1 Big Thing: Europe’s challenge to US hegemony
The Iranian sanctions have deepened a rift between the US and its European allies, principally because Europe has stronger business ties to Iran and new sanctions hurt that business. The New York Times reports the foreign ministers of Britain, France, Germany and the European Union saying in a joint statement, “we are determined to protect European economic operators engaged in legitimate business with Iran.”
Yesterday, I wrote that “the coming re-imposition of US sanctions on Iran gives you a sense of the broad power of the US government to impose its will on foreign actors”. And now, we are going to put that power to the test because the EU has instructed member companies to defy US sanctions.
European firms have been instructed that they should not comply with demands from the White House for them to drop all business with Iran. Those who decide to pull out because of US sanctions will need to be granted authorisation from the European commission, without which they face the risk of being sued by EU member states.
Will this work though? Daimler, the German car company that makes Mercedes-Benz cars and trucks, and a frequent recipient of Trumpian critique released the following statement yesterday, “we have suspended our activities in Iran, which were anyway very limited, until further notice according to applicable sanctions.” I suspect this is how many European firms will react.
Why this matters: Donald Trump clearly believes in American hegemony and is prepared to act unilaterally to impose his will. This morning, he warned the Europeans by Twitter.
The Iran sanctions have officially been cast. These are the most biting sanctions ever imposed, and in November they ratchet up to yet another level. Anyone doing business with Iran will NOT be doing business with the United States. I am asking for WORLD PEACE, nothing less!
— Donald J. Trump (@realDonaldTrump) August 7, 2018
This will be a very big showdown. For Trump, it’s not just the Europeans who support the deal; the Russians, the Chinese and the International Atomic Energy Agency all have signed off on the deal. So we are literally seeing the US vs the world on this one. How this plays out will have ramifications far into the future.
2. US financial sector hegemony at risk
The big fear for American analysts, according to the New York Times, is that the Trump administration’s go-it-alone approach here will embolden the Europe and other actors to figure out a way of circumventing the US financial system which gives the US such power. And, of course, the Russians and the Chinese would be keen for this to happen.
Why this matters: Many European leaders have always seen the EU as a vital counterpoint to American hegemony, even when the US was a vital and unwavering ally. Now that Trump has basically gone rogue and shown the US to be an unreliable partner, European leaders will rally around the EU and the euro as a bulwark against US domination.
Look at this European Council on Foreign Relations article about the US dollar, for example.
The EU is an economic giant. It should be able to weather these geo-economic battles. For years, war-averse Europeans have used economic power to influence the world. Due to the enormous weight of the European internal market, faraway companies feel compelled to adopt European regulatory standards. The EU frequently uses sanctions as a political tool, and links development aid to political and social reform. But Europe has one phenomenal weakness: in monetary terms, it is a non-entity. Internationally, it more or less permanently punches beneath its weight.
Why can America, in contravention of international law and agreements with transatlantic friends, so easily destroy European companies if it wants to? The answer is simple: because the world economy revolves around the dollar. According to the Bank for International Settlements, in 2016, 88 percent of global financial transactions were made in dollars. As the world’s reserve currency, the dollar is hard-wired to the global economy.
Deeper dive: Does the EU have enough internal harmony to do anything here? As I write this, the EU is in an acrimonious separation battle with one of its member states, the UK. And populist strains are rife everywhere within the EU.
The lack of a united front goes right across the EU’s economic and social agenda from migrant policy to financial sector regulation and bailouts to debt, deficits and fiscal policy. Elites in Europe might want to counter US hegemony. But, in practical terms, there are lots of hurdles to overcome.
3. Meanwhile the Iranian economy is collapsing
As I wrote yesterday, the Germans are talking about this as if it’s not about nuclear weapons but regime change. The US denies this. Yesterday, according to the Guardian newspaper, a US official stated, “our stated policy has not been regime change, it has been to modify the regime’s behavior.”
Another senior Trump Administration official said, “this is completely consistent with what the president has done with other less friendly regimes … to keep the maximum pressure until our goals are achieved,” perhaps as a warning to North Korea.
Even if the goal isn’t regime change, the impact on the economy is devastating. The Guardian accounts are good on this. One article from late July titled “‘Desperate to find a way out’: Iran edges toward precipice” has the fitting subtitle, “Economic grievances, lack of freedoms, global sanctions and climate change putting country under unprecedented pressure”. It’s a highly recommended read. Iran is experiencing a record drought just as these sanctions hit. And civil unrest is rising. It definitely makes Iran unstable and unpredictable.
Why this matters: As we know from the Arab Spring and also from wars in Iraq and Afghanistan, regime change is a double-edged sword. The US can get rid of a regime that it doesn’t like. But that creates a power vacuum. And it’s not clear who fills the vacuum either in Iran or in the Middle East more broadly.
More to the point economically, sanctions that target a country’s wider population are not as effective as one might think. Often they serve to maintain a power structure by defining an external enemy looking to wreak havoc on the lives of ordinary people. Targeted sanctions on a country’s leaders may be more effective.
But, in this case, the US has no leverage as Iran’s leaders are not integrated into the US-based financial system. Hence, the wider sanctions.
4. Weak German economic numbers
Something to keep an eye on is the German economy. There have been a couple of weak numbers coming out of Germany of late. Yesterday’s new orders data were weak. And this morning, German industrial production for June came in unexpectedly weak, dropping by 0.9% month-on-month versus the 2.4% MoM gain in May.
We shouldn’t be too concerned yet because industrial production is still up by 2.5% in the year from June 2017. But because the drop was broad-based, it may be something to watch later.
Why this matters: we should be looking for any signs of economic weakness with an eye toward the worsening trade climate. As the US turns protectionist, the worst case scenarios are minor hits to world GDP growth. However, in a world of weakening growth, this could be the straw that breaks the camel’s back and tips us into a downturn.
My own view is that we aren’t there yet. I still believe 2018 is going to turn out to be a good year economically on most all fronts. It’s in 2019 that the Fed’s tightening and credit cycle dynamics will start to bite.
5. The US stock market is shrinking
That’s the headline from the New York Times due to the decline in the number of publicly traded companies in the US. Here’s their take:
The American stock market has been shrinking. It’s been happening in slow motion — so slow you may not even have noticed. But by now the change is unmistakable: The market is half the size of its mid-1990s peak, and 25 percent smaller than it was in 1976.
“This is troubling for the economy, for innovation and for transparence,” said René Stulz, an Ohio State finance professor who has written a new report on these issues for the National Bureau of Economic Research.
When I say “shrinking,” I’m using a specific definition: the reduction in the number of publicly traded companies on exchanges in the United States. In the mid-1990s, there were more than 8,000 of them. By 2016, there were only 3,627, according to data from the Center for Research in Security Prices at the University of Chicago Booth School of Business.
Because the population of the United States has grown nearly 50 percent since 1976, the drop is even starker on a per-capita basis: There were 23 publicly listed companies for every million people in 1975, but only 11 in 2016, according to Professor Stulz.
Let’s stop right there. So he’s saying that companies like Dell Computer going private is a sign of less innovation? I don’t buy it. Certainly, this is worth a read. But I think the conclusions are tenuous. I am much more concerned about market concentration impacting innovation than I am about the number of public companies.
Moreover, public companies often have a short-term outlook merely because they are public and feel pressure to increase share prices or their executives will lose their jobs. I would certainly be interested to know what you make of this analysis.
That’s all I have for today. Happy Tuesday.