the berry plants again. As I limped back to the A/C I realized my tolerance is not what it used to be. As I ran an errand to the hardware store I passed a baseball game in full swing and golfers on the course opposite the field and just marveled. I no longer call being out in the heat an enjoyable experience. The cold doesn’t bother me that much although I like the idea of curling up in front of the fire.
I wonder when I lost this tolerance. In my younger days, I painted houses for a living, it is how I got through graduate school. I spent a lot of time in the heat of summer and never seemed the worse for it. I have become soft I suppose but I can’t say I am eager to regain that ability.
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Thoughts on Dairy Trends – From a Pro. I had two fortunate conversations over the past four weeks, and I wanted to share one of them with you. We were doing a project for a construction company that wanted to look at target industries in the Midwest. One of the areas that we were exploring was the dairy sector, and I made some comments about trends in the Nebraska region. One of my friends, Dave Kurzawski, and I traded notes. He gave me permission to share some of his insights on trends in the dairy sector with you, which is a treat – he’s one of the leaders in dairy sector analysis and trends.
I had made a comment that Nebraska has lost nearly 70% of its small dairy farms over the past 15 years and yet, it still had too much milk. And despite this trend, I wanted to know why milk prices were still surging significantly. Here’s what Dave offered to enlighten me (which it certainly did!). “The Midwest, to your point, has a lot of excess milk. The West not so much- around 30% of our Butter and Skim Milk Powder is made in California (which is also about 20% of our US fresh milk supply). The Midwest is cheese country. And when you can buy discounted milk every day, you don’t run pepper jack or provolone – you run base commodity cheddar and put it away. And that’s what is happening here. We have what looks to me to be discovering new inefficiencies in the dairy market in which (1) the Midwest has become the darling of US milk production and (2) we could use another 10 million lb. per day processing plant here.The other thing to remember here is nonfat dry milk or skim milk production in the US.
Over the past decade, any meaningful bull market in dairy started with milk powders. Processors skim the fat off and dry it down and sell it domestically (and to Mexico mostly). But China loves milk powder and they love to import it (see melamine issues in China circa 2007/2008). If you have money in China, you’re buying imported food. So the dairy industry moved not so quickly towards powder production. It took nearly a decade, but now we have some 7 or 8 new powder manufacturers coming online in the US. Back of envelope, these plants can take in about 13-16 million lbs of milk per day. That may not mean much to you, but it’s a lot of new powder capacity. Particularly at a time when it’s fat – not protein – that is HOT. Now you may ask, “if they skim off the fat, the fat has to go somewhere, right?” Yes, but it doesn’t have to go into butter that is traded at the Chicago Mercantile Exchange (which itself is a narrow spec). Higher fat deserts and other food items, ingredient use are big pulls on the skimmed off cream. Also some of the fat is staying in the fluid milk. People are drinking more Whole Milk nowadays. I can get the number for you, but Whole Fluid Milk for drinking demand is up around 4% every month consistently since 2015. People want the whole product.
Cheese also absorbs more than twice as much fat as butter. It’s not something you usually think about until you run the numbers, but if cheese is absorbing 50%+ of our milk, then it’s also absorbing about 50%+ of the fat too. The final kicker is that the butter market rally is really driven in large part by a material uptick in global demand for butter and fat. The prices in EU are the ones that preceded this rally in US butter. The price of butter in France right now is nearly $3.00/lb. New consumer trends, this love of fat is part of it. Milk supplies were also a little more snug in 4 of the 5 major dairy exporters over the past year (EU, NZ, AU, AR, and US). Of the 5, the US was the only country to show positive milk production year-over-year. So the way I see it is that the US dairy farmer is benefitting from the problems in production abroad.”