AN UNSETTLED WORLD
WASHINGTON SETTLED IN OVER THE PAST MONTH to its new political configuration, but uncertainly. The beginning of the 114th Congress saw a lot of House activity but little came to fruition, while the most immediate task before it hit a partisan wall. The President engaged Congress with budget, military, and trade initiatives. Bipartisan cooperation is anticipated on the third and perhaps on the second, but it is already evident that funding the federal government will once again be hard-fought, and initiatives like tax reform seem difficult to achieve. The sense of precariousness, in fact, of a fraying order, was more pronounced on the international front. Major economies, apart from the U.S., remain stagnant. Strategic crises worsened, focused on Europe, confronting both financial and military standoffs, and the Middle East/North Africa, where atrocities and consequent military action ratcheted up. This WIBR will review Washington developments over the past month, and their broader context.
THE FED: DECISION TIME – The time is approaching for the Federal Reserve to decide when to begin a slow rise (“renormalization”) of U.S. short-term interest rates. Domestic economic indicators are mixed, yet the U.S. recovery appears sustainable and the key data points for the Fed – job-creation and wages – are getting stronger. When it comes, the rate hike will be gradual and may not be quickly reflected in market interest rates, but it will have an impact. Already the mismatch in the path of U.S. and foreign monetary policy and the resulting dollar appreciation is complicating Administration efforts to win congressional support for its trade initiatives.
Patience: The statement following the Fed's late-January meeting said it “judges that it can be patient,” understood to mean that it won't raise rates before June. It meets next in March, and will have to decide whether to keep the word “patient.” The minutes of the January meeting showed concern that the market may “overreact” when “patient” is dropped by assuming a hike is imminent. The Fed also added a new factor for its deliberations: “international developments,” that is, foreign economic problems that worsen the disconnect between the Fed and other central banks, which are loosening monetary policy and thus putting upward pressure on the dollar, suppressing U.S. inflation and exports.
Lift Off – but When? This is the Fed's big dilemma. Many U.S. indicators remain weak (including consumer and business spending and factory output), and the first estimate of fourth-quarter U.S. GDP growth was disappointing at 2.6% (annualized), as was the December trade deficit, the highest in over two years at $46.6 billion.
Yet job-creation surged over the last three months, as 257,000 new jobs were added in January and the previous two months were revised up. The unemployment rate ticked up to 5.7%, because more workers joined the job search. Moreover, wages rose by 0.5% and were up 2.2% in the past year – not great, but good. So the Fed upgraded its predictions for the economy and employment. However, inflation is still far below the 2% target, suppressed by still-falling oil prices and the rising dollar, pushed up by foreign monetary loosening. The Fed expects oil prices to rise starting mid-year, and the markets agree as there is stockpiling going on, so this could ease the too-low-inflation problem. Still, until that outcome is sure the risks of a rate lift-off coming too soon may outweigh those of moving too late, and so the Fed may wait. Clues about timing should come in Fed Chairman Janet Yellen's semi-annual report to Congress, February 24-25.
ABROAD: SLOWING FASTER – Pressing on the Fed are those “international developments” it is now taking into account. The rest of the world hasn't followed the U.S. into a steady recovery, as projections for GDP growth in Europe, Japan, and China continue to be low. There have been slight upward revisions in expected 2015 growth for the EU and Eurozone – and Germany surprised on the up-side in the fourth quarter – but all see Europe growing well below 2%. Moreover, there may be economic effects from Greece's standoff with its Eurogroup creditors – e.g., on Eurozone unity and on austerity programs in other countries – especially if the expected (but not yet visible) compromise doesn't quickly materialize. Meanwhile China's growth is decelerating and Japan, though out of recession, is barely growing. These economies benefit from falling oil prices and weaker currencies vis-a-vis the dollar as their central banks, now including China's, are engaging in monetary stimulation. Still, the risk of deflation is heightened by the low oil price, and they all face slowing investment and deficient demand, while their currencies in relation to each other are problematic (China's yuan has jumped against the yen).
Treasury Secretary Jack Lew, in a February 8 Wall Street Journal op-ed written with his British counterpart, after boasting that their own economies “are now growing solidly” and can exit monetary easing, lamented the picture in the rest of the “uncertain world”: “Global growth is forecast to slow. Deflationary risks are evident …. There is a shortfall in demand. And we face rising geopolitical risks from Ukraine and the Middle East.” They called on governments to use their “full set of tools” including fiscal policy and structural economic reforms to restart growth, since central banks “cannot do the job alone.” This call for governments to bite the bullet on politically difficult fiscal and structural reform is hardly new; the Group of 20 leaders at their summit last November pledged to develop plans for doing so – as they are regularly lectured to do by the IMF and OECD. G20 finance ministers meeting February 9-10 promised to deliver an accountability report on the progress of these plans to this year's summit. But the ministers’ statement, while hedging, supported “accommodative monetary policies,” and welcomed in particular the European Central Bank's initiation of larger than anticipated quantitative easing. While the final statement had much else to say, including a new call for governments to address “rising income inequality,” continued reliance on the cyclical instrument of monetary easing to deal with secular growth stagnation is causing concern. In the meeting, Lew urged Brussels to use more fiscal stimulus and warned against using exchange rate policy to boost exports.
TRADE POLICY GAINING CURRENCY – The Obama Administration has good reason to worry about the expanding use of monetary easing among major U.S. trading partners. The upward pressure these foreign maneuvers put on the dollar – it has strengthened against the euro, yen, even the yuan – is threatening President Barack Obama's ambitious trade agenda. The ongoing negotiations for the Trans-Pacific Partnership and the Trans-Atlantic Trade & Investment Partnership are vulnerable to populist backlash, and while the TPP talks are much further along than the TTIP, the U.S. Congress is lobbing a populist grenade in their direction in the form of a demand for a provision to punish “currency manipulation.” A recent TPP chief-negotiators round and separate but related U.S.-Japan talks reported “progress” but have left difficult, politically sensitive matters still unsettled despite reports that they are nearing conclusion. Trying to add the currency-cheat issue at this late date (or, really, at any time) would be at a minimum highly disruptive, and probably impossible.
Two Tracks: In Congress those pushing the matter are traveling along two tracks: insisting on inclusion of an enforceable currency provision in legislation to give the President the fast-track Trade Promotion Authority that he needs to conclude a deal, and seeking to pass a separate bill that would enable U.S. trade law to treat currency manipulation as an unfair subsidy. Despite wide bipartisan support, these efforts are opposed by both the Administration and the Republican leadership. Both insist that the problem is best dealt with in existing multilateral forums and through bilateral pressure. The bright side for the President's trade policy is that those most strongly insisting on the currency measures are among the minority of legislators who are unlikely to vote for TPA or the TPP in any event. Others who have supported targeting currency manipulators but favor trade liberalization may be peeled away from supporting these measures or or may be given a chance to vote for the currency bill in exchange for agreeing that exchange rates not be included in TPA (thus exempting the TPP).
The President Engages: The most important development for U.S. trade policy over the past month is that following a forceful shout-out by the President for his trade agenda in his January 20 State-of-the-Union address, he has become personally involved in lobbying Democrats for support and has mobilized his Administration in the effort. Since the Republican leadership had stipulated that TPA wouldn't come to a vote unless the White House actively promoted it, this sets the stage for completing the bipartisan drafting of the bill and introducing it in the very near future (probably with the Senate acting first). If TPA is approved, then the TPP negotiations would enter their final phase as all participants would know it is time to lay down bottom-line offers and make the politically difficult trade-offs needed to cut a deal. Enacting TPA would also give a boost to the TTIP, which held its 8th round in early February. It was to be a “fresh start” to the talks that lagged under the previous European Commission, but reported no breakthroughs. In their public comments, the top TTIP negotiators focused defensively on what the pact wouldn't do – change social programs or consumer protections. These talks have a long way to go, but urgency to get there could be stepped up by a successful conclusion of the TPP.
Free traders welcomed the President's energetic focus on trade, but some objected to the negative framing: in arguing that his trade agreements will assure fair trade, high labor and environmental standards, and increased exports, he and other Administration officials contrast this to past agreements which they say are rightly denounced for having harmed American workers. While this stance may not convince the public about the benefits of trade expansion, it may make it a bit easier for some Democrats to come on board. Another part of the framing by the President and his cabinet that raised eyebrows was the new emphasis on trade agreements as a weapon against China. Whereas in the past U.S. officials have worked to calm Chinese accusations that they are using trade deals to isolate and contain China, now they tout their trade initiatives as needed to prevent China from expanding its influence. Again, this may appeal to the American electorate and thus provide cover for legislators whose constituents feel that China doesn't play fair. It may even enable these legislators to support TPA and the TPP without resort to disruptive currency provisions.
Besides competing with China for influence, the Administration has been arguing aggressively for other strategic rationales behind its trade policy. Russia's confrontation with the West over Ukraine has, according to U.S. Trade Representative Michael Froman in a February 18 article in Foreign Policy, “triggered deep unease,” yet “the TTIP will remind the world that our transatlantic partnership is second-to-none.” Regarding both the TPP and TTIP, “The economic implications” of the U.S. ceding leadership “are stark, but so too are the strategic ones.” And in the White House's new National Security Strategy document released February 6, references to the strategic importance of trade are sprinkled throughout. Russia and China have pressing economic problems and even more horrendous long-term dilemmas centered about demographics, but it is perceived in Washington that if the U.S. does not shore up its alliances across the Atlantic and Pacific, they will take advantage of the opening. As Moscow seeks to expand its influence on its western periphery, China, through its Silk Road Fund (to build a transport network through South Asia to the Middle East) and new Asian Infrastructure Investment Bank (which Washington opposes) is positioned to move into any vacuum left by an unsuccessful TPP process.
Facing Congress: While Congress may take account of the geopolitical angle in acting on the upcoming trade matters, its most immediate strategic focus is on the President's February 11 request for a new Authorization for the Use of Military Force to cover actions against the increasingly barbaric Islamic State. Both parties are split on how to respond; some legislators see the AUMF as too expansive and open-ended, while others see it as too restrictive (e.g., ruling out “enduring ground combat operations”). Moreover, some Republicans suspect the President wants them to share the blame if his efforts to defeat the IS result in failure.
The Republicans are more united in opposition to the President's $4 trillion Budget Request. Highlighting Democratic themes of middle-class rescue and fighting inequality, it would end the sequester and raise taxes on the wealthy and businesses to fund new government programs. Republicans will now craft their House and Senate Budget Resolutions as prelude to the drafting of appropriations bills. They take a different approach to middle class relief, and want to raise defense spending without breaking the domestic sequester.
The House began the new session passing an array of bills, most of which will be blocked by Senate filibuster or presidential veto. But the big item on its agenda is funding the Department of Homeland Security beyond February 27, when temporary funding expires. The House passed a DHS appropriations bill that forbids implementation of the President's executive order giving amnesty to some undocumented immigrants, but Senate Democrats blocked it. The subsequent game of chicken over federal funding, in which each party tried to position the other to either blink first or take the shutdown blame, was suddenly interrupted by the February 16 judge's stay of the amnesty order (on procedural grounds). How this messy situation works itself out when the issue is reengaged should provide clues to how the new divided government in Washington will function (or not) over the coming two years.
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