Conclusion: Last night President Obama began to define his foreign policy in more detail following the U.S. military’s involvement in the Libyan no-fly zone. Ironically, the Obama doctrine sounds a bit like the Bush doctrine, albeit a little less granular. The fiscal risk is that we could be entering a phase whereby military spending ramps up with ambiguous goals, which is negative for the deficit and U.S. dollar.
“Well, this is a new Obama doctrine that you act on threats, remember that’s what George Bush did.”
- Dennis Kucinich (D-Ohio)
President Bush’s foreign policy wasn’t fully defined until certain events helped him define it. Specifically, the events were the terrorist attacks on U.S. soil on September 11th, 2001. Shortly thereafter, President Bush began to outline the Bush doctrine in a speech to a joint session of Congress on September 20th, 2001 with this statement:
“We will pursue nations that provide aid or safe haven to terrorism. Every nation, in every region, now has a decision to make. Either you are with us, or you are with the terrorists. From this day forward, any nation that continues to harbor or support terrorism will be regarded by the United States as a hostile regime.”
The Bush Doctrine was eventually codified in a document, the National Security Strategy of the United States, which was published on September 17, 2002 and stated:
“To forestall or prevent such hostile acts by our adversaries, the United States will, if necessary, act preemptively in exercising our inherent right of self-defense. The United States will not resort to force in all cases to preempt emerging threats. Our preference is that nonmilitary actions succeed. And no country should ever use preemption as a pretext for aggression.”
While Bush’s speech to the joint session more broadly defined enemies and threats to the United States, the National Security Strategy of the United States took the Bush Doctrine to the next level and emphasized the concept of preemptive action against threats.
Based on his speech yesterday, President Obama appears to be maintaining the concept of preemptive activity, though he frames the preemptive actions in Libya with a humanitarian justification, rather than a specific threat to the United States. Specifically, the “refusing to wait” language in his speech from last night, which is quoted below, is a preemptive doctrine by another name. As President Obama said last night:
"To brush aside America's responsibility as a leader and — more profoundly — our responsibilities to our fellow human beings under such circumstances would have been a betrayal of who we are. Some nations may be able to turn a blind eye to atrocities in other countries. The United States of America is different. And as President, I refused to wait for the images of slaughter and mass graves before taking action."
This is an about-face from the views of Senator Obama, while a candidate for the Presidency, when he stated on the campaign trail in 2007:
“The President does not have power under the Constitution to unilaterally authorize a military attack in a situation that does not involve stopping an actual or imminent threat to the nation.”
Of course it is somewhat trite to “YouTube” candidate Obama. Obviously, being President has different rules and responsibilities versus being a candidate. In a campaign, the objective is to get elected, while as a President, in theory, the objective is to make the best decision for your nation.
While no doubt President Obama and his cabinet will further clarify the Obama Doctrine and their collective foreign policy actions in the coming weeks and months, a key risk, both with our allies and for that matter with our enemies, is that the Obama Doctrine remains ambiguous. In aggregate, the key questions of: when, where, and why the United States will intervene in foreign conflicts still need to be clarified.
(In fact, the name of the operation in Libya is itself ambiguous: Operation Odyssey Dawn. Whether you disagreed or agreed with President Bush’s foreign policy, the objectives of Operation Iraqi Freedom were, at least, obvious.)
While the speech last night was certainly a step towards clarity on the Obama administration’s foreign policy objectives, Romesh Ratnesar probably summed up the last couple of months of Obama’s foreign policy best when he wrote on March 21st in Time Magazine:
“He supported pro-democracy forces in Egypt and nudged out a regime the U.S. had backed for decades, but has been unwilling to do the same in Bahrain or Yemen. In Libya, his Administration was against armed intervention to stop Muammar Gaddafi before Obama was for it. American warplanes carried out the initial wave of strikes on Tripoli, but Obama's aides insist that Washington is merely following the Europeans' lead. U.S. officials were reticent for days as the nuclear crisis in Japan worsened, then declared the situation to be even direr than the Japanese government had let on.”
To be fair to President Obama, the popular unrest and regime change in the Middle East, as we’ve written, has accelerated at a pace no one could have anticipated. Over the coming weeks and months, President Obama and his cabinet will have the opportunity to refine and clarify their foreign policies, but if the Obama administration is indeed adopting the preemptive philosophy of the Bush doctrine, it will come at a cost.
In the chart below, we’ve outlined defense spending as percentage of GDP and as a percentage of the federal budget going back to the early 1970s. The Clinton presidency was relatively peaceful with limited overseas conflict and therefore defense spending dropped dramatically during that era. Coincident with this drop in spending, although obviously not the only factor, the federal deficit dropped from -$290BN in 1992 to a surplus of +$125BN in 1999. In that same period, defense spending dropped in real dollars from $319BN to $276BN.
With the advent of the wars in Iraq and Afghanistan, defense spending accelerated dramatically under President Bush and by his last year in office was $612BN. In Obama’s first year in office, 2009, defense spending accelerated again to $655BN.
The risk of an ambiguous and increasingly proactive foreign policy, as evidenced by adding troops to Afghanistan, leading the no-fly zone in Libya, and announcing a foreign policy that is predicated on “refusing to wait”, is that President Obama will continue to grow defense spending during his Presidency. Increasing defense spending, will only lead to an accelerating deficit and with a growing deficit come associated implications.
Daryl G. Jones
Some consternation surrounding relatively weak visitation rates but GDP has mattered most.
Macau visitation grew 5.2% in February and only 1.4% in January. Yet, Mass revenue increased 19% and 36%, respectively. Should we even care about visitation? Probably, but not necessarily over the near term.
We’ve run the regressions and at first blush, it appears that visitation is highly correlated with Mass gaming revenues. Makes sense. However, when China GDP is thrown into the equation, visitation loses its significance. GDP and visitation are auto-correlated but GDP is by far the dominant variable. The R Square with just GDP is 0.71 versus only 0.50 with just visitation. With a multi-variable regression including both variables, the R Square rises to 0.77. Moreover, the visitation coefficient is only 0.29 so a 1% increase in visitation drives only a 0.29% increase in Mass revenues – barely worth mentioning.
We do question if this relationship will hold over the long term. It’s hard to imagine that spend per visitor can continue to grow at the current pace. We believe long-term Mass growth will be sizable but not at current levels. The long term pace we see is China GDP plus visitation: 7-10% GDP plus 5-10% visitation. That would alter the current equation considerably but seems reasonable since Macau has barely tapped the provinces outside of Guangdong. At some point, the fine people of Guangdong won’t be able to increase their gaming spend at a multiple of their wealth growth as they appear to be doing currently.
For now, however, Mass looks like it is on track for another 20% plus growth month in March, despite a 32% comparison last March. The GDP multiplier should hold over the near term.
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Conclusion: The tea leaves from early State budget battles continue to support our view that negative growth in State and local government employment and/or employee income will be a drag on the economy in 2H11 and beyond. In addition, we refresh our intermediate-term Consumption Cannonball thesis below.
The following chart comes by way of our Healthcare team, which has been closely monitoring the progression in State & municipal budget battles to ascertain their impact on consumption growth throughout the broader economy. If there is one key call-out to make, it’s that Labor Unions are growing financially weaker at an accelerating pace – meaning that their power in negotiating with the many newfound, fiscally hawkish State legislatures grows increasingly limited.
The key takeaway here as it relates to the ongoing budget battles playing out across the nation is that State and local government employees, which are highly unionized relative to their private sector counterparts (36% vs. 15%), are negotiating from a position of marginal weakness. That means they’ll likely have to cave in to legislative demands to limit collective bargaining and front more of their incomes to help pay for burgeoning healthcare costs, as the threat of outright termination is as strong as it has been in many, many years.
Any threat to State and local government employee compensation is negative for aggregate household consumption growth – either through higher savings rates or lost wages resulting from layoffs – particularly given that they are generally compensated at higher rate relative to private sector employees.
Per a December report out of the BLS, wages and salaries for State & local government employees averaged $26.25 per hour vs. $19.68 per hour for private sector workers. In addition, State & local government employee benefits outpace those received by private sector employees by $5.65 per hour worked ($13.85 vs. $8.20). A recent study by USA Today found this to be true in 41 States (including D.C.).
All told, while the recent “successes” in negotiating with labor unions is positive for the financial health of States like NY and WI* (pending judge approval), successful negotiations with labor unions on a national scale will more than likely produce a drag on near-term consumption growth – particularly in the back half of the year.
Replacing this demand will have to come from a commensurate pickup in private sector employment and/or wage growth – two things we don’t see happening in an environment of slowing growth.
Given that we’re at the top of another US economic cycle, we wouldn’t be surprised to see more near-term improvement in private payrolls and the unemployment rate, which is notorious for being the most lagging of all economic indicators. Over the intermediate-term, however, we don’t see domestic or global growth coming in at high enough rate for meaningful improvement in the US labor situation. GDP and PCE comparisons remain extremely difficult to surmount in the absence of this much needed improvement.
While consensus focuses on lagging indicators, such as Friday’s unemployment report, keep your eyes on the leading indicators of market prices, housing prices, the yield curve, and consumer and business confidence – all of which are going the wrong way for growth bulls. Alongside Housing Headwinds II, the Consumption Cannonball is alive and well…
Positions in Europe: Long British Pound (FXB); Short Spain (EWP)
Below we update our outlook on the UK economy in light of Chancellor of the Exchequer George Osborne’s 2011 Budget release last week. We believe that the budget largely stays the course on deficit spending, which should be a bullish catalyst for the GBP-USD and continue to support the country’s credit market outperformance; however, we caution that the decision to raise taxes on energy producers is a competitive drag worth consideration. We continue to believe that while the UK’s austerity programs are positive for its longer term economic outlook, over the near to medium term we expect the UK economy to underperform its fiscally stronger European peers (Germany, Sweden, Poland).
Last Wednesday Osborne presented the UK’s 2011 Budget; notably the budget stayed the course on deficit spending and emphasized making the UK a more competitive country by attracting investment and promoting a higher skilled and better educated work force.
Very plainly Osborne addressed the ails of the economy and its peoples, recognizing that:
- Higher food and energy prices are squeezing consumers (unlike The Bernank) and relief must be given. He offered marginal income tax reductions (primarily for low income earners and a child tax credit) and relief at the pump by cutting the fuel tax by one penny per liter this year.
- The UK has dropped from 4th to 12th place in the global competitiveness league, and therefore he offered:
- Funding for 12 new University Technical Colleges
- The creation of a new work experience program to benefit 20K young people and funding for 40K new apprenticeships to tackle youth unemployment
- To improve competitiveness Osborne also called for a reduction in the corporate tax rate (currently the 6th highest in the world) starting this April by 2%, and by 1% in each of the following three years. (Effectively from 28% to 23% over 4 years)
On economic fundamentals, Osborne noted:
- Annual GDP for 2011 will be revised down to 1.7% versus the previous estimate of 2.1% and improve to 2.5% in 2012.
- Inflation is expected to remain between 4-5% for most of 2011, before dropping to 2.5% in 2012.
- The country stands for credibility on the global marketplace, with 10YR interest rates at 3.6%, near Germany’s rate, and far from the 12.5% in Greece or 10% in Ireland.
On taxes of oil production profits in the UK:
- Osborne called for profits to be taxed at 62% from 50% to pay for a lower consumer tax on gas.
- The supplementary charge levied to oil and gas production was raised from 20% to 30%.
Overall the tone of the budget was positive: Osborne sized up the country’s growth deficiencies and proposed measures to return the country to a more competitive state. However, on the point of taxing profits of oil companies invested in the UK, we caution that Osborne may be swinging the pendulum too aggressively in requiring oil companies to subsidize gas prices in the present environment of inflated energy prices.
And the repercussion of this decision may be more than Osborne had in store. Yesterday, Statoil put on hold a $10 Billion plan to develop the Mariner and Bressay fields in the UK, with CEO Peter Mellbye saying the new taxes are “tremendously negative” and that he’ll have to reconsider the project.
Of the high frequency data we follow, we’ve not seen any major inflection points from trend in the UK data over the last months. The final reading of Q4 GDP was -0.5% quarter-over-quarter and the most present threat to future numbers remains inflation, which, as reflected by the CPI, continues to trend higher. The most currently February reading is +4.4% Y/Y. PPI input costs are running at 14.6% Y/Y, suggesting that these costs too must be passed on to the consumer. The BoE continues to remain in the precarious situation that it needs to act to combat inflation by raising rates, however fears that a hike could stymie growth. At present, the BoE continues to lean dovish on a hike.
UK retail Sales fell 80bps in February versus the previous month, which we think is representative for the months ahead now that we are out of the holiday period and the consumer is faced with a higher VAT (see chart below).
We’re seeing confirmation of this malaise vis-à-vis consumer confidence surveys. According to Nationwide, consumer confidence fell to 38 in February versus 48 in January, which is the lowest reading since the survey began in 2004.
On the unemployment picture, the rate continues to tick higher, adding 10bps month-over-month in January to 8.0%, however the jobless claims figure improved remarkably, falling 10K versus expectations for a 2K gain in February.
The housing market data also fails to impress across multiple surveys.
GBP and Gilt Strength
Despite our negative outlook on the UK economy over the intermediate term, we continue to see strength in the GBP-USD and the credit market which we think is a function of the UK’s fiscal sobriety to issue austerity and cut the deficit versus, in particular, the US’s fiscal irresponsibility and USD debauchery. We’re currently long the currency via the etf FXB. We covered our short position in Italy (EWI) today and remain long Spain (EWP) in the Hedgeye Virtual Portfolio.