Brief Notes on the US Economy
• Welfare State on a Shoestring Budget – It has become nearly impossible to strip the hysterical rhetoric from economic and budgetary conversations. Both those of a liberal bent and a conservative orientation have abandoned debate in favor of name calling and this is likely due to the deep division between economic positions (as well as social ones). The liberal desire is for something that resembles the welfare state capitalism more common in parts of Europe. This means extensive government engagement in the economic welfare of the population and was once exemplified by the Swedish system. In simplest terms it meant lots of social services paid for by very high taxes. The conservative position has been to keep taxes very low and to limit the role of government when it comes to economic support (but highly interventionist when dealing with social issues). The provision of extensive benefits requires revenue and the US population seems to want its cake and to eat it too. Polls suggest the benefits are popular but taxes to pay for them are not.
• Another Fed Resignation – Robert Kaplan – Dallas Fed President – has resigned his post and that makes two regional heads stepping down early. The resignation of Eric Rosengren was not unexpected although it comes nine months sooner than required by his age. Health issues seemed to determine his decision but Kaplan seems to have stepped down over the controversy stirred by his stock trades. His actions apparently did not violate any specific rule that applies to central bank officers but there was an assertion that there was still a hint of the inappropriate. This is an unwritten rule that suggests that central bankers remove themselves from anything that might call their objectivity into question. Kaplan had been a somewhat reluctant Fed President as he spent most of his career at Goldman Sachs and it now seems that he grew weary of the limitations.
• The Political Drama Drags On -At the expense of the overall economy. Those worried about the impact of the debt ceiling debate have been as sharp and threatening as they can be. The markets are now reacting in a negative way as there is the sense that the powers that be are willing to send the economy into crisis to prove a political point. Democrats refuse to decouple their demands regarding infrastructure and Republicans refuse to allow normal operations to resume while the bigger debates continue. It is a game of political chicken where the victims will be the people and businesses and investors – not the politicians playing the game.
Brief Notes on the Global Economy
• Japan’s LDP Opts for the Status Quo – For the last few weeks it looked like Japan’s Liberal Democratic Party was going to be bold and name a leader that was popular with the voters, had the support of the younger political generation and was something of a maverick but in the end Taro Kono was not able to gain the support of the majority of LDP members. As has so often been the case in Japan, the candidate of the status quo prevailed and the next Prime Minister will be Fumio Kishida. This means a continuation of policies such as close ties to the US, monetary and fiscal stimulus and beefed-up defense against China. The social issues that Kono championed will be put off once again.
• Sweden Set for First Female Prime Minister – The current Finance Minister for Sweden has become the new leader of the Social Democrats and that ensures that she will replace Stefan Lofven as the PM. Magdelena Andersson will soon take control of the center-left coalition that has been governing the country and she has wasted little time in outlining priorities. The explosion of violent gang warfare has been the number one issue for voters and she has pledged an aggressive effort but nobody quite knows what this will entail. The violence has been extreme and has included bombings and shootings. The most immediate challenge is getting the budget passed and arguments over this issue could still split the coalition and make it harder for the Social Democrats to actually govern.
Energy Prices on the Rise
The volatility of the energy sector has been on full display for the last couple of years. In 2020 the prices fell dramatically – to levels not seen in decades. At one point the price per barrel for oil was under $20 as demand fell. The lockdown essentially killed everything from commuting to air travel and even shopping. The prices started to recover as the economy reopened but the surge in demand that took place at the start of this year overwhelmed the producers and there was a shortage sufficient to jack prices back up. In the last week the price per barrel of oil has hit levels not seen in over three years and there is speculation regarding further hikes. The price of natural gas worldwide has spiked by over 500% and there is worry over whether Europe and parts of Asia will have enough to provide heat this winter. What happened to lead to these shortages and when might this situation start to correct?
Analysis: The heart of the energy crisis this time lies in the natural gas shortage. The price per barrel of oil has been rising in part because utilities are substituting oil for the very expensive LNG they had been using. There are four dominant factors as far as the price rise in Europe – some economic and some more overtly political. At the top of the list is simply the unexpected demand created by a rapidly recovering economy in Europe. Just as was the case with the US at the start of 2021, the consumer has come out of their pandemic-inspired hibernation at a rapid clip. Europe was a bit slower than the US but by the start of summer the growth numbers were impressive and demand was far more robust than had been expected. If the usual availability of natural gas had been in place this surge would not have been much of a problem but supply was interrupted for a variety of reasons and demand was more than could be accommodated.
The vast majority of the gas consumed in Europe comes from Russia through two pipelines systems. Nordstream 1 is in the north of Europe and there is a pipeline that stretches through Ukraine into southern Europe. This is the Druzhba (Friendship) pipeline and it has been irregular and controversial from the start as relations between Russia and Ukraine have not been remotely friendly. Russia wants a second Nordstream pipeline but Europe has been dragging its feet on the needed approvals and it now appears the Russians are exerting pressure by restricting the levels of gas coming into Europe. The US had promised to help Europe reduce its dependence on Russian gas by providing LNG but these shipments have been inadequate because the majority of the LNG coming from the US has been sold to Asia where the prices paid have been higher. Europe had also been getting gas from North Africa and the Middle East but the turmoil in Libya, Algeria, Iran and Iraq has severely limited supplies.
These are not the only complications. Europe invested heavily in wind generated power with the expectation it would substitute for the use of fossil fuels and up to this year the wind farms were doing their job. This year the wind has been quieter than usual and generation has been a fraction of what it normally is. The other alternatives have been unable to keep pace and that has left the region that much more dependent on fossil fuel. At this risk of trotting out another tired phrase, this has been a perfect storm as far as energy shortage is concerned and solutions are months away.
The price of natural gas in the US has started to rise as well but not to the levels seen in Europe and Asia. The price for oil has also risen as utilities turn to oil over LNG. The expectation is that oil will end up in the $80 to $90 range for a period and gas will see a similar hike. That adds to the inflation concerns that have evolved in the last few months. The Fed continues to assert that much of the inflation seen is transitory as they expect commodities prices to fall. It is obvious that some of these prices will fall (and some already have) but this kind of energy crisis will stall the decline in some of these commodity prices.
Supply Chain Changes
The supply chain crisis has been apparent and has dominated conversation for months. We all know the primary issues by this time. There has been a surge in demand that took suppliers by surprise and that has combined with all the limitations imposed by the pandemic. There have been port closures, shortages of truck drivers and so on. There is one other major factor that might be playing a much bigger role in the future. The consumer is demanding different things and they are changing their habits on a permanent basis.
Analysis: The pandemic created a massive demand for products that had never seen that kind of attention – everything from hand sanitizer to masks. It has taken the suppliers some time to gear up. As people have been limited in terms of their service sector spending, they have switched to buying things. There has been a great deal of hoarding activity as well. If people believe that others are buying the things they want they decide to load up before there is a shortage and that guarantees the shortage they were afraid of in the first place.
Businesses are deeply concerned about the supply chain and have lost their trust in the system. The estimates regarding reshoring are as robust as they have been in years. A survey of those that currently produce or source in China and elsewhere in Asia indicates that 69% are likely, very likely or extremely likely to reshore at least part of their operation and the number one motivation for that shift is the desire to simplify the supply chain. There are other factors involved in that decision, however. The companies that are considering the shift are those that have adopted robotics and automation as a way to compete with low-cost labor. The supply chain shift is not a temporary one, it is assumed the system will be broken for the better part of a year and that is long enough to force some radical rethinking about sourcing and production.
Europe on the Rebound
The recovery in Europe was a bit slower to develop than in the US but there are indications that European consumers are catching up fast. The consumer activity in the Eurozone is back to 2019 levels across the board and in most of the nations. People have resumed their restaurant and café habits; they are attending events and shopping again and retailers are now expecting a solid holiday season. The Christmas markets will resume and people are leaving their homes to circulate again. The lockdowns in Europe were generally more severe than in the US and there is even more pent-up demand in Europe than was the case in the US. In April of 2020 the percentage of people staying in their homes in isolation was close to 40% and today that percentage is less than 2.0%. People are returning to their workplace at a faster rate than in the US. The percentage resuming that work pattern in the US has been about 30% nationally (close to 50% in Texas and 20% in California) but in Europe it is nearer 60% (70% in some states). Schools have been reopened across the continent.
Analysis: The primary motivation for all this enthusiasm has been the high rates of vaccination and the subsequent decline in the number of cases of the virus as well as drastically reduced hospitalizations and fatalities. The vast majority of those that have been catching the virus have been getting a mild version due to the vaccination and the spread has been much reduced. The concerns regarding the economic rebound no longer focus on the pandemic but on factors that are more familiar in an economic sense.
At the top of the list of worries has been the broken supply chain. There are severe shortages of parts and assemblies that have been affecting producers all over Europe. Auto assembly plants have been idled due to lack of computer chips and other parts. Construction projects stall due to shortages of steel and even bricks. Retailers are unable to keep shelves stocked – even with basic goods. This has led to more hoarding behavior as consumers and businesses buy as much as they can get their hands on as they fear they will not be able to get it later. On top of the supply chain concern there is the increased cost of energy with natural gas prices soaring to all-time highs. The end result is a very significant inflation threat that has the central bankers talking about ways to throttle the money supply. The challenge is that economic recovery has just started and acting to slow things down to deal with inflation is not a preferred strategy at this point.
It is all coming down to the levels of consumer confidence and right now these are high. People have resumed their old habits. There has been a sharp increase in the use of mass transit and a dramatic increase in attendance at events. The business community has been contributing as well. Trade show attendance is up and so is air travel throughout the region. There have been some recent changes as far as US access to European travelers but Europe is still suspicious of those coming from the US. If there is one factor that can account for the resurgence of the Eurozone economy it is the rate of vaccination. Europe is now on the verge of herd immunity with vaccine distribution between 70% and 80%. The US remains behind with around 60%.
More Problems in China
There have been a whole series of energy related challenges for China of late. There have been rolling blackouts and brownouts that have affected the northern sections of the country – the region where the majority of the industrial activity takes place. These power outages have often come without warning and in several cases, there have been deaths and injuries as ventilation systems have been shut down and power has been lost to equipment. The blackouts often last for days and even weeks. There have been several factors contributing to this crisis.
Analysis: As with many other nations China has seen a surge in demand that has pulled more power than expected. Not only has the Chinese consumer become more active, Chinese companies are struggling to meet the demand from nations importing from China. The coal industry has not been able to meet the additional demand and has little incentive to do so given the fact the government restricts the money they are allowed to make. China has reduced the levels of coal production in order to meet their climate change demands and they have been unable to import as much as they would like due to political conflicts with coal exporters such as Australia and the US. The efforts to deploy alternative production has been slow despite the investment in solar and wind. These facilities combined only account for less than 7.0% of energy needs – coal accounts for over 70%. The higher prices for natural gas have had an impact on China as well and has forced the government to subsidize heavily. Rationing of energy is now common and this has resulted in much reduced industrial output.
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.
The issue of energy consumption in China has been building rapidly as the economy has expanded and the challenge has only accelerated in the last year. In order to maintain its position as manufacturer to the world, China needs its infrastructure and that advantage has been slipping.
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”.
For more like this go to www.armada-intel.com/trial
Dealing with the Arbitrary
The world remains full of arbitrary rules and regulations, demands and requirements. To a degree this is the price paid for efficiency and life in a common environment. There have to be some limits and boundaries set or life becomes a mob scene. On the other hand, it is frustrating in the extreme to deal with a barrier that only exists because of a bureaucratic decision. Today I set off to get my booster vaccine and dutifully went through all the paperwork before being informed I was two days short of the six months required by the CDC between the second dose of the vaccine and the booster. A wasted morning and now I am trying again in about two weeks. I looked up the rationale for the six-month period and there is none. It just seemed like a nice round number. The only issue is whether the vaccine caused a reaction and, in my case, (and my wife’s) it did not – not even a little one. There is no rational or logical reason to refuse the booster because I am 48 hours “early”. That is the nature of arbitrary.
We are willing to do things that make sense. When the logic escapes us, our willingness to comply diminishes. The trouble with most of the rules and regulations we encounter is that they are rarely rooted in logic and it is even rarer for the authorities to explain why these regulations exist. The result is that people become reluctant to pay attention to even the rules that do make sense as they have become skeptical. The assumption is that the rule was for the convenience of the bureaucrat or the result of an attorney’s advice and the natural reaction is to avoid it or ignore it. Unfortunately, that has meant ignoring ridiculous rules right alongside the rules that really do matter.