What’s Happening, Both Economically and Politically

October 2019 / Updated February 2020

Thought I would take a day and reflect on what is happening economically and politically, both US centric and globally.

I will start with what seems to be good, because good news never gets the same eyeballs or readers as bad news.

Seemingly good stuff in US:

• The unemployment rate is amazingly low, something like 3.7%. To put this in context, economists used to believe that a 5% unemployment rate was full employment, given normal turn over and velocity of markets.
• I believe that the average American feels this employment metric, regardless of what the party out of power says. The fact is, jobs have never been more plentiful.
• Interest rates continue very low, reflecting an amazingly low inflation rate. (This could also be a bad thing: see below). This helps the housing market, and therefore the consumer, who dominates 70% of the US $21 trillion economy. 
• Amazingly, from what I read, consumer debt has stayed in check, actually deleveraged from what it was going into the Great Recession. Maybe a reason for this is that consumer debt ain’t cheap. A normal person gets access to credit through credit cards and is paying in the 20’s. Pay-Pal gives you zero cost credit for six months and then wants to charge you about 25% if you miss paying the debt fully inside six months, even by one day, for the entire term of the debt. So perhaps the true cost of credit for consumers is what holds them in check. The exception is home mortgages, where the cost of credit is very low by historical standards.
• Job creation is strong, as reflected by monthly numbers, and also the unemployment rate. Literally, claims on all welfare type programs – food stamps, welfare, Medicaid (health care for the poorer) – are down from where they were a couple of years ago, in some cases, by double digits.
• All stock markets have risen this year beyond historical averages, though they are getting hammered this week. If you go back to October 2018, the market has been closer to flat. 
• The ISIS caliphate is dead, though it will continue in small groups and be around for a while. Removes a thorny national security issue fromthe table for the US.
• Afghanistan is a stalemate, US offensive operations are very few, and the Taliban are not going anywhere soon. There are 14,000 or so American troops in Country and Trump is talking about cutting the number by 50%.
• Iraq is taking on the personality of a Nation state. They’re weighing the interests of Iran and the US, and then deciding what is best for Iraq. Supposedly, there is much broader support for the existing government than at any other time since the War ended. The more Iraq understands its self-interests, and the more they pursue them, the better off is the world, in my opinion.
• California is a positive reflection on the full discussion of climate change. While the Federal Government of the US is acting passively, California is out front on this discussion as much as any Nation State, and the California economy is now the fifth largest in the world, after the US, China, Japan, and Germany. CA has turned itself into a sustainability lab. It is studying everything. It has made massive commitments and has enjoyed concrete results from mandating that electrical power be fully weaned off of fossil fuels well before mid-century. It now produces more solar and wind energy than it can consume, given the shortness of the technology with regard to storage and distribution. But scientific breakthroughs will reduce that wastage. Furthermore, there is very concrete sustainability activity going on throughout the US. So, while the US government is absent from this dialogue, and both its President and his appointees talk as if this is not an issue, their public positions do not represent what is actually going on in the Country. The sustainability field will be creating a huge number of jobs over the next couple of decades.
• One of the impacts of the spat with China is that Mexico is now the US’s largest trading partner. The numbers from the US census bureau show the first six months of 2019. The US exported $129 billion to Mexico and imported $179 billion. If you straight line annualize that, the US will export $258 billion, and import $358 billion from Mexico in 2019. The US trade deficit will be about $100 billion. The same source puts US/ China at a projected $334 billion US trade deficit in 2019, with total US exports of $104 billion, and total imports of $438 billion. (Canada is the US’s second largest trading partner, and China is now third.) I find this all quite fascinating. More or less, 30% of Mexico’s economy depends on US imports from Mexico. (And it must be added, sadly, that this does not include illegal drugs which, supposedly, is a huge number, probably adding 15-30% to the imports from Mexico.) But it is equally interesting that the US’s dominant trading relationships are in the Western Hemisphere, and the largest is one of the two huge economies of Latin America. Relative to China, the US exports to China of $104 billion are a rounding error on a $21 trillion economy, or less than a half percent. Chinese exports to the US make up about 3% of their economy. So, it is probably accurate that the US trade conflict with China will little affect the US, and not greatly affect China – except that those firms which are manufacturing in China for wage arbitrage can move elsewhere, such as Vietnam.
• Though we have enjoyed a very lengthy market expansion, the experts claim that real economic growth has been slow by historical standards, more so than normal expansions, and that there is not a great amount of excess in the market.
• Russia and all of those nukes. Take away the weapons and Russia is an economy about half the size of California. Russia has huge demographic problems. While the Russians clearly invaded the US political system, and will continue to attempt such interference, I think we are less a threat to Russia than two years ago. With Russia I worry more about their worries about us, than ours about them. 
• The Mueller Report did not bring Trump to his knees, so he isn’t going anywhere until possibly 2020. This is good because, if you don’t like Trump, you want him removed politically, by voters, not institutionally, by a Congressional cabal. The later would be dangerous. It is especially also good news for those who support Trump.
• The nearly automatic adjustment mechanism of the US economy. The Chinese, the Russians, the Japanese and all other planned or near planned economies almost always look great when things are on the upswing. But when everything goes to shit, which eventually happens during every economic cycle, these planned economies can’t adjust, because adjustment is dependent on human decisions, and the choices before humans during downturns are really ugly. In the US, the adjustments happen, they are very painful, many get hurt, but once accomplished the economy is refreshed and it starts cranking again, and much of the pain gets repaired. And so long as population is expanding, markets are increasing, technology is advancing, education is keeping up, the laws are enforced, and so forth it rises to a new level. 
• Do you get a sense that there is a lot of cash out there? Apple, $250B, Google, about $100B, Microsoft, about $125B, Berkshire, about $122B, and even Amazon, who shunned making a profit until a few years ago, is sitting on $50 billion. I suppose at first blush, this is a positive metric. But, on the other hand, it also means that these companies have few new ideas about how to deploy that cash, given that treasury bonds pay next to nothing.
• The ability to make yourself smart, and almost instantly. The data and information that is available with a key stroke has to be on my top five list of the most incredible things that have happened in my lifetime.

Seemingly good stuff outside the US:

• The world is generally free of armed conflict. What does exist is manageable.
• The Syrian mess seems near resolution. What comes now can’t be much worse that continuous fighting. Assad can’t stay in power without the Russians and Iranians. But Syrians will still be Syrians. So, the Russians and Iranians might get sucked into something that is costly and distracting.
• The advances in India and China sure look like the developments my generation dreamed would happen in that part of the world. These are the two largest population centers. For decades after WW II, they couldn’t even feed their people. (There was a time when the US owned over 100% of Indian currency caused by Indian payments for US agricultural products immediately after the partition of the sub-continent, and into the 1950’s. However, the agreement was that the US would not repatriate those rupees, and so it just remained in India, and most of it was reinvested in India as a form of foreign aid or in some other way.) Now, one of these is the second largest economy in the world and the other is pushing toward $3 trillion, the 6th largest economy in the world. Moreover, India is a huge democracy. And while China’s systems of government and economics does not mirror the West, they are more similar than could even have ben imagined in the 1950s and 60s.
• Better leadership regarding Climate issues than that coming from the top of the US.
• European economies seem to sort of muddle through. Some of their economies are not even understandable, such as Italy. Some are quite easy to understand, such as Germany. Something like 22% of the global economy is in the EU, or over $19 trillion. However, it happens, the trade relationship between the EU collectively and the US dwarfs that between the US and Mexico. 

Seemingly not good stuff in US:

• Businesses have borrowed a lot of money. At the same time, it is hard to imagine them doing otherwise given the historically low cost of money. But, business leverage on average is very high globally, and this is worrisome.
• Relative to the China trade issue, the bigger risk than the impacts on the US might be the destabilizing impact this conflict might have on world trade. This could become a very big problem.

• A US exit from Afghanistan will be like Vietnam in the 1970’s. We’ll leave with some kind of a deal negotiated between the US and the Taliban, pretty much ignoring the Kabul leadership, and then the Taliban will move back into positions of power. Unlike Iraq, it will likely revert to a Taliban dictatorship, and perhaps even the pre-modern form of government that existed before 9/11. Anything better than this would be a great victory.
• US Government debt is pretty much out of control. As Howard Marks said in an interview published in the WSJ this morning, “It is a general rule in markets and life that excesses correct.”  The US Federal Government political elite are acting as if debt and deficits don’t matter. 
• There is a lot of noise in the chatter between the US and Iran, and the US and North Korea. Iran is a serious country with 80 million people, a great many of whom are just as educated and market savvy as the folks in Europe. The sanctions are really hurting them. Something has to give, and when it does it may not be pretty. On the other hand, North Korea is probably less menacing now than it was two years ago. Their nuclear weapons are not going away. So, what is there to talk about? Kim is less a mystery man, therefore, less scary.
• Presidential leadership?? Depends on who you talk to. Domestically, after all of the chatter, this is a very conservative and rather conventional Republican Administration. They pursue little legislation because they have no interest in government expansion. They deregulate anywhere they can deregulate, because they don’t favor regulation. They worry deeply about the Federal judicial system and work hard to put true constitutionalists on the bench. That means, they don’t want courts legislating. They want courts interpreting existing legislation in terms of the US constitution. In this regard, this administration has been very successful. They work hard to stop government expansion anywhere, which is what the health care debates are all about. And they tend to ignore most of these parameters when it comes to Defense, where they favor expenses. Very few of these policies are driven from the White House. This is Republican establishment orthodoxy.
• Presidential leadership??? Social and cultural issues. The facts are, the US has become brown, and the trend in that direction was reported on a decade or more ago. The US has never been a country of a single ethnicity, religion, or culture. But, for a long time, immigrant expansion came from Europe. Slavery brought in Black Africans. California agriculture brought in Mexican labor. Railroad construction brought in Chinese. Universities brought in South Asian Indians. In recent years, technology has also attracted Chinese. The huge increase in commerce between the US and Mexico since NAFTA has greatly increased movement of Mexicans to the US. And so forth. This is just the way it is. The US has a great economy because of the mixture of the new and the old. This is the way it has always been. But in the past, the government did less to steer this development. However, starting in the mid 1960’s, the government passed law after law to level the playing field among all of these groups. Then, during the past twenty years, the Internet got dropped into this mixture, the world got flat, and you didn’t even need to immigrate to the US to enjoy its economy. I have written frequently that the Internet redistributed poverty as well as wealth. Many American people have been left behind who might have done fine in the 1950s. The Household median income in the US is now about $55,000 per year. Many of these people were not accustomed to economic struggles, thought they were following the rules. Trump, of course, has played his hand with these people and has told them, essentially, that they are not responsible for their challenges, that some other evil force created all of this. So, if you blame everything on global trade and immigration, especially illegal immigration, people are not going to seek out root causes that perhaps they could combat with education or other means. In addition to economic issues, there are huge cultural issues regarding religion and other social values. The US is a free society and people are allowed to choose their beliefs, consistent with the basic rules of our constitution and our laws. A lot of people are deeply offended by many of these changes and Trump implies that they are right to be offended even though there is nothing a US president can do about law abiding social change. In this sense, he has badly misused his pulpit, and no one knows what the consequences of this misuse will be.
• Presidential leadership?? International. To begin with, he has insulted most every country which has moved into his space. This could never be described as a good thing. But vastly more important is that Trump has put most of his conversations in the public domain, and this I believe is just stupid. Historically, experts in international relations have argued that negotiations must be done in private so that leaders are given an opportunity to compromise without their political constituency believing that they have been defeated. Trump has consistently violated this rule and has accomplished almost nothing internationally. When you examine the core issues the US has with China – heavy handed demands on US companies operating in China,  intellectual property theft, security threats, and a lack of fairness in trade rules and enforcement – one might think that the Chinese would find many different ways of accommodating US interests. (I mean, after all, we are the customer.) But how can they when Trump is playing out all of these issues in public. This is also so with North Korea, and also Iran. Too much prestige is at stake to fight these issues out in public. I think his form of public negotiation stinks. Otherwise, it is true that the US has not exercised its military might very much at all under Trump. It is true, regarding NATO, that the US said to its European partners, pay your bills. That wasn’t a negotiation, and things have improved, and NATO is probably stronger now that the Europeans had to actually consider the US backing out. 

• The inverted yield curve. So, the theory is that the smart money sees a recession, that is, the term “in the long run” doesn’t feel so satisfying at the moment. At the same time, a highly leveraged business sector might be rewriting short term debt into long term debt, to their advantage, presuming that there is a market for longer term corporate debt at a lower interest rate.
• Trump putting pressure on the US central bank. This is not new to Trump. What is new is doing it so publicly. 

Seemingly not good stuff outside the US: 

• Brexit??? In effect, the Brits don’t want a united state of Europe, with Britain simply being a state. This isn’t solely about economics, it is mostly about everything else, predominantly, culture and centers of political power. In the end, Britain may be less prosperous and less safe.
• There is a lot of turmoil throughout the economically advanced world, much of it stemming from the same factors I wrote about above with regard to US cultural and ethnic issues.

• Negative interest rates in Germany?
• The Venezuela situation. Surely, if any country were to feel spillover impacts from this it would be Colombia.
• India and Pakistan are at it again with regard to Kashmir, a 72-year-old problem. But over there, it has existential properties for both parties.
• Russia is the largest country in the world, with a relatively small economy, and an aging population of 144 million, half of the former USSR. It has military might that belies its economic strength, and no real way to put that power to use except as a defensive vehicle, which itself is not really a threat. The exception to this might be countries which were once part of the USSR. But Ukraine provides an interesting example of what Russia can and cannot do. They could occupy Crimea, which had very shaky historical roots as part of Ukraine, but not do much else. And this in a country where Khrushchev was born, and a place with a very significant trading relationship with Russia.

Summary:

On balance, these hardly look like the worst of times.

Not only has the world become flat, it has become smaller.

Yes, there will always be a very real threat of a non-nation group getting their hands on a nuke and destroying half of New York City, London, Moscow, Paris, or Beijing. Or the threat of a national leader who is insane, and not able to be controlled by the sane people around him/her. For my mind, I don’t eliminate Trump from this possibility. And loose nukes will remain a problem forever.

And yes, the Chinese or Russians might take down the entire US electrical grid, but I am not sure they could do that without exciting a massive retaliation with nukes, and they know that. Any way, if China brought down the US who would then be their biggest customer?

Many of the real threats are about what might happen in the future, as opposed to what might happen next month. In this regard, I would put climate change and fresh water near the top. After that, I might put disposing of waste, all forms of waste. However, conquering these problems is more likely to bring the world together, than to separate us.

One might argue that the world is on the verge of WW III, that if you look back to 1913, as WW I was developing, one can imagine similar factors existing today. I’ll disagree for one major reasons: the fantastic, incredible and unimaginable expansion of global communications. It was easy to miscalculate when you knew practically nothing about other countries other than what your diplomats and spies could uncover. I don’t think people appreciate how much we know today about each other that would have been unimaginable in even the 1960s.

After climate and fresh water, I might list the spillover costs of technology. We will need to get a handle on this. Forecasters argue that millions of jobs will be lost. Blockchain technology, robotics, artificial intelligence, software manufacturing processes (The API world), cloud computing and other such developments will have a huge impact on what is produced, how quickly it is produced, and how inexpensively it may be to start a new set of processes. Thus, either we simply don’t understand and don’t know of the jobs that will replace the lost jobs, or we are in need of huge cultural changes, such as a time where the whole concept of work might change.

So how does an investor look at this world and act on it? Today I read an interview the WSJ did with Howard Marks, a smart guy, and a guy respected by Buffett. I found it interesting. My read of his interview: who the hell knows?

But, as I look at the world, it reinforces a world beyond prediction, and perhaps even forecasting, and maybe even to a degree, conventional economic modeling, and to a small degree, maybe even beyond conventional wisdom, such as that regarding government deficits. Flexibility would seem to be the order of the day. No bets unless you can afford to lose all you bet. 

Yes, we will eventually have a recession, perhaps one bigger than average, and it could happen tomorrow, or not for two of three years, or more. As I write, now in February 2020, we are worrying about a coronavirus and the market has dropped about 2000 points so far this week. 

Yes, governments will have a harder time responding to a big downturn because their powder is far from dry, having used so much to keep the expansion going. If we slip into a recession, Powell doesn’t have much ammo with which to work.

Yes, a lot of highly leveraged companies globally will have e very tough time.

Yes, the world competition for jobs and labor will not lessen so richer countries like the US better figure out how they are going to address this reality with the losers in their societies. If they don’t, they could have a lot of intense social conflict on their hands, if not elements of revolution.

Yes, the entire world will be brown, and whites will become a minority race sooner than ever, given the size of China, India and Africa, and the mixed-race populations of Latin America. Indeed, using the term brown is really not a color, but a mixture of races.

Yes, democracy may be regressing somewhat around the world, as well as capitalism, as many seek a more perfect system. But, at the same time, India’s economy might be bigger than China’s several decades from now. All it would take would be one very large economic recession for China and an inability to adjust, such as Japan in the late 1970’s, for China to stall out, and India to drive right by it. Not likely, but possible.