US GDP numbers and Russian sanctions scenarios
The bottom line here is that I have been and still am bullish on the cyclical prospects in the US, UK and Spain in particular. The US jobless claims numbers are unusually low and that tells you that slack in the labour market is declining. Moreover, we are likely to see inventory builds here, adding to more momentum. Nonetheless, I do have two caveats for the US.
I had been planning on writing today about Russian sanctions only but the US GDP report was so intriguing I thought I would say a few words about it. Before I get into it today, I just want to remind you readers that I will not be publishing from 6 Aug to 13 Aug due to the summer holiday. Ok, let’s get to it now.
Over the past several weeks, I have been posting some fairly upbeat articles about the data coming out of the US, using terms like acceleration to describe the economy. And I think the Q2 numbers, with GDP coming in at an annualized 4.0% uptick, show why. Now, as great as 4% growth is, I do want to remind you of my baseline position here. I’ll draw out some highlights from the last two months that will give you the gist of what I have been saying and still believe, even after such a stellar number.
- More on US growth acceleration in 2014 (27 May): “I am still pointing to Q3 2013’s 4.1% as a high water mark for growth in the US. And remember that this was followed by a 2.6% number for Q4. That’s well over 3% for one half year, due in large part to inventories. Even if you get 3.5% for Q2, the average with Q1 at –0.7% is well below 2% growth, the number I am calling trend growth in the US. In fact, if the US economy grows 3% for the rest of the year, that gets you to about 2% real GDP growth for 2014, much lower than the 2013 second-half trend.”
- Recalibrating after the 1% fall in US GDP (29 May): “Where I come out of all this is that the US is still in a 2%ish growth phase for 2014. The Q1 numbers were dragged down by weather and are not reflective of the underlying trend. I expect the US economy to pick up from Q1 but 2% growth for 2014 is not robust, it’s middling.”
- The continued expansion in the US (19 Jun): “Despite my concern over releveraging and increased household debt in the face of low wage growth, I believe the cyclical recovery in the US will remain intact for some time to come. The latest jobless claims numbers give a further boost to the economy…I think this is where the cyclical versus secular trends diverge and what makes understanding that divergence important. Policy makers have consistently shown that they are most concerned with cyclical trends in economic growth, employment, and inflation. Before the Great Financial Crisis, there was almost no concern amongst policy makers about secular issues regarding debt, leverage, and wages, which have proven to be the most potent forces in retarding growth. ”
- Where are we in the economic cycle? (24 Jun): “After a number of years of stall speed growth, the US economy seems to be breaking out, even as the Fed has turned toward a tightening bias. As this cycle continues, we should not underestimate the ability of the US economy to continue moving forward. But we still need to ask where we are in the economic cycle to gauge how to react. After 5 years of recovery and expansion, I tend to think we are nearer the end of the cycle than the beginning.
- Accelerating recovery in the US, Spain and Britain (2 Jul): “Overall, the picture we are seeing is employment growth now of 200,000 to 300,000 per month. Strong output and new order numbers in manufacturing and middling increases in personal income and wages. I believe this supports 3%+ growth for Q2 and Q3 but no more than 2% growth on average due to the lack of wage growth and weakness we have seen in retail sales as a result.”
- More on the accelerating economies in the US and the UK (3 Jul): “On the cyclical front though, it’s all positive. In the US, non-farm payrolls increased 288,000 jobs in June, the most since January 2012. The unemployment rate fell to 6.1%, the lowest since 2008. David Wessel noted that over the past 3 months, job growth has averaged 272,000 per month. Meanwhile Eric Burroughs noted that the private payrolls 3-month average of 225,000 jobs is near the post-crisis highs. The bottom line is that, even though wage growth again came up short, the US economy is creating a decent number of jobs. Unemployment is coming down, jobless claims are at multi-year lows as well. This all adds up to a tremendous amount of support for retail sales and continued recovery in the US.”
The bottom line here is that I have been and still am bullish on the cyclical prospects in the US, UK and Spain in particular. The US jobless claims numbers are unusually low and that tells you that slack in the labour market is declining. Moreover, we are likely to see inventory builds here, adding to more momentum. Nonetheless, I do have two caveats for the US. First, the now -2.1% number for Q1 is still telling us that 2% growth is the baseline here. That’s not robust, it’s average. Second, credit excesses mean financial fragility will still be an issue at the cycle trough because the growth we are seeing in the US is unbalanced in that it is not predicated on wages and household earnings.
Now, on to Russian sanctions.
I called the MH17 disaster an exogenous shock when it occurred two weeks ago. With the passage of two weeks’ time, I hold by this statement as the defining element here as to why Ukraine matters: “It is hard to make any judgment calls about what is going on with the limited information we have now. We don’t even know if the plane was shot down. But what seems clear to me is that the Ukrainian crisis has taken a serious, unexpected and negative turn. It’s hard not to believe there will no diplomatic or military consequences from the shooting down of a civilian jet airliner passing through Ukrainian air space.”
What I expected to happen then and what we now have are sanctions – punitive sanctions – against Russia. The EU believes sanctions will cost the Russian economy 1.5% of GDP in 2014 and potentially 4.8% of GDP in 2015 if reports from the EUObserver are to be believed. The Russian economy will go into recession no matter how you look at it.. The real question is whether the west will achieve its political goals through sanctions. I have serious doubts.
When I wrote about the political economy of the military conflict in Ukraine at the beginning of last week, I said then that we should see the conflict as a ‘proxy war’ between the US and Europe on one side and Russia on the other. And this has been a long-time coming due to the admission of former Warsaw Pact countries into the EU and into NATO. With the EU’s association agreement with Ukraine, we have a situation where the EU – and potentially NATO – are right on Russia’s doorstep. It’s rather like a Chinese or Russian economic union – with potential military overtones being in Panama, Cuba, Nicaragua and then finally moving into Mexico. Objectively speaking, even if one saw Russia and China as benign powers, the potential threat would be clear.
So let’s look at the sanctions regime objectively as the first salvo in a negotiation in a proxy war. I had some brief thoughts on framing the war in Ukraine last Tuesday that inform how I view the decision tree here. In terms of negotiating strategies, the best alternative to a negotiated agreement is critical in terms of thinking about the potential for mutually acceptable outcomes. if a negotiating party like the US has a good BATNA because it is the reserve currency holder with an improving economy and no ill effects from sanctions, it is less likely to compromise in negotiation, limiting the area for mutually acceptable outcomes. That means the US, as a negotiating party, is going to be the one on the US-EU side pushing the limit of what is achievable given their objective. And negotiating parties are often fixated on their own constraints, prior positioning and objectives to the exclusion of their negotiating partners’ constraints, prior positioning and objectives that they make false steps.
Here I think it is likely that the objective for the US and the EU is to get Vladimir Putin to back down on Ukraine and allow the country to pass fully into the EU – and potentially NATO – orbit as a consequence of the country’s self-determination that this is the best way forward for its citizens. But is this a reasonable goal? I don’t think it is at this stage of negotiation. We know that Putin feels threatened. US General Jim Jones described to Erin Burnett on CNN last night how Putin went on a 90-minute rant when they first met to do a reset about how the US had taken all the Warsaw Pact countries into its orbit and how this was unfair. Jones’ view is that Putin has a Cold War mentality which informs his decision-making.
I think Jones is probably correct here, meaning that Putin is strategically looking to keep a decent sphere of influence for Russia via the BRICS association and the Eurasian association it has cobbled together. But regionally, it is hemmed in in Asia by China, so it naturally looks to Europe, where the EU has made incursions. The result is a feeling of assault from all sides and a defensive and unpredictable posture. Knowing this as Jones does, he still backs escalating sanctions because the US too has been forced into these sanctions by prior positioning and concerns about losing control in foreign affairs as it has done in Iraq and elsewhere in the Middle East.
But, of course, Putin has to contend with Kremlin hardliners and popular opinion in Russia. Putin enjoys an 83% approval rating exactly because he has improved Russia’s standing in the world. Now, wading through the clear western bias in this report, you should note the following from The Interpreter’s Paul Goble:
That Moscow television plays a key role in structuring Russian views about Moscow’s policies in Ukraine is beyond question. Ninety-four percent say that they rely on television for news and information about events there, and 70 percent say they believe Russian media are giving “an objective picture” of the situation.
Aleksey Gorbachev, a political commentator for Nezavisimaya gazeta, cites a Levada Center poll showing that 64 percent of those surveyed blame the West for the war in Ukraine, 20 percent blame Kyiv, but “only three percent say that the civil war in the Donbas is the result of the interference of Russia.”
Even though there are good reasons to suspect these figures – given the climate of fear in Russia under Putin, ever more people are reluctant to say what they think if it differs with the opinion of the bosses – many opponents of the Kremlin’s policies in both Russia and the West are placing their hopes in the Internet.
The point is that, regardless of whether media propaganda is to blame, Russians see the west as the aggressor piling on Russia and Russia as the victim here. There is no political mandate for backing down over Ukraine. Just the opposite – if Putin were to back down, he would lose support and suffer political damage from hardliners. So the sanctions regime is not going to have any effect whatsoever, irrespective of the short-term economic damage.
Now if one party in a negotiation miscalculates and negotiates a position well outside the other party’s zone of acceptable outcomes – even though there are mutually acceptable outcomes – the other party could fall back on her BATNA and the negotiation will fail. Due to the downing of MH17, The EU has been forced into a negotiating stance closer to the US stance that leaves almost no room for a mutually acceptable outcome at this point.
The question is what happens in the proxy war that causes a de-escalation or escalation in this crisis. Some believe the rebels in Ukraine will be defeated and the whole fiasco will go away. But, we have a long way until we get there and there are a lot of land mines that could cause the situation to unravel. No one even knows whether Vladimir Putin would allow the rebel cause to fail. We’ll just have to wait and see.
But for now, sanctions will fail. There will be no movement from Russia. They will take the pain and see how the situation in Ukraine progresses. If we see another aggressive move from Russia, however, the EU will be forced to act and then we will have to look to Italy, which I see as the economic weak link in the periphery to determine how the EU will deal with the economic fallout.