My Amazon Review of Benjamin Carter Hett's "The Death of Democracy: Hitler's Rise to Power and the Downfall of the Weimar Republic"

The fall of Weimar and the Rise of Hitler

Hunter College history professor Benjamin Carter Hett has given us an insightful history into the collapse of the Weimar Republic and the rise of Hitler. He understands the power of myth wherein a large portion of the German population and most notably President Paul von Hindenburg believed there was unity in August 1914 at the outbreak of World War One and deceit in November 1918 when Germany surrendered. It was the power of this myth that underlay the success of the German Right.

From the outset the social democratic Weimar government was never viewed as legitimate by the German Right. Thus there was a permanent built-in opposition to the government. That was compounded by the communists in the late 1920s, following Stalin’s orders, called the social democrats “social fascists.” As a result by 1931 there was an anti-democratic majority consisting of communists and Nazis working almost in tandem to destroy democracy. Although Hett covers the communist May Day demonstration of 1929 that was put down by the Social Democrats he spends far too little time on the role the communists played in bringing down Weimar.

Although the Nazis were marginalized in the 1920s, the weakness in the farm economy, the continued burden of reparations and the onset of the global depression enabled the Nazis under Hitler’s leadership to unite the right. According to Hett German politics was based upon three “confessionals”: the Protestants, the Catholics and the socialist/communist factions. With the Left divided, Hitler utilizing the myths of August and October dominated the Protestants and picked off enough Catholics to become the leading rightwing party. As a result by 1933 the Nazis, by default, had to be part of any coalition government and with their successful bullying tactics they seized power. Of course they were aided by the deflation policies of Heinrich Bruning’s Center Party coalition government. In part the deflationary policies were designed to make things worse to relieve Germany of its reparations liabilities.

Hett gets many things right especially his view that the untimely death of foreign minister Gustav Stresemann in 1929 eliminated a democratic voice in Germany’s center-right. In my opinion Stresemann was the only politician who could have stopped Hitler. However Hett gets a few things wrong. First he over-emphasizes the opposition to globalization. He neglects to mention that globalization was at its apogee in 1914 and Germany was benefiting from it. He conflates globalization with reparations and the gold standard. Initially the real problem was with reparations which Hett notes were relatively mild relative to history, but that is a low bar, the burden on Germany was severe. He also mysteriously leaves out the 1922 assassination of finance minister Walter Rathenau by rightwing extremists. Rathenau had the confidence of both the British and French finance ministries and had he lived the reparations issue might have been ameliorated. Hett also gets wrong blaming the German farm crisis on the rise of U.S., Canadian and Australian wheat. That is not quite true. The true causes for the fall in farm prices was the return to market of Russian and southeastern European grain along with the mechanization of agriculture that reduced the need for forage crops. The farm issue is important because the core of Nazi supporters were the Protestant farmers.

Hett ends his book with the Night of the Long Knives in 1934. Here Hitler eliminates Ernst Rohm’s S.A. and more importantly much of the remaining conservative opposition. If there is a lesson to be learned from Hett’s book, it is that conservatives are play with fire when they suck up to rightwing demagogues. Hett has written an important book. Read it.

The full Amazon URL appears at:  https://www.amazon.com/review/R3GV90GRUF90X/ref=pe_1098610_137716200_cm_rv_eml_rv0_rv

My Amazon Review of Michael Batnick's "Big Mistakes: The Best Investors and their Worst Investments"

Learning from the Mistakes of Others

Michael Batnick, the research director at Ritholtz Wealth Management, is teaching us that it is important to learn from the mistakes from some of the most successful investors of all-time. This is not an original concept, but nonetheless it as an important one. Nevertheless my problem with his book is not with Batnick, but with his editors or his lack of editors. There are typos, math errors and outright mistakes (e.g. calling “Supermoney” author Jerry Goodman, Jerry Goodwyn.) Further it would have been very helpful to have stock charts where they would have been relevant.

That said he points out the most common of errors all of us have, even the great ones, in that we are victims of hubris/overconfidence, we get sucked in by the allure of leverage and out of frustration we invest outside of our circle of competence. His many examples include, Jack Bogle, Michael Steinhardt,  Stanley Druckenmiller, John Paulson, the Sequoia Fund, Long Term Capital Management, Bill Ackman and yes, Warren Buffett. In Buffett’s case Batnick believes Buffett became overconfident based on his prior experience in investing in the shoe business with his purchase of Dexter Shoe in the early 1990s. He compounded his mistake by paying in stock that would become more valuable over time only to see the business ravaged by foreign competition.

In cases of Paulson, Druckenmiller and Steinhardt we see them investing beyond their core competencies and the case of Bill Ackman we his very big ego get in the way with his giant short position in Herbalife. Of course leverage and hubris brings down Long Term Capital Management. These are all wonderful vignettes and there is much to learn, but I wish Batnick had a sharp penciled editor.

The full amazon URL appears at: https://www.amazon.com/review/RK8WMG81SKIWB/ref=pe_1098610_137716200_cm_rv_eml_rv0_rv

UCLA Ziman Center version of my "The Best of Times and the Worst of Times for Housing," June 2018

The attached link is a short version in a PDF format of my recent housing paper.

http://www.anderson.ucla.edu/Documents/areas/ctr/ziman/UCLA_Economic_Letter_Shulman_06.15.18.pdf

My Amazon Review of Sebastian Edwards' "American Default: The Untold Story of FDR, the Supreme Court and the Battle over Gold"

The Great Depression Showdown over Gold

As an economic history nerd I can only applaud the work of my UCLA colleague Sebastian Edwards in his vibrant telling the story of the long forgotten Supreme Court showdown over the United States’ abrogation of contracts written with the gold clause. Remembering the inflation of the Civil War greenback era, most creditors demanded gold clauses in debt contracts in which they would be repaid in in either gold or its paper money equivalent value.

This system worked fine until the onset of the Great Depression. It is here where Edwards begins his story as President Roosevelt adopts an inflationist policy by first abandoning the gold standard by requiring all citizens to turn in their physical gold at the then $20.67/ounce price. Then in June 1933 Congress adopts a joint resolution authorizing Roosevelt to increase the price of gold which he ultimately does to $35/ounce and the legislation abrogates the gold clause in all contracts. Indeed, most economists credit the early recovery from the depression directly to the monetary easing associated with Roosevelt’s gold policies.

If Congress hadn’t abrogated the gold clause all debts would have been written up to reflect the devaluation by 69%. Thus it would require a payment of approximately $1700 to repay a nominal debt of $1,000. Needless to say a host of bankruptcies would have ensued.

Of course several creditors sued and Edwards skillfully moves the action from Roosevelt and Congress to the Supreme Court. The Supreme Court ruled that it was in Congress’ power to alter private contracts, but it was not in its power to alter U.S. government debt. However, the court ruled that as of the date of the Joint Resolution gold was still trading at $20.67/ounce and Americans were not allowed to possess physical gold at that time. Hence there would be no damages. A brilliant 5-4 ruling by Chief Justice Hughes.

The reason why these cases have been forgotten is that if they went the other way all hell would have broken loose. Instead of rallying as the stock market did after the ruling, stocks likely would have crashed. It would have triggered a constitutional crisis with Court versus the other two branches of government. Indeed the lead up to the ruling was a precursor to the 1937 court fight that Roosevelt would have.

As an aside Edwards notes that the United States had a treaty with Panama concerning the lease payments for the Panama Canal. That treaty had a gold clause in it. After a long negotiation in 1939 the lease payment was increased retroactive to 1934 thereby reflecting the dollar devaluation. Thus, the U.S. made good on its international treaty obligations.

“American Default” is a worthy addition to the economics literature of the Great Depression. It should be read with the works of Friedman & Schwartz, Bernanke, Irwin, Eichengreen and Sumner. And because it is more a history book than an economics book the lay reader should find it very readable. Further given the rising debt/GDP ratio in the U.S. when coupled with even larger unfunded liabilities, the idea of a 21^st century American default is not totally improbable.

The full amazon URL appears at: https://www.amazon.com/review/R1JCSUKKX3TVDP/ref=pe_1098610_137716200_cm_rv_eml_rv0_rv

'The Best of Times and the Worst of Times for Housing," UCLA Anderson Forecast, June 2018

The Best of Times and the Worst of Times for Housing[1] 

David Shulman

Senior Economist, UCLA Anderson Forecast

June 2018

The outlook for housing over the next few years depends upon where you live and how you live. If you are a homeowner in coastal California, the Pacific Northwest, parts of the coastal northeast and such fast growing cities of Denver, Nashville and Austin you are sitting pretty enjoying rapidly increasing house prices. On the other hand, if you are a potential middle-class home buyer or a struggling renter in those areas you are facing a very personal affordability crisis. From the supply side, although housing starts remain significantly below the boom years of 2004-2006, well-capitalized homebuilders, apartment owners and construction workers find their products in great demand.

At its very essence, in contrast to historical experience, the core issue is that housing starts haven’t fully recovered from their nadir of just under 600,000 units a year during 2009-2010. In 2017 housing starts amounted to 1.21 million units and we are forecasting moderate increases to 1.34 million and 1.40 in 2018 and 2019, respectively and a modest decline to 1.36 million units in 2020. (See Figure 1) Although starts more than doubled off their recession lows, the current and forecast levels remain below the 59 year average from 1959-2017 of 1.435 million units a year.  Forget about the two million starts a year we experienced several times during the housing booms of the past. Simply put, the housing shortage is for real.

Figure 1. Housing Starts, 1959 – 2020F

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

Prices Rising

In response to the shortage housing prices are rising rapidly and have more than recovered from the housing crash of 10 years ago. The national Case-Shiller Home Price Index is up 47% from the low in February 2012, is now 7% above the previous peak in 2006 and is now up 97% since 2000. (See Figure 2) However, by way of comparison, the gains since 2000 for such hot cities as Los Angeles, Seattle, and Denver amount to 178%, 138% and 111%, respectively. Contrast that with the meager gain of 42% reported for Chicago and Atlanta. As we said at the outset, it depends where you live.

Figure 2. Case-Shiller National Home Price Index 2000 – February 2018, Monthly Sources: Standard and Poor’s via FRED

Consistent with the sluggishness in housing starts, the growth in existing homes sales remains tepid. Existing home sales in 2018 are estimated to be 5.6 million units, well below the 7.0 million peak recorded in 2005. (See Figure 3) In part, the slowdown is due to an older society aging in place and a change in retirement patterns where grandparents have been reluctant to move away from grandchildren. However, with less moving around, homeowners have chosen to invest in remodeling engendering a boom in that sector. (See Figure 4)

Figure 3. Existing Home Sales, 2000 – 2020F, Annual Data

Sources: National Association of Realtors and UCLA Anderson Forecast.

Figure 4. Building Material and Garden Supply Retail Sales, 2010 – April 2018, In $ millions, Monthly Data

Source: U.S. Department of Commerce via FRED

Positive Demand Fundamentals

By most conventional measures housing activity should be soaring. As noted above we have witnessed a decade of under-building which has given rise to a huge pent up demand. Employment growth has been strong and employee compensation is on the rise and until very recently mortgage rates have been extraordinarily low. (See Figures 5 and 6) With delays in major lifestyle events (marriage and childbirth) net new household formations declined to 800,000 in 2017. Nevertheless with the economy strengthening we forecast the pace to return to a more normal 1.2 million over the 2018-2020 time frame. (See Figure 7)

Figure 5. Payroll Employment, 2005Q1 – 2020Q4F

Sources: Bureau of Labor Statistics and UCLA Anderson Forecast

Figure 6. Employee Compensation, 2005Q1 -2020Q4

Sources: Bureau of Labor Statistics and UCLA Anderson Forecast

Figure 7. Net Household Formations, 2005 – 2020

Sources Bureau of the Census and UCLA Anderson Forecast

Negative Demand Fundamentals

As strong as the demand fundamentals mentioned above are, there remains strong headwinds that are working to limit the demand for housing. As mentioned at the outset, housing affordability is a major issue in the metropolitan areas where job growth is booming. For example the median home price in Los Angeles as of March 2018 was $585,000, while median household income in 2016 was only $58,000. Simply put, the numbers don’t work. Similarly rents remain high relative to income with approximately 50% of the nation’s renters paying more than 30% of their income to keep a roof over their heads.

Further, the interest rate environment which has been extraordinarily friendly is turning more hostile. The rate on the 30-year fixed rate mortgage has risen approximately 100 basis points since mid-2016 to 4.5% and is likely to approach 6% by 2020. (See Figure 8) That will be quite the headwind especially when we recognize that Fannie and Freddie are guaranteeing loans with down payments as low as 3% and allowing home buyer (total debt payment)/income ratios of up to 50%. Indeed in the second half of 2017 about 20% of Freddie and Fannie loans were to borrowers whose debt payment/income ratio exceeded 45%.[2] Reminiscent of the prior boom, non-prime loans have emerged to finance consumers with low credit scores.

Figure 8. 30-Year Conventional Mortgage Rate, 2005Q1 – 2020Q4F

Sources: Fannie Mae and UCLA Anderson Forecast

One of the reasons for lenders raising the debt/income ratio has been the explosive growth of student debt. Student loan debt has tripled from just under $500 billion in 2006 to $1.5 trillion early 2018. (See Figure 9) Although this debt is not solely due to young people borrowing money for their educations, it will remain a ball and chain holding back the millennial generation from buying homes.

Figure 9. Student Loans Outstanding, 2006Q1 – 2018Q1, In $ Millions

Source: Federal Reserve via FRED

Although household formation remains strong, a major impetus for home purchase, especially single-family homes, is the birth of children. On that score, the birthrate remains at multi-decade lows and is roughly half of what it was in 1960. (See figure 10)

Figure 10.  Births per 1000 Women 15-44, 1920 - 2017

Via The Wall Street Journal

One last negative demand factor will be the influence of the recently passed tax reform which limits the deductibility of state and local taxes to $10,000. In high tax states it is not unusual for upper-middle class tax payers to pay $20,000 -$30,000 a year in such taxes. As a result, one of the critical tax advantages, that being the ability to fully deduct property taxes, will be reduced. How this tax change will affect future demand remains to be seen, but it is certainly not a positive.

Negative Supply Fundamentals

On the supply side, housing activity is plagued by excessive zoning constraints in the hot employment markets of the Pacific Coast and the Northeast. Although there have been attempts to relax those constraints in California and Massachusetts, local opposition to new developments especially those of a higher density remains fierce. Zoning constraints along with high impact fees severely burden the ability of builders to deliver housing anywhere near an affordable price range.

Further exacerbating the land situation the market remains tight for construction labor and lumber prices have surged 50% partially in response to the Trump Administration’s imposition of a 20% tariff on Canadian lumber in January 2018. (See Figure 11) That said, because housing remains in short supply, builders have been able to pass along cost increases to consumers evidenced by the strong gross margins reported by the publicly traded homebuilders. Simply put, the larger homebuilders have learned to profit from the tight zoning controls as regulation works to reduce competition.

Figure 11. Lumber Prices, $/1000 Board Feet, May 2017 – May 2018

Source: BigCharts.com

Nevertheless, despite all of the negatives the homeownership rate has begun to rise after a long six percentage point decline that began in 2004. We anticipate that the homeownership rate will level off somewhat above its current level of 64.2%. (See Figure 12) The demand fundamentals have, at least recently, overcome the supply impediments for ownership housing.

Figure 12. Homeownership Rate, 1965Q1 – 2018Q1, Percent

Source:  U.S. Bureau of the Census via FRED.

The Boom Continues in Multi-Family Housing

The demand for multi-family housing continues to be strong as millennials (less so recently) and empty nesters seek a more urban lifestyle. In response, multi-family housing starts have approximated 350,000 - 400,000 units a year for the past several years. Indeed, we forecast that starts, which amounted to 357,000 units in 2017, will average 407,000 units/year over the 2018-2020 time period. (See Figure 13) However, because much of the construction has been at the high-end of the market, the vacancy rate has recently increased from 4.5% to 4.8% in the first quarter. (See Figure 14)

Figure 13. Multi-family Housing Starts, 2000 – 2020F

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

Figure 14. Apartment Vacancy Rate, 1980 – 2018Q1, Percent

Source: REIS via CalculatedRisk.com

The decline in vacancy rates has brought higher rents with rent growth approximating 3.5% -4.0% a year since 2015. (See Figure 15) In fact, from 2010 to 2018Q1, the cumulative increase in rents has amounted to 27%, well above the increase in the overall consumer price index of 15% and the 19% in employee compensation. It is no wonder that renters feel stressed. Indeed, as of 2016 roughly half of all renters were paying in excess of 30% of their incomes on rent and that in turn has engendered new calls for such self-defeating policies as rent control.

Figure 15. Consumer Price Index, Tenant Paid Rent, Dec 99 – Apr 18, Percent Change Year Ago.

Sources:  U.S. Bureau of Labor Statistics via FRED

Nevertheless, despite rising interest rates, real estate investors remain enamored with investing in rental apartments. It appears that these investors are willing to look through what they perceive to be temporary softness in the high-end apartment market. We would note that the publicly traded apartment REITs are reporting rent increases well below that reported by the consumer price index. Why? The REITs apartment assets are concentrated at the high end of the market. Despite this, investor demand is being sustained by default because retail real estate looks challenged and the industrial property market remains way too hot. Simply put, apartment investing remains one of the few games in town for real estate investors. Thus, the supply of rental apartments will keep coming.

Conclusion 

In terms of prices, the housing market is booming, especially on both coasts and selected booming cities in the interior. However, in terms of housing activity the market is muddling through with very mediocre levels of housing starts and home sales. Despite easier mortgage terms, consumers are being held back by high prices in areas where job growth has been strong. Meantime, lower income renters are struggling with high rent burdens where rents have risen well above the overall price index and income growth. The pricing problem is being aggravated by strict zoning controls that limit increases in supply. In contrast, the multi-family housing sector is benefitting from higher rents and despite growing vacancy rates at the high-end of the market, investor demand is keeping construction activity strong. As we said at the outset, your view on the housing market depends on where you live and whether you are an owner or a renter.

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[1] With apologies to Charles Dickens

[2] Kusisto, Laura and Christina Rexroad, “As House Prices Rise, Strains Emerge,” The Wall Street Journal, April 11, 2018, p. B6

"Interest Rates Move to the Center Stage," UCLA Anderson Forecast, June 2018

Interest Rates Move to the Center Stage

David Shulman

Senior Economist

UCLA Anderson Forecast

June 2018

The era of ultra-low interest rates is behind us. With the yield on the 10-year U.S. Treasury Note surpassing 3% and with the Federal Reserve set to push up the Fed Funds rate above 2%, interest rates are well on their path to normalization. (See Figure 1) To be sure, we are not forecasting yields to reach their pre-crisis levels of 5%+ for both short-term and long-term rates, but a Fed Funds rate north of 3% and a 10-Year Treasury yield north of 4% for late 2019 will seem awfully high compared to the past decade.

Figure 1. Federal Funds vs. 10-Year U.S. Treasury Bonds, 2008Q1 -2020Q4F

Sources: Federal Reserve Board and UCLA Anderson Forecast

The rise in rates is being propelled by high inflation, higher wages, an exploding federal deficit and the quantitative tightening policy adopted by the Federal Reserve.  An added wrinkle is the sale of fixed income securities by corporations utilizing their newly repatriated cash to buy back stock.

The Italian Job

Our interest rate forecast is largely based on domestic considerations. Now, all of a sudden, a political crisis involving the Euro in Italy along with monetary problems in Argentina and Turkey has triggered a flight to quality causing 10-Year treasury yields to plummet 30 basis points from 3.1% to 2.8% over a two week period. The flight to quality can best be seen in the Euro-area bond markets where over a four week period ending May 29, Italian 10-Year yields spiked by 138 basis points from 1.8% to 3.18% while German yields were cut in half dropping from 58 basis points to 26 basis points.  However, markets calmed down the next day. At this point we do not know how this will work out and it will largely be dependent on the Italian electorate’s position on the Euro. If the electorate decides to leave, we will face a currency/solvency crisis in the heart of Europe bringing with it even lower yields. While if the Italians decide to stay, yields will quickly snap back to where they were before. Because we do not view ourselves as experts on Italian politics we will stick to our U.S. interest rate forecast based on domestic considerations. Recall post-Brexit after dropping precipitously in the summer of 2016, markets quickly normalized.

The Domestic Backdrop for Higher U.S. Interest Rates

With year-over-year inflation as measured by the consumer price index already exceeding 2% and likely to be in the 2.5%-3% range over the forecast period, real bond yields, instead of being negative, will run in the 1%-2% range. (See Figure 2) Further, with the economy operating at full employment, wage increases will break out of the 2.5% recent growth rate to approach 4%. (See Figure 3)

Figure 2. Consumer Price index vs. Core CPI, 2008Q1 -2020Q4F

Sources: Bureau of Labor Statistics and UCLA Anderson Forecast

Figure 3. Employee Compensation, 2008Q1 – 2020Q4F

Sources: Bureau of Labor Statistics and UCLA Anderson Forecast

Further upward pressure on interest rates will come from the Fed’s policy of quantitative tightening as it continues its course to reduce its balance sheet from approximately $4.4 trillion to about $2.8 trillion over the next few years. Thus, instead of buying bonds as it did during 2008 – 2015, the Fed has become a net seller. (See Figure 4) Adding to the supply is the Trump Administration’s all-out fiscal policy of spending hikes and tax cuts layered on a fully employed economy. As a consequence, the federal deficit is forecast to increase from $666 billion in 2017 to $1.06 trillion in 2020. (See Figure 5)

Figure 4. Federal Reserve Assets, 2006 – 23May2018, In $Billions

Source: Federal Reserve Board

Figure 5. Federal Deficit, FY 2008 – FY 2020F

Sources: Office of Management and Budget and UCLA Anderson Forecast

The 3-2-1 Economy

Although we expect real GDP growth to pick up to 3%+ for the balance of the year, up from the first quarter’s 2.3% pace, we expect growth to fade in 2019 and 2020 as higher interest rates take their toll. In round numbers on a fourth quarter-to-fourth quarter basis, think of the economy growing at 3% in 2018, 2% in 2019 and 1% in 2020. (See Figure 6) Another way of looking at it is that a fully employed economy has difficulty growing without substantial increases in productivity.

Figure 6. Real GDP Growth, 2008Q1 -2020Q4F

Sources: Department of Commerce and UCLA Anderson Forecast

As the economy bumps against its full employment ceiling, job growth will noticeably decelerate over the forecast horizon. For example, employment growth averaged 200,000 jobs/month in 2017; it will average 133,000/month for the remainder of this year and then decline to 85,000/month and 60,000/month in 2019 and 2020, respectively. (See Figure 7) Concomitantly, the unemployment rate will decline from its current 3.9% to 3.4% in mid-2019 and then gradually return to 3.9% by the end of 2020. (See Figure 8)

Figure 7. Payroll Employment, 2008Q1 – 20120Q4, In Millions, SA

Figure 8. Unemployment Rate, 2008Q -2020Q4F, SAAR

Sources: Bureau of Labor Statistics and UCLA Anderson Forecast

Business Investment Drives the Bus

Spurred by a major reduction in corporate tax rates, 100% expensing for equipment purchases and deregulatory policies coming out of Washington, D.C., we forecast business investment to continue to be the driving force in the economy. For both 2018 and 2019, we forecast real investment in both business equipment and structures to increase at an approximate 7% clip. (See Figures 9 and 10) However, growth will slow in 2020 as the effects of 100% expensing wane.

Figure 9. Real Equipment Spending, 2008Q1 – 2020Q4F

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

Figure 10. Real Investment in Business Structures, 2008Q1 -2020Q4

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

Housing Activity Growing, but Less than Robust

Housing activity has been the great disappointment of the economic recovery and expansion that began in 2009. To be sure, housing starts have more than doubled off their moribund lows of 2009-2011, but still remain well below their long-term average and a far cry from the earlier boom periods.[1]  Specifically, we are forecasting housing starts to increase from 1.21 million units in 2017 to 1.34 million units and 1.40 million units in 2018 and 2019, respectively. (See Figure 11) However, we see housing starts declining in 2020 to 1.36 million units as the lagged effects of higher interest rates and a slowing economy inhibit new construction.

Figure 11. Housing Starts, 2008Q1 -2020Q4F

Sources: Bureau of the Census and UCLA Anderson Forecast

Trade Remains the Biggest Downside Risk

Despite all of the bluster, some of which is legitimate, coming out of the Trump Administration decrying the U.S. trade deficit, the trade deficit, in terms of real net exports, is forecast to increase from $622 billion in 2017 to $814 billion in 2020. (See Figure 12) Why? The trade deficit is the result of the U.S. consuming more than it produces which is the result of a very low national savings rate. Thus, in order to reduce the deficit, the U.S. has to save more and/or produce more domestically. Over the near-term it is hard to produce more, but the high deficit fiscal policy of the Trump Administration reduces national savings requiring us to import more. All the Trump Administration can do is move around the trade deficit among our import partners.

Figure 12. Real Net Exports, 2008Q1 -2020Q4F

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

The risk to the forecast is that with all of the talk about a trade war with China and repealing NAFTA, we can sleepwalk into a serious economic accident. For example, in 2017 the U.S. imported a total of over $1.3 trillion dollars of goods from China, Mexico, Canada, Japan and Germany. (See Figure 13) A trade war implies higher tariffs and non-tariff barriers that work as a tax on the American people that would raise prices and restrict output. That is hardly the recipe for economic growth. And because it is hard for import using industries to shift sources in the short-run, there exists the threat of very real economic dislocations. Put bluntly, the administration is playing with fire and the recent nervousness in the stock market is beginning to reflect the risks associated with a trade war.

Figure 13.

Source: Barrons

Conclusion

The U.S. economy is leaving behind a very long period of ultra-low interest rates. Interest rates are in the process of normalizing with 10-year U.S Treasury yields reaching 4% and the Fed Funds rate surpassing 3% as economic growth accelerates and inflation exceeds the Fed’s magic 2% level. High fiscal deficits and the Fed’s quantitative tightening policy will put upward pressure on interest rates. Meantime, the economy, spurred by strong business investment, should grow 3% this year. However, growth will slow as the economy bumps against its full employment ceiling and high interest rates work to slow housing in late 2019 and 2020. Our simplified view is that we are in a 3-2-1 economy with growth on a fourth quarter-to-fourth quarter basis will be roughly 3% in 2018, 2% in 2019 and 1% in 2020.  The two major downside risks to the forecast is the potential for a trade war to break out with one or more of our major trading partners and for the uncertainty around Italian politics to broaden into a full-blown Euro-area crisis.

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[1] See Shulman, David, “The Best of Times and the Worst of Times for Housing,” UCLA Anderson Forecast, June 2018