Issues, News and Views
SEMI-ANNUAL REVIEW - THE WORLD ACCORDING TO CHALPREM
2018/07/26 - Herewith we present our semi-annual review of and prognostication for the United States economy as well as geopolitical implications of and for the world around us.
Let's get this out of the way first: The economy is very strong. The economy grew at an annualized rate of 4.1% in the second quarter even with a 1% drawdown in inventories. If inventories had been neutral we would have seen 5.1% growth. We can expect a bit of a snap back in the third quarter which should provide economic tailwinds.
Other indicators of underlying economic activity continues to look strong in July as well: Factory Orders, Independent Business (NIFB), Purchasing Managers (PMI) and Supply Management (ISM) surveys all look good, as well as the regional Fed surveys - Atlanta, Empire, Philly, Chicago and Richmond all meeting or beating already solid expectations.
And the job data looks good too: continued job creation north of 200,000 per month, weekly jobless claims hovering at historic lows, more job openings than job seekers, and rising wages.
And that's where we being to see issues: rising wages, rising interest rates, and rising prices, especially oil prices.
There was no escape from Stalag 13, and there is no escape from the law of supply and demand. Whether you look at demand for workers, for money, or for oil, eventually demand can exceed supply and that sows the seeds of recession. The economy gets a head of its skis, and needs to slow down - a deceleration - or else it does what in technical economic terms is referred to as a "face-plant", or more colloquially amongst layman, a recession.
The Second Quarter GDP update reported a price index increase of 3%, Employment Situation reported wage increases of near 3%, the Philly Fed in its survey reported rising producer costs, oil blowing through $70/bbl, and of course tariffs on imported goods - all these statistics and factors telling a story hinting at inflation.
We are not predicting recession or runaway inflation - at least not yet. But it does seem that we are rather close to a tipping point.
Rather, we are imploring Federal officeholders and policymakers to cut government spending. The combination of an overheating economy and excessive deficits and debt make now the best opportunity ever to cut spending and reassert fiscal discipline that was lost in 2008 when the Democrats took control of the White House and Congress. But it's an election year so don't bet on even Republicans never mind Democrats showing any kind of fiscal spine.
The price of oil has been rising steadily for the past year, from $45 to $70/bbl. High oil prices almost always presage a recession. How high is too high? It's hard to tell, but $75/bbl is probably getting kind of warm. Some prognosticators - possibly just talking their book - are talking $100 oil, and that would definitely be a danger signal.
What about the global economy? It was interesting to see China report a decline in industrial production. Last week the June production was just a 0.36% increase over May, bringing the 12-month Year-over-Year down from 6.8% to 6.0%. Was that a one-month wonder, or part of the trade spat with the USA, or part of a larger cyclical decline? Too early to tell. But it's something to keep an eye on.
Also of note is the price of copper. We saw copper spike earlier in the year due at least in part on labor unrest in Chile, but hit 1-year lows last week at about $2.67/lb, down from $3.27 only six weeks ago, a plunge of nearly 20%. Is this a one-month wonder, or indicative of sagging global demand? It's too early to tell.
But on the other hand there is the Baltic Dry Index, the spot shipping rate for dry bulk materials. It hit 4-year highs last quarter above 1700 - is that indicative of growing global trade, or more likely, a rush to ship whatever wherever before tariffs kick in, followed by a plunge? Again, it's something to keep an eye on.
Tariffs are not something we have talked a lot about over the past few years, but that issued suddenly flared up over the winter just as we issued our last semi-annual review.
Chalprem is an advocate for free trade, and for fair trade. China has been conducting a trade war against us, and we have gone too long without responding. Good that we have a President with a spine, too bad Obama didn't have one, and that Bush was obsessed with Al Qaeda and not able to walk and chew gum at the same time.
We support President Trump's attempts to expand and improve trade, because that is in fact what he is doing. Tariffs are not the end, they are the means to an end. The beach is the objective, the highway is how you get there. Nobody goes on a highway to indulge their love of asphalt. You use a highway to get to the beach, you impose tariffs to get other nations' attention and get them to the bargaining table.
It is unfortunate to see so many commentators criticizing Trump on trade. None of these critics make substantive arguments against Trump's position that we are being cheated; nor do any of them offer constructive suggestions on how to achieve more fairness and freedom in trade. All they do is make personal attacks on the President.
But the best thing to do is to ignore the specious comments from the leftist media that reflexively opposes anything Trump - if 45 says the sky is blue, our media calls the President names and insists the sky is green.
Now, the question truly is, how far will China go to advance their predatory mercantilist "we-win/you-lose" trade agenda? Will they accept a "win/win" arrangement, because that is what President Trump is insisting upon. Are the Chinese willing to pull back, or are they willing to risk a two-way "lose/lose" trade war?
President Trump has made clear to President Xi that the USA will no longer accept a "we-lose/you-win" arrangement, and China's response has mostly been "Oh yes you will". And that is the black swan that faces markets and the economy over the next six months. Will Trump offer a face-saving opportunity to China, or does China even want one?
China is not as invulnerable as our leftists would like to make it seem. They have their issues with debt, unemployment, social unrest, regime opposition, and so forth. You hear that China will bury us because they graduate so many engineers; but then you also hear that so many of them cannot find employment. But don't expect to find a statistic on that coming from the Communist government.
Also, while there may seem to be a calm with North Korea, it may be the calm before the storm. Chalprem expects neither side to be honest about their true intentions, and it would surprise us not if invasion arrangements are being finalized even as the tariff smokescreen smolders.
But for the time being the issue to watch is China and its response to open up on trade - will they come clean, or will they continue to their trade war? Will the EU and the US resolve their differences and stand united against Chinese cheating?
We shall see...
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