A Change in the Weather

Fed Chair Jerome Powell's press conference signalled a change in the weather for market particpants. The Fed will no longer act as a benign supporter of asset prices as their inflationary policies are now being felt in consumer prices and wage rates. Simply put, the Fed has now recognized that asset price inflation has transmorgrified into consumer prices, a phenomenon we noted a year ago. ( Shulmaven: "Is the Pandemic Hiding Future Inflation," UCLA Economic Letter, January 2021)

By allowing for the possibilties of more than four rate hikes next year and even the potential for a 50bps move, Powell all but admitted that the Fed is behind the curve. Almost intantaniously the two-year note started pricing in five 25bps rate hikes this year. Instead of pre-empting inflation as the Fed has done in prior cycles the Fed now has to contend with a very hot 7% inflation rate in consumer prices combined with a fully employed economy. Because monetary policy acts with long and variable lags, it is in no ways certain that the inflation rate will even approach its 2% inflation target by yearend. As I have stated previously I believe that conumer price inflation will be running at 4-5% rate on a year-over-year basis in December. (Shulmaven: Way Too Complacent about Inflation and Rates)

As a result the Fed has a lot of work ahead of it and it is likely that the tightening cycle will last well into next year. Thus in my humble (a Powell word) opinion that roaring bull market we have been used has come to an end and its place will be a broadly sideways market with severe rolling adjustments that will be masked by the broad indices. In this environment value properly defined will outperform growth.

My Amazon Review of Jonathan Haslam's "The Spectre of War: International Communism and the Origins of World War II"

 

The Long Shadow of the Bolshevik Revolution

 

Jonathan Haslam, a professor at Princeton’s Institute of Advanced Studies, confirms Ian Kershaw’s thesis that the Bolshevik Revolution was the most significant event of the 20^th century. As I noted in my review of Kershaw’s “To Hell and Back: Europe 1914-1949” the Bolshevik Revolution hardened the Right and divided the Left. (Shulmaven: My Amazon Review of Ian Kershaw's "To Hell and Back: Europe 1914-1949" ) This theme plays out throughout Haslam’s very academic book that views the interwar period through the prism of the Soviet Union, but nonetheless a history nerd like me can enjoy.

 

The Russian Revolution scared the daylights out of capitalist Europe and the actions of the Comintern in the 1920’s and early 1930’s reinforced those fears. Haslam discusses the Comintern’s activities in China in support of the local Communist Party in interfering with the huge British interests there, in supporting the Indochinese Communist Party in attacking French interests and in its funding of the 1926 British general strike. The Soviet Union was not acting as rational state, but rather as a revolutionary power.

 

The fear of Communism enabled the usually cautious German establishment to support the rabble-rousing Nazis and it would prevent all too many British conservatives from supporting an alliance with Russia against Hitler. This was especially true of Chamberlain. In fact, many of those conservatives were actually pro-Hitler in viewing him as a bulwark against communism from the east. They worried that should Hitler fall, the communists would pick up the pieces. In essence they viewed Hitler as rational and Stalin as irrational.

 

With the respect to the Left, socialist parties split all over Europe into social democratic and communist factions. To Stalin and the Comintern the social democrats, not the Nazis were the true enemy up until 1934. The social democrats were called “social fascists” and the German communists worked hand-in-glove to bring down the Bruning government in 1932 thereby opening the way for Hitler

 

When the party-line shifted in 1935 to support the “Popular Front,” for the first time the Left was united. Popular Front governments were formed in 1936 in Spain and France thereby triggering the Spanish Civil War and further frightening the anxious conservatives in both France and Britain. At last, the Soviets were acting as rational state in trying to form an alliance with the capitalist powers against Hitler.

 

However, because the British were not of one mind with respect to an alliance, Stalin made his infamous deal with Nazi Germany in 1939. Stalin’s gamble was that the West would bleed itself white and he would then be able to pick up the pieces. However, when France quickly fell, Stalin was foisted on his own petards as a seemingly rational move became undone.

 

Haslam makes a compelling case that had the Bolshevik Revolution not happened European history would have been radically altered. Hitler likely would not have risen to power and the world would have been in a much better place.

For the full Amazon URL see: The Long Shadow of the Bolshevik Revolution (amazon.com)

The Rotunda Turns

This morning Senators Joe Manchin and Kyrsten Sinema are the two most vilified people in the Democratic Party. Why? They had the temerity to stand up to the rush to eliminate the legislative filibuster in the Senate. However, my guess is that by next year or almost certainly by 2025 the Democrats will be erecting statues in their honor. Simply put, they saved the Democrats from themselves.

As the the old wag goes, "the rotunda turns."  In all liklihood the Republicans will seize control of the Senate either next year or by 2025 and then of a sudden the Democrats will be speaking endearingly of the 60 vote majority needed to break a filibuster. This would especially be true if the Republicans control the White House. Thus it would not be hard to imagine in a few years that both Manchin and Sinema will be receiving Profile in Courage awards.

Way Too Complacent about Inflation and Rates

This morning the BLS reported that the CPI increased by 0.5% and the core CPI increased by 0.6% in December. On a year-over-year basis prices are up 7.0% and 5.5% for headline and core, respectively. The data came in somewhat higher than expected, yet both stock and bond prices rallied figuring that inflation has peaked and will gradually retreat througout the year, especially with the Fed signalling three or four rate hikes over the balance of the year.

I agree that we are roughly at the peak in the year-over-year inflation rate, but where I disagree is that inflation will likely running between 4-5% on a year-over-year basis in December. Why? The runrate for both owner's equivalent rent and tenant paid rent is currently 5% and that will likely increase to above 6% compared to the recent year-over-year rates of 3.8% for OER and 3.3% for tenant paid rent. Similarly medical services which increased at a mere 2.5% YOY is now increasing at at 3.6% rate and likely to go much higher given the labor shortages in that sector. Underneath all of this is that average hourly wages increased at 4.7% YOY in December, but the current runrate is more likely in the 6%-7% range. 

What this means is that sometime midyear, the Fed will wake up and instead of increasing rates at a measure 25 bps a quarter, there will be a surprise 50 bps increase. That, to say the least, will shock the markets.

My Amazon Review of Colin Woodard's "American Nations: A History of the Eleven Rival Regional Cultures of North America"

 

Uneasy Alliances

 

I wish I read Colin Woodard’s book ten years ago when it came out. He hypothesizes that the United States instead of being one united nation, it is more akin to an uneasy alliance rival regional cultures. His eleven cultures formed early in the days of the republic ignore both state and national boundaries. The book is in the tradition of Kevin Phillip’s “The Emerging Republican Majority,” Joel Garreau’s “The Nine Nations of North America” and the more scholarly “Albions Seed” by David Hackett Fischer. I too used a similar approach in an article on the economic geography of the United States.

 

From the beginning the early settlements in the United States were divided on the Revolutionary War with Yankeedom leading the charge while New Netherland (New York City and environs) and the Deep South being more reluctant. He notes that the politics of today mirror those early divisions. Specifically, the Blue State alliance includes Yankeedom, New Netherland, the Left Coast and El Norte (Joel Garreau’s Mexamerica) while the Red State alliance includes the Deep South, the Far West, and Greater Appalachia. The swing states of Pennsylvania, Ohio and Iowa are in what Woodard calls the Midlands.

 

On a minor point I would differ with Woodard when he called SDS’s 1962 Port Huron Statement the “founding document” of the youth movement. Although there were many political aspects to the youth movement at its core it was all about sex, drugs and rock and roll. This is a far cry from the original Yankee (Puritan) and Midlander (Quaker) values. To be a bit snarky what the late Tom Hayden the author of the Port Huron Statement had in common with Puritan values were rigidity in beliefs.

 

My major point of difference is that Woodard is too locked into the view that the Deep South continues to be run by a neo-colonial oligarchy. That was true prior to World War II and it far less so today. The rising cities of Atlanta, Nashville, and Raleigh-Durham and the Appalachia city of Austin have more in common with Yankeedom and the Left Coast than the old agribusiness oligarchy. In fact, those cities vote Blue. Further just as Yankeedom has an innate fear of a southern theocracy, the Deep South and Appalachia fear Yankeedom’s religious-like faith in secularism. Further the hitherto reliable blue voters of El Norte are drifting away from Yankeedom as cultural values predominate over economic ones.

Close to the end of the book Woodard offers up the horrifying possibility that a pandemic might induce the suspension of civil rights, the dissolution of Congress and the incarceration of Supreme Court justices leading to a break-up of the United States. In 2011, when the book was published, that had the sound of complete fantasy; not so much today. Despite my quibbles this is a terrific book for those readers interested in the origins of our country and its politics.

For the complete Amazon URL see: Uneasy Alliances (amazon.com)

My Amazon Review of Katja Hoyer's "Blood and Iron: The Rise of the German Empire 1871-1918"

 

Realpolitik Goes Awry

 

Anglo-German Historian Katja Hoyer has written a short history of the Second Reich. The architect of the unification of Germany and the creation of the empire was that master of realpolitik, Otto von Bismark. Bismark was a master of both international and domestic politics. Domestically he forged a union of thirty-nine separate states into a united Germany and while Chancellor after unification he brilliantly played off the liberals against the rising socialist party.  From 1871-1890 he all but assumed the powers of Kaiser Wilhelm I who gave him full reign.

 

Internationally he created the strongest power in continental Europe through his swift victories in three wars. Aside from the animosity of France he maintained excellent relations with Britain, Austria, and Russia and thus the semblance of order was maintained. Although he had no interest in colonies, he acquiesced to German commercial interests in establishing a significant German presence in Africa. However, he assuaged both Britain and France that he had no interest in taking them on in Africa. In Europe he became the “honest broker” during the 1878 Congress of Berlin which averted a Balkan crisis.

 

However, after Wilhelm II becomes Kaiser, Bismark is dismissed in 1890 and there was no one to take his place. Even if Wilhelm II were a wise ruler much of what Bismark achieved could have become undone. Of course, history might have been different if Kaiser Friedrich had not died after 99 days in office. He was a reformer who likely would have avoided the worst tendencies of his son, Wilhelm II. We will never know.

 

After Bismark leaves office, everything seems to fall off the tracks. Internationally Wilhelm II allows Russia to fall into France’s arms and thus Bismark’s nightmare of coalitions becomes very real. Wilhelm II antagonizes Britain with an aggressive naval buildup and the path to war is opened and with Germany wanting its “place in the sun” all of Europe is threatened. Instead of being most everyone’s friend, Germany is perceived as an enemy.

 

Domestically the socialists grow in strength and become harder to appease under the stress of rising military budgets. The center-right leadership fractures and by 1910 the drift is self-evident. The German military fills the vacuum with deadly consequences.

I learned a lot from reading the book, but, in my opinion, there are two real weaknesses. Hoyer underestimates the power of the German economy which began to dominate world trade through its leading position in the new industries of chemical, electrical engineering, and automobiles. The global economy had to make room for Germany and the rising United States and that would obviously create trade tensions. Second, there is not enough on the decision to go to war in 1914. Much has been written about that, but I would have like to get a better understanding of Hoyer’s take.

For the full Amazon URL see: Realpolitik Goes Awry (amazon.com)