Weekly Geopolitical Report by Bill O’Grady

Weekly Geopolitical Report By Bill O’Grady

June 8, 2020 deregulation and globalization. These policies included the rollback of regulation, The Geopolitics of the 2020 the offshoring of production, free trade Election: Part III agreements, increased immigration and sharply lower marginal tax rates. Inflation In this five-part series on the geopolitics of fell to acceptable levels; it is arguable the the 2020 election, we have divided the U.S. has experienced controlled inflation for reports into nine sections. Last week, in Part nearly four decades. II, we discussed the second and third sections, understanding the electorate and The positive outcomes of these policies party coalitions. In this report, we continue generally fell to the owners of capital, while our coverage with the fourth and fifth labor bore the costs. Put another way, the sections, the incidence of the establishment populists suffered the negative consequences coalition and the impact of social media. of these policies as the establishment flourished. Inequality rose, wages The Incidence of the Establishment stagnated, and unionization collapsed. The Coalition following charts show what occurred. Ignoring the class interests of the populists has economic ramifications. The INCOME SHARE OF THE TOP 10% OF HOUSEHOLDS establishment “rebellion” in the late 1970s 52 was in response to a serious inflation 48 problem.

32 20 30 40 50 60 70 80 90 00 10 20

Sources: Emmanuel Saez, CIM

This chart shows the top 10% share of income from 1913 through 2018. The last year available shows that 50.5% of national income has gone to 10% of households, meaning, of course, that the bottom 90% are From the mid-1960s into the early 1980s, capturing 49.5% of income. inflation rose with each business cycle, reaching a peak of 14.8%. The inflation Measuring long-term wages is quite problem was perceived to be caused by a difficult. That’s because jobs change over constrained supply side. In response, time as does the cost of living. What a policymakers adopted policies of household purchased 150 years ago doesn’t Weekly Geopolitical Report – June 8, 2020 Page 2

exactly match with what we buy now. Still, there are some series that try to capture wages. Measuringworth has a series of long-term data that can allow us to make some comparisons.

REAL WAGES, UNSKILLED PRODUCTION WORKERS

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R U

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R E

E 500

(

S E

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300

200

E X

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I 0 The persistence of these deficits is more 1775 1800 1825 1850 1875 1900 1925 1950 1975 2000 2025

INDEXED REAL ANNUAL WAGES, UNSKILLED PRODUCTION WORKERS TREND, 1775-1931 than just offshoring. The U.S. fostered TREND, 1932-72 TREND 1973-2019 increasing global trade which required larger Sources: Measuringworth.org, CIM offshore dollar balances. The best way for This chart shows inflation-adjusted wages countries to acquire dollars was by running for unskilled labor dating back to 1775.1 trade surpluses with the U.S. Consequently, We calculated trendlines from 1775 to 1931, this led to larger U.S. trade deficits. 1932 to 1972, and 1973 to the present. In However, the costs of this policy fell on the the first trend line, we see a gentle upslope working class, who was competing with in wages in the first one-and-a-half centuries lower wage labor around the world. of the U.S. Wages fell below trend in the Civil War and remained below trend during Globalization isn’t just about trade and the Industrial Revolution. By 1890, wage offshoring. It’s also about increased growth had returned to trend. During WWI, immigration. wages rose well above trend. In the PERCENT OF FOREIGN BORN POPULATION Roosevelt era into the early 1970s, wage IN THE UNITED STATES growth rose at a strong clip. Although 20 wages remained elevated in the 1970s, high 18 inflation generally prevented further growth. 16 14

But, since the early 1970s, as the trend line % % 12 shows, wage growth has been mostly flat. It 10 does tend to rise near the end of a long 8 expansion but falls back to trend. 6

1860 1870 1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010 2020 2030 2040 2050 2060 Rising globalization has been part of this 1850 Source: Census Bureau, CIM policy mix. We have seen persistent current account deficits throughout the 1980s. Compare the foreign-born level of the population and the wage trend graph. As the

1 foreign-born level of the population fell, the Because the data is indexed, it shows the change in sharp uptrend in wages rose during 1933-72. the level but not the actual dollar wage. We deflate the data with annual CPI from the same source. Although this isn’t the only reason for the rise in wages, the lack of immigration likely played a role in supporting wage growth. Weekly Geopolitical Report – June 8, 2020 Page 3

And, finally, these policies led to a decline consumption, debt rose…until the 2008 in unionization. Financial Crisis, which revealed the fact that household debt had become excessive. TOP 10 % SHARE OF INCOME & UNION MEMBERSHIP 28 56 And so, the policies of the past four decades

24 52 T T O O have generally been beneficial for the top

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% % H

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I I

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E E 8 36 less prevalent, and household debt levels 4 32 have become unsustainable. Angus Deaton 20 30 40 50 60 70 80 90 00 10 20 and Anne Case have done extensive research UNION MEMBERSHIP AS % OF THE LABOR FORCE TOP 10% SHARE OF INCOME

Sources: Emmanual Saez, Haver Analytics, CIM on what they describe as “Deaths of Despair”—fatalities caused by alcoholism, Unions can only flourish in conditions of opioid addiction, obesity and suicide. This restrained labor supply. The combination of is the situation of the populists; however, the increased technology, trade and immigration RWP are probably most affected because all contributed to the fall of union their status suffered with the breakdown of membership. the Roosevelt Coalition.

The loss of income growth led households to This situation was brilliantly captured by employ both spouses, complicating columnist Peggy Noonan in a 2016 op-ed childcare. Eventually, there was the where she described the establishment and widespread use of consumer debt to the populists as the protected and the maintain consumption. unprotected, respectively. The establishment created an economy in which DEBT VS. WAGES AS % OF CONSUMPTION they didn’t bear the risks associated with the

100

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H policies they created. She states:

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L O O The protected make public policy.

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The unprotected live in it.

% %

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O O C C 75 populists, to accept the establishment has 55 60 65 70 75 80 85 90 95 00 05 10 15 20 their best interests at heart. They were told COMPENSATION AS % OF CONSUMPTION HOUSEHOLD DEBT AS % GDP globalization and deregulation would be Sources: Haver Analytics, CIM good for them. As the above charts show, it’s hard to make that case. Accordingly, it This chart shows how much of consumption has reached the point where populists don’t is funded by total compensation and the know what to believe anymore. For level of household debt to GDP. Until the example, we suspect many populists early 1980s, wages generally accounted for understand that climate change is occurring. 90% to 97% of consumption. Since then the Anyone looking at the changes in nature can percentage has dropped below 80%. As see something is going on; areas that never compensation failed to keep up with needed air conditioning now require it. But Weekly Geopolitical Report – June 8, 2020 Page 4

the rub is that if the populists agree with this Changes in the media throughout history position, they fear the policy prescription have been important. It is quite possible the will cost them. In other words, if a carbon Reformation may not have occurred without tax is the solution, the incidence will almost Gutenberg’s moveable type, which allowed certainly be more negative for lower income for the widespread distribution of the Bible. households. So, instead, they argue that Newspapers became important vectors for climate change either isn’t real, is overstated political messaging; the Spanish-American or is due to natural changes, because to War was partly driven by the “yellow accept human actions as the primary cause press.” Franklin Roosevelt used radio for invites greater burdens. his famous “fireside chats” during the Great Depression. Television ushered in political The Impact of Social Media advertisement and the televised debate. Into the 1990s, populists in both party Political campaigns have been forced to alignments were becoming increasingly adjust to new forms of media and there frustrated with their respective parties. The appears to be a first-mover advantage. third-party candidacy of Ross Perot in the 1992 presidential election and the presence Social media has undermined the power of of Pat Buchanan in the GOP from 1992 into political parties. Prior to the advent of the new century were indicative of populist social media, politicians relied on political unrest. Among the left-wing populists, parties for funding and advertising Ralph Nader represented a similar position. assistance. This gave the party leverage in Neither the right- nor left-wing populists selecting candidates. For national or were able to win a presidential nomination, statewide campaigns, the parties would seek but these figures did represent growing candidates that fell into the “green oval” we dissatisfaction with the status quo. discussed in Part II (shown below). Essentially, political parties could exclude Despite this growing dissatisfaction within “fringe” or “radical” candidates. both wings of populism, a populist candidate was never able to win the nomination for president…until 2008. Although Barack Obama proved to be LWE in his policies, he was perceived to be LWP; simply put, the populists who voted for him in 2008 thought they were getting one of their own.

So, how did Obama defeat a paragon of the establishment in Hillary Clinton and then handily win the presidency? Much of his success came from his campaign’s ability to Social media brought two significant use social media to distribute his message. changes to how political campaigns are Using this tool occurred just as social media conducted. First, the costs of fundraising was expanding. fell and the reach expanded. It became feasible to gather small donations with scale. Weekly Geopolitical Report – June 8, 2020 Page 5

This sort of fundraising was cost-prohibitive win in a small state. But with the rise of before the advent of social media. Pre- social media, his message proved to be social media, candidates were forced to popular with the LWP and some RWP solicit large donations from the wealthy and members as well. He was able to raise rely on the party for small donations. This money from small donors and compete situation forced politicians to be beholden to much longer than expected due to the cost of the wealthy and to the party, reducing the advertising being much lower on social odds that a radical candidate could raise media. enough money for a national campaign. Nevertheless, the surprise of the election Second, social media allowed the candidate was Donald Trump. Although he was to target very small groups of voters wealthy, his election resources were dwarfed segregated by identity. In other words, by Clinton. She raised nearly twice what he voters might see ads that match their raised. Still, in the end, he was able to income, geography, education level, overcome this lack of money through savvy religious affiliation, gun ownership, race, spending and a strong social media etc. Before social media, such advertising campaign. was almost impossible. Because people tend to “tell their story” on social media There is another impact of social media that based on their internet search patterns (what has likely exacerbated the growing degree of they buy and who they follow), the data partisanship. Two political scientists, Keith gathered on social media gives campaigns a Poole and Howard Rosenthal, have done detailed profile of voters. Once this data is exhaustive research into the level of in hand, these voters can be targeted with partisanship in Congress. exclusive ads that probably won’t be seen by others for whom those ads were not directed. This means that, for the first time, a campaign can send messages to different groups and be reasonably confident another constituency which might oppose this ad won’t see it. Campaigns can also distribute negative ads against an opponent tailored to a small group of voters. Simply put, social media fundamentally changes the landscape.

The 2016 presidential election confirmed the (Source: Rosenthal and Poole) importance of social media. In the primaries, Sen. Bernie Sanders (I-VT) ran a The data is structured in such a way that the very strong campaign against Secretary of higher the score, the greater the degree of State Hillary Clinton. Under conditions of partisanship. The data suggests that dominant political parties, Sanders would Congress has never been as deeply divided have never been able to run a national between conservatives and liberals as it is campaign; he treated the wealthy with currently. contempt and could not have raised money from them. Prior to 2016, he was a It is clear there was a decline in partisanship candidate with narrow appeal, only able to after Theodore Roosevelt’s election. His progressive policies seemed to ease tensions Weekly Geopolitical Report – June 8, 2020 Page 6

that the disruption caused by the industrial define news sources; at the same time, there revolution unleashed. Bipartisanship is a high degree of distrust of news increased during the Great Depression and reporting. continued during the Cold War. It appears that three factors led to this low degree of This isn’t to say that the U.S. hasn’t had partisanship: partisan media in its history. It was not uncommon for even medium-sized cities to 1. As noted, the Roosevelt Coalition was have more than one daily newspaper, where remarkably stable and effectively one paper was considered the “conservative” sidelined opposition. and the other the “liberal” paper. But what 2. The Cold War demanded unified foreign makes the current environment different is policy. that social media reduces the costs of 3. Television media was expensive; the distribution to not just partisan media but to lack of choice among networks and fringe elements as well. The Spotlight was a regulations tended to narrow acceptable right-wing populist weekly published in the viewpoints. 1970s. It was considered populist and nationalist; its circulation peaked at 315k in As these factors changed, partisanship began 1981. Compare that to the distribution to rise. First, as we noted above, the potential for social media. breakdown of the Roosevelt Coalition led to the opposing political camps. Second, the In this hyper-partisan environment, voters waning of the Cold War disrupted the unity are inclined to believe only the positive on foreign policy. Third, the end of the aspects of their favored party and expect the Fairness Doctrine in 1987 and the rise of worst from the opposition. Again, returning cable news led to media outlets tailored to to our political grid, the new coalitions are specific audiences. divided with only modest overlap.

Social media and the internet have probably exacerbated partisanship. Not only can voters choose to watch certain cable news stations, but they can select increasingly segregated sources of information on social media. A Pew study from 2008 showed that political users of the internet tended to visit sites that shared their point of view. Twitter (TWTR, 29.71) users tend to self- segregate who they follow and retweet.

This data is supported by anecdotal reports Political divisions have mostly eliminated of deep political divisions. Surveys suggest the concept of the “loyal opposition.” that parents are more comfortable with their Historically, in a functioning democracy, the offspring marrying someone of a different losing party believes that elected officials of race or creed than one of the opposite the opposition are legitimate officeholders. political party. Political divisions now They may disagree with them on many Weekly Geopolitical Report – June 8, 2020 Page 7

issues, but they don’t believe they are support among the various identities would illegitimate. However, in the past three seem to make sense. However, there is presidencies we have seen a growing growing evidence that the conventional tendency for the opposition to view the wisdom described above only worked president as illegitimate. President George during the Roosevelt Coalition years. W. Bush was seen as illegitimate due to Increasingly, as Karl Rove and Rachel Florida’s vote being decided by the Supreme Bitecofer (among others) have concluded, it Court. President Barack Obama was in seems there is no such thing as a “swing question because of allegations that he was voter.” Winning elections has become more foreign-born. President Donald Trump is about getting your supporters to vote and seen as tainted because of Russian getting your opponent’s voters to stay home. interference in the electoral process. When The idea, known as “negative partisanship,” a president is seen as gaining office through postulates that voters are energized less illicit means the opposition is no longer about their candidate than loathing the other loyal; it becomes the resistance. Resistance side. Winning elections requires getting tends to foster attitudes in which the end one’s coalition to the polls, so that the most justifies the means, whereby preventing an effective plan may be for one side’s voters illegitimate president from exercising power to fear the other side winning rather than becomes justified. The U.S. has political loving the candidate of their own party. conditions in place to where a sizeable minority views the president as illegitimate Of course, we did see counties flip from regardless of who is in office. Obama in 2008 and 2012 to Trump in 2016. Bitecofer argues that this occurred because These divisions exhibit themselves in of the deep dislike of Hillary Clinton among different ways beyond just politics. Views populist voters; these areas went for Obama on current events are shaped by political more because they rejected the stance. For example, perceptions of the establishment GOP candidates they were number of fatalities from COVID-19 appear offered. to be skewed by political leanings. Just because this is how politics works now doesn’t mean it will be the case forever. We suspect that much of negative partisanship is a function of coalitions that can win elections but struggle to govern. A case can probably be made that it is hard to govern when the opposition views the party in power as illegitimate. Therefore, we have noticed a tendency for pundits to project that each presidency represents a seminal change (Data: Ipsos/Axios survey. Margin of error: ±3.2 that will create a new governing coalition. points. Chart: Naema Ahmed/Axios) What we have observed is that every eight

There has also been a change in how years the party in power flips because the elections have evolved. Since elections are, coalition built by the president in power was at their heart, popularity contests, it would unique to him and not transferable. seem that the largest coalition should win. And so, working to broaden a party’s Weekly Geopolitical Report – June 8, 2020 Page 8

Creating a longer lasting coalition probably estate developer with no political experience requires at least two of the alignments are clear breaks from normal. This tells us addressing both identity and class goals. that conditions have deteriorated enough for Currently, the establishment is addressing many voters to “take a chance” on an only their class interests and using identity unconventional candidate. In addition, the to capture votes. The secret of the fact that an avowed socialist ran two strong Roosevelt Coalition was that it did address primaries is prima facie evidence that voters the class interests of the RWP. One are dissatisfied with establishment potential outcome is the Nader coalition, candidates. We suspect voters will continue which was attempted by Bobby Kennedy; to trend toward the unconventional until the this would be a coalition of the LWP/RWP lot of the RWP and LWP improves. that would better represent the class interests of populists. Ralph Nader has argued that Second, the elections since 2008 reflect that this alignment is workable,2 although it isn’t the coalitions are in flux. Eventually, a obvious how the differences in identity political figure will rise who can build a could be overcome. Italy did have such a working coalition that will be stable. government from June 2018 into September Current coalitions have been remarkably 2019 but feuding among the League and the dependent on a political figure; Hillary Five-Star Movement led to calling new Clinton was unable to maintain the Obama elections which left the League out of the coalition and it remains to be seen if the next ruling coalition. So, for the foreseeable GOP leader can hold the Trump coalition future, we expect the current state of affairs together. We believe these conditions to remain. suggest that the U.S. is in the process of resetting coalitions, perhaps for the post- Before we move on to the next section, there hegemonic America. are two more observations we want to make. The last two presidents have been Part IV unconventional selections—a young, Next week, sections six and seven will cover African American, first-term senator with a our projection for the election and examine modest political track record and a real foreign interactions on our election.

2 Nader, Ralph. (2014). Unstoppable: The Emerging Bill O’Grady Left-Right Alliance to Dismantle the Corporate State. June 8, 2020 New York, NY: Nation Books.

This report was prepared by Bill O’Grady of Confluence Investment Management LLC and reflects the current opinion of the author. It is based upon sources and data believed to be accurate and reliable. Opinions and forward-looking statements expressed are subject to change without notice. This information does not constitute a solicitation or an offer to buy or sell any security.

Confluence Investment Management LLC

Confluence Investment Management LLC is an independent Registered Investment Advisor located in St. Louis, Missouri. The firm provides professional portfolio management and advisory services to institutional and individual clients. Confluence’s investment philosophy is based upon independent, fundamental research that integrates the firm’s evaluation of market cycles, macroeconomics and geopolitical analysis with a value-driven, company-specific approach. The firm’s portfolio management philosophy begins by assessing risk and follows through by positioning client portfolios to achieve stated income and growth objectives. The Confluence team is comprised of experienced investment professionals who are dedicated to an exceptional level of client service and communication.