Saturday, January 13, 2018

My Amazon Review of Douglas A. Irwin's "Clashing over Commerce: A History of U.S. Trade Policy"

Trading Places

Dartmouth economist Douglas Irwin has written a very long (832 pages in the print edition) and sometime tedious history of U.S. trade policy, but in many respects it is a tour de force. In a way he is writing American history through the lens of trade. His history starts with the economic impact of the French and Indian War’s (The Seven Years War globally) on Britain’s fiscal and colonial policy. The Boston Tea Party was the result. After independence and the chaos caused by the failed Articles of Confederation one of whose attributes were tariffs among the states a new constitution was written that centralized trade policy within the national government. In fact the second law enacted by the first Congress was a tariff. It was needed to fund the government. Thus Trade policy is as old as the Republic.

Irwin divides his history into three eras: tariffs for revenue (1789-1860), tariffs for restriction (1861- 1933) and tariffs for reciprocity (1934-Present?). Initially export oriented (cotton and tobacco) South favored low tariffs (for revenue only) and the North supported tariffs to restrict imports as well. Given that geography Democrats were for low tariffs and Whigs/Republicans were for high tariffs. By the late 20th century the two parties traded places with Republicans favoring open trade while the Democrats became far more restrictionist. Irwin tells his story by going into the details of all of the major congressional debates on tariff questions. Sometimes this is very interesting and sometimes it gets a bit tedious, but it is history in the making.

The first real battle over trade took place in the 1820s where the political genius of Henry Clay pushed through a restrictive tariff which both protected northern industry and raised revenue to fund internal improvements. That was his American System. By 1832 led by John C. Calhoun the South rose up in protest against what he called the Tariff of Abominations and introduced the doctrine of nullification. Irwin notes that the fight over the tariff became a proxy war over slavery. Nevertheless, with the Southern Democrats largely in control tariffs were largely used for revenue only prior to the civil war.

With the Republicans coming to power in 1861 the tariff was first used to raise revenue to fund the civil war and afterwards to restrict the entry of foreign goods into the United States.  Irwin found no real evidence the high tariff policies of the Republicans promoted economic growth. This was due, in part, to the economy being wide open to immigration and technology transfers. It was also helpful that the U.S.’s leading trading partner was Britain which then had a zero tariff policy. It is unfortunate that Irwin did not note that the success of textile manufacturing in New England was due to stolen technology from Britain.

Although the Republicans were in the high tariff camp, both Presidents Garfield and McKinley in his second term were open to reciprocity. Unfortunately both were assassinated before they could implement their new ideas.

After growing unrest with the high tariff policies of the Republicans which were thought by the Democrats to promote monopoly and act as a tax on consumers, the new Wilson Administration moved swiftly to lower tariff. Irwin highlights how Wilson was very hands on in working with Congress to pass the Underwood Tariff which significantly lowered import duties. Something else was going on as well. The U.S. was becoming a major exporter of industrial goods. This was due to the discovery of huge iron deposits in the Mesabi Range of Minnesota which made the U.S. the world’s lowest cost producer of steel.

However after World War I and the Republicans returned to power tariffs were raised dramatically in 1923 with the Fordney-McCumber Tariff. That was followed by the Hawley-Smoot Tariff of 1930 which raised the already high tariffs by 15%. Irwin debunks the idea that the Hawley-Smoot Tariff caused the stock market crash and the depression. It did, however, exacerbate the global collapse of the early 1930s.

With the arrival of the Roosevelt Administration tariff policy takes a U-Turn. Secretary of State Cordell Hull established a policy of reciprocal trade, first with Latin America and then with the rest of the world. If anyone person is a hero in the book it is Cordell Hull. Under the leadership of state department official Will Clayton, the Truman Administration follows up deal by deal reciprocal trade agreements with broad multinational agreements(GATT now the WTO).

By the 1970s the parties traded places. The Republicans supporting trade in financial services and high technology products become free traders, while the labor oriented Democrats fearing the loss of union jobs become protectionists. Further the long free trade oriented South, switches sides as its textile manufacturing business come under stress. All of this came to a head with Democrat Bill Clinton supporting NAFTA against a majority of his party. NAFTA passed with Republican votes, but the fissures the battle engendered made Americans more suspicious of trade deals.

Those fears bore fruit with the leading Democratic candidates in 2016 opposing the Trans Pacific Partnership along with Donald Trump. Now with a protectionist in the White House and a protectionist Democratic Party it appears that the long era of reciprocal trade might be behind us. Irwin thinks there is too much momentum and it took the Civil War for policy to transition from revenue to restriction and it took the Great Depression to transition for restriction to reciprocity. My question is whether the Great Recession was another such trigger. I hope not.


In sum Irwin’s book is a long slog, but for those serious about how our trade policy came to be, it is well worth the effort.





Friday, January 12, 2018

E-Commerce Dominates Holiday Sales

Although brick and mortar retail had a much better than expected holiday sales season, e-commerce dominated the retail scene. Between October and December e-commerce accounted for 49% of the growth in seasonally adjusted total retail sales and 60% of the growth in its addressable market (Defined as total minus autos, gasoline and food services and bars). What this means is that more store closings are on tap as traditional retail reconfigures its store base to account for the growing competition.  Needless to say this eventuality will not be helpful for the struggling mall REITs. The data are below:

                                            In  $ Millions

Category                     October       December      Change

Total                              489,468        495,381        5,913

Less: Autos                    102,794         102,060
          Gasoline                 39,322           40,497
         Rest. & Bars            56,884           57,549

Addressable Mkt.            290,468          295,275      4,807

Non-Store Retail                52,677            55,562      2,885

Non-Store Percent of Total Change  - 49%
Percent of Addressable Change        -  60%

Wednesday, December 27, 2017

Too Soon for the Democrats to Break Out the Champagne

All of the signs are now pointing to a Democratic wave election this coming November. Both the President Trump and the Republican Congress are in the doghouse in terms of poll numbers and 2018 is looking like a mirror image of the Republican sweep in 2010. For example in the 2009/10 period the Republicans took the governorships in New Jersey and Virginia and won a surprise victory in the special election for a Senate seat in Massachusetts. This year the Democrats won in Virginia and New Jersey and won a special election for a Senate seat in very red Alabama. Moreover the Democrats passed Obamacare with a straight party-line vote and this year the Republicans passed a massive tax cut on a straight party-line vote.

So what's wrong with this picture? Unlike 2010 when the economy was in the dumps the economy appears to be entering a boom phase. The unemployment rate in November 2018 will approximate a very low 3.5%. Moreover the expectations for the Trump tax cuts are so low that most voters will be pleasantly surprised when they see the tax cuts in their pay checks in February and the real pain on the limitation of state and local tax deductions won't show up until tax filing time in 2019. Thus the Republican poll numbers have nowhere to go but up.

Of course we shouldn't under-estimate the ability of the Republicans to screw up. For example Trump could blow up NAFTA triggering a stock market drop and increasing the likelihood of a recession in 2019. And over all of this looms the ongoing Mueller investigation of the 2016 election and likely a host of irregularities in the Trump Organization.

As a result the Democrats will make big gains in the House of Representatives, but whether it will be  enough to take control remains to be seen.





Wednesday, December 20, 2017

My Amazon Review of Victor Sebestyen's "Lenin: The Man, the Dictator, and the Master of Terror"


Paving the Way for Stalin

Victor Sebestyen has written a masterful biography of V.I. Lenin in which he covers both the personal and the political. On the personal side it is obvious Lenin, the son of an upper middle class family was no proletarian. His tastes and lifestyle strived to be middle class. Although he lived austerely he was very sensitive for the need for creature comforts. He enjoyed mountain walks and hunting. He also skillfully managed his very socialist ménage a trois with his wife Nadya Krupskaya and his 10 year mistress Inessa Armand.

However it is on the political side where Lenin becomes a man of history. He was strategically inflexible in pursuing a socialist dictatorship for Russia, and oh did he succeed. Nevertheless on the tactical side Lenin was extraordinarily flexible and was willing to be expedient to further his strategic goals. He could be for democracy and against democracy, he could hate the Germans and then become their ally, and when “war communism” failed he flipped and supported the proto-capitalist New Economic Program (NEP). All of this was in the service of his communist dictatorship.

Sebestyan clearly portrays how Lenin paved the way for Stalinism. It was Lenin who created the Cheka (forerunner to the KGB) with its terror cells for political opponents. It was Lenin who initiated the forced grain requisitions from the peasantry and made villains out of the better off by calling them Kulaks. Stalin would kill millions of them a decade later. It was Lenin who attacked deviations from the Left and the Right turning those into anti-party enemies. And it was Lenin who showed no mercy when he crushed the Kronstadt sailors rebellion. All of this was in place by 1924, the year he died. All Stalin had to do was to refine it and make a cult out of Lenin in whose name he ruled.

On two minor notes, I am glad that Sebestyen highlighted the role of the Russian feminist Alexandra Kollontai as one who was very close to Lenin and was in the room when the decision was made to overthrow the Kerensky government in October 1917. I did catch one error in that Sebestyen described Armand Hammer as an oil magnate when he entered into deals with the Soviet government under the NEP. True Hammer was an oil magnate, but that came much later. In Russia he sold pencils.


All told Sebestyen has told the story of a personality whose iron will made Soviet communism possible. For reader interested in learning more about this period in history I would suggest the Stephen Kotkin biographies of Stalin.






Wednesday, December 13, 2017

Mall Valuation Post Unibail-Rodamco/Westfield

Earlier this week France based Unibail-Rodamco announced the acquisition of Australian based Westfield, a major owner of A+ malls in the U.S. and Europe for a total valuation of $24 billion. There was a significant difference of opinion on the transaction between The Wall Street Journal and The New York Times today. The Times headline read "Acquisition Signals Hope For the Future of U.S. Malls," while The Journal headline read "Big Name in Malls Heads for the Exits." We side with The Journal.

This is our fourth blog on mall valuation this year and readers familiar with our view know that the Class A mall business is in transition from being a great business to a good business which implies higher cap rates going forward. According to sources we believe to be reliable,  the U.S. assets were valued at a cap rate in the high 4% range, say approximately 4.7%-4.9%. In our view the seller received more than a full price and we might just get a hint of that tomorrow when November retail sales are reported. It is our guess that although traditional retail did well, online retail had a blowout month.

We believe that Westfield's founding Lowy family came to the realization that their huge investments in redevelopment (e.g. Century City) and technology might not payoff and that future investments in redevelopment would be of a defensive nature. Hence it was hard to turn down an offer that approximated Street net asset value.

Nevertheless the stock market responding by boosting the share prices of Simon Property Group, Macerich and GGP. We would view rally as a selling opportunity if only because one of the potential bidders (Unibail) will likely be out of the market for the next two years.











Friday, December 8, 2017

"Sunny 2018, Cloudy 2019," UCLA Anderson Forecast, December 2017

Sunny 2018, Cloudy 2019

David Shulman
Senior Economist
UCLA Anderson Forecast
December 2017

Of a sudden, propelled by strength (8% quarterly growth) in equipment spending, the economy is growing at a 3% clip and the near term outlook has become decidedly sunny. (See Figures 1 and 2) Moreover the 3% pace of growth is expected to continue through the second quarter of 2018. However as the unemployment rate drops below 4% and employment growth stalls in the face of a labor shortage, economic growth will drop back to the 2% growth rate we have been used to since the end of the financial crisis eight long years ago. Indeed by the end of the forecast horizon in 2019 real GDP growth could very well be running at a rate below 1.5% as the outlook becomes cloudy. (See Figures 3 and 4)


Figure 1. Real GDP Growth, 2007Q1 – 2019Q4F
Sources: U.S. Department of Commerce and UCLA Anderson Forecast

Figure 2. Real Equipment Spending, 2007Q1 – 2019Q4
Sources: U.S. Department of Commerce and UCLA Anderson Forecast

Figure 3. Nonfarm Employment, 2007Q1 -2019Q4
Sources: U.S. Bureau of Labor Statistics and UCLA Anderson Forecast
Figure 4. Unemployment Rate, 2007Q1 -2019Q4
Sources: U.S. Bureau of Labor Statistics and UCLA Anderson Forecast

Questions about Fiscal Policy

As we are writing in late November many questions remain about the major tax bills now working their way through Congress. There is uncertainty surrounding the corporate tax rate, state and local tax deductions, child credits and the permanence of the entire package. For modeling purposes we have assumed a ten year $1.5 trillion tax cut, with a 25% corporate tax rate (a compromise from 20%), some allowance for state and local tax deductions and $100 billion in revenues coming from a tax on repatriated corporate profits in 2018. This last point is one of the reasons why the federal deficit declines in 2018. (See Figure 5)

Figure 5. Federal Deficit, FY2007 – FY2019F

Sources: Office of Management and Budget and UCLA Anderson Forecast

We are more certain that the next few years will reverse the seven year annual decline in defense spending. (See Figure 6) With the potential for missiles from North Korea reaching the West Coast, continued fighting in the Middle-East and growing worries about Russia and China defense spending will likely be on the rise over the next several years. We are assuming real defense spending will increase by 2% and 2.7% in 2018 and 2019, respectively. If anything, our forecast is more likely to be low than high.

Figure 6. Real Defense Spending, FY2007 – FY2019F
Sources: U.S. Department of Commerce and UCLA Anderson Forecast

Monetary Policy in the Post-Yellen Era

With the appointment of Jerome Powell as Fed chairman the Janet Yellen era is coming to an end. Because Powell’s views on monetary policy are very similar to Yellen’s we do not anticipate any significant changes. However, with respect to regulatory policy, Powell is believed to be far more open than Yellen to reviewing the financial crisis regulations that were put into place from 2009 – 2012.

Thus we expect that the gradual interest rate normalization policy that has been underway for a year will continue well into 2019 with a 25 basis point increase from the current 1.375% rate in December and three more increases in 2018. By the end of 2019 the fed funds rate will likely approximate 3%. (See Figure 7) We caution that the futures markets, in contrast to our forecast and the Fed’s “dot plots”, are forecasting only one rate hike next year.

Concomitantly with the rise in short term interest rates long rates will rise as well and we would not be surprised to see the yield on 10-year U.S. Treasury bonds to exceed 4%, up from the current 2.4%. Rising inflation will be the driver in the increase in long rates, more on that below.

Figure 7. Federal Funds vs. 10 Year U.S. Treasury Bond Rates, 2007Q1 – 2019Q4F
Sources: Federal Reserve Board and UCLA Anderson Forecast

The Powell Fed will also continue the policy of gradually shrinking the Fed’s bloated balance sheet that began in October. (See Figure 8) Simply put after three phases of quantitative easing that expanded the balance sheet from $800 billion to over four trillion dollars will be unwound over a period of several years with the ultimate target of $2.5 - $3.0 trillion, quantitative tightening if you will.  (See Figure 8) But make no mistake the balance sheet shrink the Fed is attempting to do is unprecedented.


Figure 8. Federal Reserve Assets, 2003 –Nov 15, 2017, In $ Millions, SA



Source: Federal Reserve Board via Fred

Inflation on the Rise

It now appears that the second quarter slowdown in inflation was transitory and the future quarterly track in inflation will be in excess of 2% throughout the forecast horizon. (See Figure 9) This will hold true for both “headline” and “core” consumer prices. Further oil prices now appear to be tracking about $10/barrel higher than our forecast of just one quarter ago.

Figure 9. Headline vs. Core Inflation, 2007Q1- 2019Q4F
Sources: U.S. Bureau of Labor Statistics and UCLA Anderson Forecast

The primary source of the rising rate of inflation will be a significant rebound in wage growth. After creeping along in the 2% range, we forecast acceleration in total compensation growth to approximately 4% by late 2018 on a year-over-year basis. (See Figure 10) The recent rise in labor productivity buttresses our view that the long anticipated increase in wages is at hand.

Figure 10. Total Compensation per Hour, 2007Q1 – 2019Q4
Sources: U.S. Bureau of Labor Statistics and UCLA Anderson Forecast

Consumer Spending Supported by Rising Wages and Asset Prices

Real consumption spending is rebounding from the 1.5% increase in 2016 to 2.7% and 2.8% in 2017 and 2018, respectively. (See Figure 11) However, as auto sales slow in 2019 consumption growth will slip back to 2.2%. (See Figure 12) Simply put it is getting very late in the auto cycle. However as long as stock and house prices remain elevated the consumer, or at least the high end consumer, will remain in good shape. (See Figures 13 and 14) In the case of the lower end consumer we are encouraged by Wal*Mart reporting a strong 2.7% increase in year-over-year same store sales in their latest quarter.

Figure 11. Real Consumption Expenditures, 2007 – 2019F
Sources: U.S. Department of Commerce and UCLA Anderson Forecast

Figure 12. Light Vehicle Unit Sales, 2007 – 2019F
Sources: Bureau of Economic Analysis and UCLA Anderson Forecast




Figure 13. S&P/Case-Shiller 20-City Composite Home Price Index, Dec 1999 – Aug 2017, December 1999 =100, SA


Sources: Standard & Poor’s via FRED

Figure 14. S&P 500 Stock Index, 18 Nov 2007 – 17 Nov 17


Sources: Standard & Poor’s via BigCharts.com

One of the big puzzles in recent years is the lack of robustness in new single family housing construction. Given low interest rates and strong employment growth housing activity should be doing much better. Two factors that are being discussed more and more are the unwillingness of the baby boom generation to move as they age in place and highly restrictive zoning in the booming coastal cities. As a result housing starts have remained below the underlying demographic demand of 1.4 – 1.5 million units a year for a decade. We are forecasting modest increases in housing starts from an estimated 1.19 million units this year to 1.27 million and 1.34 million in 2018 and 2019, respectively. (See Figure 15)



Figure 15. Housing Starts 2007Q1 -2019Q4F
Sources: Bureau of the Census and UCLA Anderson Forecast

Exports Rebounding, But NAFTA Risk Looms

In response to a recovering global economy real exports are recovering from the near zero growth of 2015 and 2016. Real exports are estimated to increase by 3.2% this year and 4.5% and 4.1% in 2018 and 2019, respectively. (See Figure 16) According to a recent Goldman Sachs report world economic growth is forecast to increase 3.7% this year and 4.1% in 2018.[i] Growth will come from, 2+% growth in the Euro Area, 6.5% in China, a very strong 8% in India and a rebound in Brazil from O.9% in 2017 to 2.7% in 2018.  (See Figure 17)


Figure 16. Real Export Growth, 2007 – 2019F
Sources: U.S. Department of Commerce and UCLA Anderson Forecast

Figure 17. Global Real GDP Growth, 2016 – 2019F, Annual Data

Country/Region
2016A
2017F
2018F
2019F
Japan
1.0
1.6
1.6
1.3
Euro Area
1.7
2.3
2.2
1.8
UK
1.8
1.5
1.3
1.6
China
6.7
6.8
6.5
6.1
India
7.1
6.4
8.0
8.3
Brazil
-3.6
0.9
2.7
3.1
World (incl. U.S.)
3.2
3.7
4.0
3.9

Source: Goldman Sachs

The real risk to our export forecast and for that matter the entire forecast is political. In less than a year President Trump has blown up the Trans Pacific Partnership (TPP) trade treaty and the global climate accord. The North American Free Trade Treaty (NAFTA) could be next especially given the hawkish views espoused by Secretary of Commerce Wilbur Ross and Trade Representative Robert Lighthizer. Although news from the Mexico City negotiations is not on the front burner, it would be advisable to pay very close attention. Why? Leaving NAFTA is not so simple because it would undo countless supply chains among the three countries (U.S., Canada and Mexico) involved. Just as a reminder the gross trade volumes among the three NAFTA partners amounts to over one trillion dollars per year.[ii] Especially hard hit would be the U.S. automobile industry where parts cross borders several times in the manufacturing of a single automobile. In our view should the U.S. leave NAFTA the growth outlook would deteriorate and the chance of a recession in late 2018 or 2019 would significantly increase.

Conclusion

With our weather forecast analogy for a title we are hoping to be as accurate as modern weather forecasting. Economics has a lot to learn from near term weather forecasting. It looks like 2018 is shaping up to be a pretty good year. There is momentum coming from the recent strength in 2017, strong equipment spending, the likelihood of a tax cut and a consumer that is benefiting from higher asset prices and the prospect of higher wages. Unemployment will drop below 4% and remain there throughout most of the forecast horizon and inflation will experience an uptick. The Fed will respond by continuing to normalize short term interest rates with the Fed Funds rate on a path to 3% by 2019. However as we get into 2019 inflation could be approaching 3% and the economy will slow as it reaches capacity constraints.

The risks to the forecast include the unknowable consequences of the Fed reducing its balance sheet and the potential failure of the ongoing NAFTA negotiations. All told a sunny 2018 with clouds coming in 2019.



[i] See Hatzius, Jan et.al., “As Good as it Gets,” Goldman Sachs, November 15, 2017
[ii] See Shulman, David, “Extreme Makeover: Second Pass at Trumponomics,” UCLA Anderson Forecast, March 2017

Sunday, December 3, 2017

My Amazon Review of David Ignatius' "The Quantum Spy: A Thriller"


Spy vs. Spy

David Ignatius, the Washington Post’s national security columnist, has written quite the spy novel whose backdrop is the ongoing war between the CIA and the Chinese Ministry of State Security (MSS). In this case MSS develops a mole in the CIA whose work involves funding contractors engaged in the development of quantum computers, a revolutionary computing technology that allows photons (Qubits)to superposition themselves in such a manner as to simultaneously be switched on and off. Instead of the current binary system of 0 and 1, the qubit can be both 0 and 1 at the same time.  There are primitive quantum computers in existence today, but once they are scaled up there is no encryption technology that cannot quickly be broken. Thus the first nation that develops such a technology will truly become the sole global super-power.

Thus the stakes are high. Ignatius’ protagonist is Harris Chang, ex-Army and now a CIA operations officer. He is tasked to find the mole. Along the way he sets up a Chinese scientist in Singapore, visits a lab in Seattle, spends quite a bit of time in CIA black sites in Washington D.C. as well as the Langley headquarters, meets up with an MSS operative in Mexico City and the book ends with a fast paced denouement in Amsterdam.

The book also deals with Chang’s ethnicity and how MSS uses that to put him under suspicion in the CIA. He maybe all-American, but to some in the CIA his loyalty is questioned.

We learn quite a bit about CIA tradecraft along the way. We also learn that the U.S. is likely at a disadvantage relative to China because there are far more Chinese students studying in America than there are American students studying in China. Simply put they know more about us than we know about them and there more than a few Chinese students studying computer science in the U.S. 

Although the book is slow at times, I recommend “The Quantum Spy” for those readers interested in what the post-Cold War spy versus spy is like.



















readers interested in what the post-Cold Wa