How Will the World Economy Affect the U.S. over the Next 18 Months?

September 2014
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The world appears more unsettled at present than it has over the last 20 years. It is clear that when the world becomes ripe with ten- sion, it cannot help but impact the world economy. One reality of our age is that our economy is now globally connected.
Our past have discussed how the U.S. has been the dominant Newslettersworld economy and how the U.S., Chinese, Indian and German economies are in- ter-related and can materially affect the performance of the economies of all parts of the world. (See our May 2013 article, “Is the U.S. Still the NewsletterWorld’s Dominant Economy”) The U.S., China, Germany and India, remain four key economic drivers of the global economy. How will they affect each other and other parts of the world over the next 18 months?
World events may both impact and are impacted by how the economies of these countries are behaving. We have seen that when the U.S. and Europe are in conflict with Russia that it af-
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fects economic patterns. Even smaller economies like Russia can have an effect on the Global economy. Today, the U.S. and Europe are trading economic sanctions with Russia. The expansion of Russia’s oil and gas industry has been largely financed by European banks, especially German banks, and in turn, Europe currently buys a substantial part of its energy from Russia.
As Europe has been trying to reduce its dependence on Russian energy, Rus- sia has been working with China to divert more of its energy sales to China in or- der to blunt the impact of the West’s sanctions. This has been changing interna- tional trade patterns while also affecting European economic activity. At the same time, China and the U.S. have been experiencing difficult relations over China’s expansionist policies.
This has affected Chinese trading patterns. The ripple effect of China’s change in trade patterns is being felt across the economies of Asia. The cumulative effect of the fallout from the multitude of world conflicts is impacting the economic cycle of each of the world’s regions. The China/Russia situations have impacted worldwide capital investment patterns adversely affecting the Columbian economy, for example.
Russia is now focusing on improving its trading relations with Iran and other economic partners in the Middle East. At the same time, China is moving to reduce it’s trading with the U.S. Like our government’s internal domestic economic policy, another variable becomes how will the economic situation of these regions affect our economy over the foreseeable future?
In spite of the limited actions taken by the U.S. and Europe, the Russian economy, as measured by industrial production, is expanding mildly, having grown 1.3% year over year. Construction and job creation has been helped by Russia’s beginning of construction of a major pipeline to transport the natural gas it just agreed to sell China. Russia’s new trading push, like its deals with the UAE and

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China, will limit the effectiveness of the West’s sanctions to harm Russian economic growth.
Many of Russia’s gains in trading with Middle East countries come at the expense of the U.S. and Europe, with Russian goods replacing goods formerly pur- chased from the U.S. and Europe. Russia’s shift in trading will benefit many new trading partners like Turkey at our expense. Turkish Exports to Russia have been gaining as Russia’s embargo on foods from the EU and the U.S. takes hold. Tur- key was the fifth largest supplier of food to Russia in 2013, increasing its food sales to Russia this year, especially in the poultry and seafood categories at U.S. and Europe’s expense.
China and Asia are having their economic problems as well, reducing their support for U.S. exports as 2015 approaches. China’s industrial production, while still rising, is rising at a substantially diminishing pace. Growth in 2014 has been at the slowest pace in nearly five years. Our strategic partner the Institute for Trend Research (“ITR”) has predicted that China’s rate of growth will continue to diminish at least through mid-2015.
China is in the midst of a structural problem with its housing and financial sector. Housing prices in China fell in August for the fourth consecutive month adding to fears that the housing market could collapse. This is very significant for local Chinese governments, because until now, local governments financed ap- proximately 60% of their budgets through a tax on property sales.
This has led to local governments encouraging over construction in many cities. In major cities, like Beijing and Shanghai, the drop in housing prices and over building has caused homebuilder debt to reach 128% of equity.
This type of problem may sound familiar to Americans, and a collapse of China’s housing market could put China into recession. China’s central government, as part of its financing reforms, is now allowing local governments to issue

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bonds to help finance their budgets and relieve some of the pressure of falling housing prices. Eventually they will need to address how to repay these bonds.
While Japan and Asia are experiencing moderate growth, much in their future depends on their biggest customer, China. ITR predicts that Japan may move toward recession in 2015. For the U.S., China’s efforts to dominate trade with these countries may limit our exports to them in the near term.
India is also experiencing moderate growth even as its 1.1% growth drove its industrial production to the highest level on record. ITR predicted that India’s growth “will remain modest through the end of 2015.”
On the down side, India is beginning to experience a power shortage affecting its industrial operations as well as creating fear of blackouts. Coal power produces approxi- mately two-thirds of India’s electric power. A domestic coal shortage has forced a move to costlier coal imports and higher energy prices. This could turn the Indian economy from growth back to recession. Currently India’s coal imports are helping the U.S. economy.
Thus, our economy cannot expect exports other than coal to India to contrib- ute much to our growth, and if India is one of your suppliers, you should be look- ing for more cost effective alternatives. As higher wages and inflated costs hit In- dia, it will put more pressure on potential U.S. inflation.
Will European growth help support the U.S. economy? Eastern Europe, led by Poland, has been growing at 4% and, absent a more intense problem between the West and Russia, should continue to grow through 2014. However, this will mainly benefit Western Europe rather than the U.S.
Western Europe is a mixed bag. The engine of Western Europe’s economy, Germany, is growing at 1.7% annually and should continue to expand through 2016. It is experiencing a housing boom with construction up 5.9% year over year. By contrast France’s economy dropped 0.7% and is expected to continue contract-

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ing. The economies of Italy, Netherlands, Denmark, Finland, and Malta are also all down, hurting Western Europe’s economy.
Taken as a whole, with Western Europe’s economy at its highest level in 14 months, industrial production is only up 0.3% year over year. ITR predicts that Western Europe as a whole will “fall back into recession by the end of 2014.” The U.S. economy cannot count on much help from Europe next year.
South America, like Western Europe, is a mixed bag. Brazil, Chile, and Ar- gentina are leading the downturn. Brazil, the leading economy in the region, has seen industrial production fall 1.2% over the past year to the lowest level in 15 months. Job creation hit the lowest level since 1999. The other economies in the region are also beginning to experience difficulties. The U.S. cannot look to South America as a source of strength to grow our economy.
That leaves our two neighbors, Canada and Mexico, to complete the picture. Canada’s economy is growing at a 3.4% annual rate. Much of the strength of the Canadian economy is due to the growth in the U.S. economy. Strong U.S. car and truck sales this year have increased the demand for cars, trucks, and parts made in Canada.
Many U.S. businesses have moved operations to Canada with tariff free sales back into the U.S. This is because, among other things, the combined federal and state tax rate on businesses in Illinois, for example, is over 40% while in Canada it is 15%. That more than 25 percentage point difference buys a lot of inventory, increased jobs, and lower pricing to keep a business competitive and expanding.
Likewise, Mexico has strongly benefited from the growing U.S. economy. The U.S. is Mexico’s largest export market. Mexico’s industrial production has continued to expand. Mexico’s cheap labor and exemption from U.S. tariffs have encouraged a substantial shift in manufacturing from the U.S. to Mexico, and with it high paying jobs. Rather than currently contributing to the growth of the U.S.

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economy, both Mexico and Canada’s manufacturing growth are largely dependent on our economy remaining strong.
Unlike in 2013, the U.S. economy over the next 18 months cannot count on the world economy contributing a strong support for our economy. Rather it is the U.S. economy and our imports that will need to help sustain the world economy. ITR has slight- ly improved its forecast of how the U.S. economy will perform in the latter half of 2014 and the first half of 2015.
While consensus economists have not mentioned it, a very important factor in why the U.S. has experienced a positive bump is that we are in the midst of the most expensive Mid-Term election campaign in U.S. history.
All of that advertising, chicken dinners, campaign consulting, etc. puts a very meaningful group of broadly spread expenditures into the U.S. economy at a time when the U.S. needs it. (See our October 2011 Newsletter Article, “The Great Six Billion Bipartisan Stimulus Of 2012” discussing the $6 billion of spend- ing the Presidential campaign was adding to the economy in 2012.)
The economic problem is that in 2015 the U.S. will not be able to count on the stimulus of either a Mid-Term or the world economy to move the U.S. forward. Will a change in government policy be the antidote?
Recent Cartoon

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While the economy continues to grow, based upon current condi- tions, ITR is still forecasting a recession in 2019. Presently, the continuing improvement is being driven by manufacturing with an 11.4% increase year over year. This has come in large part from a 21.4% increase in durable goods manufacturing. There continues to be poor performance in construction and employment with long term unemployment being a very real disconnect.
Different sectors of the economy are per- forming at substantially different levels. New orders, financial, housing, and retail sales remain areas of slower growth while production, nonresidential construction, foreign market, medical, and wholesale trade are areas of accelerating growth.
The economy has never returned to a normalized growth pattern of a “V” shaped recovery, but has essentially remained in a stagnant slow growth trajectory. This means the economy is subject to even small disruptions causing problems. ITR has forecast the rate of change of industrial production over the next several years, which when graphed, illustrates more of the same.
To grow your business you should take this into account in your strategic planning. Each segment of the economy will see this reflected in a different way. Give us a call; we can help you plan to maximize your revenue growth and profits.
The Wise Old Owl

How Will the World Economy Affect the U.S. over the Next 18 Months?

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