Daily Comment (July 27, 2018)

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EDT] It’s GDP day!  We detail the data below but the quick take is that it was a very solid number, up 4.1%.  Unfortunately, hyperbolic comments from the White House in front of the report increased the odds of disappointment.  The initial market reaction is showing disappointment.  However, it should not be lost that this was a really strong report.  Other than that, it was a fairly quiet overnight session.  Here is what we are watching:

Trade: The recent truce between the EU and the U.S. has sparked all kinds of speculation of a process behind the rhetoric.  Some see the potential for an EU/U.S. united front against China; this idea is being pushed by Larry Kudlow.[1]  If the U.S. makes a trade deal with the EU, the two could isolate China.  This is a very worthwhile geopolitical tactic.  However, that process was already underway—it was called the Transatlantic Trade and Investment Partnership, or TTIP.   The president killed that deal but it was already on the rocks before his election.  The combination of TPP and TTIP[2] would have completely isolated China and Russia and forced them to deal with the lynchpin state, the U.S., to remain relevant to trade.  It should be noted that both were dead letters before the last election.  And so, the real issue isn’t Trump, it’s that the American people are no longer on board to support American hegemony.  Is it possible that Kudlow is correct?  Sure, but the risk is that there isn’t sufficient support for any such program.

We are working from the position that the president’s primary goal is to reduce imports and boost domestic manufacturing activity by forcing firms to shorten supply chains.  If we are correct, the “Juncker truce” is a tactical retreat.  The pushback the White House is getting from sectors of the economy adversely affected by trade impediments is leading the president to moderate his trade position in front of the mid-term elections.  But, we see no evidence that his central policy goal is changing.

A take on Russia: There are reports that former SoS Henry Kissinger suggested to Trump administration officials that they should consider a reversal of the policy that became “Nixon to China” in the 1970s.[3]  Kissinger offered the idea that the incoming administration should improve relations with Russia and use that to isolate China.  This isn’t a bad idea.  Russia naturally fears China; the former is facing a demographic catastrophe and fears that China will eventually take the far eastern reaches of Russia.[4]   The problem with this policy is that it isn’t clear whether the friendliness the president shows to Vladimir Putin is to isolate China or if he just likes the Russian leader.  At this point, we don’t know, but if it is the latter the improvement in relations may not lead to isolating China at all.  It may simply isolate our post-WWII allies, Japan and the EU.

Bitcoin strikes out again: The SEC rejected an application by the Winklevoss twins to launch a Bitcoin ETF.  This is the second time in two years that the SEC has rejected the application.  Bitcoin fell on the news.

Turkey threats: Andrew Brunson is a Christian pastor who has been in a Turkish prison for 21 months; he is one of 20 other Americans who were arrested after the failed coup against President Erdogan.  It seems highly unlikely that Brunson participated in any action to support the coup.[5]  He has been working in Turkey for 23 years.  Instead, Erdogan is using Brunson as a bargaining chip to swap Fethullah Gulen, an Islamist figure who was once allied with Erdogan to oppose Turkey’s then secularist government.  However, as Erdogan rose to power, the two had a falling out and the current Turkish president has feared that Gulen’s followers will try to oust him.  Gulen currently lives in a rural Pennsylvania compound.  The U.S. has, so far, refused to extradite Gulen.  On this issue, instead of swapping Gulen for Brunson, the Trump administration worked out an agreement where Israel would trade Ebru Ozkan, a 27-year-old Turkish woman currently imprisoned on smuggling charges, for Brunson.  From the perspective of Turkey, this wasn’t much of a trade.  The case against Ozkan isn’t very strong; in fact, it’s weak enough that an Israeli court released her to house arrest.  That agreement apparently fell apart when a Turkish court kept Brunson under house arrest, although they did release him from prison.  Both President Trump and Vice President Pence reacted with great anger to this development and both promised new sanctions against Turkey.[6]  The embattled Turkish lira took another leg down on the U.S. reaction.   From our perspective, Turkey overplayed its hand.  The U.S. does not appear compelled to extradite Gulen.  He may be useful to American interests because he does seem to threaten Erdogan and thus can be used to control Erdogan’s behavior. After all, Turkish and American interests don’t completely align; Turkey systematically oppresses the Kurds who are a reliable U.S. ally in the region.  Erdogan has also flirted with Russia and has allowed Middle Eastern refugees to surge into Europe.  As a result, the U.S. views Turkey as rather unreliable.  The idea that this pastor would be important enough to swap Gulen is fairly farfetched.  The U.S. could inflict rather severe pain on Turkey; the drop in the lira is causing problems for the economy[7] and the administration could sanction the country for dealing in Iranian oil.  We would expect Turkey will realize at some point that it isn’t going to get Gulen and conclude that continuing to hold Brunson isn’t worth the trouble.

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[1] https://www.reuters.com/article/us-usa-trade-eu-kudlow/white-houses-kudlow-says-eu-will-help-trump-confront-china-idUSKBN1KG2FF and Weekly Geopolitical Report, The TTIP and the TPP: An Update (10/17/16)

[2] See Weekly Geopolitical Report, The TTIP and the TPP (1/27/14)

[3] https://www.thedailybeast.com/henry-kissinger-pushed-trump-to-work-with-russia-to-box-in-china?ref=home

[4] https://www.nytimes.com/2016/08/01/world/asia/russia-china-farmers.html and https://www.scmp.com/week-asia/geopolitics/article/2100228/chinese-russian-far-east-geopolitical-time-bomb

[5] For background, see Weekly Geopolitical Reports, The Turkish Coup, Part 1 (7/25/16); Part II (8/1/16); and Part III (8/8/16).

[6] https://www.washingtonpost.com/politics/trump-says-us-will-impose-large-sanctions-on-turkey-for-detaining-american-pastor-for-nearly-two-years/2018/07/26/75dcde32-90e5-11e8-bcd5-9d911c784c38_story.html?utm_term=.e6b299282fd1 ; https://www.nytimes.com/2018/07/26/world/europe/turkey-sanctions-trump.html?emc=edit_mbe_20180727&nl=morning-briefing-europe&nlid=567726720180727&te=1

[7] https://www.ft.com/content/c114d1ca-90d6-11e8-b639-7680cedcc421