My Review of Jill Eichler's "Mellon vs. Churchill"

 Duel over Debt

On the surface it appears that only a history/economics nerd would read Jill Eichler’s book on the inter-Allied debts arising out of World War I. However, Eichler discusses that history through the lens of its two main protagonists, Secretary of the Treasury Andrew Mellon (1921-1932) and Chancellor of the Exchequer Winton Churchill (1925-1929) It is through their eyes we see how complicated the debt duel was. 

At the end of World War I the allies owed the United States something over $10 billion with the bulk of the borrowings coming from Great Britain and France. Simply put, the allied viewed the debt as a cost of winning the war and therefore did not have to be repaid, while the United States viewed the debt a commercial transaction that had to be repaid. Making matters worse was that the United States in 1922 passed the Fordney-McCumber Tariff which made it more difficult for the Europeans to earn the need dollars to repay the debt. 

In the first round Mellon and then Chancellor of the Exchequer Stanly Baldwin renegotiated the $4.6 billion owed to the U.S. at 4.5% interest rate with a 25-year term, down to a phased 3% and 3.5% loan with a 62-year term in 1922. This took quite some doing on Mellon’s part to convince a recalcitrant Congress to accept the new terms. Nevertheless, Britain was very unhappy with the agreement and when Churchill became chancellor, he worked to further ease the burden. Later in 1926 Mellon negotiated a restructuring of the $4 billion French debt on easier terms than what Britain had agreed to. It took until 1929 for France to finally ratify the deal. France received better terms because Mellon viewed that their ability to pay was less than that of Britain.

Hanging in the background was the issue of German reparations. To Britain and France, the reparation was linked to the repayment of debt to the U.S., while the U.S. viewed it a separate issue. The Dawes Plan of 1924 which enabled U.S. loans to Germany which then were used to pay France and Britain who in turn paid the U.S... For full discussion of this and other inter-related issues see Liaquat Ahamed’s “The Lords of Finance” and Straumann’s “1931: Debt Crisis and the Rise of Hitler.” ( https://shulmaven.blogspot.com/2019/07/my-amazon-review-of-tobias-straumanns.html)

My criticism of Eichler is that she views the Dawes Plan in the light of history rather than how contemporaries experienced it. The Dawes Plan set off a boom in Germany and put Europe on the road to recovery in 1925. That along with the Locarno Treaty which established the borders of Western Europe engendered an uptick in confidence. That was true on the continent, but that was not true of Britain where Churchill returned to the gold standard and over-valued the pound at its pre-war level. Thus, Britain missed out on the boom. It was only with the 1929 stock market crash that the inherent flaws of the Dawes Plan became manifest. In the end most of the debts would never be repaid so it would have been much better had the slate were wiped clean in 1921. The world would be a much different place today had that happened.

Further, Eichler gives us a real sense of the high society that Mellon and Churchill moved in from London parties to excursions in Paris and the south of France. Three people in Mellon’s entourage would go on to bigger and better things. Assistant Secretary of the Treasury Russell Leffingwell would chair JP Morgan and the Council on Foreign Relations; Parker Gilbert who succeeded Leffingwell at treasury would go on to chair the Reparations Commission, and later Morgan Stanley (his son would also do that); and his son-in-law David Bruce would be an early hire in the OSS and later become a distinguished diplomat.

To sum up, Jill Eichler has tuned what could have been a nerdy story into an interesting history of some of the financial aspects of diplomacy of the 1920’s. 

My Review of Donald Chew Jr.'s "The Making of Modern Corporate Finance"

An Ode to Modern Financial Theory

As a former professor of finance, I read Donald Chew’s book with great interest. His book is a history of the development of modern financial theory from its early roots in John Burr Williams’ 1938 “Theory of Investment Value” to its beginning in the late 1950’s with the works of Miller and Modigliani on capital structure and dividend irrelevance. He made a mistake in attributing Myron Gordon’s model to Williams. 

Chew writes in a very breezy style by referring to Michael Jensen as Mike and Stewart Myers as Stu. From his post as an editor of Stern Stewart’s “The Journal of Applied Corporate Finance,” he got to know most of the major players in academic finance. I too met many of the academics he discusses, and indeed I was an early adopter of Brealey and Myers textbook he highly praises in my corporate finance class during the 1982-83 academic year. I also met, on several occasions, his mentor, Joel Stern.

Chew makes the case that earnings per share don’t count, but rather it is the ability of a corporation to earn a return above the cost of capital with return measured as net operating profit after taxes. It is with this insight that Stern Stewart pioneered the concept of economic value added. (EVA) Indeed, instead of using earnings to value a corporation, value can be defined as the present value of the cash flow associated with existing assets plus the present value of future growth opportunities. Hence, Amazon for example, can trade at values divorced from current earnings.

However, he oversells his point that earning per share doesn’t count. Corporate management and analysts continue to stress earnings per share and woe to the company that misses its quarterly earning estimates.  In the short run earnings seem to count a great deal.

He also oversells private equity. To be sure private equity posted extraordinary returns in its first twenty years starting in the 1980’s. Since then, returns have eroded, and their risks have been underrated. Put simply, the industry is guilty of what Cliff Asness of AQR, calls “volatility washing.”

This book is of interest to readers who are interested in how modern financial theory evolved and it is helpful in understanding what forces drive stock prices in long run.

 

Regime Change: The End of the Economy as we have Known it

 “There are decades where nothing happens: and there are weeks where decades happen.”

                       Attributed to V. I. Lenin

In the short span of twelve weeks, Donald Trump has undone the Bretton Woods monetary order established in 1944, the GATT free trade order of 1947, and the NATO collective security order of 1949. (See: https://shulmaven.blogspot.com/2018/02/my-amazon-review-of-benn-steils-marshal.html) As a result the world is now facing a simultaneous geopolitical and economic crisis and it is no surprise,  that stocks and especially treasury bonds and the dollar have sold off. (See: https://shulmaven.blogspot.com/2025/04/a-broken-stock-market-and-broken-trust.html) Simply put, the old world order is gone, an there is nothing, as of yet, to replace it. The transition will be painful.

Those who expect that the Trump tariffs are negotiating tactic will be sorely disappointed. Trump needs the revenue to finance his tax cuts, and the Democrats only differ with Trump as to the way his policy has been conducted. They still hope to reclaim their union support by being pro-tariff and they too need the revenue to finance an ever-larger welfare state. The era of free trade, as we have known it, is over.

Three years ago, I wrote that the United States was about to enter a new 13-year economic cycle. I noted:

“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 multi-year 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.” ( See: https://shulmaven.blogspot.com/2022/05/the-useconomy-is-entering-new-thirteen.html)  

Although it has taken a bit longer to play out, we are now in the midst of it and perhaps something much more. We are likely entering an eighty-year super cycle in what Neil Howe has called a “fourth turning” which will involve economics, politics, values, and the way we relate to each other in society. (See: https://shulmaven.blogspot.com/2023/09/my-review-of-neil-howes-fourth-turning.html)  This is far bigger than my 13-year cycle in that it encompasses six 13-year cycles that began in, not coincidentally 1945.

If this is close to correct, then we are now entering unchartered waters. The stock market and economic histories that we have been used to over the past 80 years may no longer be relevant in understanding the future. Instead of ever rising share prices we may now be in an era where stocks go sideways for an extended period of time. I would note that between 1924-1949 the Dow Jones Industrial Average traded in a range of between 100-200 with the significant upside exception of 1928-30 and the significant downside exception of 1931-1933. For example, in 1927 the high in the Dow was 201 and which was nearly identical to that recorded in 1949 and the 1929 high was not exceeded until 1954. The equivalent going forward would be for the S&P 500 to trade in a broad 3500-6500 trading range over the next several years.

The recent action of the bond, currency and stock market is indicative of a sea change in the markets. Instead of rallying in a time of turmoil both the treasury bonds and the U.S. Dollar have sold off. Indeed, the dollar has declined 9% since the end of February. Simply put foreigners are losing trust in the U.S. Dollar and with 18% of U.S. stocks held by foreigners the selling is only now beginning. I would say the same thing for foreign holdings of U.S. real estate.

Over the weekend the Trump Administration announced that it would reduce the Chinese tariff of 145% to 20% on smart phones, computers, and other electronic products. That action has lifted the Sword of Damocles hanging over Apple. This suggests a major relief rally for Apple and the stock market as a whole, but what multiple can you put on company and the stock market as whole whose share prices are subject to the whim of one very unstable man? I would sell the rally.  

Bond Market Carnage Bombs Trump Back to the Table

With the yield on the 10-year Treasury bond skyrocketing from 3.9% last week to 4.4% today, the Trump Administration called for a 90 day pause on the extortionate tariffs  announced last week.  Going forward there will be a minimum tariff of 10%, except for China(125%), steel, aluminum, and automobiles. The tariffs announced last week are now a ceiling and 10% is now a floor. In response the S&P 500, as of this writing (2:43 EDT) soared 8%. I would remind readers that the best single days in the stock market occur in bear markets. 

My guess is that the downturn will resume in a few days as investors realize the huge uncertainty associated with negotiating tariffs with 80 countries over the next 90 days will have a deleterious effect business and consumer investment. As a result my call for a recession starting this quarter still stands.( See: https://shulmaven.blogspot.com/2025/03/the-recession-of-2025.html ) My view is reinforced by the fact that the  backup in interest rates will drive another stake in the already weak housing market. A 7% interest rate on a 30-year fixed rate mortgage is a killer.

Lastly something very negative is going on in the bond market. Whether it is trillion dollar basis trades going south or selling by international holders losing trust in the United States, the fact remains a 4.4% 10-year Treasury bond in a weak economy signals something is very wrong. (See: https://shulmaven.blogspot.com/2025/04/a-broken-stock-market-and-broken-trust.html)

A Broken Stock Market and Broken Trust

 The headline read:

“Selling Swamps Exchange

Leading Issues Tumble

As Wall Street Assails

The New Tariff”

This is not from yesterday; it is from the front page of The New York Times dated June 17, 1930. The day before President Hoover announced he would sign the Smoot-Hawley Tariff Bill and stocks responded with an 8% decline in the Dow Jones Industrial Average. Responding to President Trump’s tariff announcement the S&P 500 declined by 9% last week, wiping out $6 trillion in market value. Simply put, just as in 1930, high tariffs are poison for the global economy. And to add insult to injury, the Trump tariffs are higher than Smoot Hawley.

My sense is that the decline in stock prices is not over. In the week leading up the October 19th,1987 20+% crash in stock prices, the S&P 500 witnessed a similar 9% decline. As we wrote last month, we believe that the recession of 2025 has now begun. ( See: https://shulmaven.blogspot.com/2025/03/the-recession-of-2025.html) In response to the tariff announcement and the wealth destruction that it caused, consumption and investment are freezing up and as a result of the DOGE cuts, government spending is heading lower. The recession is baked in the cake.

Adding to the unease is that in less than three months the Trump Administration has broken the trust in America with respect to our military alliances and our reliability as a trading partner. What has taken decades to build up has been destroyed in a few months. Further, even if Trump tries to repair the damage, his administration is staffed by D and F players who are incapable of playing on the global stage. Commerce Secretary Howard Lutnick, trade advisor Peter Navarro and Economic Council Director Kevin Hastett hardly inspire confidence. 

Although Scott Bessent is potentially a B or an A player, he was, according to Bloomberg News, not in the room when the tariff schedule was decided upon. Indeed, Secretary of State Marco Rubio has proved himself to be so much of a Trump sycophant that would be incapable of healing the breach with our allies and Secretary of Defense Pete Hegseth is clueless.

This is a far cry from the team Nixon had when he broke the dollar’s link to gold and devalued it. Nixon had Secretary of State William Rogers and Secretary of the Treasury John Connally, neither of whom were A players. In the background, however, were National Security Advisor Henry Kissinger and Under Secretary for Monetary Affairs Paul Volcker. ( See: https://shulmaven.blogspot.com/2021/07/my-amazon-review-of-jeffrey-gartens.html) During the 1987 stock market crash Ronald Reagan was guided by the expert advice of George Schultz and James Baker, both consummate A players. Thirty years later George W. Bush had the steadying hand of Secretary of the Treasury Hank Paulson during the financial crisis of 2008 and Obama benefitted from the advice of Tim Geithner his treasury secretary.

As a result. It is hard to see how we are going to get out of this mess with minimum damage. The easier way would be for Trump to take that advice of former Goldman Sachs CEO Lloyd Blankfein. He tweeted the other day:

Lloyd Blankfein

@lloydblankfein

“The switchboard at the WH must be burning up with gov’ts trying to surrender in this trade war. Why not give them a chance? Make the 10pct min tariff immediate but defer the “reciprocal” part 6 mos. Take the win! The Prez said he’d make us tired of winning…I’m there “

That would certainly give the markets some breathing space. The much harder way is for the Republicans in Congress to become so fearful of the midterm elections that they break with him on the tariff issue. To get there will require a lot of carnage in the markets. Similarly, a court action to declare Trump’s actions illegal will take time.

Finally, we have to remember that the Trump Administration needs the revenue from the tariffs to fund its tax cuts and to protect American industry.  A 10% tariff would raise $300 billion/year and a 20% tariff $600 billion/year. Tariffs aren’t going away. So, my guess is that when the markets open tomorrow, it won’t be pretty.

My Review of Ezra Klein's And Derek Thompson's "Abundance"

Two Liberals Take a Walk on the Supply Side

Card carrying liberals New York Times columnist Ezra Klein and Atlantic writer Derek Thompson have created quite a stir with their walk on the supply side. They have concluded that the “blue model” of California, New York and Illinois is not working. Simply put, those states are bogged down with procedural liberalism that makes process more important than the end result. Making matters worse the blue states are guilty of “everything bagel” liberalism where before a project is approved every erogenous zone associated with the Left has to be satisfied. (e.g., union labor, day care, affirmative action quotas for contractors and workers, neighborhood input, affordable housing, environmental protection). 

As a result, nothing gets built, or it takes forever. No wonder house prices are out of control in California. And perhaps more stunning is an "affordable" housing project in Santa Monica was recently approved at an estimated cost of one million dollars a unit.

Procedural liberalism arose in the 1970’s to deal with the excesses of the prior decades where projects were built without regard to the environment and the neighborhoods affected. In response a host of national and state laws were passed to control development. Unfortunately, what seemed reasonable in the 1970’s, turned into monstrosity in the 2000’s. 

The change in the development regime can be seen through the window of Pat Brown’s administration in California from 1958-1966 and his son Jerry’s first administration from 1974-1982. Under the first Brown, freeways, water projects and universities were built. Under Jerry Brown’s administration we were in “the era of limits.” Liberalism stopped dreaming big and when it did with its plans for high-speed rail, it got completely bogged down in a procedural morass.

Klein and Thompson’s solution calls for a radical deregulation of the housing permitting process. They look admiringly at the Texas cities of Houston and Austin. The solution to a housing shortage is to build. However, California’s sacred environmental quality act (CEQA) would have to be drastically amended for this to work. That act has been weaponized by homeowners and environmental groups to stop or drastically curtail developments and by construction labor unions to extort project labor agreements into major development projects. Furthermore, in deep blue Santa Fe, a major neighborhood group is using every available legal channel to block a major solar/battery storage facility. What was designed to halt fossil fuel projects is now being used to halt clean energy projects.

The authors cite what can happen when the regulatory burden is lifted. For example, Governor Josh Shapiro rebuilt a break in the I-95 corridor in less than two weeks. Had the normal procedures been followed it would have taken two years just to go through all of the approvals needed. Similarly, Operation Warp Speed delivered COVID vaccines in less than a year, saving the lives of millions. Unfortunately, the liberals did not want to praise the effort in fear saying something nice about Trump, and Trump himself walked away from it because he worried too much about his anti-vax base. 

Government can work and Klein and Thompson rightly believe that we can return to a more efficient model of government. My own thought is that Roosevelt’s New Deal would never have gotten off the ground if it had to operate within today’s regulatory framework. I would note that where after two years Biden’s electric vehicle charging stations and rural broadband; both of which are bogged down in bureaucratic red tape. 

The buzz around “Abundance” is justified. Whether the silos within the Democratic Party yield to the book’s logic remains to be seen, but one can only hope. If I would have major criticism, it would be that nowhere, do they discuss the abject failure of America’s public schools. I guess the teachers’ unions are too sacred a cow for them. I would note that the path to their abundant society has to be built by an educated workforce.