Sanctions and crisis in Turkey, China 5G supremacy, drought driving food prices

1 Big Thing: Sanctions on Turkey not helping crisis go away

Yesterday, I wrote about a late May interview with Russell Napier that hit on Turkey as a weak link in emerging markets. This is a view I share. But I would say that the Turkish lira is, if anything, undervalued on a fundamental basis. Given the right policies and circumstances, we could see a rally. But, so far, nothing the Turks have done inspires confidence.

Today though, it’s interesting to see a New York Times article on Turkey that underlines my point on Iran yesterday that often sanctions “serve to maintain a power structure by defining an external enemy looking to wreak havoc on the lives of ordinary people. ”

Here’s what the Times says that’s relevant:

Supporters of Mr. Erdogan took to Twitter with the hashtag #Emperyalizmeköleolmayacağız (#We will not be slaves to imperialism), even while acknowledging that the political crisis will not help an already souring economy.

“I have my own company and dollar affects almost our entire business,” said a Twitter post by Erkan Babur, an engineer from Tokat, a province in the Black Sea region, and a local executive member of the right-wing Nationalist Movement Party. “But we are not born as bosses from our mothers. And it is not the dollar that made us the boss.”

“We will close down our company if necessary and paint shoes, sell bagels, thanks to God, but never make Turkey bait for you,” he added.

Newspapers, most of them now under control of businessmen close to the president, took fiercely anti-American stances as well.

“Know your limits, U.S.,” said one headline in the daily Milliyet. Even the newspaper Sözcü, an aggressive nationalist opponent of Mr. Erdogan, called on the government not to bow its head. “Stand tall, that’s enough for us,” one headline read.

Why this matters:  Patriotism isn’t about rationality and long-term thinking. It’s about belonging, camaraderie and pride. I am sceptical about the efficacy of sanctions…ever. I think the reason countries use sanctions is because they must show displeasure in some way without engaging in military action. Sanctions are a way to do that. But they don’t necessarily alter outcomes.

With Turkey, already in a war of words with the EU, an escalation in this spat with the US would be bad. Erdogan would feel isolated within NATO. And it might drive the Turkish leader to make economic decisions for political reasons, particularly regarding interest rates. And that would mean the currency and debt crisis in Turkey would ramp up another notch

2. More European defiance on Iran

Sticking with the sanctions theme here, yesterday we saw Federica Mogherini, the EU’s high representative for foreign affairs, urge companies domiciled in the EU not to adhere to US sanctions on Iran.

She said:

“If there is one piece of international agreements on nuclear non-proliferation that is delivering, it has to be maintained. We are encouraging small and medium enterprises in particular to increase business with and in Iran as part of something [that] for us is a security priority.”

Why this matters: It is not at all clear the EU can make European companies whole if they violate US sanctions and feel the wrath of the US government. I mentioned Daimler as an example yesterday, saying it would suspend its “very limited” activities in Iran in order to maintain access to the US market. I believe most European firms will follow this example.

Deeper dive: Frankly, There is basically nothing the EU can do about this in the short term. Trump is correct in assuming the US has unilateral power to force non-American actors to heel. The real question is longer term.

Trump is but one President. And although he may be in office for as long as eight years, Europeans have been trying to maintain a status quo in transatlantic relationships for longer-term stability. But the strains are significant and wide-ranging from the Paris Climate Agreement to sanctions on Iran to tariffs on steel and aluminum. We should watch for signs that the Europeans are making plans to lessen dependence on the US in defense and in finance.

3. Europe as the regulator-in-chief

Take this news however you are inclined. Those of you with an anti-regulatory bias may see regulatory overreach. Others may differ.

The European Commission has been pushing for a common charger for nearly a decade as it cited the more than 51,000 tons of electronic waste yearly from old chargers as well as the inconvenience to consumers.

IPhone and Android users have long complained about using different chargers for their phones…

“Given the unsatisfactory progress with this voluntary approach, the Commission will shortly launch an impact assessment study to evaluate costs and benefits of different other options,” Vestager said in an Aug. 1 response to a query from an EU lawmaker.

Such studies help the Commission decide whether there is a need for action and analyze the impact of various options.

Why this matters: The EU is increasingly a standard setter on regulation simply because it takes a much firmer hand in regulatory control than the US. By requiring companies that want access to the European market to adhere to EU regulations, they can also influence global standards. For me, this mobile phone charger issue makes that clear. If handset makers are forced to harmonize charger interfaces for mobile phones in Europe, they will also do so in the US, Japanese markets and elsewhere.

To the degree the EU wants to fight US economic hegemony, this is a role I believe they will increasingly use.

4. US falling behind China in 5G technology

Sticking with the technology theme here, note the following via Reuters:

The United States is being outspent by China in the race to build the next generation of wireless communication, known as 5G, and it risks losing out on the potential economic benefits, according to a report by consultants Deloitte published on Tuesday.

China currently has ten times more sites to support 5G communications than the United States. In just three months of 2017, Chinese cell phone tower companies and carriers added more sites than the U.S had done in the previous three years, the Deloitte Consulting report found.

The first countries to adopt the next generation of wireless communications will experience “disproportionate gains,” as 5G brings an “era of untapped economic potential”, the report said.

A couple of things: first, where is Europe on this? There was no mention of European 5G efforts in the article. That brings out my inner sceptic because Deloitte are consultants who may have an ulterior motive for business. Second, is it true that first adopters will win here? I don’t know the answer. But I won’t take the statement at first blush.

Why this matters: It is interesting to see China dominate a new technology because ‘technological theft’ is less of an issue. The question is why China is ahead. Their state-supported, centralized model has made 5G a priority and that is paying dividends in this arena. But is that going to reap benefits down the line? We will find out. But it won’t be for years to come.

5. Drought in Australia, severe damage in Europe

The headlines of severe weather patterns are mounting, with drought in Iran, wildfires in California, Spain, Portugal and Greece, record temperatures across Europe. Australia is also experiencing a drought across the entire state of New South Wales, Australia’s most populous state where about one-quarter of Australian agriculture is based.

Why this matters:  This has to feed through into food prices.

Farmers in NSW are spending up to $10,000 Australian for a truckload of hay to feed animals. Half of neighboring Queensland is also experiencing drought, while parts of Victoria and South Australia have extremely dry conditions. Grain and red meat stocks have dwindled. The National Farmers Federation CEO Tony Mahar is warning that Australia will be “bordering on disaster”.

Hot conditions across Europe have also devastated northern European wheat fields. Evidence of a weak crop harvest is mounting in Germany, the European Union’s second largest wheat producer, and in Scandinavia. Meanwhile, in the Black Sea, an unusual combination of dry conditions on the one hand and extreme rain on the other has hurt output. Prices have already started to soar.

How this will impact inflation and monetary policy, I don’t know.

6. How banks make money as rates rise

I caught a good headline over at the Guardian which reinforces the fact that rising rate environments are generally good for bank earnings in the beginning.

Nationwide is not passing on last week’s Bank of England’s 0.25% rate rise in full to savers in the first sign that big financial institutions will use the base rate to increase profit margins.

The building society, one of the biggest mortgage and savings institutions in the UK, said that while its tracker mortgage customers will see a 0.25% rise in their payments, many of its savers will see only a 0.1% increase in rates.

Nationwide is the first large player to announce its new rates, in a move likely to be followed by the high street banks.

Why this matters: We have seen this in the US already. Until credit problems begin to swamp bank bad debt provisions, we should expect rising rates to flatter bank earnings. They will increase rates that debtors must pay but not fully pass through the rate hikes to savers. The result is higher net interest margins.

7. Refiners doing well in this environment

As oil prices rise, refining margins can get squeezed. That’s what we saw in 2008, for example, when refiners had trouble passing on higher oil price costs to car-driving customers. But right now, that’s not what’s happening despite high prices globally, due in large part to a glut in US oil production. The Wall Street Journal is reporting refiners with very healthy margins and positive earnings outlooks.

Why this matters: This is yet another industry that is swimming in profits. Of the 500 companies in the S&P 500 that have reported earnings so far for Q2 2018, well over three-quarters have reported earnings above analyst expectations. Energy companies are leading the pack with a 123% increase in earnings and 20% in revenue. Expect more of the same in Q3.

I am going to leave it there for today.

Cheers,

Edward