My Amazon Review of Ben Bernanke's "21st Century Monetary Policy"

Fighting the Last War

Central bankers are like generals; they fight the last war. In his updated history of Federal Reserve policy since the 1960’s former Fed Chairman Ben Bernanke spends much of his effort in his too long and textbook-like book on monetary policy from the financial crisis of 2008-09 to the present. He is rightly concerned with operating monetary policy under the constraint of a zero-bound policy rate that for the most part has been the case since 2008. However, he ignores the new war to come as inflation becomes more endemic.

 

He discusses the role of the Fed as a lender of last resort in the tradition of Walter Bagehot where unprecedented lending in face of the financial crisis in 2008 and the pandemic of 2020 where the Fed came close to discounting practically anything, perhaps even my personal IOU. To be sure the Fed did save the day in both cases, but in the case of 2008, it gave rise to a populist movement on both the right and left which saw the Fed bailing out the big banks, but not the proverbial little guy/gal.

 

Bernanke cites his interest in monetary policy came from reading Friedman and Schwartz’s “A Monetary History of the United States 1867-1960.” I too had a similar experience. However, where the role of money is central to Friedman & Schwartz, aside from the 1970’s, it is only peripheral in Bernanke’s work. My guess is that Bernanke will regret not mentioning the explosive growth in the money supply over the past two years.

 

I wish he would have devoted more time to the role of the Plaza Accord in 1985 in which the finance ministries of the G-7 orchestrated a decline in the international value of the dollar. The Fed aided and abetted that process which in my mind ignited the commercial real estate bubble of the late 1980’s. That did not end well, and it nearly broke the U.S. banking system, so much so that the Greenspan Fed in late 1991 lowered the discount rate by 100 basis points. As an aside I participated as a real estate expert in a briefing to the Board of Governors just prior to the rate cut.

 

The reason Bernanke and the Fed are fighting the last war is that it is my contention that the U.S. economy entering a new thirteen-year cycle (Shulmaven: The U.S. Economy is Entering a New Thirteen Year Cycle) that will be characterized by much higher inflation than we have been used to. It will involve more than a cyclical rise in inflation that Summers-Furman-Blanchard warned of that Bernanke rightly noted in his book. ( Also see my comments  Shulmaven: "Is the Pandemic Hiding Future Inflation," UCLA Economic Letter, January 2021 ) Further, if inflation were measured the same way it was in the 1970’s where house price changes rather than owners’ equivalent rent was used to calculate the housing component of the consumer price index, year-over-year inflation would be running in the 12-13% range, not the 8% currently being reported. Simply put, the house is on fire.

 

Inflation will become more endemic because the economy is deglobalizing and decarbonizing at the same time. Both will lead higher energy prices specifically and higher overall prices as limitations will be put on the international division of labor in an environment of an aging global workforce. This will lead to a substantial increase in capital expenditures as production is in-shored and huge investments are made in energy transition. As a result, not only will inflation increase, but the real neutral rate of interest, R*, will increase as well. Add to this higher defense spending to deal with an aggressive Russia and increased concerns about China, interest rates have nowhere to go but up.

 

Net net. Instead of worrying about the last war’s zero bound, the Fed will be worried about the new war of fighting an inflation amidst a capital spending boom.

For the full Amazon URL see: Fighting the Last War (amazon.com)

WSJ Editorial Board Follows Shulmaven's Lead Breaking Ukraine Grain Blockade

 

Breaking Russia’s Ukrainian Grain Blockade

A Black Sea mission to escort commercial ships may be needed to prevent a global food shortage.

May 25, 2022

Breaking Russia’s Ukrainian Grain Blockade - WSJ  (paywall)

See Shulmaven May 20:

Shulmaven: Blockade Runners

We are in a Bear Market

Forget about what the financial press said on Friday and Saturday with The Wall Street Journal headline of May 22 screaming “S&P 500 Briefly Dips into a Bear Market.” The story below the headline noted that on an intraday day basis the S&P 500 was trading 20% below its all-time high reached on January 3. There is nothing magical about a 20% decline defining a bear market. In the 1990’s while I was Chief Equity Strategist at Salomon Brothers, I helped popularize the notion that a retreat of 20% by a broad market average constituted a bear market. A 20% decline was not a hard and fast definition, but rather a rule of thumb. There is little difference between the 18.7% decline on Friday’s close and 20%.

 

Further evidence that we are in a bear market is that the Dow Jones Industrial Average has decline for eight weeks in a row. The last time that streak happened was in 1932. The S&P 500 has declined for seven weeks in row, the first time that happened since 2001. Needless to say, both 1932 and 2001 were bear market years. Just to note a bear market is also defined as a sustained drop in stock prices from its recent high.

 

Indeed, if you look at the 29% decline in the NASDAQ Composite, the 27% decline in the Russell 2000 and the 21% decline in the Wilshire 5000; stocks as whole are deeply in bear market territory. Further the 50%-90% declines in a host hitherto high-flying and non-earning technology stocks reminiscent of the 2000-02 bear market and the break the SPAC stocks, a dubious Wall Street invention, the carnage is visible for all to see.

 

Further evidence of the bear market is the fact that recent market favorites such as large cap technology and consumer staple stocks were taken out and slaughtered over the past few weeks. Remember when the police raid a whorehouse, the good girls and the bad girls alike are taken in the paddy wagon.

 

Adding to the carnage is the collapse of the crypto currency market. Total global losses there are estimated at $1.5 trillion with some so-called stable coins rendered worthless. More than a few hedge funds were caught off-sides in this market which converted their losses in crypto currency into margin calls against their stock positions. Even legendary investor and longtime bull on Bitcoin Bill Miller on CNBC admitted to selling part of his position due to a margin call.

 

So, forget the headlines, the carnage all around us is obvious. How long the bear market will last and how deep it will be remains unknown. However, my guess is that we are closer to the end than the beginning in terms of price, but not necessarily of duration. My biggest worry remains that the stock market decline is signaling the start of a new thirteen-year economic cycle bringing with it heightened uncertainty. (See: Shulmaven: The U.S. Economy is Entering a New Thirteen Year Cycle )

 

Blockade Runners

Russia in its war of aggression against Ukraine is blockading the port of Odessa from which much of Ukraine's grain and cooking oil flows to Africa and Asia. Put bluntly, by this action Russia will cause mass starvation among the poorest people in the world. The Russian blockade is, in essence, a war crime.

In order to free up Ukrainian grain the United States along with NATO should send a fleet into the Black Sea to break the blockade and establish a humanitarian assistance corridor. The legal justification for this action would be to enforce the long-established notion of freedom of the seas.,

Of course, the Russians might not sit idly by and fire on the U.S. led naval force. Let them because it will prove to the world that Russia wants mass starvation in a cynical rerun the Russian enforced starvation of Ukraine in the early 1930's. My guess is that Russia will back down.

However, in order to send warships into the Black Sea, under the 1936 Montreux Convention Turkish permission is required to enter the Bosporus and Dardanelles Straits. Yet again Turkey is in the middle of the Ukraine War, most recently with its bid to hold up NATO membership to Sweden and Finland. In this case President Erdogan would likely support a NATO humanitarian mission, even if it risks a major altercation with Russia. Otherwise, he would be viewed as a co-conspirator with Russia in starving the world.

My Amazon Review of Matti Friedman's "Who by Fire: Leonard Cohen in the Sinai"

 

Redemption in the Sinai Desert

 

Canadian-Israeli journalist Matti Friedman has written a moving commentary on Canadian singer-songwriter Leonard Cohen’s experience in the Siani desert during the 1973 Arab-Israeli War. The book opens with Cohen feeling sorry for himself on the Greek island of Hydra with his partner and young son. After success with “Suzzane” and “Bird on the Wire” he feels his career at age 39 is washed up.

 

Of a sudden Egypt invades the Sinai and Israel is at war with Egypt and Syria. And for whatever reason this scion of a very orthodox and very prominent Jewish family from Montreal feels the urge to go to Israel. On arrival in Tel Aviv, he hooks up with the Israeli version of a USO tour and he ends up entertaining the troops in a very active war zone.

 

Author Freidman pieces together the story from previously unpublished notes written by Cohen, articles from a defunct Israeli music magazine and seeking out after nearly 50 years the Israeli troops who witnessed his concerts. He also memorializes many of the soldiers who present at the time and more than a few of them died in combat. Cohen was there at the early stages of the war where casualties were high, and the prospect of an Israeli defeat loomed large. It was in these vignettes where Friedman’s reporting skills came to the fore.

 

Out of his experience in the Sinai Leonard Chen is redeemed and he becomes a new person. Within a few years he authors “Lover, Lover, Lover,” “Hallelujah,” “Who by Fire,” based on the Yom Kippur prayer Unetanah Tokef. He also sings and writes my favorite, “Dance Me till the End of Love.” With those songs Leonard Cohen becomes a legend in the music world.

 

Friedman has told a great story about Leonard Cohen, Israeli life during a time when Israel felt most threatened, and the heroism of Israeli soldiers in the early days of the Sinai War. Along the way there are many interesting vignettes such a wedding performed on a military barge. It adds life to the story.

For the full Aazon URL see: Redemption in the Sinai Desert (amazon.com)

 

 

 

 

The U.S. Economy is Entering a New Thirteen Year Cycle

 

I believe the U.S. is about to enter a new thirteen-year cycle with unknown consequences. I first became interested in the topic of thirteen-year cycles in 1995 when I was Chief Equity Strategist at Salomon Brothers. I wrote “1996: Stock Market Bubble or Paradigm Shift?” in December 1995. In that report I discussed what appeared to be distinct 13-year stock market cycles in equity valuations. After a long 27 years this post updates that view to help explain the U.S. economy over the past eight decades. In fact, I have identified seven such cycles.

 

In that report I noted that there was a thirteen-year period, 1918-1931, between the end of World War I and the onset of the Great Depression. I choose 1931 instead of 1929 because the year 1931 was the year when the depression became Great. Because the Great Depression was not the only episode where a major economic contraction followed a war, investors and economists wondered if history would repeat after World War II ended in 1945.

 

The first cycle occurred from 1932-1945 where the hitherto laissez faire economy of the United States was transformed in the dying moments of the Hoover Administration, the New Deal, and the war economy into an economy with substantial government involvement, the rise of industrial unions, the creation of a social safety net and the commandeering of resources to win World War II. It truly was a revolution in economic affairs.

 

The second cycle (1945-1958) was characterized as the transition from a war economy to a peacetime economy leading to a sustained consumer boom centering on suburban housing and automobile production. The boom was reinforced with a high level of peacetime defense spending to handle both the Korean War and the exigencies of the Cold War. Despite the boom, the gret fear during that period was the fear of a renewed depression.

 

The third cycle began with the 1957-58 recession which was the third and worst downturn since the end of the war. The economy did not evolve into a depression, but rather fiscal and monetary policy came to the rescue and a sharp recovery ensued. With the arrival of the Kennedy Administration in 1961, Keynesian economics offered the promise that government policy had the ability to tame the business cycle and fear of a new depression disappeared. Both investors and economists cheered the “soaring 60’s.” Thus, a thirteen year cycle was born beginning in 1958 and ended in 1971 with Nixon taking America off the gold standard and implementing wage and price controls. Something went awry in the Keynesian wonderland.

 

What went awry was, of course, inflation. In December 1967 Milton Friedman delivered his now famous presidential address to the American Economic Association. He argued that there was no long run trade-off between unemployment and inflation. As a result, the counter-cyclical policies advocated by the Keynesians would lead to ever higher inflation, which was proved out in the 1970s. The next thirteen-year cycle 1968-1981 was a period of high inflation and stagflation. Admittedly there is some overlap here. Thus, if the 1960’s represented the heyday of Keynesian economics the 1970’s represented the heyday of monetarism.

 

A new cycle emerged in 1982-1995 where after Fed Chairman Paul Volcker broke the back of inflation, the fear of a renewed inflation dominated both the economy and the financial markets. Instead of fearing depression, investors feared a renewal of inflation. It was the mirror image of the 1945-1958 period.

 

However, a new thirteen-year cycle, 1995-2008, emerged after Fed Chairman Alan Greenspan pre-empted an emerging inflation in 1994 by doubling the federal funds rate from 3% to 6%. That action put a dagger into inflation expectations and ushered in the heyday of the Federal Reserve. Economists and investors believed that price stability was the path to long term growth and the Fed had the ability to keep the economy on an even keel. A key feature of the period was the full flowering of globalization which suppressed inflation.

 

The Fed was so good at maintaining economic stability that a “Minsky moment” arrived in 2008. Macroeconomic stability led to financial instability where investors were lulled into taking and unprecedented level of financial risks. As a result, housing crashed, and layers of financial derivatives caused the financial system to buckle as it had not done so since 1931-32.

 

The 2008-09 financial crash signaled the onset of new cycle which forced the Federal Reserve to engage in hitherto unprecedented monetary policies and caused to the new Obama Administration to revive expansionary fiscal policies that were long thought to be obsolete. To head off an impending debt deflation the Fed adopted a zero-interest rate policy, bought trillions of dollars of questionable paper and proceeded on a policy of quantitative easing to keep the economy flush with liquidity. Those policies were reintroduced on steroids in 2020 with the emergence of the COVID pandemic. The great fear during this period was the potential for new financial crisis and the ongoing risk of an incipient deflation.

 

With respect to fiscal policy the Obama Administration offered up a large, but inadequate, $900 billion fiscal package. In 2021 the Biden Administration overlearned the lesson of 2009 and offered up an unprecedented level of fiscal stimulus. That stimulus along with supply constraints associated with the pandemic brought with it an inflation rate unseen since the early 1980’s. Put bluntly, the thirteen-year cycle that began in 2008 came to an end in 2021.

 

My guess is that we are at the very beginning of new thirteen-year cycle with unknown consequences. I would speculate that the next thirteen years will bring with it a much higher rate of inflation than we have been used to, a multiyear bond bear market and a partial deglobalization of the economy caused by local politics, supply chain issues and geopolitical tensions. To me the big question is whether this cycle will bring with it a stagflation or a high cap-ex/high inflation economy with a cap-ex boom coming from the in-shoring production and energy transition. As they say, time will tell.

My Amazon Review of Richard Overy's "Blood and Ruins: The Last Imperial War, 1931-1945"

 

A Long Slog

 

Reading “Blood and Ruins” is a long slog vaguely reminiscent of the German Army’s long retreat from Stalingrad to Berlin from 1943-1945. Richard Overy, a distinguished British historian, has written an encyclopedic history of World War II which he rightly starts with the Japanese invasion of Manchuria in 1931. However, with the book running 1040 pages in the print version, it is way too long for the average lay reader interested in the history of that time.

 

He makes up excuses for German, Italian and Japanese aggression in arguing that they were frozen out of the international trading system by colonial preferences of the British and the French. Other countries were frozen out, but they did not start aggressive wars. He also argues that the British and French motivations were to preserve their empires. True, but they were also out to save their own necks in Europe.

 

Overy is a distinguished historian, and I am the rankest of amateurs. Nevertheless, I think he wrong on two major points. He characterizes Chamberlain’s appeasement policy as “containment.” Give me a break. If it were a containment policy, it failed disastrously. He refuses to characterize Soviet Russia as an imperial power. That is flat out wrong. Starting with the Ribbentrop-Molotov Pact the goal of the Soviets was to create an empire in Eastern Europe which they succeeded in implementing with the advancing Red Army. He also ignores that the Soviets had designs on the West with the Communist parties it controlled. In many respects the Soviets were as much as an aggressor as Hitler.

 

Where Overy shines is his discussion of the horrors of the Pacific war and life under the Japanese occupation. Having known someone who fought in the Battle of Tarawa as a 17-year-old Marine, Overy brings that battle to life. He is also correct in noting that the war resulted in ending the imperial system that had to give way to new nation states in Africa and Asia.

 

There is much in this book, but as I noted at the outset, it is a slog.

For the full amazon URL see: A Long Slog (amazon.com)

The Defanging of the Stock Market

 

April has brought with it the defanging of the stock market where the hitherto invulnerable FAANG stocks crashed and burned bringing with it a full-fledged bear market in the NASDAQ Composite Index. FAANG stands for Facebook (now Meta Platforms) Apple, Amazon, Netflix, and Google (now Alphabet). From their respective 52-week highs Meta is down 48%, Apple is down 13%, Amazon is down 33%, Netflix is down an astounding 73% and Alphabet is down 23%. Taken as a whole the NASDAQ Composite is down 23%. The weakness in these five stocks which at one time accounted for nearly a quarter of the market value of the S&P 500 brought that benchmark index down 14%.

 

Market behavior of this type is reminiscent of the 1973-74 and the 2000-02 bear markets. In the 1970s the so-called Nifty-50 group of one-decision growth stocks which were trading at 50-60X earnings experienced declines in excess of 50 -80% during the course of the bear market. In the collapse of the 2000 dot.com bubble such stalwarts as Cisco, Microsoft, Intel, and Oracle (a group of stocks that I then characterized as “The Four Horseman of the NASDAQ”) which traded at multiples in the 80-100X range lost about three quarters of their market value. Indeed, just as today, the stock market was bracing for a tightening of monetary policy. Needless to say, the history is not encouraging.

 

There are, however, two distinct differences between then and now. First, from 1972-74 the 10-year Treasury traded in a 6-8% range and in 2000-02 it traded in a 5-6% range far higher than the current 2.9% yield. Second, with the exception of Netflix valuations are nowhere near as demanding with Alphabet trading less than 20X earnings, Apple at around 25X, Meta at a below market 14X earnings. As a result, even if Treasury yields rise to 4%, my sense is that the worst of the declines in FAANG and the market as whole are behind us.

 

To be sure, we could soon be looking into the teeth of a recession triggered by a very aggressive Fed and continued high inflation which would haircut earnings estimates across the entire market. We are sure to have a recession at some point, but I do not believe it is soon. Simply put the end of the pandemic is fueling a consumer boom and capex remains strong fueled technology and energy related spending of all types. Thus, it will take more than 250 basis points of tightening to break this economy. Of course, if we are in a rerun of “That 70’s Show,” all bets are off. (Shulmaven: Roaring 20's or That 70's Show)

 

As I wrote in February(https://shulmaven.blogspot.com/2022/02/the-unravelling.html), my sense is that we are in a structural bear market in bonds and in for a very volatile stock market. Whether or not the lows are in or not, I do not know, but the world will not look as bad in December as market participants feared last week. Net, net although 2022 will be a down year for stocks, the market will end the year higher than where it is now.