Saturday, December 13, 2014

My Amazon Review of Roger Moorhouse's "The Devils' Alliance: Hitler's Pact with Stalin, 1939-1941"

In “The Devils’ Alliance” British historian Roger Moorhouse delivers a highly readable account of the immediate aftermath of the Hitler-Stalin Pact of August 1939. His keen eye focuses in, not on the hows and whys the alliance was formed, but rather on how it operated to the advantages of both parties and how brutally efficient they both were in their respective occupation zones in Eastern Europe. He sheds much light on this aspect of World War II that few Western historians focus on. But it is certainly part of the history of Poland and the Baltic states.    

He goes into great detail about economics of the deal in terms pricing and delivery of raw materials from Russia and capital goods from Germany. Though this sounds like boring stuff, he shows how the Germans lost patience with the Soviets nit-picking the terms of each and every shipment. Remember that at the outset, Hitler needed the deal more than Stalin, but after the German lightening victory in France, Stalin needed the deal far more than Hitler. It is no accident that Stalin occupies the Baltic States as France is falling. Hence we get a ringside seat to Molotov’s visit to Berlin in November 1940 which sets into motion a reorientation of Hitler’s thinking. As a sidebar the tactics used by Stalin in the Baltics in 1940 are identical to what Putin is using in the Ukraine today.

It is with the German victory in France and the subsequent German defeat over the skies of Britain that Hitler turns east and according to Moorhouse the flashpoint that ended the pact was the territorial division of the Balkans which was mostly outside of the initial deal. I think Moorhouse makes too much of the disputes in the Balkans, in particular the disagreements in the rather obscure Danube Commission. My guess is that Hitler’s decision to invade Russia was more on the level of grand strategy than a localized dispute. 

Moorhouse puts to rest the myth that Stalin was surprised by the German invasion in June 1940.  For the prior six months he spent practically every waking hour trying to avoid war and to get his armies battle ready for the coming onslaught. His problem was that he couldn’t mobilize for fear of giving Hitler an excuse to invade. Simply put he was practicing the very same appeasement policy that Britain and France followed three years earlier.

Along the way Moorhouse brings to life the dour personality of Molotov and the rather flippant personality of his counterpart, Ribbentrop. Both of whom were at the beck and call of their puppet masters. One interesting note Moorhouse follows up with the British-Russian –Polish conference of July 1941 where Russia offers concessions to the Polish government in exile to receive British support in their new war against Germany. One of those concessions was the freeing of Polish nationals held in the Soviet gulag. Although Moorhouse doesn’t mention it, one of those so freed was Menachem Begin.

For the Amazon URL see:     

Friday, December 12, 2014

"From Wall Street to Main Street," UCLA Anderson Forecast, December 2014

While stocks have tripled off of their financial crisis
lows of March 2009 and are now trading well above the
old high reached in November 2007, the feeling on Main
Street has been far less ebullient. (See Figure 1) As we have
noted in prior quarters, we believe that the tepid 2% growth
path experienced from 2009-2014 is now in the process of
ramping up to a sustained period of 3% growth in real GDP
which will bring with it a sense of economic progress on
Main Street. (See Figure 2) Specifically we are forecasting
2.8% growth in the current quarter and for growth to average
3.1% in both 2015 and 2016.

Figure 1 S&P 500 Index, November 2004 – November 2014, Weekly Data

In this environment the economy will be generating
200,000 – 260,000 jobs a month and that will engender a
fall in the unemployment rate to 5% by the end of 2016.
(See Figures 3 and 4) We note that this forecast allows for
a decline of about 0.1% per quarter, half the 0.2% decline
experienced from 2012Q1 – 2013Q3. The reason for this
is that in response to the rising demand for labor, the labor
force participation rate will begin to increase. Our forecast is
consistent with the recent history where household employment
gains have averaged 315,000 jobs a month and payroll
employment gains have averaged 220,000 a month over the
past year ended in October. Perhaps more importantly, the
rate of increase in employee compensation will rise from an
average of 1.8% a year from 2009-2013 to 3.2% this year
and next and then to 3.9% in 2016. (See Figure 5)

Figure 2 Real GDP Growth, 2006Q1 – 2016Q4F
Source: U.S. Department of Commerce and UCLA Anderson Forecast
Figure 3. Payroll Employment, 2006Q1 – 2016Q4
Sources: Bureau of Labor Statistics and UCLA Anderson Forecast

Figure 4. Unemployment Rate, 2006Q1 – 2016Q4F
Bureau of Labor Statistics and UCLA Anderson Forecast

Figure 5. Total Compensation per Hour, 2006Q1 -2016Q4F
Sources: Bureau of Labor Statistics and UCLA Anderson Forecast

Mostly Good News and Some Bad News from the
Drop in Oil Prices

In recent weeks, the price of oil went into a free fall.
After trading for much of the year in the $100 a barrel range,
the price of oil plummeted to around $75 a barrel. (See Figure
6) Should the oil price remain at this new level, and we
expect it will, there will be huge benefits to consumers. For
example, such a price reduction translates to at least a 50
cent a gallon price cut for gasoline. With the U.S. consuming
about 135 billion gallons of gasoline a year that calibrates
into a $67 billion a year boon to consumers.

With lower oil prices adding fuel to rising employment
and wages, consumer spending will ramp up from a 2% or
so pace to over 3% over the next two years. (See Figure 8)
Unlike prior cycles, these gains will not be funded out of a
lower savings because the income growth will be there to
support the higher level of spending.

On a more macro basis, the U.S. consumes about 19
million barrels a day of oil and natural gas liquids of which
we will produce about 11 million barrels and import about
8 million barrels each day. Thus, a $25 cut in the price of
oil yields a gross cost reduction of about $173 billion a
year; the net reduction is a far lower $73 billion. Simply
put, more than half the consumer benefit of lower oil prices
will be absorbed by U.S. producers.

That, in turn, will lead
to lower than otherwise incomes, employment and capital
spending in the oil producing regions of the United States
which have been the fastest growing regional economies
in recent years. We note that this has become a high class
problem as domestic oil and gas liquid production has surged
from seven million barrels a day in 2009 to an estimated ten
million barrels a day in 2014 and will likely reach 11 million
barrels a day in 2015.

Meantime, headline consumer prices will actually
decrease in the current quarter and will be flat first quarter of
2015. (See Figure 7) However, once the oil price reductions
run through the system we forecast that consumer prices
will begin to increase at a clip in excess of 2%. Why? The
higher wages we are forecasting along with rising rents will
work to elevate the core consumer price index that excludes
food and energy. Further, the broader consumption deflator
used in the GDP accounts, and the critical targeting variable
of the Federal Reserve will be running at a much cooler
1.8%-2.0% until late in 2016. A major difference between
the two measures is that housing costs have a lower weight
and healthcare costs have a much higher weight in the
consumption deflator.

Figure 6 West Texas Intermediate Oil Price, 2006Q1 -2016Q4
Sources: Commodity Research Bureau and UCLA Anderson Forecast

Figure 7 Consumer Price Index vs. Core CPI, 2006Q1 -2016Q4
Source: U.S. Bureau of Labor Statistics and UCLA Anderson Forecast

Figure 8 Real Consumption Spending, 2006Q1 – 2016Q4F
U.S. Department of Commerce and UCLA Anderson Forecast

In contrast, housing will not be as strong as we previously
forecast. To be sure, housing starts will advance at a
21% clip in 2015 to 1.21 million, up from an estimated 1.0
million units this year. (See Figure 9) Our 2015 forecast
is now far lower than the 1.38 million units we expected
as recently as June. Simply put, still tight credit standards
which are in the process of being eased, the lack of cash for
down payments and the impact of the Great Recession and
recovery on delaying major life events have rendered housing
activity far more modest than we expected. Nevertheless,

Figure 9 Housing Starts, 2006Q1 -2016Q4F
Sources: U.S. Department of Commerce and UCLA Anderson Forecast

Figure 10 U.S. Trade Weighted Dollar with Major Currencies,
2006Q1 – 2016Q4

Figure 11 Federal Reserve Balance Sheet, 18 Dec 02 – 19 Nov 14, In $ millions
Sources: Federal Reserve Board and UCLA Anderson Forecast
Source: Federal Reserve Board via Fred

the multi-family housing boom that we have been talking
about for years will continue unabated.

The Fed Waits until June

Although the Fed ended its third and largest quantitative
easing program in October as we expected, with falling
oil prices and a strong dollar suppressing near-term inflation,
the Fed will take longer than we previously thought to start
normalizing interest rates. (Figures 10 and 11) For over
year we thought the first increase in the Federal Funds rate
would take place in March; we now think it will be June
2015. (See Figure 12) Thereafter, we anticipate that the Fed
will be on a gradual path to return the economy to more
normal interest rates. However, our forecast for the fourth
quarter of 2016 calls for a still low Fed Funds rate of 2.8%.
This is just barely above the 2.3% (2.1% core) increase in
the consumption deflator that we expect at that time--hardly
a “normal” funds rate, especially when the unemployment
rate will be approximating 5% then.

The big surprise to us and to most forecasters this year
has been the decline in long-term interest rates. Like most
forecasters, we predicted a substantial rate rise, but instead
we got a substantial decline. In our view, the rate decline
has its origins internationally as long-term rates dropped
across Europe and Japan. As of mid-November, European
and Japanese sovereign were plumbing record lows as both
the Bank of Japan and the European Central Bank announced
further easing programs. (See Figure 13) Thus, in order for
our 4% forecast for long-term interest rates in 2016, there
almost has to be at least a modest revival in Europe and
Japan that will begin to elevate their rates.

Figure 12 Federal Funds vs. 10-Year U.S. Treasury Bonds, 2006Q1
– 2016Q4F
Sources: Federal Reserve Board and UCLA Anderson Forecast

Not A Lot of Help from Exports

With the strong dollar, Japan in recession and Europe
stalled, we do not expect much help to come from the export
sector. Thus, we forecast that real exports will grow modestly
in the 3-4% range over the next two years

Figure 13 10-Year Yields in Selected Countries,
November 28, 2014
Source: Bloomberg

Figure 14 Real Exports, 2006Q1 -2016Q4
Sources: U.S. Department of Commerce and UCLA Anderson Forecast

Capital Spending Strengthening, Ex-Energy

A major source of strength in 2015 will be strong
gains in equipment and software spending as corporations
shift from buying back stock to increasing capital spending.
Specifically we forecast equipment and software spending
to increase 8.8% and 6.6% in 2015 and 2016, respectively.
(See Figure 15) By contrast, investment in nonresidential
structures will stall with a gain of only 1.5% overall in 2015
as oil drilling declines in response to lower prices. (See
Figure 16) What few people realize is that mining-related
construction will account for 30% of nonresidential activity
in 2014. Put simply, it is a big sector and much larger than
all of commercial construction. The decline here is the flipside
of the gains to consumers coming from lower oil prices.

Defense Spending on the Rise

The three-year decline in real defense spending is over.
(See Figure 17) The rise of ISIL in Iraq and Syria along with
what appears to be an emerging Cold War with Russia will
cause defense spending to modestly increase in 2015 and
2016. Moreover, with the Republican takeover of the U.S.
Senate it is likely that the “sequestration” of defense department
funding will either be modified or ended. As a result,
overall Federal purchases will increase modestly in 2015
and 2016. And real state and local spending will increase at
a 1.3% rate over the next two years.


Overall, the economy appears on track to grow at a
3% growth path over the next two years. Lower oil prices
and higher wages will buttress consumer spending as the
unemployment rate declines to 5%. Growth will be led by
strong gains in consumer spending along with more aggressive
corporate investment in equipment and software. In
response, the Fed will begin to normalize interest rates in
next year’s second quarter, but the Fed Funds rate will remain
at historically low levels. Housing activity will increase,
but it will be far less than what we previously thought and
oil related capital spending will decline. All in, Main Street
will begin to feel the recovery that Wall Street has already
experienced over the past several years.

Wednesday, December 3, 2014

My Amazon Review of James Grant's "The Forgotten Depression: 1921: The Crash that Cured Itself"

“Liquidate Labor, Liquidate Stocks…”

I have known Jim Grant for about 25 years and he never ceases to amaze me with his lucid style of writing. As the proprietor of “Grant’s Interest Rate Observer” he continually demonstrates his ability to bring to life the most mundane of economic and financial topics. His “Forgotten Depression,” an account of the 1919-1922 boom, bust and recovery, is no exception.

Grant’s thesis is that left to its own devices an unfettered price system without the intervention of government policy gives the economy the ability to shake off the effects of a depression. In this case study Grant admires the stand-offish policies of Presidents Wilson and Harding. If anything fiscal policy was extremely contractionary and the nascent Federal Reserve was tightening credit well into the contraction. It is as if Grant is channeling his inner Andrew Mellon, the attributed author of my title quote.  And remember the 1920-21 decline was severe with wholesale prices dropping by an astounding 56% and unemployment rising well into the double-digits. As a side-bar Grant notes that a small haberdasher in Kansas City failed. The co-owner was one Harry S. Truman.

To Grant the key to the pricing mechanism working was the ability of wages to exhibit downward flexibility With wages falling with prices, businesses adjusted to find profitability with a much lower cost structure. Although the downward spiral did feed on itself for a while, a new equilibrium was quickly found, at least relative to the early 1930s and our recent experience this decade. By contrast in 1929 it was government policy to keep wages up, and hence all of the adjustment had to fall on the quantity of labor.

What Grant seems to undervalue is the role of the Fed in easing credit in 1921 that helped the economy find a bottom. To be sure the inflow of gold, responding to the U.S. economy’s improved competitive position, made their life much easier, but the fact remains that Fed policy became highly expansionary as 1921 progressed.

Grant is correct in arguing the recovery in 1922 laid the basis for the great boom that was to follow. It also made policy makers complacent about the recuperative powers of the economy. When the next crunch came in 1929 the outcome wasn't nearly as favorable. To Grant it was Hoover’s wage maintenance policies that were at fault; to the economic mainstream it was the workings of the gold standard. Nevertheless Grant tells a compelling story about a long forgotten episode in American history.

The Amazon URL is:  

Sunday, November 23, 2014

My Amazon Review of Craufurd Goodwin's, "Walter Lippmann:Public Economist

The Columnist as Economist

Duke University economic historian Craufurd Goodwin has written, but probably too lengthy, biography of the preeminent columnist Walter Lippmann’s writings.  However, it is not a biography of Lippmann. Although he focuses on Lippmann’s “Today and Tomorrow” columns from the early 1930s through the 1960s, he takes up his earlier writings and books along the way.

What the book brings out is Lippmann’s grappling with the economic crisis of the Great Depression. In column after column Lippmann is concerned about the economic collapse and the tragedy of mass unemployment that comes with it. For the most part Lippmann gets it right. Early on he is against the gold standard, for a flexible monetary policy and for free trade. Lippmann is an anti-monopolist to the core and it explains his opposition to the National Recovery Act. Lippmann, a friend of Keynes since the Versailles Conference of 1919, brings his ideas to the American public.

In column after column Lippmann is a true believer in both Keynesian Economics and the competitive market system. In the case of the latter, that makes him an anti-New Dealer and for that conservatives flock to him. One of the lessons for today is that in the 1930s both Lippmann and Keynes urged that economic recovery should take precedent over economic reforms. Would that President Obama follow that important advice in 2009-10.

Walter Lippmann stopped writing in 1967 and died in 1974 just as the Keynesian consensus was collapsing. One wonders what how he would have responded to the stagflation of the 1970s. Unfortunately Goodwin is silent on this question.

For Amazon URL see:   


Saturday, November 22, 2014

My One Sentence Letter to The New York Times, Published Nov 22

Well-intentioned liberals impatient with the normal workings of the democratic process will rue the day they supported President Obama’s expansion of executive power when a different administration wields it in a far more malevolent manner.

Note: See my prior post for more details.

Wednesday, November 19, 2014

The Lawless Law Professor

The online edition of The Wall Street Journal reported this morning that President Obama will announce his recently promised defacto legalization program for approximately four million undocumented/illegal residents on Friday at an event in Las Vegas. This is a far cry from his 2011 statement noting that going it alone (i,e, without Congress) is "not how our democracy functions." What the president is doing, under the guise of prosecutorial  discretion, is that he is refusing to enforce the existing body of immigration law.

The issue here is not immigration reform which is something I support, but rather an unprecedented reach of executive power. Instead of being the cautious law professor he once was, I guess President Obama is channeling his inner Richard Nixon or his inner Dick Cheney. As others have noted the day will come when a future Republican president refuses to enforce environmental protection and income tax laws using the same lame excuse. Simply put if he wants to change the immigration law he needs the Congress. That is how the system works.

I close by noting that when/if fascism comes to the United States it won't come from jack-booted thugs marching in the streets , but rather it will come in on the cat feet of well intentioned liberals who have grown impatient with the more orderly processes of democracy.  

Sunday, November 9, 2014

My Amazon Review of Francis Fukuyama's "Political Order and Political Decay: From the Industrial Revolution to the Globalization of Democracy"

Good Governance is Hard to Do

Francis Fukuyama of “The End of History and the Last Man” has written a lengthy history of comparative government from 1800 to the modern era. In Political Order he discusses why certain governments succeed while others fail.  His sweep covers the globe from Europe to the Americas, to Asia and to Africa. Though too long the narrative is breathtaking.

His thesis is that successful governance requires a coherent state, laws that are equally enforced and system of accountability, usually, but necessarily through elections. Weak governance gets one or all three of these factors wrong, Fukuyama although in many ways quite conservative, is political progressive in the early 20th Century sense in that a successful state needs a highly trained impartial bureaucracy. Examples of such are the U.S. between 1900- 1950, Germany and England in the 19th century. To be sure bureaucracies that become too independent can go out of control. His example of this is the German military on the eve of World War 1.

On the other hand there can be too much accountability. In this instance he highlights the role of interest groups in the U.S. who in total possess veto power over what the state can do, a “vetocracy” if you will.

Fukuyama’s book should be read in conjunction with Daron Acemoglu and James Robinson’s “Why Nations Fail.” Simply put both argue that the success of rent seeking clienteles have the power corrupt government for their own ends.

Although “Political Order…” is a great text, it is a tough read for the lay reader, hence four stars.

For the Amazon URL see:  

Wednesday, November 5, 2014

A Bad Night for the Democrats; A Good Night for Shulmaven

As we predicted on Sunday the Republicans did very well last night as Democratic hopes of forestalling a Republican turnover in the Senate crashed and burned. As of this morning the Republicans have picked up seven seats and are likely to win Alaska later today. Along with a likely win in the Louisiana runoff in December the Republican majority will expand to 54. Its better to be lucky than smart, but it looks like we were on the money. Moreover we noted, contrary to conventional wisdom, that the races in Virginia and New Mexico would be close. with a recount coming in Virginia we were dead right there, but not so right in New Mexico where Udall won by 10 points.

In the governor races the Republican did far better than what we thought. We had an above consensus pick-up a net gain of one governorship. As of this morning the Republicans are up 3. We were right on Scott Walker and were pleasantly surprised to see Republican wins in Democratic Massachusetts and Maryland. With Democrat Gina Raimondo winning in Rhode Island and Republican Bruce Rauner winning in Illinois, the public employee "Blue State" model suffered major defeats. Unfortunately education reformer Marshall Tuck lost to teachers union backed Tom Torlakson in the Superintendent of Public Instruction race in  California. It is clear that the Republican Party in California is still not ready for prime time.

In the House it looks like the Republicans will pick up between 15-20 seats. We had them up by 10-15 seats. A big loss for the Democrats and look for Nancy Pelosi to step down as Democratic Leader. The other big Democratic loser was Harry Reed whose $100 million PAC outspent everybody. Look for Schumer to challenge him in January.

On the Republican side the big winner was John Kasich who reelected Ohio governor by 30 points. He will be much talked about in the coming weeks as presidential candidate. Just to note he expanded Medicaid in his state. Also a big winner was Chris Christie whose leadership of the Republican Governors Association brought in a $100 million and provided the sinews of victory.

The Republican was victory opens the way for real legislative progress in 2015. Why? The Republicans have to govern and President Obama needs a legacy. If cooler heads prevail, admittedly an heroic assumption, there is the potential to do corporate tax reform, trade promotion, Keystone Pipeline, partial immigration reform, a minimum wage increase and some relief on student debt. Remember Mitch McConnell is a deal maker and he has worked very well with Vice President Joe Biden. Of course if the Republicans go after Obamacare on day one or if President Obama does a major executive order on immigration the well will be poisoned. As of today the ball is in the President's court. Watch his news conference this afternoon.

Sunday, November 2, 2014

A Long Night for the Democrats

Despite the almost innate ability of the Republicans to snatch defeat from the jaws of victory, I think
Tuesday will be a long night for the Democrats. Why? A real trend seems to be in the making with late deciding voters breaking for the Republicans. Specifically my best guess is that by the time we wake up Wednesday morning the Republicans will have picked up 7 Senate seats and be favored to win the run-offs in Georgia and Louisiana making for a total gain of 9 seats. Moreover although the
Democrats will likely win in Virginia and New Mexico those two races will be surprisingly close. In terms of the House, the Republicans appear to be on track to picking up between 10-15 seats thereby surpassing their 2010 majority and possibly passing their postwar record majority in 1946. In terms of governor races, contrary to all earlier expectations the Republicans might net one governorship, with their only major loss in Pennsylvania. Until a week ago I thought Scott Walker would lose in Wisconsin, but I now think he will eek it out.

In my mind three very important races in the country involve the fight against one of the most reactionary elements in the Democratic Party, the public employees unions. In Rhode Island Democrat Gina Raimondo had the audacity as State Treasurer to push through fundamental pension reform against stiff union opposition. No surprise the unions are backing Republican Allan Fung. In the failed state of Illinois incumbent  Democrat Pat Quinn is hanging on by his finger nails against Republican Bruce Rauner. A Rauner win would signal that there is still hope for Illinois to deal with the biggest unfunded public employee pension liability in the country. Lastly in California in the race for Superintendent of Public Instruction education reformer and Democrat Marshall Tuck is squaring off against the incumbent Democrat fully backed by the teachers unions, Tom Torlakson. A Tuck win would send a message that Sacramento's most powerful lobby can be beaten and ignite the long smoldering civil war within the Democratic Party.

As they say in poker, "read em and weep." I'll comment on Wednesday morning on how far off base this is and the implications for next year's governing.

Wednesday, October 8, 2014

Calpers Makes the Top

The Wall Street Journal reported today that the giant $300 billion California Public Employees Retirement System (Calpers) will increase its real estate allocation from $26 billion to $33 billion. It is not news that commercial real estate prices have surged and are now well above the frothy peak or early 2007. Just as in the late 1980s and and in 2005-2007 it appears that Calpers is weighing in at the top of the market.

Recall that Calpers bought the California land play Catellus and the UK property company Randsworth Trust at the peak of the late 1980s real estate boom. Those investments, to say the least, soured. In 2007 Calpers bought into the giant and highly leveraged Stuyvesant Town apartment project in Manhattan as de-rent control play. Like Randsworth Trust that investment was a wipe-out.

To be sure one can say that Calpers has learned from their previous episodes. This time it will be concentrating on lower risk "core" assets that have become extraordinarily pricey in the global search for yield. Therefore the risk here is very straight forward, cap rates could rise. Basically to take a major position in commercial real estate today the investor has to believe that cap rates will remain low for a decade. To me this could be the riskiest bet of all. After all more money has been lost in the search for yield than in practically any other investment endeavor.

As a result real estate investors should be forewarned. It looks like, yet again, Calpers will be making another top.

Monday, September 29, 2014

My Amazon Review of Henry Kissinger's "World Order"

You can’t be a Kantian in a Hobbesian World

Herr Doktor Professor Kissinger proves that a 19th Century man can offer much needed foreign policy advice for the 21st Century.  Although it would be ideal to bring reason and rationality to bear to solve the world’s problems, we unfortunately live in a world that is an inherently dangerous place. The goal of U.S. foreign policy is to “achieve equilibrium while restraining the dogs of war” while being mindful that “our universal principles don’t necessarily hold in other parts of the world.”

“World Order” is a logical follow-up to Kissinger’s “A World Restored,” his history of The Congress of Vienna and its aftermath and “Diplomacy,” his treatise on the history and craft of international relations of Europe since the middle ages. As always he is a fan of the Westphalian System created in 1648 which gave birth to the modern state. The four principles of the Treaty (ies) of Westphalia are 1) noninterference in the domestic affairs of other states, 2) inviolability of borders, 3) that states are sovereign and 4) encouragement of international law. All these four principles were to be enforced by a balance of power among the various states. When the balance of power was disturbed, war was the result. Further, because Westphalia was value neutral, it did not speak to legitimacy. You have to take the good with the bad.

His heroes are the grandmasters of the Westphalian system. Among them are Cardinal Richelieu, Metternich, Castlereagh, Talleyrand and Palmerston. He also admires Kautilya of ancient India and Theodore Roosevelt. Each and every one of them are foreign policy realists. His greatest disdain is for Woodrow Wilson who placed values, many of them noble, over the need to preserve the peace.

Unfortunately radical Islam, for example, does not play by Westphalian rules. This is especially true because there are so many non-state actors associated with it. Indeed one of the most vexing foreign policy questions we face is whether Iran is a state or an Islamic movement.

“World Order” is up to date in that he discusses the rise of ISIS in Iraq and Syria. Kissinger also devotes an entire chapter to the role of the internet. Here this 91 year old man was tutored by Google’s Eric Schmidt. Would we all be actively learning at that age? He discusses the implications of cyber warfare and the hyper speed of communication that can outrun more deliberate pace of diplomacy. This makes life more difficult and dangerous because when the chips are down states people have to act on limited information.  

You don’t have to agree with all of it and his personal history is far from perfect but, Kissinger has written a book that should be required reading for President Obama, Secretary Kerry and all of the candidates for president in 2016.  We can’t afford the foreign policy disasters of the past dozen years.

Saturday, September 13, 2014

My Amazon Review of T.G. Otte's, July Crisis: The World's Descent into War, Summer 1914"

T.G. Otte, a Professor of Diplomatic History at the University of East Anglia, has written an exhaustive and difficult to read study of the diplomatic maneuvers undertaken by the major powers on the eve of World War I. He covers the period from the assassination of the Archduke Ferdinand on June 28, 1914 to Britain’s entry into the war the following August 4th on a day-by-day basis. The problem for the lay reader is that there are way too many characters and you have to continually update your score card to understand what is going on.

Otte is not interested in the broad historical forces that caused World War I, but rather he focuses in on the flesh and blood human beings who by their actions precipitated the war. His theme is similar to Margaret Macmillan’s “The War that Ended Peace…..” which discusses how the major powers increasingly narrowed their options making war more or less inevitable. Instead of taking 24 years to narrow options, the diplomats in his story take less than six weeks as peaceful option after peaceful option is foreclosed upon.

Otte has a set of clear villains. They are the Austria-Hungary leadership, mainly Foreign Minister Berchtold, who are so narrowly focused on Serbia; they fail to understand the European consequences of their actions. They are the “Sleepwalkers” Christopher Clark writes about. Next are the Germans, Kaiser Wilhelm, Chancellor Hollweg and Foreign Minister Jagow, who issue the “blank check” to Austria on July 5th thereby surrendering their foreign policy to that narrowly focused dying empire.

Other diplomats singled out for blame include Maurice Paleologue, the French Ambassador to Russia, who conveys far more hawkish sentiments than that of his government to his Russian counter-party Foreign Minister Sazanov. Had Paleologue been more discreet and Sazanov less aggressive, the Russian mobilization of July 29th might have been delayed giving more time for diplomacy.

Britain’s Sir Edward Grey comes off the best as he frantically tried to come up with diplomatic solutions to the crisis. This is a different take because many historians blame Grey for not forcefully signaling Germany that Britain would enter the war on the side of France thereby acting a major deterrent. Here Grey is the neutral mediator. I am not sure what to believe. One last point when Otte discusses the role of Eyre Crow an Assistant Under-Secretary in the foreign office rather than being an above the fray civil servant, he fails to disclose that he was the long time anti-German hawk in British foreign policy circles.  

Friday, September 12, 2014

UCLA Anderson Forecast, September 2014

Executive Summary

Growth Ramping to a 3% Economy from a 2% Economy

After declining by 2.1% in first quarter and growing at 4.2% in the second quarter we forecast that real GDP growth will now run at about a 3% over the next few years. Specifically we are forecast growth of 3.2% in the current quarter and 2.9% in the fourth quarter. On annual basis GDP growth will rebound from 2014’s 2.1% to 3.1% and 3.4% in 2015 and 2016, respectively. Payroll job growth should average 230,000/month and by the end of 2016 the unemployment rate will drop to 5.3%.

Instead of Contracting Defense Spending will be on the Rise

In a major change from prior forecasts, we now anticipate that defense spending will increase rather than decline. The rise of ISIL in Syria and Iraq along with the presence of Russian troops in Ukraine will cause a rethinking of the U.S.’s defense posture. We have modeled in an additional $24 billion in defense spending by 2016. For those with a long memory we would note that the Reagan defense build-up started under President Carter in 1979 after the Iranian Revolution and the Soviet invasion of Afghanistan.

Inflation on the Rise

As we discussed in prior forecast we believe that inflation as measured by the headline and core consumer price indices at 2% or higher over the next two years. The main drivers of the inflation will come from rising residential rents and increasing healthcare costs. Thus the core CPI will be rising by about a ½% higher than the overall index.

Fed to Raise Rates in March 2015

In response to declining unemployment and rising inflation we forecast that the Fed will increase interest rates at its March 2015 meeting. Thereafter we expect a gradual increase in the Federal Funds rate to about 3% by the end of 2016.

Growth Leaders to be Housing, Nonresidential Construction and Investment in Equipment and Software

Despite the housing recovery being slower than we anticipated we forecast that housing starts will rise from this year’s estimated 1.025 million units to 1.32 million and 1.47 million units in 2015 and 2016 respectively.  Because of continuing investment in energy production and a revival in commercial construction, non-residential construction will start to increase rapidly in mid-2015. In 2016 investment in nonresidential construction is forecast to expand at a robust 8.2%. Continued strength in equipment and software spending will continue to buoy the economy.

Monday, September 1, 2014

From No Drama Obama to No Strategy Obama

“We don’t have a strategy yet.”
President Obama, Press Conference, August 28, 2014

From Bagdad on the Tigris to Kiev on the Dnieper U.S. foreign policy is in disarray. At his press conference President Obama noted that he was awaiting a strategy from the Pentagon to deal with ISIL. Wrong!! It is the civilian leadership who makes strategy. Therefore it is up to the Pentagon to come up the appropriate military response to achieve the political ends dictated by the strategy. Simply put the President has it backwards.
Secretary of Defense Chuck Hagel, hardly a hawk, referred to ISIL “as sophisticated and well- funded as any group that we have seen…beyond anything we have seen.” If that is anywhere close to being the case then a clear and present danger exists to the national security of the United States. Up to now the President has authorized air strikes in Iraq, but not in the ISIL heartland of Syria. I fear that will not be nearly enough and that both air strikes in Syria and ground combat troops will be necessary as well. ISIL is too well entrenched to be handled by air power alone.

Yes the American people are war weary. But it is up to the President to make the case. Great leaders don’t follow polls they change them and the sooner the President lays the groundwork for action the sooner it will happen. He has to remember he is President first and party leader second.

He has to spend the time to do the hard work of coalition building that will be necessary to dislodge and ultimately neuter ISIL.  President Bush ’41 was successful at it, but it took real work internationally to create it and he also had to overcome real opposition in Congress. In order to this the President will have to spend less time on the golf course and schmoozing political contributors and more time with foreign leaders and members of Congress.

Meantime Russia has all but formally invaded Ukraine and is now talking about a creating and independent state in the eastern part of the country. Such an open act of aggression must not go unpunished. It is now time for very real and very hard sanctions on Russia that would end all technology transfers and their access to the western banking system. Further NATO should send advanced weaponry to the Ukraine so that the can defend their homeland against the onslaught of Russian tanks and artillery. Hopefully there will be the will at the upcoming NATO meeting in Wales.

The White House has become a theme park of strategic indecision. The President has to snap out of it quickly because we do not have the luxury of waiting more than two years for a new president. The locomotive of history waits for no one. Just as reminder 75 years ago today, after several years of watching Britain and France vacillate, the German army crossed into Poland starting World War II.

Friday, August 22, 2014

My Amazon Review of Rick Perlstein's, "The Invisible Bridge: The Fall of Nixon and the Rise of Reagan"

Rick Perlstein has written a long book, perhaps too long. “The Invisible Bridge…” is really three books: a biography of Ronald Reagan, a political history with an emphasis on the continued rise of the Republican Right and a social history of the mid-1970s. This book follows his two prior books, “Before the Storm…” and “Nixonland…” on the emergence of the Republican Right. Perlstein is a man of the Left, but he tries to understand the motivations behind the success of the Right. In some respects he succeeds, but in others he doesn’t fully emphasize that the period he discusses was one of retreat abroad and recession at home. With the latter along with virulent inflation ends the Keynesian consensus that ruled economics in the postwar period up to that time. Thus the way was open for a politician who offered hope to a nation where it seemed there was only despair. That politician was Ronald Reagan.

Pearlstein enabled me to relive the period that I remember all too well. It seemed that the wheels were falling off the train of history. For example the 1973-76 period encompassed the following:
   * Defeat in Vietnam
   * CIA scandals
   * The rise of OPEC which triples gasoline prices
   * Assassination attempts on Jerry Ford
   * Patty Hearst and the Symbionese Liberation Army
   * The widespread distribution of porn
   * The bankruptcy of New York City
   * The growth of weird self-improvement groups like est.

Into this milieu comes the former actor and former governor of California who offers what appears to be simplistic solutions to the liberal elite, but to a yearning public he offers hope and a return to the greatness of America that as Perlstein notes resonates with the 1976 Bi-Centennial. Always under-rated by the pundits Ronald Reagan was far smarter and cannier a politician than his critics realized. And boy did he know how to give a speech.

Perlstein spends a great deal of time on the 1976 Republican convention where Reagan almost rests the nomination from Jerry Ford. Much of this ground was covered by Craig Shirley’s very pro-Reagan, “Reagan’s Revolution.” In fact Shirley has sued Pearlstein for infringing on his material. Shirley’s book is a good read and I recommend it.

What Perlstein gets wrong is his treatment of Reagan’s failed attempt to pass Proposition 1 his tax and spending limitation initiative in 1973. He highlights what he perceives to be its radical nature. In my opinion had Proposition 1 passed the far more “radical” Proposition 13 of 1978 might never have seen the light of day. Pearlstein also get wrong the notion that California coastal development was banned in 1973; not true. What actually happened was new permitting regime under Proposition 20.

Although he opens his book the the return of the Vietnam POWs, he doesn't really deal with the moral crisis associated with the treatment of the returning veterans. To the Right they were drug crazed losers and to the Left they were war criminals. The resentment that this engenders adds fodder to the growth of the Right later in the decade.

One last point Perlstein should remember Eric Ambler’s maxim in “A Coffin for Demitrios,”  “In a dying (although I would use “threatened”) civilization political prestige is the reward goes not to the shrewdest diagnostician, but to the man with the best bedside manner.” Most dour liberals fail to understand this while an optimistic liberal like Bill Clinton knows this in his guts.

All told for readers who have the time for this very long book, it very well worth the read.

The Amazon review appears at the following url:

Wednesday, August 6, 2014

Reliving the 1930s - Part 2

On May 7 I blogged that we were reliving the 1930s with the Great Recession being the analog to the Great Depression and the appeasement of Vladimir Putin in the Ukraine being an analog to the appeasement of Hitler. Unfortunately we also are reliving the virulent anti-Semitism the 1930s as well.

There is no question that if Hamas had the power there wouldn't be a Jew alive in Israel today. If you are skeptical all you have to do is to read Hamas’ charter and listen to the statements of their leadership. The Gaza War was not about a two state solution for Palestine, but rather it was an attempt to kill as many Jews as possible and to make martyrs out of innocent Palestinian children. The killers of those children do not reside in Tel Aviv, but rather they sit comfortably in Hamas headquarters in Gaza and places far away from the battlefield.

Of course to much of the European Left and to some extent the American Left along with a few on the far Right, the right of Israel to defend itself from rocket attack and an invasion from underground tunnels metastasized itself into a most virulent anti-Semitism. There is a straight line from the Hamas killers to the street demonstrators in Paris to the anti-Israel marches in the United States. For those who argue that the marchers and demonstrators were concerned about human rights rather than bashing Israel in particular and Jews in general, all I have to say is where are the protests against the carnage in Syria, ISIS terror in Iraq and Libya? I guess for them it is OK for Arabs to kill other Arabs.

Monday, July 28, 2014

Geopolitics and the Stock Market: A Lesson from the Start of the Great War

World War 1 started 100 years ago today and to the stock market it seemed to come from totally out of the blue. Simply put the stock market failed miserably as a discounting mechanism. Why? The markets were unduly complacent about international affairs where from 1900 – 1914 there were two Moroccan crises and two Balkan Wars that many thought that any one of them would lead to a general war. Those crises were settled diplomatically and thus when the Austrian Archduke Franz Ferdinand was assassinated in Sarajevo by a Bosnian terrorist in the pay of Serbia, the markets thought nothing of it.

Although the U.S. was far away from the enveloping European Crisis as an emerging market, it was unduly dependent upon the inflow of foreign capital. As the crisis came to a boil European investors liquidated their U.S. holdings and the Treasury feared a run on gold. The stock exchange closing along with other measures short circuited the run and enabled the U.S. to remain on the gold standard.

The July 1914 complacency is eerily reminiscent of the world today. We are now in the midst of the second Ukrainian crisis of the year, from Libya to Iraq the Middle East is in flames, and China is making serious naval probes in Southeast Asia. In all likelihood the world will muddle through, but the lesson of 1914 is disquieting.

Here is a thumbnail history of the Dow Jones Industrial Average matched with the events of 1914. A casual reader will note that the stock market did not respond to the events in Europe until war was imminent.

Date           DJIA       Event

January 2 –  57.6       Year Opens

March 20 -   61.1       Year High

June 27    -    58.7       Day before Assassination

June 29   -     58.6       Day After Assassination (Market closed on June 28)

July 22     -    59.2       Day Before Austrian Ultimatum

July 23     -     59.0      Austria Delivers Ultimatum to Serbia

July 28     -     55.9      Austria Declares War on Serbia – WW 1 Begins

July 29    -      56.2       Relief Rally

July 30    -      52.3       Russia Mobilizes

July 31    -                    Stock Exchange Closes

Aug  3     -                   Germany Invades Belgium

Dec 12    -       54.6        Market Reopens

Wednesday, July 23, 2014

My Amazon Review of Frederick Lewis Allen's, "The Lords of Creation"

This is far from Frederick Lewis Allen’s best books. “Only Yesterday,” his social history of the 1920s was his best and “Since Yesterday,” his history of the 1930s and “The Big Change,” his social history of the first half of the 20th Century come pretty close. Nevertheless if readers want to get a real flavor of the big business and high finance milieu in America from 1900-1930, “The Lords of Creation” does a credible, if biased, job. You see the House of Morgan, the other New York bankers, the railroad magnates and the new Wall Street men of the 1920s in full flower. They were “the 1%” of that era. He vividly illustrates the stock manipulation that was almost taken for granted and the way commercial banking was integrated with investment banking though affiliated organizations. Those abuses led to the Securities Acts of 1933 and 1934 and the Glass-Steagall Act of 1933.

Remember Allen wrote his book from the vantage point of 1935. In the popular imagination big business and big finance were the leading players in causing the depression the nation was then experiencing. To him and President Roosevelt the causes of the depression were domestic in origin. We have since learned as President Hoover thought at the time, that the depression had its origins in the dislocations caused by World War I and the transmission of deflation through the workings of the gold standard.

My criticism of the book is that Allen only pays lip service to the very real improvements in the living standard of the average American from 1900-1929. Unlike today real wages were consistently rising and we saw in the 1920s the glimmers of the kind of prosperity that occurred in the 1950s.

One last point, I would avoid the very snarky introduction to this edition written by New York Times columnist Gretchen Morgenson. 

The Amazon URL is:

Saturday, July 12, 2014

My Amazon Review of Amanda Vaill's, "Hotel Florida: Truth, Love and Death in the Spanish Civil War"

Amanda Vaill has written a terrific book about the romantic attachment the western Left during the heyday of the Popular Front period had for the loyalist cause in the Spanish Civil War (1936-39). She tells her story through the eyes of three couples:  the writers Ernest Hemingway and Martha Gellhorn, the war photographers Robert Capa and Gerda Taro, and the chief censor of the foreign press Arturo Barea and his Austrian companion Ilsa Kulcsar. They are all people of the Left who utilized their exceptional skills to promote the loyalist cause. In their zeal, with the notable exception of Barea, the truth was sometimes shaded, bent or completely distorted to present the Republic in the most favorable light.

Little do they realize that despite all of their zeal they are pawns in a titanic struggle between Hitler and Stalin. Spain is a proxy war designed to further their respective foreign policy interests and when Stalin had a need to cozy up to Hitler he cut his Spanish pawns loose and kept Spain’s gold reserves. Along the way the purge trials then underway in Moscow found their way to Spain where all too many loyalist supporters were summarily executed or simply disappeared. Vaill, to her credit, is very clear about all of this.

Although “Hotel Florida” is not a history of the Spanish Civil War, there is much history to be learned. Its locus of attention is on the Hotel Florida where many of the journalists along with NKVD operatives hung out and it was there where the “war” tourists of the Left would pass through. Think Lillian Hellman, for example. In a way the book is analogous to Orwell’s classic “Homage to Catalonia” where the locus of action was Barcelona; here most of the action takes place in and around Madrid with side-trips to Paris, New York and Key West.

The most interesting character, all of 26, is the blond crop-haired Gerda Taro. She was always where the action was trying to get the best photograph and showed little concern for her own personal safety. She had both grit and verve to overcome the very real hardships faced by a war photographer. Unfortunately she dies in what can be characterized as a battlefield accident and is given a martyr’s funeral in Paris.

For all of this and much more, including appearances by the Soviet Spy Kim Philby and the future German Prime Minister Willy Brandt, I highly recommend “Hotel Florida” to readers interested in Spain and the prelude to World War II.

The Amazon URL is:

Sunday, June 22, 2014

An Open Letter to Janet Yellen

Dear Chair Yellen,

As a kid from Queens I am always willing to give the benefit of the doubt to a kid from Brooklyn. Nevertheless in your great fear of avoiding an error of commission I fear you are on track to a make an error of omission. I realize that you rightfully fear that Fed might raise rates prematurely thereby stalling or even reversing the economy’s painful progress since the Great Recession lows of 2009. Although it happened 77 years ago, the Fed is still haunted by its policy tightening in 1937 that was one of the proximate causes of the severe 1937-38 downturn. Never mind that my reading of the history of that period would assess much of the blame on a sudden contraction of fiscal policy.

More recently we all witnessed the severe bond market effects a year ago of your predecessor’s comments about the need to start tapering the Fed’s bond buying program. Although not the only cause, it certainly knocked the wind out of what was looking like a very strong housing upturn. Just as in medicine, the principle of “do no harm” certainly works for central bankers.

However, when you called the recent uptick in the consumer price index “noisy”, you ignored some really important evidence that the economy shifted its bias away from deflation and towards inflation. You know the data far better than I, but to state a few facts on a year-over-year basis headline inflation as measured by the CPI is now running at 2.1% and the core rate is 2.0%. And for two important categories, tenant paid rent and medical care services the year-over-year rate of increase is 3%, hardly benign. Moreover the rent component is understated because the over-weighting of rent controlled jurisdictions in the data tends to suppress measured inflation in a rising rent environment.  Indeed, over the last three months headline inflation is now running at a 3.3% rate and core inflation 2.8%. To me there is more signal than noise in the data.

Yes, I know the Fed uses the deflators for personal consumption expenditures to measure inflation and by those measures year-over-year inflation as of April is running at around 1.5% (1.6% headline and 1.4% core), well below your 2% target. But I caution you, the public likely measures inflation by the widely publicized CPI and if that appears to running well above 2%, the well anchored inflation expectations that the Fed loves to brag about might soon give way.

To be sure measured wage inflation remains modest at 2% and if we looked at that alone, there would not be much to worry about on the inflation front, but a lot to worry about on the labor market front. However there is hard statistical evidence that the labor market is improving with the unemployment rate on the road to below 6% by yearend and anecdotal evidence that wage rates are picking up. A good thing, but when you combine that with the other inflation data cited above, it will be harder for you to be so cavalier about the uptick in inflation .It would be better to start laying the ground work now, rather than waiting until it is too late. History suggests that a Fed behind the inflation curve wreaks far more havoc on the financial markets than one modestly ahead of it.

On that score I would note that after your press conference last week both the TIPS market and the gold market rallied strongly. A few days don’t make a trend, but these auguries of inflation might just be sending you a message.

Let me add that you may have something more to worry about than signs of “irrational exuberance” in the credit markets and recent surge in corporate mergers and acquisitions. There are signs in the real economy of what the Austrians, and I do not call myself an Austrian economist, of malinvestment. For example there is real evidence that the demand for electric power generating facilities, office building, shopping centers and hotels are about to be technologically disrupted. Yet investment, in those areas, especially in existing assets, continues unabated because the capital market remains wide open to them. Trust me, an unwind here will not be pretty.

Finally, let me close by rephrasing what I noted earlier. Sometimes an error of omission can be just as dangerous as an error of commission. Meantime enjoy your trip to beautiful Jackson Hole later this summer.

Yours truly,

David Shulman

Wednesday, June 18, 2014

My Amazon Review of Hillel Halkin's "Jabotinsky (Jewish Lives)"

Hillel Halkin brings to life in a short and very readable biography, the story of Vladimir Jabotinsky (1880-1940), the founder of Revisionist Zionism. Jabotinsky was far from the prototypical Zionist of the early 20th Century. Being born in the cosmopolitan port city of Odessa, he was far from the shtetls of Poland and Russia. He was far from religious and didn’t really like living in the Palestine of the 1920s.

Nevertheless he was extraordinarily clear-eyed about the future of Zionism. Jabotinsky understood:

·       * The real need for Jewish Legion to assist in the British invasion of Ottoman Palestine thereby establishing the first organized Jewish fighting force in nearly 2000 years.

·      *  The local Arab population would not be passive to a surge in Jewish immigration. He leads in the formation of the Haganah out of the remnants of the Jewish Legion. The Haganah was the forerunner of today’s Israel Defense Forces.

·      *  The Nazi nightmare would wipe out European Jewry and urged the Jewish community to pack up and leave. He supplied chartered steamers to illegally transport Jews to Palestine.

·        *The Israeli economy organized along the socialist lines of Labor Zionism would not be viable and urged more market oriented policies.

Halkin discusses in great detail Jabotinsky’s long time and very acrid rivalry with David Ben Gurion. They fought each other for control of the Zionist Organization in the 1930s. To put it mildly they did not like each other and Ben Gurion prevented Jabotinsky’s reburial in Israel until after he stepped down as prime minister in 1964.

A failing of the book is that Halkin expends too many words on Jabotinsky the journalist and the writer and not enough on his leading his Revisionist Zionist group and his founding of Betar, its youth group. Menachem Begin was so inspired by Jabotinsky that he joined and became a leader of Betar. Nevertheless I would recommend “Jabotinsky” for those readers who want to go beyond the standard Labor Zionist version of the founding of the State of Israel. A great companion piece would be Daniel Gordis’, “Menachem Begin: The Battle for Israel’s Soul.”

For the Amazon URL see:

Tuesday, June 17, 2014

"Technology vs. Commercial Real Estate: Retail, Office and Hotel Markets Face Major Disruption," UCLA Economic Letter, June 2014

This is a condensed version of my previous post on commercial real estate. It does, however, include two charts. The URL is:

Saturday, June 14, 2014

"The Changing Landscape of Commercial Real Estate," UCLA Anderson Forecast, June 2014

On the surface it would appear that the commercial real estate asset market is booming. The prices of “institutional grade” real estate have surpassed the prior boom levels of 2006-2007, the commercial mortgage backed securities (CMBS) market has risen from its nadir in 2009 and is half way back to the level of 2007, interest rates remain extraordinarily low, and commercial construction generally remains constrained, at least for now. (See Figures 1, 2, 3, and 4) Capitalization rates (net operating income divided by purchase price) for high quality properties are in the 5% range or lower and investors in a yield-starved world are willing to accept ten year pro forma internal rates of return in the 6-7% range. We are in truly heady times.

However, beneath the surface commercial real estate, with the notable exception of apartments, faces the challenge of disruptive technology that is undermining tenant, as opposed to investor, demand for commercial real estate.[i] Put simply, disruptive technology is defined as a low cost solution that offers lower performance but, represents a true value at the price.  Think tablet computers compared to personal computers. In the following sections I will discuss the major issues facing each property type in turn.

Figure 1. Green Street Advisors Commercial Property Index, Dec 97 –April 14, 2007 Peak = 100.

Source: Green Street Advisors

Figure 2.  CMBS Issuance, 1999-2014F, In $ Billions

Source: Real Estate Alert and UCLA Anderson Forecast

Figure 3. Real Commercial Construction Spending, 2000Q1 – 2016Q4F

Sources: U.S. Department of Commerce and UCLA Anderson Forecast

Figure 4. Federal funds vs. 10 Year U.S. Treasury Yields, 2005Q1 – 2016Q4F
Sources: Federal Reserve Board and UCLA Anderson Forecast


Fifteen years ago fear of internet competition stalked the retail real estate world. Then the fears were premature; today it is reality. The share of retailing going to e-commerce has risen from 1% in 2000 to 6.2% today. (See Figure 5) Indeed if you strip out the non-e-commerce intensive automobile, gasoline, retail food and restaurant groups the share of retail spending devoted to e-commerce doubles to 12.5%.  In fact since the recession lows e-commerce sales have advanced 110% while retail sales ex- autos have risen just 23%; not a pretty picture. Slowly but surely e-commerce is eroding the very foundations of retail real estate.

Figure 5. E-Commerce Sales as a Percent of Total Retail Sales, 2000Q1 – 2014Q1

Source: U.S. Department of Commerce via FRED

This trend is manifested in still very high mall vacancy rates which are at recession levels, and in the bifurcation of the mall business. (See figure 6) For now the Class A malls are thriving with sales per square foot exceeding $700. However the bottom tier malls with sales/ square foot of less than $300 are suffering. They are certainly not being helped by the slow motion demise of JC Penney and Sears. Of the 1050 open and enclosed malls in the U.S. about 150 of them have vacancy rates in excess of 20%.[ii]  Instead of being retail draws they have become places where retailers go to die. At the end of the most of those malls will be “scraped” with alternative uses found for the land.

Figure 6. Mall Vacancy Rates, 1980-2014Q1

Sources: and REIS.

Although the top tier malls appear to thriving underlying sales growth has been eroding over time. For example Simon Property Group, the nation’s largest mall owner, has reported consistently rising leasing spreads (new leases above existing leases), sales growth is stagnating. (See Figure 7) This trend is not sustainable. Simply put retailer profitability is eroding in the face of sluggish consumer spending and greater pricing transparency induced by smart phones and to the detriment of the mall; retailers are upping their own e-commerce games. Thus it is no surprise that mall operators are keen to add more restaurant tenants into their mix and they too will have to up their investment in technology. Thus the travail of the B-malls might just represent the canary in the coal mine.

Similarly power and community and even neighborhood centers are facing digital competition. Home Depot is no longer expanding its store count as it is now concentrating its efforts on e-commerce. Although there are e-commerce retail food distribution models, the entrance of Amazon into this arena certainly bears watching. Needless to say e-commerce is making huge inroads into kitchen, bath personal care and pharmacy items. Look out Bed, Bath and Beyond.

Figure 7. Simon Property Group, Sales/Square Foot, Percent Change, Year over Year vs. Releasing Spread, 2011Q4 – 2014Q1

Source: David Harris, Imperial Capital

What is working in retail appears to be street level retail in dense urban centers that have a significant tourist component to support underlying demand. For example retail rents in Manhattan have been known to exceed $2000 a square foot with rents in high hundreds common. Contrast this with top mall rents of around $100 a square foot. Critical for this model to work is a dense environment of high income consumers. Aside from Manhattan, think Boston, Chicago, San Francisco and parts of West Los Angeles/Beverly Hills/Santa Monica.


Aside from a few exceptions such as Manhattan, San Francisco, San Jose, Seattle, and Houston, the office market remains in the doldrums. The national office vacancy rate stands at a high 16.8% and has only marginally come down from its recession peak of 17.5%. (See Figure 8) There are two very important factors at work. First as we discussed previously, the historic drivers of office demand, financial and legal services employment are but a shadow of their former selves.[iii] (See Figures 9 and 10)  For example, financial activities and legal services employment increased by historically modest 55,000 and 1,000 jobs over the past year and both are still below their pre-recession peaks. In contrast employment in computer systems design, management and technical consulting and support services for mining (largely oil and gas) increased by 63,000, 51,000 and 29,000 jobs, respectively. Indeed all three categories are at new highs.

This change in the pattern of office employment growth explains why the technology and energy related office markets are doing so much better than the more traditional markets. And it also explains why the previously out of favor mid-town south markets of Manhattan, where technology firms tend to concentrate are doing far better than the very traditional Park Avenue market. In the Los Angeles the same goes for Silicon Beach compared to Brentwood.
 Figure 8. National Office Vacancy Rate

Sources: and REIS.

  Figure 9. Financial Activities Employment, 2000Q1 – 2016Q4F

Sources: Bureau of Labor Statistics and UCLA Anderson Forecast

Figure 10. Legal Service Employment, Jan 2000 – April 2014, In Thousands

Sources: Bureau of Labor Statistics via FRED.

A far more serious challenge to office demand is that under the impetus of changes in technology and technology-oriented tenants, the space demanded per office worker is dramatically contracting. Instead of 200 square feet of office space per worker, office space is now being designed around utilizing 150 square feet per worker. Moreover in many new buildings for tech-oriented tenants space planners are now allotting only 120 square feet per worker.

Why is this happening? First technology has reduced the demand for file space and reference rooms as records have become digitized. Second technology firms emphasize collaborative work environments utilizing open floor plans. The densification of work spaces has not been limited to technology firms as Goldman Sachs, Credit Suisse and Unilever have adopted floor plans allocating 150 square feet per worker.

What this means is that much of the existing office stock is technologically obsolete. It is no easy task to go from 200 square feet per employee to 150 square feet or less. At higher employment densities existing building have issues with elevator, restroom, ventilating and fire stairwell capacity. Further in suburban markets with limited mass transit, the traditional parking ratio of 4 spaces per 1000 square feet of office space will prove to be inadequate. Thus even in high vacancy markets we will see new construction to accommodate the new workplace of the 21st century. Put bluntly, even at higher rents an office building in a dense configuration can cost less on a per employee basis than a lower density building.  As a result the national office vacancy rate will stay high for many years to come. And it should surprise no one that urban office buildings are being converted to residential use and suburban office buildings are being “scraped” to make way for high density residential development.


The industrial market is gradually recovering from recession as the availability rate has gradually declined from 14.5% in 2010 to around 11% today according to CBRE. Industrial space has and will continue to benefit from e-commerce as warehouse space is substituted for retail space and the need to be closer to the consumer. However the main driver of demand on the coasts has weakened with softer import growth.

Of greater consequence will be the completion of the delayed widening of the Panama Canal in 2016 to accommodate the larger container ships. That mega-project has the potential to shift warehouse demand from the west coast to the gulf and east coast ports benefiting such port cities as Houston, Savannah and Charleston. (See Figure 11)

Figure 11. Panama Canal Logistics

Source: Google


Technology has made the hotel business far more transparent. There are a host of on-line services that supply up-to-the-minute pricing data for hotel rooms throughout the world. There are also consumer reviews available for practically every hotel in America. More than ever hoteliers have to be on their toes. All of this has been true for about the past decade. What is new is the rise of the “sharing economy” where individuals offer up their own houses, apartments or rooms to be made available for temporary rental.

The prototype of this new form is Airbnb a website that offers up private accommodations in people’s homes. Earlier this year Airbnb received venture financing that established a $10 billion value for the firm, greater than the market capitalization of Hyatt Hotels. This is truly disruptive competition. It doesn't have to be as good as a hotel room. All it has to be is cheap and convenient. Of course it should not be surprising that the regulation-heavy cities, under the guise of protecting rent control, of New York and San Francisco are making moves to stifle this new form of competition to the hotel industry. There is also the issue of collecting hotel taxes where the owner is responsible for both collection and payment of the tax. Airbnb is in the process of seeking legislative change to allow it to collect and pay the required taxes. Meantime a recent perusal of the Airbnb found a host of accommodations in or near Westwood Village at prices ranging from $50-$350 a night.

Multi-Family Housing

Multi-family housing is in the sweet spot. The sector is benefiting from:
·                 A decline homeownership rate (See Figure 12)
·               An increased consumer preference for urban and suburban density.
·              A still sluggish economy that is delaying such life cycle events as marriage and           childbirth.
·             The need for 24/7 tech workers to be close to their employment.
·            Transit-related development being viewed as “green.”

Figure 12. Homeownership Rate, 1995Q1 -2014Q1.

Source: Bureau of the Census

All of these forces have led to a free fall in the apartment vacancy rate to 8% from the recession high of 4%, increasing rents, and a surge in construction. (See Figures 13, 14 and 15) We would also note that the 3% increase in year-over year rents reported by the Bureau of Labor Statistics is understated because of a few technical issues. Specifically we are forecasting multi-family housing starts to easily exceed 400,000 units a year in 2015 and 2016 which will represent their highest level since the mid-1980s. Of course by 2016 the increases in construction and a leveling off in the homeownership rate will cause vacancies to rise and rent increases to abate. Meanwhile the boom is on.

Figure 13. Apartment Vacancy Rate,

Sources: and REIS.

Figure 14. Consumer Price Index, Rent of Primary Residence, Jan 2000 – Apr 2014, Percent Change Year Ago.

Sources: Bureau of Labor Statistics via FRED.

Figure 15. Multi-Family Housing Starts, 1980 – 2016F
Sources: Bureau of the Census and UCLA Anderson Forecast


In this report we have outlined several very important issues facing commercial real estate. We do not expect investors will focus on the technological disruption facing retail, office and hotel real estate until capital market conditions become less favorable. There is too much money pouring into real estate to worry right now. Simply put the worriers don’t get the deals. Nevertheless when the capital markets turns investors will wake up to the changing landscape for commercial real estate.

[i] For a discussion of disruptive technology see, Christensen, Clayton M., “The Innovator’s Dilemma: When New Technologies Cause Great Firms to Fail,” (Boston: Harvard Business School Press, 1997)
[ii] See Kapner, Suzanne and Robbie Whelan, “Struggling Malls Suffer as Penney, Sears Shrink,” The Wall Street Journal, May 10,11, 2014, p.1.
[iii] See Shulman, David, “An Uneasy look at office Space Demand,” UCLA Economic Letter, December 2012