Davos 2019: No more heroes for the global elite

The message from the World Economic Forum this year was that enthusiasm and ideas are in short supply

Gideon Rachman



Everybody needs heroes — even Davos plutocrats. But the “global elite” is currently out of enthusiasm and ideas.

In the corridors of the World Economic Forum last week, Kenneth Rogoff, the Harvard economist, summed it up: “This is the flattest Davos I can remember. Normally, there is a star country or a star industry that everybody is talking about. But this year, there is nothing.”

That enthusiasm deficit has implications well beyond the easily parodied world of the Davos conference. For the past 30 years, Davos has been the best place to monitor the ideas and crazes that were exciting the rich and powerful. It is the place where elite consensus was both formed and promoted.

Last year, the two Davos stars were easily identified. The fashionable technology was blockchain and the fashionable politician was France’s president, Emmanuel Macron. But, since then, Mr Macron’s poll ratings have fallen almost as fast as the price of bitcoin. The French president stayed at home this year to deal with domestic discontents.

Mr Macron and bitcoin can now join the growing club of discarded Davos darlings. These are the countries, politicians or industries that were once deemed to represent the future but whose reputations have since taken a dive.

The star countries of previous forums have often been fast-growing emerging economies that were preferably also democracies, or at least “moving in the right direction”. Brazil used to tick all these boxes. In 2010, the WEF awarded its “Global Statesmanship Award” to Luis Inácio Lula da Silva, then Brazilian president, who had spoken at several previous forums. Lula was almost designed to delight Davos. He was a former radical, who had embraced capitalism and globalisation, while retaining his credentials as a social reformer. His country’s economy was growing fast.

But the Brazil of 2019 has just been through a deep recession and a corruption scandal and Lula is in prison. Brazil is now represented by Jair Bolsonaro, a president famous for insulting gays and praising torturers. As an advocate of liberal economic reforms, Mr Bolsonaro had a chance to repackage himself for the Davos audience. But his appearance at this year’s forum was brief and stilted.

Other former Davos darlings have followed a similar trajectory. Turkey was once the star country. Its president, Recep Tayyip Erdogan, was hailed as the model of a moderate Islamist leader, presiding over a country that was both democratic and capitalist. But Mr Erdogan stalked out of Davos in 2009 after an onstage row about Israel — and he has never returned. These days, Mr Erdogan is increasingly authoritarian and his country is teetering on the edge of a debt crisis.

The apparent transformation of the Russian elite from faceless apparatchiks into raucous, rough-edged capitalists was also one of the wonders of the WEF. But, ever since the invasion of Crimea in 2014, Russia has been in the Davos doghouse.

Britain has disappointed Davos by voting for Brexit — and merely baffled delegates at this year’s conference by draping vast banners over the Belvedere Hotel proclaiming, “Free trade is great”. Donald “Tariff Man” Trump is clearly not somebody who would endorse that WEF-friendly slogan. The US president stayed away from the forum this year to deal with the government shutdown.

China’s claim to be “star country” is also tarnished. Slowing growth, rising antagonism with the US and increasingly authoritarian politics at home makes Xi Jinping’s government an increasingly tough sell in Davos. That leaves India, or “Incredible India” as it branded itself in a PR blitz at Davos 2006. Narendra Modi, the Indian prime minister, made a slick appearance at the WEF last year. But since then, news has reached Davos that economic reforms have slowed in India and central bank independence is under threat. So even India seems less incredible this year.

As a result, this year’s search for star countries and politicians in Davos reached into the second tier — with Austria and Ethiopia getting positive attention. Sebastian Kurz, the 32-year-old Austrian chancellor, is a smooth performer and is pursuing liberal economic reforms. One German pundit enthused: “I would love him to be chancellor of Germany, but we have had unfortunate experiences with Austrians in the past.”

Abiy Ahmed, the Ethiopian prime minister, came across like one of the Davos heroes of the early 1990s with his talk of releasing political prisoners, peace treaties with neighbours, regional economic integration and (of course) liberal economic reform. But positive change in Ethiopia is not enough to change the global mood.

In the past, when politicians have seemed particularly hopeless, Davosites have turned to industry for inspiration. But the tech groups are mired in controversy and the future they represent looks increasingly dystopian.Davos is also the place where legacy industries rebrand themselves as futuristic. Oil companies talk about renewables and car companies show off their electric vehicles. But this year, the oil companies are reeling from shareholder divestment drives and the German car companies are still struggling with the aftermath of the diesel scandals. So there was no cheer to be found there.

It seems as if the world has disappointed Davos. But, then again, maybe Davos has disappointed the world.

Technically Speaking: Too Fast, Too Furious

by: Lance Roberts
Summary
 
- The recent rally has primarily been a function of short-covering and repositioning in the markets rather than an "all-out" buying spree based on a "conviction" the "bull market" remains intact.

- It is too early to suggest the "bear market of 2018" is officially over.

- But, the rally has simply been "Too Fast, Too Furious," completely discounting the deteriorating fundamental underpinnings.

     
    
On December 25th, I penned "My Christmas Wish" wherein I stated that is was "now or never" for the bulls to make a stand.
"If we take a look back at the markets over the last 20-years, we find that our weekly composite technical gauge has only reached this level of an oversold condition only a few times during the time frame studied. Such oversold conditions have always resulted in at least a corrective bounce even within the context of a larger mean-reverting process."

"What this oversold condition implies is that 'selling' may have temporarily exhausted itself. Like a raging fire, at some point the 'fuel' is consumed and it burns itself out. In the market, it is much the same. 
You have always heard that 'for every buyer, there is a seller.' 
While this is a true statement, it is incomplete.
The real issue is that while there is indeed a 'buyer for every seller,' the question is 'at what price?' 
In bull markets, prices rise until 'buyers' are unwilling to pay a higher price for assets.  
Likewise, in a bear market, prices will decline until 'sellers' are no longer willing to sell at a lower price. It is always a question of price, otherwise, the market would be a flat line."
 
We now know where the buyers were willing to start buying again.
 
Let's take a look at that same technical indicator just one month later.

Now, let me remind you this is a WEEKLY indicator and is therefore typically very slow moving. The magnitude of the advance from the December 24th lows has been breathtaking.

Short-term technical indicators also show the violent reversion from extreme oversold conditions back to extreme overbought.
 

The McClellan Oscillator also swung from record low readings to record high readings in the same time frame as well.
 

But it isn't just the technical change that has had a violent reversion but also the rush back into equities by investors.
 
Oh wait, that didn't actually happen.
 
As Deutsche Bank's Parag Thatte noted recently:
"While the S&P 500 rallied +15% since late December, equity funds have continued to see large outflows. As Thatte elaborates, "US equity funds in particular have continued to see large outflows (-$40bn) since then, following massive outflows (-$77bn) through the sell-off from October to December."
 
 
This confirms our concern the recent rally has primarily been a function of short-covering and repositioning in the markets rather than an "all-out" buying spree based on a "conviction" the "bull market" remains intact.
 
David Rosenberg recently confirmed the same:
"Let's go back to December for a minute. This was the worst December since 1931, mind you, followed by the best January since 1987. This is nothing more than market that has gone completely manic. 
To suggest that there is anything fundamental about this dead-cat bounce in equities is laughable. This is an economy, and a market, that couldn't even sustain a 3% yield on the 10-year T-note. It sputtered at the thought of the Fed taking the funds rate marginally above zero on a 'real' basis, even as it feasted on unprecedented stimulus for a such a late-cycle economy. 
Yes, Powell et al. helped trigger this latest up-leg, not just at last week's meeting, but in the lead-up to the confab as well. The Fed has been crying uncle for weeks now."
 
As I discussed previously, this also highlights the importance of long-term moving averages.
"Again, as noted above, given that prices rise and fall due to participant demand, long-term moving averages provide a good picture of where demand is likely to be found. When prices deviate too far above, or below, those long-term averages, prices have a history of reverting back to, or beyond, that mean."
Well, as we now know, the market found support at the 200-week (4-year) moving average. As you will notice, with only a couple of exceptions, the 200-week moving average has acted as a long-term support line for the market. When the market has previously confirmed a break below the long-term average, more protracted mean-reverting events were already in process.
 
Currently, the "bull case" remains intact as that long-term average has held… so far.
 
 
 
However, just because the initial test of the trend has held, it doesn't mean the correction is over. As was seen in late 2015 and early 2016, the market held that trend during two sequential tests of the lows. While the bulls remain in charge for the moment, it will be whether the bulls can successfully manage a retest of lows without breaking the long-term trend.
 
The same goes for the 60-month (5-year) moving average. With the market currently sitting just above the long-term trend support line, the "bull market" remains intact for now.
 

Again, a monthly close below 2,280 would suggest a more protracted "bear" market is underway.
 
The Bounce Hits Our Targets
 
As I noted in the Christmas report, we were looking for an oversold retracement rally to push stocks back toward the previous October-November closing lows of 2,600-2,650. The rally has hit, and slightly exceeded those original estimates.
 
 
But, we also said that on a monthly basis the rally could extend as high as 2,700 which is roughly where January closed.
 

And, not surprisingly, it all turned out precisely as I stated:

"From yesterday's closing levels, that is a 12.7% to 14.8% rally. 
A rally of this magnitude Will get the mainstream media very convinced the 'bear market' is now over."
It is too early to suggest the "bear market of 2018" is officially over.
 
But, the rally has simply been "Too Fast, Too Furious," completely discounting the deteriorating fundamental underpinnings:
  • Earnings estimates for 2019 have sharply collapsed as I previously stated they would and still have more to go.
  • Stock market targets for 2019 are way too high as well.
  • Despite the Federal Reserve turning more dovish verbally, they DID NOT say they actually WOULD pause their rate hikes or stop reducing their balance sheet.
  • Trade wars are set to continue as talks with China will likely be fruitless.
  • The effect of the tax cut legislation has disappeared as year-over-year comparisons are reverting back to normalized growth rates.
  • Economic growth is slowing as previously stated.
  • Chinese economic has weakened further since our previous note.
  • European growth, already weak, will likely struggle as well.
  • Valuations remain expensive
 
You get the idea.
 
But more importantly, as recently noted by Sven Henrich, it also resembles much of what was seen at the previous two bull market peaks.
"Note the common and concurrent elements of the previous two big market tops (2000, 2007) versus now:"
  • New market highs tagging the upper monthly Bollinger band on a monthly negative RSI (relative strength index) divergence - check.
  • A steep correction off the highs that breaks a multi-year trend line - check.
  • A turning of the monthly MACD (Moving Average Convergence Divergence) toward south and the histogram to negative - check.
  • A correction that transverses all the way from the upper monthly Bollinger band to the lower monthly Bollinger band before bouncing - check.
  • A counter rally that moves all the way from the lower Bollinger band to the middle Bollinger band, the 20MA - check.
  • A counter rally that produces a bump in the RSI around the middle zone, alleviating oversold conditions - check.
  • All these events occurring following an extended trend of lower unemployment, signaling the coming end of a business cycle - check.
  • All these events coinciding with a reversal in yields - check.
  • All these events coinciding with a Federal Reserve suddenly halting its rate hike cycle - check.
The rally we "wished" for on Christmas has come to fruition. However, it isn't a rally to become overly complacent in as there remain significant challenges coming from weaker economic growth, rising debt levels, and slowing earnings growth.
 
But as I concluded in this past weekend's missive:
"While markets can certainly remain extended for much longer than logic would predict, they can not, and ultimately will not, stay overly extended indefinitely. 
The important point here is simply this. While the Fed may have curtailed the 2018 bear market temporarily, the environment today is vastly different than it was in 2008-2009. Here are a few more differences: 
  • Unemployment is 4%, not 10+%.
  • Jobless claims are at historic lows, rather than historic highs.
  • Consumer confidence is optimistic, not pessimistic.
  • Corporate debt is a record levels and the quality of that debt has deteriorated.
  • The government is already running a $1 trillion deficit in an expansion not half that rate as prior to the last recession.
  • The economy is extremely long in a growth cycle, not emerging from a recession.
  • Pent up demand for houses, cars, and other durables has been absorbed.
  • Production and Services measures recently peaked, not bottomed.
    In other words, the world is exactly the opposite of what it was when the Fed launched "monetary accommodation" previously. Logic suggests that such an environment will make further interventions by the Fed less effective.
The only question is how long will it take the markets to figure it out?"
I suspect not too much longer.


Caterpillar’s Stumble Was No Chinese Puzzle

Analysts weren’t pessimistic enough about Caterpillar because the China slowdown story has misled them so many times in the past

By Justin Lahart

Heavy-equipment maker Caterpillar lowered its profit targets for 2019 on slower Chinese growth.
Heavy-equipment maker Caterpillar lowered its profit targets for 2019 on slower Chinese growth. Photo: aly song/Reuters


One message from Caterpillar ’s CAT -9.16%▲ disappointing results: The China slowdown is real this time.

It is something that ought to have been apparent already. China last week reported that its gross domestic product last year advanced at its slowest pace since 1990, and anecdotal evidence abounds that its economy has hit a rough patch. Moreover, Caterpillar is hardly the first company to point to slower sales in China recently. PPG Industries and Stanley Black & Deckerare among those that have highlighted weaker Chinese demand.

Even so, Caterpillar shares fell sharply on Monday after the company reported results that missed estimates and lowered its profit targets for 2019 on slower Chinese growth.

Part of the problem may be that analysts and investors have heard the China slowdown story repeatedly over the past several years. There was a constant refrain that the country’s growth was unsustainable, dependent on debt and overinvestment.




But while China’s growth did face challenges, the country’s leaders seemed able to keep it on a smooth glide path, as in 2015 when they ramped up mortgage lending to offset troubles elsewhere. Betting that a slowdown in China was about to cause real problems for U.S. companies that did business there was consistently a bad bet.

The idea of policy makers putting China’s economy just where they want it looks naive. GDP slowed more than Beijing expected it to in response to its crackdown on the nonbank “shadow finance” system, and the trade fight with the U.S. has compounded the problem.

China’s growth over the past 20 years been astounding and lot of companies placed bets accordingly. Now they may be about to find out what happens when the world’s second-largest economy catches a cold.


The Push to Tax the Rich

By Randall W. Forsyth

A federal employee organizer at a rally protesting the government shutdown.
A federal employee organizer at a rally protesting the government shutdown. Photograph by Jim Watson/AFP/Getty Images


“Tax the rich, feed the poor, till there are no rich no more.”

Alvin Lee of Ten Years After appears to have been prescient in the British blues band’s sole hit single, “I’d Love to Change the World.” The 1971 tune anticipates what may emerge as the Democratic Party’s economic policy plank for next year’s presidential campaign.

First came the proposal for a 70% top marginal tax rate on incomes over $10 million floated by Alexandria Ocasio-Cortez, the newly elected 29-year-old member of Congress from the Bronx and Queens and an avowed democratic socialist. Not to be outdone by AOC, as this rising star on the left is known on social media, Sen. Elizabeth Warren of Massachusetts unveiled a plan for a wealth tax of 2% on assets over $50 million and 3% on fortunes over $1 billion.

Clearly, the aim of these taxes is to rake in a lot of dough for government. The schemes, at least in part, are based on the Willie Sutton school of public finance—you take from the rich because that’s where the money is. Warren, who has set up an exploratory committee for a 2020 presidential run, says her wealth tax would raise almost $3 trillion over 10 years. But the avowed aim of these levies is also to reduce inequality.

And rarely have the uber-wealthy been such a fat, tempting target.

Before the White House and Congress declared a truce Friday that will at least temporarily end the partial shutdown of the federal government, Commerce Secretary Wilbur Ross wondered aloud why some of the 800,000 workers about to miss a second fortnightly paycheck might have to resort to food banks. They should get loans, since “the obligations that they would undertake—say, borrowing from a bank or credit union—are, in effect, federally guaranteed,” he said in a CNBC interview. In other words, “Can’t we all just get a loan?” as Jimmy Kimmel quipped.

It didn’t occur to Ross (whose financial disclosure forms show he is worth a mere $700 million net and isn’t a billionaire, as he’s typically described) that some folks might be up to their credit limit and may also have other debt they’re struggling to pay. And that the interest rate might be more like 18%, instead of the 2% on T-bills.

Paying even small unexpected expenses remains a challenge to many. According to the Federal Reserve’s most recent study of consumer finances in 2017, four in 10 Americans would have difficulty meeting a $400 emergency expense—far less than any household’s monthly outlays when no money is coming in. And of those who did have trouble meeting that emergency, most did follow Ross’ suggestion: Fifty-eight percent said they would use a credit card, a loan or line of credit, or a payday advance or overdraft to meet obligations. And his billionaire boss, President Donald Trump, advised that grocery stores would “float” federal workers until they got paid. I haven’t seen a “float” checkout line at my local Stop & Shop, however.

The real importance of AOC’s 70% top marginal income-tax rate and Warren’s wealth tax isn’t that they are likely to be implemented. That would require a radical takeover of the White House and Congress by left-leaning Democrats in 2020. The proposals, however, do show that the political and economic pendulum has swung from the opposite side of where it was four decades ago. California’s Proposition 13 was passed in 1978, a precursor to the Kemp-Roth tax reduction that formed the basis of Reaganomics (along with the sound-money policies of the Volcker Fed that crushed double-digit inflation).

Now, these Democratic proposals would do the opposite and more: Raise the top marginal income-tax rates to pre-Reagan levels, while introducing a wealth tax, something unprecedented at the federal level. Modern Monetary Theory would complement these measures by simply issuing the currency to cover deficits already exceeding $1 trillion annually.

We are a long way from Jimmy Carter’s 1977-1981 malaise of stagflation, double-digit interest rates, and a Dow Jones Industrial Average under 1000—lower than it had been in November 1972, when it first topped triple digits. Despite a current economic nirvana of unemployment under 4% and inflation around 2% that would have been unimaginable in Carter’s day, the benefits of a Dow that’s soared 24-fold haven’t been evenly shared. At the same time, the U.S. economy has become more dependent than ever on asset values, and especially stocks, for better or worse. And whatever the perceived pluses of the Democrats’ increased taxes on incomes and wealth on what Warren calls the “tippy-top” of Americans, enhancing asset values aren’t among them.

According to a recent research note from Goldman Sachs ,the wealth of, and spending by, not just the very wealthiest Americans but also middle- and upper-middle-income households have become tied more closely to the stock market. That’s contrary to the standard economic assumption that the “wealth effect” from moves in stock prices should be diminished since so much equity wealth is now in the hands of the tippy-top, who can readily absorb a hit from a bear market without cutting back.

The wealthiest 0.1% of households account for 17% of the stockholdings of all households, while the top 1% own 50%, according to Goldman’s parsing of Fed data on consumer finances. Those percentages are up from 13% and 39%, respectively, in the late 1980s.

Relative to their incomes, all households’ stockholdings have tripled. As a result, for the top 10%, the impact of a 1% drop in equity prices is now three times as large as it was in the late 1980s, according to Goldman. Even for the upper middle-class (those in the 50th-90th percentiles), the impact of stock price declines is one-third greater. As a result of an 11% decline in equities from their September peak until Jan. 15 (the date of the report), Goldman economists expect 2019 gross-domestic-product growth to decline by 0.5 of a percentage point.

Were the ultrarich to have to render unto President Warren under her proposed wealth tax, they presumably would have to sell liquid assets. Some billionaires might simply write a $30 million check (3% of $1 billion), but it’s more likely that most would unload some liquid stocks or bonds, rather than putting a Palm Beach mansion, a Hamptons house, or one of those skinny high-rises on Billionaires Row in mid-Manhattan up for sale. In addition, assessing the value of some of their assets might be a bit problematic. (“That old Mercedes 300SL Gullwing? Can’t be worth more than a few thousand bucks.”)

The impact of a 70% top marginal tax rate could actually be positive, as Barron’s Matthew Klein concluded last week. Taxing wealth, meanwhile, is unlikely to be positive for asset prices, which could have a negative effect on spending and GDP, as Goldman’s economists suggest.

In any case, the debate is certain to become increasingly intense as the 2020 election approaches, and it’s sure to become an important focus for investors. In the meantime, Alvin Lee’s refrain seems apt:

“I’d love to change the world, but I don’t know what to do. So I’ll leave it up to you.”

What to Watch at the Fed

Friday’s news of the end of the partial federal shutdown helped the Dow Jones Industrial Average notch its fifth straight weekly gain, if only barely. (The Dow is up more than 10% over those five weeks.)

Arguably more important to financial markets was a Wall Street Journal article reporting that the Fed may end the runoff of its balance sheet sooner than currently anticipated, leaving it with a bigger portfolio of U.S. Treasury and agency mortgage securities and ensuring more liquidity in the financial system.

No actions are expected at the two-day meeting of the Federal Open Market Committee that winds up on Wednesday, but the key will be the panel’s policy statement and Fed Chairman Jerome Powell’s press conference (one will now follow every Fed meeting, rather than every alternate gathering). After December’s one-quarter-percentage-point increase in the key federal-funds range, to 2.25%-2.50%, there never was an expectation of a similar increase anytime soon. Just the opposite—the fed-funds futures market had begun to price in a chance of a rate cut in early 2020 as slides in stocks and speculative-grade bonds suggested rising recession fears.

Then, on Jan. 4, Powell changed his tune. In an appearance in Atlanta, he said that the central bank would be “patient” in tightening monetary policy, a shift from the December FOMC statement that “some further increases” would be appropriate. He also said that the Fed would change the pace of balance-sheet reduction, which Powell previously said was on “autopilot.”

The best justification for a policy pause would be to assess the impact of the government shutdown, which will affect economic data in various ways. While the Commerce Department was shuttered, data such as retail-sales totals weren’t released, leaving data-dependent policy makers less to go on. January’s employment report is due out Friday, as usual, and the numbers may be affected by the shutdown, as noted here a couple of weeks ago.

The Fed’s shift in verbiage earlier this month is one of three “puts” that Deutsche Bankmacro strategist Alan Ruskin sees as providing insurance against declines in risk markets. In addition to the “Powell put” resulting from the U.S. central bank’s sensitivity to financial conditions, Ruskin also points to a “widely perceived” “Trump put,” owing to the U.S. administration’s attention to stock prices, especially as they affect its negotiating power with China. Finally, Ruskin points to a “Xi put,” as the bank’s clients see a “line in the sand” at 6% Chinese economic growth. Given this array of puts, you might say that failure is not an option for the markets.


A New Chapter in US-Cuba Relations

By Allison Fedirka

 


Summary

During a speech outlining U.S. policy in Latin America in November, U.S. national security adviser John Bolton branded Cuba, Venezuela and Nicaragua a “troika of tyranny.” Bolton criticized the prevalence of poverty, violence and oppression in these countries, stressed that the U.S. would increase pressure on their autocratic governments, and vowed that Washington would stand with those fighting for freedom. It was no coincidence that he delivered the address in Miami, the home of many expats from these nations.

For Cuba, the United States’ new hard-line approach has meant intensifying economic pressure, and, in many ways, the timing couldn’t be worse. The Cuban economy has been struggling for the past few years with sluggish growth and disappointing investment levels. Its closest allies are also struggling with their own domestic challenges and disputes with the U.S. and are in no position to come to Cuba’s aid. This Deep Dive will look at the history of U.S.-Cuba relations and the new efforts of U.S. President Donald Trump’s administration to squeeze the Cuban government.

Cuba’s Strategic Value

Cuba is an island that stretches 780 miles (1,250 kilometers) long and lies about 100 miles south of the U.S. state of Florida and 125 miles east of Mexico’s Yucatan Peninsula. Because of its location, between the Atlantic Ocean and the Gulf of Mexico, it plays a major role in U.S. maritime interests. Cuba, or whoever controls it, could block access to the Gulf of Mexico and leave exports departing vital ports like New Orleans with no way to access international markets. The prospect was dire enough that in 1823 U.S. Secretary of State John Quincy Adams told U.S. diplomats Washington intended to annex Cuba within half a century for fear that another foreign power would claim it.



Cuba’s location cemented its status as a subject of competition among regional and global powers. As a Spanish colony, it served as a major port for ships arriving from Spain whose cargo needed replenishing and whose crews needed rest before moving on with their journey. It also served as a military hub in Spain’s quest to fend off other powers, such as Britain and France, that wanted to establish colonies in the Americas. When anger against Spain started growing in Cuba, the U.S. and Mexico began to court pro-independence groups on the island. Mexico was already much weaker than the U.S. by this time, and Washington managed to align with independence movements to more or less control the island in the early years of its statehood. After Cuba’s revolution, however, Cuban leader Fidel Castro allied the country with the Soviet Union to dry to deter U.S. aggression and influence.

With the end of the Cold War, Cuba’s place in great power competition diminished. Russia was a shadow of the former Soviet Union, and the U.S. solidified its dominance in the Americas, turning its attention and resources to other parts of the world. But nearly three decades later, countries outside the Western Hemisphere, particularly those the U.S. sees as rivals, are once again looking to project power and influence in the Americas. Though they don’t represent much of a challenge to U.S. ascendancy in the region, they are nonetheless a source of frustration that Washington can’t afford to ignore. The scenario may well lead to a revival of the Monroe Doctrine, the 19th-century U.S. policy of opposing foreign (at the time, European) interference in the Americas.

U.S.-Cuba Relations Over Time

Economics have always played a key role in U.S.-Cuba relations. Trade ties between the two, in fact, were a decisive factor in ending Spanish rule over the island. As a colony, Cuba officially traded with only Spain (though it carried out illicit trade with other countries), but as Spanish control over the island declined, it opened up trade with the United States. Their economic ties boomed in the 19th century, so much so that some Cubans pushed for U.S. annexation of the island.

Once Fidel Castro’s Communist Party took power in Havana, relations between the U.S. and Cuba deteriorated. Washington imposed a range of sanctions against the Cuban government starting in 1960, when President Dwight Eisenhower cut Cuba’s sugar quota to the U.S. in response to the nationalization of U.S.-owned refineries on the island. Eisenhower then banned all exports to Cuba except for food and medicine. President John F. Kennedy expanded the embargo, banning all imports from and business transactions with Cuba unless explicitly approved by the executive branch. Trade with the United States fell from 68 percent of total Cuban trade in 1958 to zero percent in 1962, while trade with the Soviet Union jumped from less than 1 percent to 49 percent over the same period. President Lyndon Johnson then led a broader effort to isolate Cuba from Western Europe and Latin America.

In the 1970s, the U.S. began to ease these efforts after realizing they weren’t having the desired effect, since the Soviet Union continued to prop up the Cuban economy. President Gerald Ford started backdoor talks with Cuba to try to normalize relations, exempting foreign-based subsidiaries of U.S. companies from the embargo and helping to relax restrictions imposed on Cuba by the Organization of American States. U.S. President Jimmy Carter also tried to normalize relations – even though Cuba sent troops to Angola to back a leftist movement there – and eased measures such as a ban on U.S. travel to the island. But in the 1980s, as several leftist revolutions in Central America turned the tide of U.S. foreign policy, these efforts stalled. President Ronald Reagan reinstated the travel ban, restricted the flow of hard currency and remittances, and banned the import of products containing nickel (one of Cuba’s top exports) from Cuba or the Soviet Unión.

Following the Soviet Union’s collapse, Cuba’s economy became more vulnerable to U.S. economic pressure. From 1989 to 1993, Cuba’s gross domestic product fell by 35 percent, its real income decreased by 75 percent and its capacity to import fell by 74 percent. The U.S. decided the time was right to intensify the pressure in an attempt to bring down the government. President George H.W. Bush once again barred overseas subsidiaries of U.S. companies from trading with Cuba and restricted access to U.S. ports for ships that had docked in Cuba. During his administration, Congress passed the 1992 Cuban Democracy Act, which promoted “a peaceful transition to democracy in Cuba through the application of sanctions.” The administrations of both Bill Clinton and George W. Bush redoubled measures to limit business ties, remittances and tourism to Cuba before Barack Obama’s administration reversed many of them. Obama opened up travel between the two countries, allowed for business and remittance flows, called for an end to the embargo, and removed Cuba from the U.S. list of state sponsors of terrorism.

Trump Changes Course

Over the past two years, the Trump administration has, in turn, reversed the Obama-era moves to warm relations with Cuba. Trump outlined his position on the country in October 2017, stating that the purpose of his Cuba policy was to further the United States’ national security and foreign policy interests and to empower the Cuban people. He introduced two major changes targeting Cuba’s tourism sector, one of the country’s most lucrative industries. First, he restricted travel to Cuba for U.S. citizens. Second, and more important, he restricted U.S. companies from doing business with certain firms linked to the Cuban military – which is heavily involved in tourism. (The initiative built on legislation – introduced in 2015 but never ratified – that would have prohibited dealings with companies tied to Cuba’s military and government.) The U.S. State Department released a list of firms banned from doing business with the U.S. in November 2017 and updated it last year. All of them are tied to tourism.



Just last week, the U.S. also signaled that it may implement the 1996 Helms-Burton Act. The controversial legislation enables U.S. citizens to sue companies profiting from property the Cuban government seized from them after the 1959 revolution and also allows those who were Cuban citizens when their property was confiscated to sue. When the bill – whose implementation could affect all businesses operating in Cuba, including cruise companies that dock there – first passed, major U.S. trade partners that still do business with Cuba, such as the European Union, Canada and Mexico, condemned it. Every administration since its passage has suspended the key clause, Title III, to avoid angering allies. Then on Jan. 16, U.S. Secretary of State Mike Pompeo warned that the Trump administration would suspend the clause for only 45 days, instead of the usual six months. Pompeo added that the government would use the waiver period to carry out a review of all articles of the law “in light of the national interests of the United States and efforts to expedite a transition to democracy in Cuba.”

Cuba’s Transition

These moves come at a time when Cuba is undergoing a political and economic transition. Its president, Miguel Diaz-Canel, became the first person outside the Castro family to lead Cuba in nearly six decades, after taking over for Fidel Castro’s brother, Raul, in April 2018. The Diaz-Canel administration has proposed a series of constitutional reforms, including measures to introduce a prime minister to oversee the government’s day-to-day management, along with provincial governors, who would replace the presidents of provincial assemblies. Under the proposed changes, which will be put to a referendum Feb. 24, the president could serve a maximum of two five-year terms and would have to be under 60 years old on taking office. (Raul Castro was 76 when he stepped in for his brother in February 2008.)

One of the goals of the changes is to move the country away from a governing style dominated by one leader while still maintaining a single-party system – similar to the systems in place in China and Vietnam today. (The new constitution, if passed, may increase the military’s role in government, too, which explains why the Trump administration has targeted firms with ties to the armed forces.) In addition, many of the changes aim to improve efficiency in the economy. The draft constitution acknowledges recent economic reforms aimed at improving the business environment, streamlining government and reducing debt. It also allows for more transparent foreign investment, gives state-owned companies more autonomy and introduces a tax system. It even recognizes private property and the role of markets, though it maintains the primacy of the state in land ownership, production and economic planning. According to the government, these changes will help Cuba attract sorely needed foreign capital.

Many of these changes build on reforms that Raul Castro introduced in 2011, to little avail. Diaz-Canel hopes his government can succeed where its predecessor did not and is shooting to achieve 1.5 percent economic growth in 2019 by boosting foreign direct investment, increasing exports and reducing imports. (Annual imports are already on the decline, down to $11.3 billion in 2017 from $15.6 billion in 2013.) He also wants to pay down Cuba’s external debt – which hit $15.8 billion in 2015, the last time official figures were released – by implementing austerity measures and using inventory and emergency reserves. And to reduce fuel imports, the government plans to cut fuel consumption, a risky move considering that energy helps drive the economy.



The U.S. plans to target the tourism sector, one of Cuba’s top sources of foreign currency, could damage the Cuban economy. The Cuban government made an estimated $3 billion through tourism last year, while private businesses related to the sector, such as taxi services and restaurants, pulled in an estimated $1 billion. Canada and the U.S. were the top two tourist markets for Cuba, followed by various Western European countries. It seems the Trump administration’s moves to tighten travel restrictions haven’t deterred U.S. tourists yet: U.S. visitors to the island increased last year by about 20,000 – admittedly a more modest bump than in previous years – to reach 630,000. Still, restrictions on business with certain companies in the tourism industry and the uncertainty surrounding the Helms-Burton Act may make U.S. tourists and businesses think twice about spending their dollars in Cuba.

 



External Factors

Complicating matters for Havana is the lack of an external benefactor it can rely on for financial support. After the Soviet Union’s collapse, Russia was too weak to be a reliable economic partner, and courting the U.S. wasn’t an option. Cuba thus looked to strengthen ties with an array of countries, rather than to depend on a single power, as it had for much of its history. It maintained good relations and economic ties with Russia, as well as with like-minded nations such as China and Venezuela. It also increasingly opened up to Western Europe. The problem now is that many of Cuba’s allies are dealing with political and economic problems at home that prevent them from being the country’s patrón.

Venezuela, for example, is in the midst of a crisis. Its oil exports to Cuba have fallen by at least 40 percent since 2014, and that’s a generous estimate. Meanwhile, a political scandal in Brazil, and the election of right-wing President Jair Bolsonaro, mean that Cuba can no longer rely on the country for support. Brazil has scrapped plans for new investments in Cuba and has sent the thousands of Cuban doctors it hosted, whose salaries went to the Cuban government, back home. Making matters worse, Cuba recently defaulted on a loan from Brazil’s development bank.

Though Russia has stepped up to help Cuba with oil shipments and small loans, these measures have had a limited effect. Russia is facing economic problems of its own and can’t offer to sell Cuba large amounts of oil at a favorable price. Of course, it wants to support Cuba as much as it can so that it has an ally in the United States’ backyard. Moscow, in fact, sent a delegation of advisers to the island just a couple of months ago. But it has too many bigger concerns, in places like Syria and Ukraine, to spend much of its time or resources propping up the Cuban economy. Similarly, China is too busy managing the fallout from its economic slowdown and the U.S. trade war to come to Cuba’s aid.

As for the European Union, it has taken a renewed interest in Cuba over the past couple of years. Western Europe is Cuba’s leading source of FDI, and many Spanish companies, in particular, are involved in Cuban tourism and infrastructure. Europe, however, may be one of the regions most affected by the Helms-Burton Act, if the Trump administration decides not to suspend it past March. Furthermore, the European Union is already engaged in disputes with the U.S. over trade, the Iran nuclear deal and energy projects involving Russia. It likely wouldn’t want to put a possible deal on these issues at risk by backing the Cuban government against Washington’s wishes. Cuba, then, will have to hope its political and economic reforms will help it weather the storm of the U.S. crackdown on the “troika of tyranny.”