Brief Notes on the US Economy
• No End in Sight for Coal – If there is a public enemy number one for those that are concerned about climate change it would have to be coal. There is a desire to reduce the world’s dependence on all fossil fuels but coal is the fuel that contributes most to the greenhouse gas issue. The problem is that burning coal is still the most common means by which utilities generate power and the tension between the two sides of the debate has been intense. In the simplest of terms, the efforts to reduce coal use has driven the price of coal up and that drives the price of energy up to the consumer. As eager as people are to support climate change policy there is concern about ramping up the price of heating and cooling their homes and providing energy for the production of goods and services. As is always the case – people want their cake and to eat it too. The fact is that choices have to be made and there are consequences that will make people most unhappy.
• The Biden Shift – This has not been a formal policy declaration and will likely never be. The US (and the rest of the world) labored under the opinion that China could be made to change. This has been a mantra that has been trotted out over and over again and is based on an assumption that everybody in the world wants to live in a system like ours. They don’t. The assumption was that China could be pulled into the democratic/capitalist orbit through a combination of carrot and stick. The sense now is that China will never change and will never change its goals. It is just as determined to expand its presence as the US. The implications for economic policy are that the focus shifts from trying to get China engaged and towards building the US economy from within. That means more domestic support and more focus on allies that want to do business with the US.
• Time is Running Out – We have made our positions on the debt ceiling pretty clear over the last several weeks. In the simplest of terms, it is a political move that places the entire US economy at risk. There is nothing at all wrong with debating the core issue facing the US – spending far too much without adding the revenue to support it. The debt the US has built is absurd and must be controlled. This is not the way to do it. If this is basically a shot across the bow to demonstrate the need to come to grips with this it might be justified. If this is a tactic designed to appeal to a hard-core base and to attack political enemies it is idiotic and destructive. We have two weeks and can only hope that an end to this crisis comes soon.
Brief Notes on the Global Economy
• Taiwan Asks Bluntly for Help – The government of Taiwan has now set a date as far as the Chinese threat is concerned. Days after the massive incursion into their air space the Taiwanese government has declared that they believe China will have the ability and desire to invade and occupy the ROC by 2025. Many analysts assert that China has that ability now. Taiwan wants assurances of defense and not just pious pleas for China to cease and desist. They want tangible help and it would start with the stationing of foreign troops on Taiwanese soil in sufficient numbers that an attack on the ROC would mean the deaths of these soldiers. It would be one thing to stand by and watch China invade and quite another to stand by and allow hundreds of soldiers to be killed. Taiwan wants commitments from the US, Australia and the UK (the new alliance) and has hinted it would want troops from Japan and South Korea as well.
• The South Korean Balancing Act – The US has hinted that it would like to see South Korea become a closer ally in the contest with China but that puts the South Koreans in an awkward position – both politically and economically. There is a great deal of trade between the two nations and even more investment activity. Politically the focus is North Korea and the South Koreans depend on China to restrain the ambitions of the Pyongyang regime. If South Korea turns its back on China the retaliation would hurt the economy and could also mean that North Korea would be given the opportunity to attack the South in a very direct way.
Another Record Trade Deficit – Is That Bad?
The gap between what the US sells and buys widened again last month. In July, the trade deficit was 70.3 billion and now it has widened to $73.3 billion. This is a record – surpassing the one set in June of this year when the gap was $73.2 billion. This month featured $287 billion in imports and that is also a record. The burning question is whether this is an altogether bad thing. A second question is whether anything could or should be done about this imbalance. As with all good economist responses, this one depends on one’s perspective.
Analysis: In the simplest of terms the consumer benefits from these trade deficits and many producers and manufacturers do not. The consumer is getting access to the goods and services of the world and at lower prices than might be available if these were produced domestically. The overwhelming majority of the imports that come to the US are consumer goods – things like toys, electronics, furniture, clothing, foods, pharmaceuticals and so on. We also import heavy machinery and tech. The reality is the US treats the world as its shopping center and businesses all over the US seek the best and cheapest alternatives. The majority of the benefit of trade goes to the consumer but deficits are not universally bad for the manufacturers. Those that are trying to compete directly with the operations overseas will be the biggest losers but many manufacturers take full advantage of those global prices by importing the raw materials and parts they need.
The reason the US is now staring down this record deficit is relatively easy to explain. The consumer has ramped up their spending over the last several months and the demand for these products has been impressive. Then more so because there have been more than a few inhibitors at work. The supply chain has been in shambles and still is. At this writing it has been reported that over 80 container ships are stuck off the coast of California unable to dock. These ships are carrying thousands of containers with loads destined for the Christmas season and there is serious worry they will not be distributed in time. To a degree, the supply chain disruptions have been adding to the deficit issue as companies are now routinely ordering more than they really need as they fear they will not be able to get the material later. The polite word for this is stockpiling but it is actually hoarding and although it is a logical response to the situation it only makes the matter worse as it perpetuates the shortages and that feeds inflation.
There are a few other elements of the trade deficit issue to consider before deciding if it is a bad thing. The first is whether the level of exports have been falling and they have not. The US is still seeing gains in the level of exports to other nations even as the US consumer gobbles up the products from other nations. The US has been dominant in the export of everything from food to technology and machinery and the reality is that when other nations sell to the US they have the money to buy the things the US produces. A second point is that increased appetite for imports has been very good for a whole host of industries that are aimed at the consumer – everything from the retailers that sell the stuff to the companies that transport it, warehouse it and otherwise distribute it.
What, if anything, needs to be done to address the issue of a trade deficit? A starting point would be to focus on the real issue. It is not that the US imports too much, it is that the US exports too little. The majority of companies in the US focus almost exclusively on their home market as it is easier. Getting into the global stream is complex and expensive (at least at first). The US lends some assistance to companies seeking a global market but not as much as many other nations. The export sector in the US accounts for roughly 15% of the GDP but the share of the German GDP accounted for by exports is well over 50%. The US could do a lot to balance trade by promoting exports and defending the ability of US companies to sell in other markets. Limiting imports ends up hurting consumers and compromises US manufacturers that require these foreign made products. Expanding exports allows consumers to benefit as they have and it gives manufacturers and others new opportunities. In the end we don’t mind if we spend a lot of money in another country if they turn around and spend that money on US goods.
The Biden Trade Policy
The statements from the US Trade Representative Katherine Tai were fluent and eloquent and revealed next to nothing. It is easy to see why she has been so good as a diplomat and attorney. It is hard to tell exactly what she has in mind for trade policy or what differentiates the Biden plan from the Trump plan and that may be the point. China is seen as a rival to the US by Biden and no longer a partner. This is tricky given the amount of business done between the two nations. The intent of the new policy seems to be to keep pressure on China to take in more goods from the US and to limit their opportunities in the US but without doing damage to the US economy.
Analysis: One aspect of the plan worth noting is the reintroduction of the exemptions. The most consistent complaint from US companies has been that tariffs have been placed on products from China that have no equivalents. The US buyer can’t source from anywhere else as nobody makes what they need so they are forced to pay that tax and pass it on to their consumers. The fact is that tariffs are a tax on the consumer of that product and that means that it is American businesses and consumers that pay for these tariffs. In a perfect trade world, there are alternatives to the items that are hit with a tariff and US buyers can switch but too often that is not an option. The challenge is to provide an opportunity for US producers to make the needed items without leaving consumers of that product stranded during the transition.
Energy Crisis Deepens
As is always the case a great deal of economic forecasting depends on assumptions and we all know the joke that “assume” makes an ass out of “u” and “me.” The assertion from the central banks over the last year has been that inflation will calm as commodity prices returned to normal levels. The assertion has been that these prices only rose because the producers had been caught unprepared for the surge in demand. Once they adjusted and caught up, the threat of inflation would recede and that is why inflation has been considered transitory. Suddenly a wrench has been tossed into the works by energy – a development that is all too common. The combination of expected and unexpected factors has driven the price of energy to higher levels than anticipated and the markets are getting more than a little nervous.
Analysis: The price surges have rippled throughout the world with the most dramatic taking place in Europe. A recent contract for gas in the UK increased by 40%. Natural gas prices in Europe have been soaring by over 500%. The price per barrel of oil is surging right past the expected boundary of $80 a barrel and could be headed to over $100 if the producers do not step up output and thus far there has been a refusal to do anything of the kind. OPEC and Russia have decided to stick with their current production plans despite the high prices as they still insist that demand will fall in the coming year. This may indeed be a self-fulfilling prophecy as the higher prices for energy will indeed slow economies all over the world. The factors involved in the price hikes are varied and largely unexpected. The output from wind farms in Europe is only 20% what was expected, gas from Russia has been blocked as Russia tries to leverage the situation, US LNG is being sold to Asia and not to Europe and there has been some improvement in consumer demand as economies tentatively recover.
The inflation fear is now gripping all the markets. The expected pattern is what worries the investment community. The inflation triggered by the energy crunch will reach levels that central banks can’t ignore. The assertions of interest rate hikes by the end of 2022 or early 2023 are abandoned as the need to react becomes obvious. Rates could then rise as early as early 2022 and that changes the dynamics of the market in a hurry. The era of easy money was always going to have to come to an end but the expectation was that the Fed and others would be able to “taper” rather than have to slam on the brakes. If there are a series of rate hikes in the near future the markets will undergo a major set of corrections as there are a great many radical bets out there that depend on low interest rates. This kind of financial meltdown is just what Fed hawks like Esther George and Loretta Mester have been warning about for years. The concern revolves around the fact that many investors have been taking advantage of the very low rates to borrow cheaply, invest heavily and assume they can pay that loan back with the proceeds. If the rates jump this pattern will be much harder to repeat.
Latest Word from the Russians
The statements coming from Russia have started to calm the markets a little but now there is worry that the efforts will not match the rhetoric. Vladimir Putin has declared that Russia will seek to stabilize the energy markets and that implies that Russia will turn on the spigots and ship more gas and oil to market but this is something the Russians and OPEC declared they would not be prepared to do just a few days ago. Part of the issue of gas shortage has been the refusal of the Russians to ship the natural gas promised through either the Nordstream 1 pipeline or the Druzhba pipeline in the south. Russia wants Europe to give approval for the second Nordstream project and has been holding gas hostage to a degree. Is there a catch to the Russian promise to stabilize? Most analysts think so but thus far it is not clear what that catch might be.
Analysis: The markets have reacted positively to the news but there is a note of caution as most want to know if the OPEC states will follow suit. The issue is actually more complex than just supply. The problem is as much a transportation and distribution issue as anything else and that has no immediate solution. The crucial question is still demand. The producers are willing to add capacity but they want to see what real demand looks like. Will the consumer resume the behavior seen earlier this summer? Will the daily commute return in the US as people start to come back to their offices? Thus far the national average has been just over 30% but is much higher in places like Texas (at over 50%) and lower in states like California (less than 20%). The financial crush of 2020 still resonates with the energy producers and they do not want a repeat of $16 a barrel oil and massive untapped inventories. It is almost an economic game of chicken as everyone waits for the other side to blink. Investors are betting on one side or the other and have been making their own decisions based on their opinions.
Armada Strategic Intelligence System Starts to Show Some Weaker Numbers
The most recent data from the Strategic Intelligence System is showing some signs of weakness as the pandemic threat reignites around the world. This is consistent with many of the global economic assessments released lately. The projections are still showing progress but it is not as robust. Check this out for yourself, the latest issue has been released. Your two-month trial is absolutely free – no obligations at all. Simply go to www.asisintelligence.com and engage with us. We continue to tweak the report with every issue – adding the content that readers have requested.
For those that like their bad news in a graph – here you go. These are radically high prices and even if the current crisis fades it will be a while before they come back to what might have been considered normal.
What We Are Watching – From the Black Owl Report
Global Energy Crisis in the Offing? We have a much longer article about this in today’s brief, but there will need to be some significant policy changes or other dramatic steps taken to safeguard consumers and corporations this fall/winter because of a pending energy crisis. The hardest hit markets will be in Asia and Europe as energy shortages have already started to flare up. But this “contagion” could spread around the world based on a variety of factors that have perhaps created the energy equivalent of the “perfect storm”.
Three Joys of Aging
A conversation with a contemporary proved enlightening. He and I are now pushing past the time when many retire. Neither of us has plans to do so but both of us know that we have reached a point where that decision could be made for us. On the other hand, we have discovered three advantages. The first is that we will likely not be around to confront the world’s problems a whole lot longer – these will be left to other generations. On the other hand, we have been around long enough to know that we have survived many emergencies and many worse than now. We are the generation of Cold War angst – the knowledge that nuclear annihilation was real. We are the generation of the Vietnam war, decolonization, Earth Day, racial injustice on an even more epic scale. Lots has changed in seven decades and not all for the worse or for the better. We seem to have gained some perspective.
The third and perhaps the most important observation is that we learned what is of real value in all this chaos and we know just how lucky we really are. I have a truly remarkable wife and lifetime companion, the most talented and honest business partner one could hope for, a loyal and patient woman who has been putting up with the “Armada boys” for two decades. I have a house full of cats, true friends, stepsons and grandkids and great grandkids that I treasure along with their spouses. The stuff that matters I have in abundance and I just have to remind myself of this when I get annoyed by the day to day.