Welcome to The GERM Report by Dan Graeber, a commentary on the intersection between geopolitical events and the price of oil. GERM stands for Geopolitical Energy and Risk Monitoring. Our indicator is based on the expected price volatility by the end of the current trading week.
Risk level: Orange
RED: Severe (+/- 4%) ORANGE: High (+/- 2%) YELLOW: Elevated (+/- 1%) BLUE: Guarded (+/- ½%)
THE BOOSTER SHOT
- Protectionism becomes a four-letter word.
- Support level for Brent now $2/bbl away.
- Why your mistakes aren’t as important someone else’s.
Capitulation set in last week after yield curve inversions suggested an eventual economic slowdown and US President Donald Trump threatened one of the country’s top trading partners, Mexico, with sanctions. Headline figures like unemployment, wages and US GDP are all indicative of a healthy economy, but it’s the deep-dive numbers like the core PCE price index, the Fed’s preferred inflation barometer, that indicate something is amiss. Meanwhile, analysts are debating whether or not the latest yield curve inversion is a red flag or more of a red herring. In the foreign policy arena, the balance of power is shifting amid the dissolving influence of the United States, the tenacity of European liberalism and the steady rise of Asia.
At Harvard last week, German Chancellor Angela Merkel riled against US protectionism, saying it jeopardizes “the very foundations” of prosperity. More than a century ago, Germany’s first chancellor, Otto von Bismark, worked to maintain the foundations of prosperity by preserving a status quo through overlapping European alliances. When that method failed, the wars that followed changed the entire international system. While Bismark stated that no one learns from history, he also noted that the wise leader learns not from their mistakes, but the mistakes of others. The question for international thinkers and market analysts alike is: who is making the mistakes today?
Global markets nose-dived on Friday after Trump cited national security concerns in threatening to impose escalating tariffs on Mexico. As stock market indices went, so too did the price of crude oil. Beyond the so-called base that supports Trump’s policies, the real players in the market are alarmed. On Sunday, the International Air Transport Association slashed its profit forecast by 21 percent from December, citing the risks from rising protectionism. For the second time in as many weeks, the price for Brent crude oil lost more than 4 percent in a single trading day. In the end, Brent was down 10 percent from Monday’s open to close the week at $61.69 per barrel.
Despite vocal opposition from his top economic advisers, Trump during the weekend continued to hammer on tariffs as a foreign policy tool. Tariffs, he said, are a beautiful thing, noting the United States is tired of being taken advantage of in international trade and has had enough. “We are no longer the ‘fools’ of the past!,” he said through his Twitter account. Tariffs can be used to coerce trading partners to change their behavior, and in this case, Trump is using them as a bullhorn for immigration policy. Diplomatically, tariffs do have a track record of success, but the domestic consequences can be severe, especially when they disrupt the flow of basic consumer goods. Critics of tariffs instead favor liberal models like the theory of comparative advantage, where both sides play to their strengths, as a way to compel each side to play to at least the lowest common denominator of national behavior for the greater good.
Tariffs, by design, are a form of protectionism, seeking to give domestic industries an advantage. But that ignores the interconnectivity of the global market. Delivering the commencement address at Harvard last week, German Chancellor Angela Merkel made veiled swipes at Trump’s “America First” agenda, a decidedly self-help doctrine, saying protectionist policies and the trade wars that threaten international trade are damaging not only to the global economy, but the international system itself.
“If we want to go it alone, we could not achieve much,” she said.
More than a century ago, Otto von Bismark sought a stable world order through overlapping alliances. Bismark was among the masters of balance-of-power politics, advocating a type of comparative advantage model of international affairs. The British model of “splendid isolation” in the 19th century sought intervention on behalf of the weaker side when the stronger pursued domination. Bismark, however, warned that it was the destiny of the weak to be devoured by the strong. Instead, Bismark thought that overlapping alliances would moderate any bids for hegemony. When his model collapsed, however, and Germany did make a bid for hegemony, it failed. The consequence of that failure was a change in the international system.
Hegemony is not only rare, but possible only after great conflicts like the two world wars. After the wars, it was left to the United States, the only power that was both able and willing to lead, to shape the new international system, largely through the Marshall Plan and the Bretton Woods regime. As a result of US sanctions and trade policies, that system is facing a challenge. Last week, the IMD World Competitiveness Rankings saw the United States drop two spots to the No. 3 position as Singapore rose to the top. IMD officials said the initial boost from Trump’s tax breaks for corporations and individuals have faded and the US economy was now hit by higher fuel prices, weaker exports and a fluctuating US dollar, the linchpin of the global economy.
While still ranking No. 1 in terms of economic performance, the United States did not even break the top five in the government efficiency category. Meanwhile, Europe is developing its Instex system, a financial arrangement that would avoid risks of exposure to US banking channels and the US dollar. It will be slow, but the might dollar is facing real competitors. In a white paper published Sunday by China’s state council, Beijing said the trade war has not “made America great again.” Instead, the paper said, it has done “serious harm to the US economy.”
As German economic and national power expanded in the early 20th century, it needed the capital and manufacturing capacities of its neighbors to succeed. As Rousseau noted, however, a “surplus awakens greed; the more one gets, the more one desires.” Merkel may be trying to keep the liberal order in place, though self-help players are susceptible to awakening greed. Once economic and national power past the zenith, however, the nation-state grows frustrated and aggressive. As a nation gains in power relative to others, its capacity to lead grows; as it falls behind, the capacity – or willingness - to lead wanes. Periods of fluctuation is where mistakes are made.
The Federal Reserve Bank of Atlanta on Friday lowered its estimate for US GDP growth in the second quarter from 1.3 percent to 1.2 percent. The latest estimate for first quarter GDP was 3.1 percent. There are direct relationships between national power and manufacturing strength so the Monday release of the ISM Manufacturing Survey will be telling. On Tuesday, Europe releases data on the consumer price index, while US Fed Chair Jerome Powell speaks in Chicago. Wednesday brings the composite index from ISM as well as German PMI for May. A rate decision from the European Central Bank is Thursday, followed by a speech from ECB President Draghi. And apart from jobs data from the United States, Mexico’s reading Friday of the consumer price index may be worth attention. With the recent dramatic drop in oil prices, the market is left trying to assess if further downside lies ahead. Strong sell signs are ringing and support in some models is still at least $2 per barrel away, so another Orange alert is in place, with the price for Brent expected to move by at least plus or minus 2 percent.