Daily Comment (April 13, 2016)

by Bill O’Grady and Kaisa Stucke

[Posted: 9:30 AM EDT] Financial markets are stronger this morning on better than expected trade data out of China.  March exports rose 11.5% from last year.  Last month the same measure fell 25.4%.  However, the data does fluctuate due to the variance in dates of when the Chinese New Year is celebrated.  On a rolling three-month basis, both exports and imports are down around 10%.  Overall, the data is good news for China, but somewhat less so for the world economy.  After all, if China is running a trade surplus, it is essentially acquiring aggregate demand from the rest of the world.  These conditions would be appropriate if the world was dealing with inflation, but that is not the case and so China running trade surpluses will become a bigger issue for the developed world.  It is already an issue in the U.S. presidential primary season.

Two interesting articles in the FT and NYT are focusing on the problem of IS.  Although IS remains in control of significant territory in Syria and Iraq, airstrikes and ground attacks are taking their toll on the group.  Targeting its oil flows and the drop in oil prices have cut its funding.  Attacks from Kurdish troops and Iraqi forces are reducing the area controlled by the group.  Although this is good news, like most things in life, even good outcomes carry unexpectedly negative consequences.  As IS has been losing territory in the Middle East, it has been stepping up terrorist attacks in Europe.  It is unclear if the group can maintain operational tempo as it loses territory; we suspect it may not as it will lose its training ground and funding for operations.  Another problematic development is that as IS has been losing territory in the Levant, it has been gaining territory in what is left of Libya.  History has shown that terrorist groups tend to thrive in failed states and Libya may be the most significant failed state in the world today.

The FT article notes that something of a power vacuum is developing as IS loses territory.  In most cases, IS leaves behind a shattered infrastructure that neither Iraq nor Syria can afford to rebuild, and no outside power will be comfortable providing funding for rebuilding without a working government in place.  Defeating IS is a worthwhile goal but there does not appear to be a plan for the aftermath.  Given that the government in Baghdad is Shiite-dominated, we doubt the Sunnis who live in what was western Iraq will be comfortable with a return of Iraqi dominance.  Western Iraq and eastern Syria are ripe for an outside Sunni power to move in and take control.  We will be watching to see whether Saudi Arabia and/or Turkey decide to fill the void created by defeating IS.

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