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: