Daily Comment (February 20, 2018)

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EST]

Looking for something to read?  In our travels we are often asked about books we recommend.  As a result, we have created The Reading List.  The list is a group of books, separated by category, that we believe are interesting and insightful.  Each book on the list has an associated review to help you decide if you want to read it.  We will be adding to the list over time.  Books marked with a “*” are ones we consider classics and come highly recommended.

The next Japanese PM?  The NYT[1] had a profile on Taro Kono, a 55-year-old LDP leader who is setting himself up to be the next PM when the current holder, Shinzo Abe, likely retires in five years.  Kono is the current foreign minister; he was educated at Georgetown, interned with both Alan Cranston and Richard Shelby in the 1990s (when the latter senator was a Democrat) and speaks fluent English.  Although he has mostly stayed aligned with the Abe government’s policies, he is thought to be more liberal (in Japanese political structure, that would mean less nationalistic) and would probably be a figure American policymakers could negotiate with given his familiarity with the U.S.  Of course, in five years, Japan may be looking for someone who will foster a more independent Japan.

Is the U.S. comfortable with Europe rearming?  The FT[2] reports that the U.S. is expressing concern about an EU effort to coordinate military activity among the 27 member nations.  Although it’s nearly a ritual for U.S. administrations to complain about European nations free riding their military commitments to NATO, Americans tend to forget this isn’t really a bug in the system but part of the design.  After WWII, the U.S. set up NATO and essentially guaranteed European security.  The goal was to create conditions where another world war would not originate among the nations of Europe which, for a number of reasons, were predisposed to conflict.  By taking over European security through NATO, Europe was mostly forced to follow U.S. foreign policy goals.  Although there were costs to American taxpayers and generations of GIs forced to deploy in Europe, the policy was successful; we haven’t fought another world war over European issues since 1945.  However, recent comments from President Trump seemingly have encouraged the EU to think about its own collective defense absent the U.S.  If the EU continues down this path, the U.S. could find itself not only with a competitor on the global stage but one that would develop foreign policies that may contradict U.S. goals.  American administrations are all for more EU defense spending under NATO because the U.S. can generally control that organization.  A larger EU military sans NATO could be a serious problem.

Tariff and quota threats: The Commerce Department has declared that the inflows of industrial metals from abroad pose a national security threat to the U.S.  The metals were found to harm American firms and thus could put the U.S. at risk if war were to occur.  The recommendations included a sweeping 24% tariff hike on all steel imports.  There is no doubt foreign nations take steps to improve the competitiveness of their products through policy; the provider of the reserve currency is going to be subject to these sorts of behaviors.  For the financial markets, closing trade is risky because it will (a) reduce the efficiency of the U.S. and world economy, and (b) invite retaliation and reduce global trade, in general.  We are adherents of hegemonic stability theory, which means the world economy cannot function effectively without a superpower that provides global security and a reserve currency, which also requires being the importer of last resort.  Protectionism is a retreat by America from this hegemonic role, and it raises the potential for an inflation problem.

The Saudis as price hawks: The Kingdom of Saudi Arabia (KSA) was instrumental in the Arab Oil Embargo in 1973.  The KSA wanted to punish the West for its support of Israel in the Yom Kippur War.  The jump in oil prices contributed to the 1973-75 recession and stoked higher inflation in the U.S.  From that point, the KSA was mostly moderate on boosting prices though OPEC price actions.  The KSA did cause some major price declines when it was defending market share but it generally didn’t support aggressive actions to boost prices.  The KSA and its other Arab Peninsula neighbors are “high oil reserve/low population” nations that generally support moderate prices to avoid demand destruction.  Comments over the weekend[3] from

Saudi Energy Minister Khalid Al-Falih clearly indicate that the KSA is willing to keep production cuts in place even if supplies tighten and oil prices rise.  His comments not only signal that the KSA is favoring higher oil prices, but they suggest a change in policy direction.  For the time being (we suspect until the Saudi Aramco IPO prices), the KSA is going to be a price hawk on oil.

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[1] https://www.nytimes.com/2018/02/17/world/asia/japan-taro-kono-political-maverick.

[2] https://www.ft.com/content/a1e82b7a-147c-11e8-9376-4a6390addb44

[3] https://www.bloomberg.com/amp/news/articles/2018-02-19/once-opec-s-oil-price-dove-saudi-arabia-takes-a-harder-line?__twitter_impression=true