Daily Comment (April 9, 2018)

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] There is a whiff of “risk-on” this morning, with global equities higher while “risk-off” assets, such as gold and Treasuries, are lower.  Presidential tweets were relatively calm over the weekend.  Here is what we are watching this morning:

Social media to Capitol Hill: Facebook (FB, 157.20) CEO Mark Zuckerberg will testify later this week before Congress.  According to media reports, he is furiously preparing for the event.  The core issue facing the social media part of the tech industry is the public’s general lack of understanding of how these firms make their revenue.  There are no free services; if a service doesn’t include a charge, the firm is making money by collecting your data.  To some extent, this is how media has made money for a long time—newspapers sold advertising based on circulation.  Although they usually required a subscription, that was not the key source of revenue.  Social media has taken that model and expanded it by encouraging users to willingly offer up information about their behavior.  Previously, a firm advertising in a paper could know how many readers would receive their advert and maybe target a region for circulation.  By gathering information about you, social media can help advertisers target their segment (or, more to the point, “you”) directly.  An old line about advertising is, “50% of what I spend on advertising is wasted, but I can’t determine which 50%.”  Social media helps reduce the waste in advertising, so the more info the social media firm can gather about our behavior the more efficient advertising can become.[1]  Of course, the more social media knows about me the less privacy I have.  The debate society is now having is, “How much data-gathering is legitimate?”  Don’t expect social media firms to offer a reasonable response; it’s like asking a realtor if it’s a good time to buy a house.  This is where regulation will be required.  Regulation will tend to undermine the business model of social media but we won’t know to what degree until new rules are put into place.  But, in any case, the threat of regulation will tend to weigh on the tech sector.

Syria: Over the weekend, there were widespread reports that the Syrian government used a gas attack on civilians.  President Trump tweeted against the action and has, in the past, attacked Syrian military bases for using gas.  It appears Israel did launch missiles at a Syrian airbase.  Iran accused the West of fabricating the attack as a pretext to attack Assad.  President Trump has recently expressed the desire to pull U.S. troops out of the region.  It is probably no accident that Assad engaged in these horrendous acts after Trump’s comments.  The gas attack puts the U.S. in a difficult dilemma.  The Middle East has become uncontrollable.  Ever since the U.S. invasion of Iraq disrupted the balance of power in the region, Iran has been trying to expand its influence, Turkey has been countering against Kurdish statehood aspirations, IS rose and fell and Saudi Arabia has been trying to expand its influence as well.  Essentially, removing Saddam Hussein created a power vacuum and regional powers have been vying to fill the gap since.  The U.S. has been trying to extricate itself from the costs of being the balancing power in the region because (a) it is costly and distracting, and (b) we don’t need the oil anymore.  So, if Trump reacts by increasing American military presence in the Middle East, it means less resources to contain Russia in Europe and China in the Far East.  If the U.S. does nothing, we look weak, and Assad, Russia and Iran will try to expand their influence further.  With John Bolton taking over this week as national security advisor, we would not be surprised to see a rather robust response to Syria’s actions.

Lula turns himself in: Although former Brazilian President Lula resisted beginning his 12-year prison term for corruption, he has turned himself in, ending a potential source of civil unrest.  As we noted last week, the Brazilian Supreme Court’s decision to uphold his conviction throws open the presidency; there are no clear front-runners for October’s vote.

Orban wins: Although there was little doubt that PM Orban’s Fidesz party would prevail in this weekend’s elections in Hungary, the result was sweeping, bringing a two-thirds majority to the legislature.  Orban has been running on a nationalist and populist platform, opposing the EU and immigration.  European nations are turning toward populist and anti-EU parties (the recent Italian elections show a similar trend), and this is yet another election suggesting that populism is on the rise.

China talks CNY devaluation: Another part of the trade war threat came from China over the weekend as the country hinted it is “studying” the potential for devaluing the CNY.  We have been somewhat surprised that the administration hasn’t moved to weaken the dollar as a tool against the trade deficit.  China may be seeing this lack of currency commentary as an opening.  Although the CNY has been appreciating recently, China does control its currency and could decide to weaken it.  However, there is a danger for China, too.  History shows that fears of currency weakness seem to trigger capital flight out of China.  Chairman Xi may be confident that he has enough controls in place to prevent widespread capital flight, but money does tend to “find a way” under pressure.

North Korean denuclearization: Over the weekend, North Korea indicated it is open to discussing denuclearization with the U.S. in upcoming summit talks.  Although this assertion raises hope of a major deal, it also carries the risks that (a) Kim may be using this to lure President Trump into talks, and (b) the term “denuclearization” is fraught with strategic ambiguity.  Regarding point (a), just getting the meeting is a boost for North Korea.  Previous presidents have been reluctant to talk directly, using that as the ultimate “carrot” for Pyongyang.  So, even if the talks don’t bring about any major developments, the photo-ops of the two leaders together will improve Kim’s stature.  Concerning point (b), denuclearization for Kim probably means that he allows inspectors if all U.S. troops leave South Korea and North Korea is no longer a target for regime change.  For the U.S., the term means that North Korea gives up its nukes.  Both leaders can agree on denuclearization and come away with completely different positions.  A reasonable expectation?  North Korea keeps its nukes but gives up long-range missiles, which would reassure the U.S. but terrify Japan, South Korea and China.

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[1] An old, but famous, incident of data-gathering and advertising was documented here:  https://www.nytimes.com/2012/02/19/magazine/shopping-habits.html?_r=1&hp=&pagewanted=all