Daily Comment (November 21, 2017)
by Bill O’Grady and Thomas Wash
[Posted: 9:30 AM EST] Happy Thanksgiving week! We want to pass along a heads up that the Daily Comment will not be published this Friday, November 24. Although financial markets are quiet, there was a good bit of news. Here’s what we are watching:
Merkel leans toward new elections: Yesterday, we laid out the four options for Germany, suggesting that new elections were the least market-friendly because this outcome raises uncertainty. Increasingly, it looks like Merkel is leaning toward new elections, unwilling to ask the SDP to join a grand coalition or form a minority government. Senior leaders within the CDU/CSU are giving the parties three weeks to form a government but are putting increasing pressure on the SDP to change its position. There are two reasons the SDP is reluctant to join Merkel to form a government. First, voters across Europe are shunning center-left parties for ignoring the needs of lower income citizens and opting for more market-friendly policies. The SDP took a drubbing in the polls and fears that joining Merkel again could lead to the end of the SDP as a functioning political party. Second, joining Merkel would raise the status of the AfD by making it the official opposition. There are hints that the SDP will join the CDU/CSU on one condition—Merkel steps down from the chancellor position. This is why Merkel is instead willing to take a shot at another round of elections. One important issue to remember is that Merkel has had a tendency to destroy junior partners in coalitions. The Free Democrats slipped badly after joining Merkel from 2009 to 2013. As noted above, the SDP has had a similar experience. If talks finally fail, the German president will hold votes in the Bundestag for chancellor; the first two rounds of votes require a majority in order to become chancellor. A third vote is held if a majority isn’t reached, giving the chancellor post to the highest vote winner, which will almost certainly be Merkel. At this point, either Merkel can operate a minority government, piecing together votes to pass various measures, or the president can declare the government too unstable and call for new elections. We may be seeing the end of Merkel’s political career. Political tumult in Europe’s largest economy will tend to weigh on EUR sentiment. It may help PM May get a better deal on Brexit and will open up the chance for Macron to boost France’s status within the EU and the Eurozone.
North Korea a state sponsor of terrorism: President Trump officially labeled North Korea as a state sponsor of terrorism yesterday, joining Iran, Syria and Sudan with this designation. The DPRK was initially put on the list in 1988 after its agents detonated a bomb on Korean Air Flight 858 in 1987. President George W. Bush removed North Korea from the list in 2008 in an attempt to improve relations during nuclear negotiations. For the most part, this won’t make a huge difference; North Korea is already heavily sanctioned and anything that comes from this change won’t be material. It is a global shaming for the DPRK and may increase Chinese pressure on Pyongyang. After all, a rising global power doesn’t want to be seen supporting a designated terrorist state. The move was also welcomed in South Korea and Japan, which live in fear of North Korean terrorist behavior. On a related note, Kim Jong-un is disciplining the leadership of the nation’s most powerful military organization. Although there is no information suggesting a purge of the military’s leadership, they are being “punished.” We suspect two issues here. First, Kim wants to put his own people in place and has been steadily removing his father’s cronies; this action may be part of that. Second, Kim’s father had increased the power of the military over the civilian structures of the government, including the party. Kim may be deciding that he wants to reverse that program. We watch this because unexpected outcomes are possible any time important parts of the North Korean government come under pressure.
Yellen out: Although it isn’t a huge surprise, Chair Yellen made it official, saying she would not serve out her term as Fed governor when she steps down as chair in February. Her governor term lasts until 2024. This move is precedent at the Fed; when chair and vice chair terms expire in this particular office, they retire. This is done to allow the replacements to more easily conduct their policy. Imagine if Greenspan had stayed around as a governor after Bernanke became chair. Divisions and second-guessing, especially during the Great Financial Crisis, would have been a real problem. Thus, the president will have three governors in place after February—Brainard, Powell and Quarles. He can appoint four more governors and really put his stamp on the FOMC.
No to a major merger[1]: We rarely discuss company-specific issues. This is a macro publication and thus we don’t comment on individual company issues unless they have a macro impact. The DOJ’s decision to reject the AT&T (T, 34.64) and Time-Warner (TWX, 87.71) merger is one of those events. Since Reagan, the DOJ has generally been merger-supportive. Anti-trust legislation from the Progressive era of President Theodore Roosevelt to Reagan generally prohibited large combinations. Size was a key determining factor. The legal arguments tended to center on whether the combined firm dominated an industry. During the Reagan administration, anti-trust regulation shifted its focus to outcomes. If a monopolist did not abuse its pricing power, mergers were generally approved. A theory called “contestable markets” emerged, which suggested that mergers were usually approved even if an industry was concentrated so long as there was ease of entry so the oligopolist firms could not act with pricing power. The key determinant seemed to be how the firms in an industry treated consumers. If consumers didn’t face higher prices after the union, the DOJ generally didn’t object. Thus, “vertical” mergers, combining industries together, were usually approved whereas “horizontal” mergers, firms in the same industry, faced greater scrutiny. The aforementioned merger is considered vertical because one firm is in the distribution business while the other is in content.
What we may be seeing here is a change in precedent away from the Reagan model to the pre-Reagan model. In practice, firms have discovered that they can reach mammoth size if they don’t adversely affect customers. Thus, labor tends to get hammered by companies. The whole move to the “gig” economy appears to simply be a way to push down labor costs. Mergers seem to do the same thing. The bigger firms become in an industry, the more they become monopsonists in the labor market for that industry. In other words, if there were only one tech firm, it could keep programmer wages low because there wouldn’t be competition from other firms bidding up wages. If the Trump DOJ stands its ground on this merger, it could have a chilling effect on the mega-tech industry.[2]
DACA: Don’t sleep on a December 8th shutdown. Democrat Party leaders are making DACA a key element in approving a continuing resolution to fund the government and perhaps raise the debt ceiling. With the GOP tied up with tax issues and the president generally open to the “dreamers,” we expect Chuck and Nancy to use their leverage to try to get a win even if it leads to a government shutdown.
[1] A potential tongue twister…similar to https://www.youtube.com/watch?v=2OBZf0QdKdE
[2] See https://www.axios.com/the-ripple-effect-of-the-att-merger-lawsuit-2511164001.html and https://www.axios.com/the-facebook-whistleblower-wave-2511168571.html?utm_source=newsletter&utm_medium=email&utm_campaign=newsletter_axiosam&stream=top-stories