Monday, October 24, 2016

My Amazon Review of Sebastian Mallaby's "The Man who Knew: The Life and Times of Alan Greenspan"

From Sideman to Conductor of the Global Economic Orchestra

Sebastian Mallaby has written a magnificent well-written book about Alan Greenspan and the times that shaped him. (Full Disclosure: I am mentioned in the book.) It is a story about a musically talented Jewish kid from Washington Heights who became a sideman playing the saxophone in a 1940s jazz band and who by the dint of his intelligence rises to become chairman of the Federal Reserve Board. We follow Greenspan through his undergraduate days at NYU where is math geekiness shines through to his stint in an economics graduate program at Columbia. There he meets future Fed Chairman Arthur Burns and learns the importance of knowing every number in the economic data set. By doing this he sees the economy from the ground up rather from the top down approaches of grand theory. His knowledge of the data will become most useful as his career progresses.

After a brief interlude he forms the economic consultancy of Townsend-Greenspan and garners a host of industrial and Wall Street accounts. He becomes the man who knew. About the same time he falls into the ultra-libertarian cult of Ayn Rand. Somehow he managed to keep the practicalities of his work separate from the extremes of the cult. In 1959 he authors a paper describing how share prices influence corporate capital expenditures. It is a precursor to Tobin’s Q for which James Tobin wins the Nobel Prize in economics. Simply put when share prices exceed replacement cost there is an incentive to expand and vice versa. Forty years later Larry Summers jokes that Tobin owes Greenspan a share of Nobel cash.

By the late 1960s Greenspan catches the political bug and works as an insider on Nixon’s presidential campaign. It is from that beginning he has an involvement in every Republican administration that came later. He learns how to wield power and bests Henry Kissinger in a bureaucratic fight over an Iran oil deal that never came to pass. By 1980 he was one of the key negotiators in the aborted attempt to have Jerry Ford become Reagan’s 1980 running mate. Far from being a sideman he was inside in the thick of it.

In 1987 Reagan appoints him to chair the Federal Reserve and of a sudden the stock market crashes. He with others work to prevent a repetition of 1929 and he comes out of it with an enhanced reputation. He has an icy relationship with the Bush Administration but gets along famously with the Clintons. It is then when the late 1990s economy takes off that he becomes the conductor of the global economic orchestra and is practically deified for a sustained period of high growth, low unemployment and low inflation. He rightly diagnoses well ahead of the data that productivity was surging. That was brilliant, but all those factors lead to “irrational exuberance” in the stock market.

But herein lies the problem that would haunt his reputation 10 years later. By targeting inflation and employment he necessarily ignored the asset markets and their potential to trigger instability. He ignored the warning of Hyman Minsky who noted that “stability leads to instability” as investors anticipate that the good times will last forever. When they don’t the financial system is undermined and with that the safety and soundness of the banking system.

Greenspan’s critics argue that he should have stopped the housing bubble of the mid-2000s through increased regulation. Mallaby rightly argues that getting the regulations right is a difficult task and in the midst of a bubble it is hard to do politically. Greenspan was unwilling to spend his political capital on this.  Where Greenspan failed was that he believed that bankers in their own self-interest would prevent risk from getting out of control. They didn’t. I made a similar mistake in thinking that the Wall Street investment banks would not end up eating their own cooking by keeping so much bad paper on their balance sheet. They did. On the other hand Mallaby supports the critics in thinking that Greenspan should have been more aggressive in raising rates in 2004-06. To be sure bubbles are hard to detect and there was belief that the authorities could clean up a mess after the fact, but as it turned out the cleanup costs in 2008-2010 and still ongoing were enormous.

Mallaby also discusses Greenspan’s private life. After a failed marriage in the 1950s Greenspan becomes a serial monogamist dating staff members at Townsend-Greenspan, a speech writer in the Ford Administration, television personality Barbara Walters, and a host of others until he marries NBC newswoman Andrea Mitchell.

My few quibbles with the book is that in Mallaby’s discussion of the economic history he leaves out the importance of the Garn-St.Germain Depository Institutions Act of 1982 which enabled savings and loan associations to diversify their asset portfolios. That in combination with the new Reagan depreciation schedules created a marriage made in hell between the S&L’s and the tax syndicators that helped overbuild America in the 1980s. He doesn’t discuss the 1985 Plaza Accord whose effect was to flood the global economy with money setting up the 1987 crash and the final surge of the commercial real estate boom. He also fails to note that the Fed missed the rolling recession in commercial real estate that began in Texas, went to Phoenix and finally the Fed woke up when it reached New England. But New England was a weigh station on the road to Southern California and the New York City metropolitan area. Leaving these points aside I would highly recommend this book for readers interested in the life of a very interesting man and how economic policy is really made.

Thursday, October 13, 2016

My Amazon Review of David Reid's "The Brazen Age: New York City and the American Empire: Politics, Art and Bohemia"

Art and Politics in Late 1940s Greenwich Village

David Reid over-promises with his title. To be sure it is about the arts community in Greenwich Village and the left leaning politics associated with it. However it is not about New York City and what he calls the American Empire of the late 1940s. He rightfully opens his book with FDR’s open car tour in the rain for three million New Yorkers in the late days of his 1944 reelection campaign. After all as Michael Barone wrote so eloquently that New York City was the city that was winning the war. Unfortunately that is the last we see of the average New  Yorker. He also doesn’t flush out the role of New York’s foreign policy elite in shaping Truman Administration policy.

Reid’s book would have been far better if he placed the political left and the arts community in the context of the hopes and aspirations of eight million New Yorkers who suffered through the privations 15 years of depression and war. What they wanted was to move to the suburbs or the new apartment blocks rising in Queens, buy cars and above all else they wanted to have babies. These wants were hardly a priority for the villagers he discusses. Also nowhere is there a discussion of the important role played by baseball in the lives of the average New Yorker. There were far more discussions about the 1947 pennant races than the potential for a Henry Wallace campaign in 1948. Further in 1947 Jackie Robinson broke the color line in baseball which had far reaching political consequences.

What Reid does discuss is the minutia of Greenwich Village going way back to the 1800s and the denizens who lived there. He brings to life the beginnings of abstract expressionism, the rise of Norman Mailer as a great novelist and the differences between “The Partisan Review” and “Commentary”. Then of a sudden he goes into a discussion of the Truman Administration and its growing Cold War posture. To me Truman is a hero, not so to Reid.

As a result I was disappointed. Those interested in in the narrow comings and goings of the Greenwich Village of the late 1940s would have a more positive review of the book than me. 

Monday, October 10, 2016

Stocks too Complacent about Politics

The stock market has become way too complacent about the November election in assuming that Hillary Clinton will be elected and that the Republicans would end up controlling the House of Representatives. Today's WSJ/NBC snap poll has Hillary ahead by 11 points. If that holds through November the House will likely go Democratic and with that the market is nowhere near prepared for a wave tax and regulatory policies that a Clinton presidency will bring with it.

That is why House Speaker Paul Ryan "broke the glass" today in declaring that he would no longer defend Trump. He told his caucus members that they were on their own. A week ago I thought the Republicans had an even chance of holding the Senate and would only face modest losses in the House. Today the Senate is gone and the House is at risk. Gerrymandering or not, if Republicans don't show up to vote, the ball game is over. Consider yourself warned.

Saturday, October 8, 2016

Republicans Commit Political Malpractice

Wow! Donald Trump is a profane guy with respect to women. I'm shocked! I met Donald Trump once 25 years ago in a business setting. He didn't know me or my colleague and all he talked about was pussy and sports. So I was not surprised to see the out-takes from Access Hollywood. He sounded just like the Trump of 25 years ago. I am sure there will be more, but my question is where were the Republican "oppo" researchers. They should have had this during the primary season.

This is especially true of Jeb Bush's team because Trump's interviewer Bobby Bush is his cousin. The failure of the Bush, Rubio, and Cruz staffs to come up the real dirt on Trump represents political malpractice of the highest order and the whole lot of them should go into a hole somewhere and never be seen again. It is their failure that has given the Republican Party its most flawed candidate in history.

Monday, October 3, 2016

Promises, Promises.., UCLA Anderson Forecast, September 2016

Presidential candidates Hillary Clinton and Donald
Trump are making all kinds of promises which they believe
will improve the economy for the average person.2 In
very simplified terms Trump wants to substantially reduce
taxes on businesses (including 100% expensing of capital
outlays) and individuals, increase tariffs, deport at least five
million people, increase spending on immigration control,
infrastructure and defense. Needless to say, the federal
deficit would explode should all of his ideas be enacted. In
contrast, Hillary Clinton wants to increase taxes on high
income earners and use the proceeds to enable free tuition
at public colleges for most students, expand social security,
increase healthcare spending, refinance/forgive student debt
and increase spending on infrastructure. Her plan would
modestly increase the deficit, but it is silent on its potential
to make economic growth even slower than it is now. Of
course, whether any or all of these proposals get through
Congress remains an open question.

The problem is that in order to be effective, any economic
plan has to be able to jump start productivity growth
that has been extraordinarily weak for more than a decade.
As our colleague Ed Leamer noted last quarter, it will be
extremely difficult for the U.S. economy to return to a 3% a
year growth path without productivity growth moving from
near zero to about 2%.3 Put bluntly, the growth in real GDP
is a function of the growth in labor hours and the increase in
the output per hour or productivity. Presented below is the
long-trend in the growth in output per hour. (See Figure 1)

Figure 1 Productivity Growth, Output/Hour Worked
Sources: U.S. Department of Commerce, UCLA Anderson Forecast

By simple arithmetic if we posit that the labor force
is growing at around 1% or less per year and if we assume
that the average person is not going to step up the number
of hours worked, then with 1% productivity growth the
steady state growth for real GDP is about 2% a year. This
is, in fact, the history of recent years. Thus the question
before the candidates is how are they going to improve the
outlook for productivity? And note the mass deportation
of workers would reduce hours worked in the short-run.

The answer to this question is not simple. There is no
magic wand and improvements in productivity take time
to implement and are largely dependent on technological
innovation. To economist Robert Gordon, the growth in
productivity experienced by the United States between
1870- 1970 was based on a series of one-off events based
on the internal combustion engine, the harnessing of electromagnetic
energy, indoor plumbing and improvements in
public health. 4. To him our fascination with the computer/
communications technology of today pales in comparison
to the arrival of electricity and the automobile. Perhaps he
is too pessimistic, but the burden of proof is on the technoenthusiasts.

Nevertheless, even if you are a techno-enthusiast, productivity
improvements don’t take place over night. It takes
time for technology to diffuse into the broader economy,
workers have to be educated and trained and new infrastructure
has to be built. Thus, the policies that both Clinton
and Trump are talking about potentially would only have a
limited impact in the short-run. Over a longer time period
an improved infrastructure, a more efficient tax structure
and a better educated workforce will help, but again, in the
fullness of time.

In any event, with both Clinton and Trump calling for
more spending and with tax increases difficult to pass, the
path of the federal deficit will be decidedly higher thereby
reversing the trend of lower deficits in recent years. (See
Figure 2) In the meantime we have modeled in increased
federal spending on infrastructure, a program both candidates
agree on.

The Forecast

Although the inventory correction has taken longer
than what we had previously anticipated, the economy
appears to be rebounding from the 1% growth recorded in
the first half to about 2.7% in the second half. (See Figure
3) Thereafter the growth in real GDP is forecast to run at a
2%- 2.5% clip for the years, 2017 and 2018, respectively.
In other words, it will not be much different from the past
seven years. And to be very explicit, we are assuming
that Hillary Clinton will be elected in November with at
least one house of Congress remaining Republican, the
conventional wisdom as of this writing.

Figure 2 Federal Surplus/Deficit, FY 2000 - FY 2018F
Sources: Office of Management and Budget and UCLA Anderson Forecast

Figure 3 Real GDP Growth
Sources: U.S. Department of Commerce, UCLA Anderson Forecast

With the economy approaching full employment,
employment growth will inevitably slow. After consistently
averaging about 200,000 job gains a month since 2011, employment
growth will slow to about 150,000 jobs a month
in 2017 and 125,000 jobs a month in 2018. Remember
the closer an economy is to full employment the more the
demographics of the work force takes hold. (See Figure 4)
The unemployment rate is forecast to be in a very tight 4.8%
-5.0% range for most of the forecast period as the labor force
participation rate rises modestly.

The modest growth we are forecasting will come from
continued gains in the consumer and housing sectors along
with a rebound in capital spending. Although real consumption
expenditures will not approach the 3.2% increase of
2015, there will be solid gains of 2%+ over the next two
and half years. (See Figure 5) The drop off will largely be
due to a peaking in the automobile market with light vehicle

sales running at about a 17.5 million unit rate. (See Figure 6)

Similarly, housing activity continues to grind higher.
Rising wages, low interest rates and higher rents are underpinning
housing demand with the last factor beginning to
trigger a shift away from rentals towards ownership units.
Although well off peak production, we forecast that housing
starts will increase to 1.19 million units this year and to 1.38
million units and 1.41 million units, in 2017 and 2018, respectively,
up from 1.11 million units in 2015. (See Figure 7)

Figure 4 Unemployment Rate
Sources: Bureau of Labor Statistics and UCLA Anderson Forecast

Figure 5 Real Consumption Expenditures
Sources: U.S. Department of Commerce and UCLA Anderson Forecast

Figure 6 Light Vehicle Sales
Sources: U.S. Department of Commerce and UCLA Anderson Forecast

Figure 7 Housing Starts
Sources: U.S. Department of Commerce and UCLA Anderson Forecast

With respect to business fixed investment we expect
the declines in both equipment and structures in 2016 to
reverse next year. (See Figures 8 and 9) This reversal of
fortune will largely be due to the end of the collapse in oil
and gas drilling investment and the beginnings of a modest
recovery in that sector. Similarly, the hesitancy in overall
corporate investment experienced in the first half appears
to be waning.

The real wild card for the next few years involves the
export sector. The dollar has been strong, foreign economies
generally weak and there has been an obvious increase in
protectionist sentiment worldwide. As a result, global trade
has not been a source of growth in recent years. We are
assuming that there will be a modest increase in export volumes
over the next few years after two years of essentially
zero growth. If there is a risk to our forecast you can do no
worse than starting here.

Figure 8 Real Investment in Equipment
Sources: U.S. Department of Commerce, UCLA Anderson Forecast

Figure 9 Real Investment in Nonresidential Structures
Sources: U.S. Department of Commerce, UCLA Anderson Forecast

Figure 10 Real Exports
Sources: U.S. Department of Commerce, UCLA Anderson Forecast
Inflation on the Rise

Although the Fed is reluctant to admit it, the era of
very low inflation is behind us. On a year-over-year basis,
core inflation is already running well above a 2% annual
rate. (See Figure 11) By next year the headline consumer
price increase will approximate 3% as service sector inflation
combines with modestly higher oil prices. And even
the Fed’s preferred gauge for inflation, the chain weighted
deflator for personal consumption expenditures will exceed
2% in both 2017 and 2018.

The rebound in inflation is being fueled by higher
energy prices, coupled with large increases in service prices
especially residential rent and higher wages. The average
worker is in the process of getting a raise as private sector
wage compensation will be increasing at a 4% rate over the
next two years. Simply put, there are growing spot shortages
of labor appearing in many parts of the country and the
July JOLTS data indicated a record amount of job openings.

After years of experimenting with zero interest rates,
quantitative easing, and forward guidance and internationally
with negative interest rates and corporate bond buying,
it now appears that monetary policy is at the end of its rope.
Despite it all, globally, inflation is not budging. There isn’t
much more monetary policy can do except for the central
banks to directly fund government spending by printing
money through the purchase of zero coupon perpetual bonds.
It may come to that and perhaps a field trip to Caracas,
Venezuela is in order where a former bus driver is on the
road to generating quadruple digit inflation. Of course that
would mean the end of central bank independence. Thus,
the answer lies in fiscal policy and that is something that
both Ms. Clinton and Mr. Trump are advocating in their
own unique ways.

As for long-term interest rates, we expect them to
rise in tandem with short rates and the higher inflation we
expect to see. In order for this to happen both Europe and
Japan will have to leave negative interest rates behind and
we are beginning to see the first signs of this. Put bluntly
the Central Banks have run out of bonds to buy and there is
growing recognition that the sustained period of very low
long-term interest rates is creating systemic risk in the form
of bankrupting pension plans and life insurance companies.
This problem is more acute in Europe than the U.S., but the
state and local pension plans of the U.S. are in dire straits
and it is getting worse with each passing day.
Figure 11 Consumer Price Index vs. Core CPI
Sources: U.S. Bureau of Labor Statistics, UCLA Anderson Forecast

Figure 12 Employee Compensation/Hour
Sources: U.S. Bureau of Labor Statistics, UCLA Anderson Forecast

The Fed Begins to Move….Slowly

This was supposed to be the year of three or four
increases in the Fed Funds rate. Instead, the ever data
dependent Fed will likely raise rates only once this year.
However, as transitory worries fade (i.e. Brexit) and the
economy demonstrates its ability to grow at a 2%+ clip, we
anticipate that 2017 could very well bring with it three 25
basis point rate hikes taking the funds rate by yearend to
around 1.5%. (See Figure 13)

Figure 13 Federal Funds Rate vs. 10-Year U.S. Treasury Bond
Sources: Federal Reserve Board, UCLA Anderson Forecast


The economy having survived a first half slowdown
is on track for 2%+ growth over the next few years. Don’t
expect much help from the political system because we
will not see a meaningful improvement in growth unless productivity picks up. Public policy in this regard can be
successful, but it will take time. Meantime, inflation will
pick up modestly in a roughly full employment economy
causing the Fed to gradually raise interest rates.  

1. With apologies to Neil Simon.
2. In the interests of full disclosure I wrote an Op-Ed in support of Hillary Clinton and in opposition to Donald Trump. See Shulman, David, “I’m a
Republican and I Don’t Like Hillary Clinton – but I’m Voting for her.” Los Angeles Times, Op-Ed, August 8, 2016.
3. Leamer, Ed, “It’s not 9.8 Meters per Second Squared Anymore,” UCLA Anderson Forecast, June 2016.
4. See Gordon, Robert J., “The Rise and Fall of American Growth: The U.S. Standard of Living since the Civil War,” Princeton: Princeton University