Monday, April 20, 2015

Double-Speak from Iran's Foreign Minister

In an op-ed in today's New York Times Iran's foreign minister Mohammad Javad Zaref stated and I quote directly:

"On a broader level, regional dialogue should be based on generally recognized principles and shared objectives, notably respect for sovereignty, territorial integrity and political independence of all states; inviolability of international boundaries; noninterference in internal affairs; peaceful settlement of disputes; impermissibility of threat or use of force; and promotion of peace, stability, progress and prosperity in the region."

Would that only be true with respect to the State of Israel? I won't hold my breath waiting for President Obama, Secretary Kerry and their choir in the media to comment on this notorious example of double-speak.

Monday, April 13, 2015

My Amazon Review of Brian McGinty's "Lincoln's Greatest Case: The River, the Bridge and the Making of America"

Lincoln as Railroad Lawyer

Abraham Lincoln made his living as a railroad lawyer specifically for the Illinois Central and the Chicago and Rock Island. Lawyer/historian Brian McGinty turns his keen eye on the now obscure struggle between steamboat and rail interests for dominance over Midwest transportation that chrystalized with sinking of the steamboat Effie Afton at the Rock Island Bridge. The owners of the Effie Afton supported by the St. Louis river interests sued for damages and argued that the bridge should come down because it was a hazard to navigation. Lincoln’s role in the case was to assist Norman Judd in defending the bridge and its railroad owners. This is a book more for history nerds than for the general reader.

The Rock Island Bridge was the first to cross the Mississippi in 1853 and sinking occurred in 1856. The steamboat interests rightly feared the railroads and fought tooth and nail against them with a strong ally in Washington, Secretary of War Jefferson Davis. Davis was not anti-railroad; he just wanted a more southern route to extend slavery into the southwest. As a Secretary of War he surveyed the west and came up with four potential routes. Although not mentioned in the book, those routes ultimately became the backbones of the Union Pacific, Southern Pacific, Santa Fe and Northern Pacific railroads, but that was to come later.

Lincoln’s main role at the trial was in his summation where without notes he demonstrated his knowledge about all things mechanical and his deep understanding of the currents of the Mississippi River. Although the jury verdict was not unanimous, the 9-3 vote in favor of the bridge opened the way for railroad penetration west of the Mississippi. Norman Judd, the lead counsel, ultimately would become one of the key backers of Lincoln’s presidential run three years later.

McGinty tells a good story, but there is lots of trial stuff here that only a lawyer would love.

Saturday, April 11, 2015

The Iran Deal: Congress Must Advise and Consent

Let me say at the outset that engaging Iran in negotiations on their nuclear programs is a good idea. However engagement is not enough and making a deal is not enough. It has to be a good deal that stands the test of time and is in the interests of both parties. It seems to me that President Obama and Secretary Kerry are far more eager to get a deal than the Ayatollah Khamenei and therein lies the problem.

For example President Obama is now in the process of selling a deal where there are two distinct interpretations with respect to the removal of sanctions, the intrusiveness of the inspections and the coverage of the inspections with respect to military facilities. Now Administration flacks are telling us that the Ayatollah's recent comments are for domestic political purposes only. Wrong! New York Times columnist Tom Friedman taught me a long time ago that unlike politics in the U.S. where private comments from political leaders should weigh more heavily than public comments; in the middle-east it is the reverse. It is practically irrelevant what the Ayatollah's minions say in private. What counts is what he says in public.

Furthermore with the Administration so invested in the deal, my guess is that they will look the other way if violations occur in the coming years. Indeed after the "red- line" in Syria and continued cuts to the military budget it makes it hard to believe that the current administration would act forcibly to correct violations of the deal.

Thus the deal has the smell of appeasement and it is the reason why Congress must use its power to advise and consent. If the shoe were on the other foot with a Republican president in power, Senators Obama, Biden and Kerry would screaming from the ramparts for Congressional involvement.

Thursday, April 2, 2015

My Amazon Review of Charles Calomiris' and Stephen Haber's "Fragile by Design: The Political Origins of Banking Crises and Scarce Credit"

Banking in a Political Context

According to Professors Calomoris and Haber banking does not exist in a political vacuum. In fact banks are product of a bargain between political coalitions and bankers; a social contract, if you will. In a very long book, too long in my opinion, the authors delve into the history of the banking systems of the United States, the United Kingdom, Canada, Brazil and Mexico and the political coalitions that underpin them.

Calomoris is a self-described Hamiltonian; he likes large banks with extensive branching systems. He credits Canada where a bank bargain between the political elites enabled a crisis free banking system. In contrast the United States with its agrarian populist combining with local banks created a crisis ridden small unit banking system. That system ended when a new coalition of mega-banks and urban activists enabled the creation of the banking system we have today. Simply put in exchange for supporting mega-mergers, banks channeled trillions of dollars into urban mortgages, some of which being of dubious quality. One thing that comes through is that lending on illiquid real estate lurks behind most of the banking crises experienced in the U.S. and U.K.

The political context rests on the fact that politicians need banks to fund government debt, support favored activities and to make it easy to finance government though an inflation tax. Brazil and Mexico are prime examples of using inflation to fund the government. In the United States banks and government sponsored agencies exist to fund housing programs off the budget.

This is more a history book than an economics book. Nevertheless it is very important for economists to understand the milieu their models are operating in.

The full Amazon URL is:

Monday, March 16, 2015

My Amazon Review of Joseph Kanon's "Leaving Berlin: A Novel"

Spy vs. Spy

You can taste the rubble of 1949 Berlin in Joseph Kanon’s new novel. Along with the rubble there is intrigue, duplicity and the beginnings of the East German secret police, the Stasi. Alex Meier, Kanon’s protagonist, is a Jewish writer formerly of Berlin and most recently of Hollywood who has returned to his home city to spy for the CIA after suffering the wrath of Congress’ investigations of the role of Communists in Hollywood. Simply put he made a deal to return and as someone who was denounced by Congress, he has the perfect cover.

Along the way we meet several Berlin returnees who still believe that the path to a better world is through communism and the wisdom of the Party in playing traffic director. They will soon be subject to a purge that was far worse than the contempt citations handed out by the Congress of the 1940s. There are more than a few cameo appearances of Bertolt Brecht and a scene in the novel involves the opening of his play, “Mother Courage.” Of course it would not be a spy novel without the Adlon Hotel and as you would have it Meier hooks up with his prewar love interest, who is, to say the least, active in the spy business.

All told “Leaving Berlin” is a terrific spy novel in the tradition of Alan Furst and John le Carre. We might just get a sequel.

The Amazon url is:

Saturday, March 14, 2015

An Island of Stability in a Volatile World, UCLA Anderson Forecast, March 2015

Amid slow growth and currency devaluations
throughout much of the developed world, the United States
looks like an island of stability in a very volatile world. We
continue to believe that the U.S. economy is on a 3% real
GDP growth tack over the next two years. (See Figure 1)
With that, payroll employment will be increasing at a solid
250,000 jobs a month pace and the unemployment rate will
hit 5% by yearend. (See Figures 2 and 3) To be sure, the
labor force participation rate will remain far lower than what
it was prior to the financial crisis.

Figure 1 Real GDP Growth, 2007Q1 -2017Q4F
Source: Sources: U.S. Department of Commerce and UCLA Anderson

Figure 2 Payroll Employment, 2007Q1 – 2017Q4F
Sources: U.S. Bureau of Labor Statistics and UCLA Anderson Forecast

Currency Wars

In a rerun of the 1930s, the developed world is witnessing
a series of central bank driven competitive devaluations
that was initiated by the United States in 2010 with what is
now known as QE2. Put bluntly, each trading bloc is seeking
to export the economic weakness they are experiencing to the
rest of the world. As a result, along with policy uncertainty
within the Eurozone, the U.S. dollar has soared, rallying 16%
from the 2014Q3 to 2015Q1F. (See Figure 4)

For the world economy as a whole, a series of competitive
devaluations cannot work unless the cumulative rounds
of quantitative easing ignite global growth. Meantime, with
Europe and Japan mired in near-zero growth, the U.S. looks
like an exception.

The combination of very sluggish growth in Europe
and Japan, near zero inflation rates and the implementation
of quantitative easing policies has created an unprecedented
environment of negative interest rates. Where the so-called
zero bound for interest rates has previously been broken in
periods of extraordinary financial crisis (i.e. 2008 and 1933)
negative short-term interest rates have become rather com-

Figure 3 Unemployment Rate, 2007Q1 -2017Q4F
Sources: U.S. Bureau of Labor Statistics and UCLA Anderson Forecast

Figure 4 Trade-Weighted Dollar with Major Currency Trading
Partners, 2007Q1 – 2017Q4F
Source: Federal Reserve Board and UCLA Anderson Forecast

Figure 5. Global Economic Forecasts, 2014-2017, Real GDP, %chya
Sources: Goldman Sachs Global Economics Weekly, February 12, 2015

mon place. Furthermore, 10-year sovereign debt for much
of Europe and Japan now trades well below 1% making U.S.
yields at 2% looking like Mount Everest. (See Figure 6)

A strong dollar that raises export prices mixed with
weak economic activity abroad is not a good recipe for export
growth. As a result, real exports will only grow a modest
3-4% pace over the next few years, well below the 9% clip of
nearly a decade ago. (See Figure 7) Concomitantly a stronger
U.S. economy coupled with cheaper import prices will suck
in imports from most of the world. Real imports are forecast
to increase at a 7% pace this year and next, well above the
3.4% average from 2012-2014. (Figure 8) Remember here
we are talking about real imports which ignore the huge
drop in the price of oil.

Figure 6 Sovereign Debt Yields for Selected Countries at
Various Maturities, February 24, 2015
Sources: CNBC and Bloomberg

Figure 7 Real Exports of Goods and Services,
2007-2017F, Annual Data
Sources: U.S. Department of Commerce and UCLA Anderson Forecast

Figure 8 Real Imports of Goods and Services,
2007 -2017F, Annual Data
Sources: U.S. Department of Commerce and UCLA Anderson Forecast

Figure 9 Federal Funds vs. 10-Year U.S. Treasury Bonds,
2007Q1 -2017Q4F
Sources: Federal Reserve Board and UCLA Anderson Forecast

Getting Ready to Move Off of Zero

Despite getting a major break from the dramatic decline
in oil prices and the strong dollar which are temporarily
suppressing inflation, we believe that the Fed will soon
move to end its 6+ year zero interest rate policy. Given the
strengthening labor market and the likely bottoming of inflation
in the second quarter, we think the Fed will embark on
a very gradual pattern of increasing the federal funds rate.
(See Figure 9) By this we mean that instead of raising rates
.25% at every meeting as was done in the mid-2000s, we
believe that the Fed will initially increase rates at alternate
meetings. Similarly, it seems that long-term interest rates
bottomed in early February and despite very low rates of
interest in Europe and Japan the yield on the 10-year U.S
Treasury bond is now on a path to rise from the current 2%
to about 4% in late 2016.

The very low rates of inflation we are now experiencing
will soon reverse as oil prices rebound, more on that
below. Indeed headline inflation as measure by the consumer
price index will likely rise to 3% or more by late 2016. (See
Figure 10) In a similar vein, core CPI will likely to be running
above 2.5% as well. Moreover, wage compensation
after being muted for many years is about to show more
robust gains from about 2% to somewhat over 4% during the
next few years. (See Figure 11) We believe that Wal-Mart’s
move to raise their lowest wage to $9.00 an hour in April,
above the current national minimum wage of $7.25 an hour,
of this year and to $10 an hour next year “rang the bell” to
a new regime of higher wage growth.

The Mostly Ups and One Big down from Lower Oil

The $50/barrel collapse in oil prices brings a gross
savings to the economy of about $350 billion a year and
net savings of about $150 billion a year; the latter being the
reduced cost of imported oil. (See Figure 12) More simply,
with the United States consuming 135 billion gallons
of gasoline a year, a $1.00 a gallon reduction amounts to
$135 billion. Although much of this savings has yet to flow
through to retail spending, we do note that restaurant and
bar sales were up 11% year-over-year in January and overall
consumer spending is strong. (See Figure 13)

Figure 10 Consumer Price Index vs. Core CPI,
2007Q1 – 2017Q4F
Sources: U.S. Bureau of Labor Statistics and UCLA Anderson Forecast

Figure 11 Total Compensation per Hour, 2007Q1 – 2017Q4F
Source: Bureau of Labor Statistics and UCLA Anderson Forecast

Figure 12 West Texas Intermediate Crude Oil, 2007Q1
Source: Commodity Research Bureau and UCLA Anderson Forecast

Figure 13 Real Consumption Spending,
2007Q1 -2017Q4F, Quarterly Data

It’s very obvious the drop in the price of crude oil,
has put the domestic oil industry in a world of hurt. We
estimate that the industry is losing about $200 billion a year
in revenues. Moreover, the oil intensive regional economies
of Texas, Louisiana, Oklahoma, Alaska and North Dakota
will suffer with them. However, the decline in oil prices
involves more than a loss of revenues for the domestic oil
producers; it is also causing a dramatic drop in the capital
spending associated with new oil wells. Most people including
more than a few economists do not realize that mining
nonresidential fixed investment (almost all of it related to oil
and gas production) is larger than commercial construction.
As a result, investment in this sector will plummet over the
next few quarters from an annual run rate of $140 billion to
about $100 billion. (See Figure 14)

Housing Construction Accelerating

The combined effect of lower gasoline prices along
with relaxed down payment requirements, strong employment
growth that is supporting new household formations,
low interest rates that are likely to stay lower longer is causing
us for the first time in several years to raise our estimates
for out year housing starts. For example, last quarter we were
forecasting 2015 and 2016 housing starts at 1.209 million
and 1.344 million, respectively. We are now at 1.248 million
and 1.392 million for those years. (See Figure 15) As
with prior forecasts we continue to believe that multi-family
housing starts will exceed 400,000 units a year in both 2015
and 2016. Thus, the increase from prior forecasts will be
coming from the single-family starts.

Figure 14 Real Gross Investment in Mines and Wells,
2007Q1 -2017Q4F
Sources: U.S. Department of Commerce and UCLA Anderson Forecast

There is a lot of anecdotal evidence that housing activity
began to significantly improve in late January. Traffic
is up at new developments and builder optimism is rising.
Perhaps the drop in gasoline prices is showing up in the
form of increasing demand for housing. While consumers
are probably wisely concluding that today’s gasoline prices
might not be here forever, they are likely not to go back to
their old highs for many years to come.

Defense Spending to Increase

You don’t have to be a geopolitical strategist to figure
out that the world is in disarray. With the United States
policy facing challenges in Ukraine, the middle-east and
the South China Sea, the post Iraq War decline in defense
spending is behind us. As we have done in prior reports,
we believe that defense spending is now on the rise. (See
Figure 16) Our view is buttressed by the fact that President
Obama has asked Congress to lift the sequestration limits
on both domestic and defense spending. We believe that the
Republican Congress will be more than willing to give him
the higher defense spending he is requesting.

Figure 15 Housing Starts, 2007Q1 -2017Q4F
Sources: U.S. Bureau of the Census and UCLA Anderson Forecast


Despite weak global growth and the very strong U.S.
dollar, the economy remains on a 3% growth path for real
GDP over the next two years that will bring the unemployment
rate down to 5% by the end of this year. While inflation
is being temporarily suppressed by the drop in oil prices,
it will soon be running above 2% as oil prices gradually
recover. In response to the improved labor market and the
expectation of higher inflation, the Fed will begin a gradual
tightening process in June. The near-term downside for the
U.S. economy will come from a collapse in the capital spending
associated with oil and gas production, while housing
starts will advance more quickly than previously predicted.

Sunday, March 8, 2015

My Amazon Review of William Thorndike's "The Outsiders: Eight Unconventional CEO's and Their Radically Rational Blueprint for Success"

Too Much of a Good Thing

As I write this review there are 183 reviews of “The Outsiders…” on Amazon. Why another? It is because private equity investor William Thorndike offers keen insights in his highly readable book into what makes a successful CEO. Drawing inspiration from such CEOs as Tom Murphy of Capital Cities, Henry Singleton of Teledyne, John Malone of TCI and Bill Stiritz of Ralston he shows how great fortunes were made for their shareholders.  To him it is all about CEO's who run lean decentralized operations with a keen sense of capital allocation and the use of leverage. Appropriately timed share repurchases along with leverage is what makes for strong shareholder returns and he correctly predicted in 2012 that major tech companies would soon adopt such policies. All true, but to my mind he overstates his case because he leaves out the downside of financial engineering and ignores the role of research and development and the investment in great ideas that have built some of America’s greatest companies.

For example CEOs such as Bill Gates of Microsoft and Steve Jobs of Apple took quite a different path to build their companies. Similarly away from technology look at the great success of Wal-Mart, Starbucks and Whole Foods in retailing. Their success did not come from share repurchases and leverage. To be sure all those companies just mentioned, for the most part, benefited from strong capital allocation skills, but their success came from sourcing and developing highly profitable investment projects.

The American economy was built on such investments. While share buybacks can make sense for an individual company, it might not make sense for the economy as a whole. This I fear is what is happening today as share buybacks explode and capital investment remains tepid.

For the Amazon URL see: