Globalization, Financialization Are Dead

This post Globalization, Financialization Are Dead appeared first on Daily Reckoning.

A popular claim is that the 1918–19 flu pandemic killed millions but no biggie, the Roaring ’20s started the following year. It’s onward and upward, baby, once we toss the masks.

Wrong. Completely, totally, dead wrong.

The drivers of the past 75 years of growth — globalization and financialization — are dead, and so is everything that depended on them for “growth.”

Here’s what’s poorly understood: Globalization and financialization die when they stop expanding.

Just as a shark dies if it stops swimming forward, globalization and financialization die once they stop expanding, because their viability depends on expansion.

Globalization and financialization have been losing momentum for years.

Globalization Has Strip-Mined Economies

Under the guise of “opening markets,” globalization has strip-mined every economy that can’t print a reserve currency and hollowed out economies globally as only globally competitive sectors survive globalization.

The net result is that once vibrant, diversified economies have been reduced to fragile monocultures completely dependent on global flows of capital and spending for their survival.

Tourism is a prime example: Every region that has seen its local economy crushed by global corporations, leaving global tourism as its sole surviving sector, has been devastated by the drop in tourism, which was always contingent on disposable income and credit expanding forever.

But credit can’t expand forever, as it eventually runs out of income to service additional debt.

Financialization is not just the expansion of credit and leverage to marginal borrowers; it’s also legalized looting, as the true risks of soaring debt and leverage are hidden in obscure financial instruments and bogus claims of “safety” and “hedging.”

Excesses of debt and leverage funneled into risky speculations inevitably end in default.

Asset and Consumption Bubbles

Financialization manifests as asset bubbles and hyperconsumption as people who never had credit spend up to the credit limits and beyond.

Both asset and consumption bubbles pop, pushing the financial sector that feasted off the unsustainable expansion of credit into insolvency.

In other words, neoliberal globalization and financialization — essentially one dynamic — are inherently destabilizing, as all the incentives are perverse.

Just as asset and consumption bubbles are inevitable, so too is the bursting of those bubbles and the devastation of everything that had become dependent on the expansion of those bubbles.

And that has real consequences.

Food security, to take a basic example, is impossible once globalization has destroyed local agricultural production, and financialization has rewarded factory-farming since Big Ag can borrow capital at scales that only make sense in a world of globalized monoculture agriculture.

1919 Is Not 2020

Everyone touting 1919 as the model for 2020 is deeply ignorant of history and the destructive ontologies of globalization and financialization. There is virtually no overlap between the world of 1919 and the world of 2020 in terms of financial structures and excesses.

That globalization and financialization are dead is revealed by what Federal Reserve bailouts and fiscal free-for-alls cannot do:

1. They cannot create creditworthy borrowers out of thin air like the Fed creates dollars out of thin air.

2. They cannot force lenders facing mass defaults to loan more money to uncreditworthy borrowers

3. They cannot force creditworthy borrowers to borrow money.

4. They cannot reflate asset and consumption bubbles that have popped.

5. They cannot restore confidence in long, fragile supply chains.

6. They cannot magically turn unprofitable enterprises into profitable enterprises.

7. They cannot create income streams — revenues, profits, wages, etc. — with bailouts that continue the perverse incentives of moral hazard or “free money” designed to give debt-serfs enough cash to continue making their loan payments.

8. They cannot forgive debt payments without destroying the wealth held as debt: Mortgages, student loans, auto loans, credit card debt, corporate junk bonds, etc., are assets that lose their value once borrowers default.

9. The Fed can buy impaired debt, but that doesn’t change their abject powerlessness (points 1–7 above).

Financialization was never sustainable, and neither was the destructive globalization it enabled.

Any system that depended on the ever-expanding exploitation of new resources, debtors and markets could never be anything but fragile. The ferociousness of its rapacity masked its inherent weakness, a weakness that is now exposed as fatal.

But let’s stick to the U.S. alone for now. The pandemic is having a dramatic long-term effect on Main Street local tax revenues.

First- and Second-Order Effects

To understand how, we need to consider first- and second-order effects.

The immediate consequences of lockdowns and changes in consumer behavior are first-order effects: closures of Main Street, job losses, massive Federal Reserve bailouts of the top 0.1%, loan programs for small businesses, stimulus checks to households that earned less than $200,000 last year and so on.

The second-order effects cannot be bailed out or controlled by central authorities. Second-order effects are the result of consequences having their own consequences.

The first-order effects of the pandemic on Main Street are painfully obvious: Small businesses that have barely kept their heads above water as costs have soared have laid off employees as they’ve closed their doors.

The second-order effects are still spooling out: How many businesses will close for good because the owners don’t want to risk losing everything by chancing reopening?

How many will give it the old college try and close a few weeks later as they conclude they can’t survive on 60% of their previous revenues?

How many enjoy a brief spurt of business as everyone rushes back, but then reality kicks in and business starts sliding after the initial burst wears off?

How many will be unable to hire back everyone who was laid off?

Falling off a Cliff

As for local tax revenues based on local sales taxes, income taxes, business license fees and property taxes: The first three will fall off a cliff, and if cities and counties respond to the drop in tax revenues by jacking up property taxes, this will only hasten the collapse of businesses that were already hanging on by a thread before the pandemic.

The federal government can bail out local governments this year, but what about next year, and every year after that?

The hit to local tax revenues is permanent, as the economy became dependent on debt and financialization pushed costs up.

Amazon and online sellers don’t pay local taxes except in the locales where their fulfillment centers are located.

Yes, online sellers pay state and local sales taxes, but these sales are for goods; most of the small businesses that have supported local tax revenues are services: bars, cafes, restaurants, etc.

As these close for good, the likelihood of new businesses taking on the same high costs (rent, fees, labor, overhead, etc.) is near zero, and anyone foolish enough to try will be bankrupted in short order.

Now that working at home has been institutionalized, the private sector no longer needs millions of square feet of office space. As revenues drop and profits vanish, businesses will be seeking to cut costs, and vacating unused office space is the obvious first step.

What’s the value of empty commercial space?

Trying to Get Blood From a Stone

If demand is near zero, the value is also near zero. Local governments will be desperate to raise tax revenues, and they will naturally look at bubble-era valuations on all real estate as a cash cow. But they will find that raising property taxes on money-losing properties will only accelerate the rate of property-owner insolvencies.

At some point valuations will adjust down to reality and property taxes collected will adjust down accordingly. If municipalities think they can make up the losses by jacking up the taxes paid by the survivors, they will quickly find the ranks of the survivors thinned.

This doesn’t exhaust the second-order effects: Once Main Street is half-empty, the attraction of the remaining businesses declines; there’s not enough to attract customers, and the virtuous circle of sales rising for everyone because the district is lively and attractive reverses: The survivors struggle and give up, further hollowing out the district.

The core problem is the U.S. economy has been fully financialized, so costs are unaffordable.

The commercial property owner overpaid for the buildings with cheap borrowed money, and now the owner must collect nosebleed-high rents or he can’t make the mortgage and property tax payments.

Local governments spend every dime of tax revenues, as their costs are insanely high as well. They cannot survive a 10% decline in tax revenues, much less a 40% drop.

The Lesson of Yellowstone

The metaphor I’ve used to explain this in the past is the Yellowstone forest fire. The deadwood of bad debt, extreme leverage, zombie companies and all the other fallen branches of financialization pile up.

But the central banks no longer allow any creative destruction of unpayable debt and misallocated capital; every brush fire is instantly suppressed with more stimulus, more liquidity and lower interest rates.

As a result, the deadwood sapping the real economy of productivity and innovation is allowed to pile higher.

IMG 1

The only possible output of this suppression is an economy piled high with explosive risk.

Eventually nature supplies a lightning strike, and the resulting conflagration consumes the entire economy.

Regards,

Charles Hugh Smith
for The Daily Reckoning

The post Globalization, Financialization Are Dead appeared first on Daily Reckoning.

Why Assets Will Crash

This post Why Assets Will Crash appeared first on Daily Reckoning.

The increasing concentration of the ownership of wealth/assets in the top 10% has an under-appreciated consequence: when only the top 10% can afford to buy assets, that unleashes an almost karmic payback for the narrowing of ownership, a.k.a. soaring wealth and income inequality: assets crash.

Most of you are aware that the bottom 90% own very little other than their labor (tradeable only in full employment) and modest amounts of home equity that are highly vulnerable to a collapse of the housing bubble.

(The same can be said of China’s middle class, only more so, as 75% of China’s household wealth is in real estate, more than double the percentage of wealth held in housing in U.S. households.)

As the chart illustrates, the top 10% own 84% of all stocks, over 90% of all business equity and over 80% of all non-home real estate. The concentration of ownership of assets such as vintage autos, collectibles, art, pleasure craft and second homes in the top 10% is likely even greater.

The more expensive the asset, the greater the concentration of ownership, as the top 5% own roughly 2/3 of all wealth, the top 1% own 40% and the top 0.1% own 20%.

In other words, the more costly the asset, the narrower the ownership. Total number of U.S. households is about 128 million, so the top 5% is around 6 million households and the top 1% is 1.2 million households.

This means the pool of potential buyers is relatively small, even if we include global wealth owners.

Since price is set on the margins, and assets like houses are illiquid, then we can anticipate all the markets for assets owned solely by the wealthy to go bidless — yachts, collectibles, vacation real estate — because the pool of buyers is small, and if that pool gets cautious due to a drop in net worth/unearned income, there won’t be any buyers except at the margins, at incredible discounts.

As we know, in a neighborhood of 100 homes currently valued at $1 million each, when a desperate seller accepts $500,000, the value of the other 99 homes immediately drops to $500,000.

Since few of the current bubble-era asset valuations are supported by actual income fundamentals, then the sales price boils down to a very small number of potential buyers and what they’re willing to pay.

Houses have a value based on rent, of course, but rents will drop very quickly for the same reason: prices are set on the margins. The most desperate landlords will drop rents and re-set the rental market from the margins.

If demand plummets (which it will as people can no longer afford rents in hot urban markets once they lose their jobs), then vacancies will soar and rents will crash as a few desperate landlords will take $1200/month instead of $2500/month.

Due to the multi-year building boom of multi-family buildings in hot job markets which inevitably leads to an oversupply once the boom ends, there are now hundreds of vacancies where there were once only a few dozen, and thousands where there were previously only hundreds.

As millions of wait staff, bartenders, etc. who made good money in tips find their jobs have vanished, all the urban hotspots will see mass out-migration: Seattle, Portland, the S.F. Bay Area, L.A., NYC, Denver, etc. as demand for rentals will evaporate and rents will be set on the margins by the most desperate landlords. Everyone holding out for the previous bubble-era rent will have $0 income as their units are vacant.

Tech start-ups and Unicorns are melting like ice cubes in Death Valley, and tech-sector layoffs are already in the tens of thousands. This wave of highly paid techies losing their jobs will become a tsunami, further reducing the pool of people who can afford rents of $2,500 to $3,000 for a studio or one-bedroom apartment.

The concentration of ownership generates a self-reinforcing feedback that further depresses prices: since the top 10% own most of the assets of the nation, they are most prone to a reversal of “the wealth effect.”

As their assets soared in value, the top 10% felt wealthier and more confident in future gains, enabling them to borrow and spend freely on second homes, pleasure craft, new vehicles, collectibles, luxury travel, etc.

Once even one class of assets plummets in value–for example, the recent decline in the stock market — the wealth effect reverses and the top 10% feel poorer and less confident about future gains, and thus less enthused about borrowing and spending.

The demand for other costly assets quickly evaporates, further reducing the wealth of the “ownership class,” which further reduces their desire and ability to buy bubble-era assets.

The high-priced assets owned by the top 10% will be the assets least in demand due to their high cost and potential for enormous losses: nothing loses value faster in a recession that narrowly owned assets such as vintage cars, art, vacation homes, yachts, etc.

Once assets start sliding in value, the reverse wealth effect quickly dries up demand for all asset classes with narrow ownership. Since these assets are illiquid — that is, the market for them is thin, with buyers few and far between–the prices are set by a very shallow pool of buyers and desperate sellers.

Consider a pleasure craft that retails new for $120,000. In the boom era of rising stocks and housing, a used boat might fetch $65,000. But as the wealth of the small pool of households able to buy and maintain a costly craft evaporates, the number of qualified buyers evaporates, too.

The seller might be aghast by an offer of $35,000 and reject it angrily. Six months later, he’s praying someone will take it off his hands for $15,000, and in another six months, he’ll accept $500 just to get out from underneath the insurance, slip-rental and licencing fees.

This is how it happens that boats that were once worth tens of thousands of dollars are set adrift by owners who can no longer afford to pay slip fees, and vacation homes are abandoned and auctioned off for overdue property taxes: the market for these luxuries dries up and blows away, i.e. goes bidless — there are no buyers at any price.

Once housing and real estate valuations fall, that will trigger a decline in the value of all other costly, narrowly owned assets, which will reinforce the reverse wealth effect.

This is the systemic payback for concentrating ownership of assets in the hands of the few: when their bubble-era priced assets plummet in value, the bottom falls out of all assets with narrow ownership.

The price of superfluous assets such as boats, vintage cars, collectibles, art and vacation homes can quickly fall to a fraction of bubble-era valuations, destroying much of what was always fictional capital.

The Federal Reserve reckons it can “save” the bubble-era valuations of junk bonds by being the “buyer of last resort,” but it will end up being the “only buyer,” effectively making the system even more fragile and prone to collapse.

The public will eventually have to decide if the nation’s central bank should be bailing out assets owned by the financial elite while the upper-middle class watches its assets collapse in value.

Regards,

Charles Hugh Smith
for The Daily Reckoning

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A Better World Is Emerging

This post A Better World Is Emerging appeared first on Daily Reckoning.

The era of waste, fraud and living on borrowed money is dying, and those who’ve known no other way of living are mourning its passing.

Its passing was inevitable, for any society that squanders its resources is unsustainable. Any society that rewards fraud above all else is unsustainable. Any society which lives on money borrowed from the future and other forms of phantom capital is unsustainable.

We know this in our bones, but we fear the future because we know no other arrangement other than the unsustainable present.

And so we hear the faint echo of the cries filling the streets of ancient Rome when the Bread and Circuses stopped: what do we do now?

When the free bread and entertainments disappeared, people found new arrangements. They left Rome.

The greatest private fortunes in history vanished as Rome unraveled. All the land, the palaces, the gold and all the other treasures were no protection against the collapse of the system that institutionalized corruption as the ultimate protector of concentrated wealth.

The most jealously guarded power of government is the creation of money, for without money the government cannot pay the soldiers, police, courts and administrators needed to enforce its rule.

Western Rome created money by controlling silver mines; in the current era, governments create money (currency) out of thin air.

Once the government’s money loses purchasing power, the system collapses.

Our “money” is nothing but phantom entries on digital ledgers, and so its complete loss of purchasing power is inevitable.

Without “money,” the government can no longer enforce the will of its self-serving elites.

Once the government’s ability to sustain its enforcement with money created out of thin air vanishes, the entire order vanishes along with it.

The destruction of the value of central bank-created “money” is already ordained, for there is no limit on the elites’ desire to maintain control, and so governments will create their “money” in ever-increasing amounts until the value has been completely eliminated.

But here’s the good news:

The outlines of a better world are emerging, an arrangement that prioritizes something more than maximizing and institutionalizing the corruption needed to protect today’s phony gains.

We will relearn to live within our means, and relearn how to institutionalize opportunity rather than corruption designed to protect elites.

We will come to a new understanding of the nature of centralized power, that centralized power only knows how to extend its power and so the only possible outcome is collapse.

We will come to understand technology need not serve only monopolies, cartels and the state, that it could serve a sustainable, decentralized economy that does more with less, i.e. a “DeGrowth” economy.

The Federal Reserve will fail, just as the Roman gods failed to sustain the corrupt and bankrupt Roman elites.

A host of decentralized, transparently priced non-state currencies will compete on the open market, just like goods, services and commodities.

The Fed’s essential role — serving parasitic elites at the expense of the many, under the cover of creating currency out of thin air — will be repudiated by the implosion of the economy as all the Fed’s phantom “wealth” evaporates.

Yes, the outlines of a better world are emerging. The old system is unsustainable and cannot last.

Below, I show you why assets will crash — it’s inevitable. Read on to see why.

Regards,

Charles Hugh Smith
for The Daily Reckoning

The post A Better World Is Emerging appeared first on Daily Reckoning.

This Isn’t Just Another Crash

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Like addicts who cannot control their cravings, financial analysts cannot stop themselves from seeking some analog situation in the past which will clarify the swirling chaos in their crystal balls.

So we’ve been swamped with charts overlaying recent stock market action over 1929, 1987,2000 and 2008 — though the closest analogy is actually the Oil Shock of 1973, an exogenous shock to a weakening, fragile economy.

But the reality is there is no analogous situation in the past to the present, and so all the predictions based on past performance will be misleading. The chartists and analysts claim that all markets act on the same patterns, which are reflections of human nature, and so seeking correlations of volatility and valuation that “worked” in the past will work in 2020.

Does anyone really believe the correlations of the past decade or two are high-probability predictors of the future as the entire brittle construct of fictional capital and extremes of globalization and financialization all unravel at once?

Here are a few of the many consequential differences between all previous recessions and the current situation:

1. Households have never been so dependent on debt as a substitute for stagnating wages.

2. Real earnings (adjusted for inflation) have never been so stagnant for the bottom 90% for so long.

3. Corporations have never been so dependent on debt (selling bonds or taking on loans) to fund money-losing operations (see Netflix) or stock buybacks designed to saddle the company with debt service expenses to enrich insiders.

4. The stock market has never been so dependent on what amounts to fraud — stock buybacks — to push valuations higher.

5. The economy has never been so dependent on absurdly overvalued stock valuations to prop up pension funds and the spending of the top 10% who own 85% of all stocks, i.e. “the wealth effect.”

6. The economy and the stock market have never been so dependent on central bank free money for financiers and corporations, money creation for the few at the expense of the many, what amounts to an embezzlement scheme.

7. Federal statistics have never been so gamed, rigged or distorted to support a neo-feudal agenda of claiming a level of wide-spread prosperity that is entirely fictitious.

8. Major sectors of the economy have never been such rackets, i.e. cartels and quasi-monopolies that use obscure pricing and manipulation of government mandates to maximize profits while the quality and quantity of the goods and services they produce declines.

9. The economy has never been in such thrall to sociopaths who have mastered the exploitation of the letter of the law while completely overturning the spirit of the law.

10. Households and companies have never been so dependent on “free money” gained from asset appreciation based on speculation, not an actual increase in productivity or value.

11. The ascendancy of self-interest as the one organizing directive in politics and finance has never been so complete, and the resulting moral rot never more pervasive.

12. The dependence on fictitious capital masquerading as “wealth” has never been greater.

13. The dependence on simulacra, simulations and false fronts to hide the decay of trust, credibility, transparency and accountability has never been so pervasive and complete.

14. The corrupt linkage of political power, media ownership, “national security” agencies and corporate power has never been so widely accepted as “normal” and “unavoidable.”

15. Primary institutions such as higher education, healthcare and national defense have never been so dysfunctional, ineffective, sclerotic, resistant to reform or costly.

16. The economy has never been so dependent on constant central bank manipulation of the stock and housing markets.

17. The economy has never been so fragile or brittle, and so dependent on convenient fictions to stave off a crash in asset valuations.

18. Never before in U.S. history have the most valuable corporations all been engaged in selling goods and services that actively reduce productivity and human happiness.

This is only a selection of a much longer list, but you get the idea. Basing one’s decisions on analogs from the past is entering a fool’s paradise of folly.

While the stock market euphorically front-runs the Fed and a V-shaped recovery, the reality is the crash has only just begun. To understand why, look at income and debt. Income, earned and unearned, is in free-fall, while debt — which must be serviced by income — is exploding higher.

Bailouts are not a permanent substitute for income. In the short-term, bailouts are a necessary substitute for lost income. But longer term, subsidizing income with borrowed money weakens the currency and the economy, as productivity stagnates.

As for servicing debt — the unemployed working class is getting an extra $600 a week not out of kindness but to make sure these households can continue to service their debts: auto and truck loans, student loans, credit cards, etc. Absent a federal bailout, millions of unemployed would cease making loan payments, creating a financial crisis for lenders.

Investment income is also crashing as companies slash dividends and stock market gains dry up. Oil exporters are facing a $1.2 trillion cut in annual income, and institutional property owners are facing steep declines as tenants stop paying rent and structural declines in employment will pressure rents lower in housing and commercial properties.

As the housing market implodes, capital gains from flipping houses will also collapse. As Corporate America realizes it no longer needs vast office spaces for its (reduced) workforce as millions are working from home, the demand for commercial properties will fall off a cliff, and the rental income generated by commercial property will also fall off a cliff.

Even if interest rates fall to zero, the interest paid by borrowers will not be zero. But even if borrowers get very low rates, they still have to make the monthly principal payments, which can each run into the hundreds of dollars. Lowering interest rates doesn’t reduce the principal payments or reduce the interest due to zero.

Indeed, the student loan and credit card rackets are experts at sucking borrowers dry with late fees and much higher rates than initially advertised.

Capital isn’t flowing into productive investments; it’s front-running the Federal Reserve’s free money for financiers in grossly overvalued stocks and seeking “dead money” safe havens.

The money that’s being sent to unemployed workers is borrowed, and small businesses are being offered loans, much of which will be forgiven if the funds are used to pay wages. In other words, all of these trillions of dollars being substituted for earned income are borrowed.

And with capital going to grossly overvalued Big Tech stocks and “dead money” safe havens, there are no capital flows which will support a return to commerce and productivity that will pay wages or generate investment income (unearned income).

Bulls can argue that “this time it’s different,” that debt doesn’t matter and earnings don’t matter, but where is the history to support their claim that capital flowing into overvalued stocks is going to generate earned income that can service the exploding debt load?

The crash has only just begun. Everything, including a rational, connected-to-reality, effective financial system, is on back-order and unlikely to ship any time soon.

Regards,

Charles Hugh Smith
for The Daily Reckoning

The post This Isn’t Just Another Crash appeared first on Daily Reckoning.

Bailouts Can’t Save This Fragile System

This post Bailouts Can’t Save This Fragile System appeared first on Daily Reckoning.

It’s obvious the global economy is painfully fragile. What is less obvious is the bailouts intended to “save” the fragile economy actually increase its fragility, setting up an inevitable collapse of the entire precarious system.

Systems that are highly centralized, i.e., dependent on a handful of nodes that are each points of failure — are intrinsically fragile and prone to collapse.

Put another way, systems in which all the critical nodes are tightly bound are prone to domino-like cascades of failure as any one point of failure quickly disrupts every other critical node that is bound to it.

Ours is an economy in which capital, wealth, power and control are concentrated in a few nodes of the network we call “the economy.”

A handful of corporations own the vast majority of the media; a handful of banks control most of the lending and capital; a handful of hospital chains, pharmaceutical companies and insurers control health care; and so on.

Control of digital technologies is even more concentrated, in virtual monopolies: Google for search and YouTube for video. Facebook/Instagram and Twitter for social media. Microsoft and Apple for operating systems and services.

The vast majority of participants in the economy are tightly bound to these concentrated nodes of capital and power, and these top-down, hierarchical dependencies generate fragility.

When unexpectedly severe volatility occurs, the disruption of a few nodes brings down the entire system. Thus the disruption of the subprime mortgage subsystem — a relatively small part of the total mortgage market and a tiny slice of the global financial system — nearly brought down the entire global financial system in 2008 because it is a tightly bound system of centralized concentrations of capital, power and control.

Currently, we’re seeing the fragility of a meat production system that has concentrated ownership and production of meatpacking into a relatively few nodes on which the entire food supply chain is totally dependent.

And so what’s the status quo “fix” when this intrinsically fragile system comes apart?

Increase its fragility by bailing out the most tightly bound, dominant nodes. This is what the monopoly on creating currency, the Federal Reserve, is doing on a vast scale.

Rather than reducing the fragility of the system, the Federal Reserve is increasing the fragility, guaranteeing a collapse of not just the financial system but the currency as well.

To better understand systemic fragility, we turn to Nassim Taleb’s description of antifragile systems:

Some things benefit from shocks; they thrive and grow when exposed to volatility, randomness, disorder and stressors and love adventure, risk and uncertainty. Yet in spite of the ubiquity of the phenomenon, there is no word for the exact opposite of fragile. Let us call it antifragile. Antifragility is beyond resilience or robustness. The resilient resists shocks and stays the same; the antifragile gets better. This property is behind everything that has changed with time: evolution, culture, ideas, revolutions, political systems, technological innovation, cultural and economic success, corporate survival, good recipes, the rise of cities, cultures, legal systems, equatorial forests, bacterial resistance… even our own existence as a species on this planet.

And we can almost always detect antifragility (and fragility) using a simple test of asymmetry: Anything that has more upside than downside from random events (or certain shocks) is antifragile; the reverse is fragile.

We have been fragilizing the economy, our health, political life, education, almost everything… by suppressing randomness and volatility. Much of our modern, structured, world has been harming us with top-down policies and contraptions… which do precisely this: an insult to the antifragility of systems. This is the tragedy of modernity: As with neurotically overprotective parents, those trying to help are often hurting us the most.

Given the unattainability of perfect robustness, we need a mechanism by which the system regenerates itself continuously by using, rather than suffering from, random events, unpredictable shocks, stressors and volatility.

Does our financial system advance via unexpected shocks, extreme volatility, unknown unknowns and ceaseless variability? You’re joking, right?

The smallest perturbation in any node brings the system to the edge of collapse. Exhibit No. 1 is last fall’s crisis in the obscure financial node known as the repo market.

This relatively modest part of the financial system almost triggered a stock market crash, so the Fed immediately printed hundreds of billions of dollars to bail out every single player in the repo market — all behind the scenes, of course, lest the extreme fragility of the entire overleveraged, speculative contraption become visible.

Making an incredibly fragile system more fragile via bailing out every node of concentrated capital, power and control guarantees the entire rotten structure will collapse.

Risk cannot be made to disappear; it can only be shifted. By bailing out the sources of systemic fragility with trillions of dollars, the Fed has shifted the risk to the entire financial system and the nation’s currency.

Simply put: The only possible output of Fed bailouts is the complete collapse of the entire financial system, including the currency the Fed is creating with such abandon.

Below, I show you why the current collapse can’t be compared to any other, and why the collapse has only begun. Read on.

Regards,

Charles
for The Daily Reckoning

The post Bailouts Can’t Save This Fragile System appeared first on Daily Reckoning.

Go Big or Go Home

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To understand why the financial dominoes toppled by the Covid-19 pandemic lead to global insolvency, let’s start with a household example. The point of this exercise is to distinguish between the market value of assets and net worth, which is what’s left after debts are subtracted from the market value of assets.

Let’s say the household has done very well for itself and owns assets worth $1 million: a home, a family business, 401K retirement accounts and a portfolio of stocks and other investments.

The household also has $500,000 in debts: home mortgage, auto loans, student loans and credit card balances.

The household net worth is thus $1,00‌0,00‌0 minus $500,000 = $500,000.

Let’s say a typical financial crisis and recession occur, and the household’s assets fall 30%. 30% of $1 million is $300,000, so the market value of the household’s assets falls to $700,000.

Deduct the $500,000 in debts and the household’s net worth has fallen to $200,000. The point here is debts remain regardless of what happens to the market value of assets owned by the household.

Then the speculative asset bubbles re-inflate, and the household takes on more debt in the euphoric expansion of confidence to buy a larger house, expand the family business and enjoy life more.

Now the household assets are worth $2 million, but debt has risen to $1.5 million. Net worth remains at $500,000, since debt has risen along with asset values.

Alas, all bubbles pop, and the market value of the household assets decline by 30%, or $600,000. Now the household assets are worth $2,00‌0,00‌0 minus $600,000 or $1,400,000. The household net worth is now $1,40‌0,00‌0 minus $1,50‌0,00‌0 or negative $100,000. The household is insolvent.

On top of that, the net income of the family business plummets to near-zero in the recession, leaving insufficient income to pay all the debts the household has taken on.

This is an exact analog for the entire global economy, which pre-pandemic had assets with a market value of $350 trillion and debts of $255 trillion and thus a net worth of around $100 trillion.

The $11 trillion that has evaporated in the market value of U.S. stocks is only a taste of the losses in market value. Global stock markets has lost $30 trillion, and once yields rise despite central bank manipulations (oops, I mean intervention), $30 trillion in the market value of bonds will vanish into thin air.

The market value of junk bonds has already plummeted by trillions, and that’s not even counting the trillions lost in small business equity, shadow banking and a host of other non-tradable assets.

Then there’s the most massive asset bubble of all, real estate. Millions of properties delusional owners still think are worth $1.4 million will soon revert to a more reality-based valuation around $400,000, or perhaps even less, meaning $1 million per property will melt into air.

Once the market value of global assets falls by $100 trillion, the world is insolvent.

Everyone expecting the financial markets to magically return to January 2020 levels once the pandemic dies down is delusional. All the dominoes of crashing market valuations, crashing incomes, crashing profits and soaring defaults will take down all the fantasy-based valuations of bubblicious assets:

Stocks, bonds, real estate, bat guano, you name it.

The global financial system has already lost $100 trillion in market value, and therefore it’s already insolvent. The only question remaining is how insolvent?

Here’s a hint: companies whose shares were recently worth $500 or $300 will be worth $10 or $20 when this is over. Bonds that were supposedly “safe” will lose 50% of their market value. Real estate will be lucky to retain 40% of its current value. And so on.

As net worth crashes below zero, debts remain. The loans must still be serviced or paid off, and if the borrowers default, then the losses must be absorbed by the lenders or taxpayers, if we get a repeat of 2008 and the insolvent taxpayers are forced to bail out the insolvent financial elites.

Here’s the S&P 500. Where is the bottom?

There is no bottom, but nobody dares say this. Companies with negative profits have no value other than the cash on hand and the near-zero auction value of other assets. Subtract their immense debts and they have negative net worth, and therefore the market value of their stock is zero.

But don’t worry, the government is on the case…

That governments around the world will be forced to distribute “helicopter money” to keep their people fed and housed and their economies from imploding is already a given. Closing all non-essential businesses and gatherings will crimp the livelihood of millions of households and small businesses that lack the financial resources to survive weeks without any revenues.

The only question is whether governments which can borrow or print fresh currency will get ahead of the implosion or fall behind, creating a binary choice: go big now or go home.

Half-measures in helicopter money work about as well as half-measures in quarantine, i.e. they fail to achieve the intended objectives. Dribbling out modest low-interest loans is a half-measure, as is cutting payroll taxes.

Neither measure will help employees or small businesses whose income has fallen below the minimum needed to pay essential bills: rent, food, utilities, etc.

Meanwhile, the ruling elites will be under increasing pressure to bail out greedy financial elites and gamblers. Those are the scoundrels and parasites they bailed out in 2008-09. But this is not just another speculative bubble-pop, this is a matter of life and death and solvency for the masses of at-risk households and small businesses.

It is a different zeitgeist and a different crisis, and bailing out greedy parasites (banks, indebted corporations, speculators, financiers, etc.) will not go over big while households and small businesses are going bankrupt.

The Federal Reserve has been handed a lesson in the ineffectiveness of the usual monetary “bazooka” in bailing out the predatory-parasitic class of overleveraged gamblers. Nearly free money for financiers isn’t going to save the economy or non-elites sliding toward insolvency.

Instead of leaving the bottom 99.5% to twist in the wind while enriching the predatory-parasitic class, the ruling elites will have to let the top 0.5% twist in the wind and save the bottom 99.5%. This will require going against all the thousands of lobbyists, all the chums at the club, and all the millions in campaign contributions, but it’s a binary choice.

Either save your citizenry or sacrifice your legitimacy by bailing out the predatory-parasitic class. If the ruling elites save their parasitic pals, the public will demand the scalps of the predatory-parasitic class, and as the crisis deepens, they will eject every craven, greedy elected toady who caved in to the predatory-parasitic class.

So listen up ruling elites: either go big or go home. Either accept that it’s going to take several trillion dollars in helicopter money to insure the most vulnerable households and real-world enterprises remain solvent, or quit and go home.

The pandemic crisis isn’t going to end in April or May, though the urge to indulge in such magical thinking is powerful. It might still be expanding in August and September.

This is why it’s imperative to go big now, and make plans to sustain the most vulnerable households and small employers not for two weeks but for six months, or however long proves necessary.

Regards,

Charles Hugh Smith
for The Daily Reckoning

The post Go Big or Go Home appeared first on Daily Reckoning.

It’s Over

This post It’s Over appeared first on Daily Reckoning.

The financial elites are pushing a narrative that asset prices, sales and profits will all return to January 2020 levels as soon as the Covid-19 pandemic fades.

Get real, baby.

Nothing is going back to January 2020 levels. Rather than the “V-shaped recovery” expected by Goldman Sachs et al., the crash in asset prices will eventually gather momentum.

Why? It’s simple: for 20 years we’ve over-invested in speculative bubbles and squandered borrowed money on consumption and under-invested in productivity-increasing assets.

To understand why the market value of assets will relentlessly reprice lower, a process sure to be interrupted with manic rallies and false dawns of hope that a return to speculative good times is just around the corner, let’s start with the basics:

The only sustainable way to increase broad-based wealth is to boost productivity across the entire economy.

That means producing more goods and services with less capital, less labor and fewer inputs such as energy.

Rather than boost productivity, we’ve lowered productivity via mal-investment and by propping up unproductive sectors with immense sums of borrowed money.

The poster child for this dynamic is higher education: rather than being pushed to innovate as costs skyrocketed, the higher education cartel passed its inefficiencies and bloated cost structure onto students, who have paid for the bloat with $1. 6 trillion in student loans few can afford.

As for Corporate America squandering $4.5 trillion on stock buybacks, the effective gains on productivity from this stupendous sum is not just zero. It’s negative, as the resulting speculative bubble suckered in institutions and individuals who’d been stripped of safe returns by the Federal Reserve’s low-interest-rates-forever policy.

What could that $4.5 trillion have purchased in terms of increasing the productivity of the entire economy?

Considerably more than the zero productivity generated by stock buybacks. The net result of uneven gains in productivity and the asymmetric distribution of whatever gains have been made is stagnant wages for the bottom 90% and rising costs for everyone.

Those of us who are self-employed or owners of small businesses know that healthcare insurance costs have been ratcheting higher by 10% or more annually for years.

Whatever gains in health that have been purchased with the additional trillions of dollars poured into the healthcare cartels have been offset with declining life spans, soaring addictions to opioids and numerous broad-based declines in overall health.

The widespread addiction to smartphones and social media have deranged and distracted millions, crushing productivity while greatly increasing loneliness, insecurity and a host of social ills.

Two dynamics define the economy in the 21st century:

1. We have substituted debt-driven speculation for productive investment

2. We have substituted debt for earnings

This is why the repricing of speculative-bubble assets can’t be stopped: debt-driven speculation is not a sustainable substitute for investing in increasing productivity, and debt-fueled consumption masquerading as “investment” is not a sustainable substitute for limiting consumption to what we earn and save.

All bubbles pop, period. Once Corporate America’s credit lines are pulled and its revenues and profits plummet, the financial manipulation of stock buybacks will end. That spells the end of the 12-year bull market in stocks.

As the tide of speculative mania ebbs and confidence wanes, the world’s housing bubbles will all pop, and the $1.4 million bungalows will drift back down to their Bubble #1 highs around $400,000, and perhaps even drop from there.

As for collectibles and other play-things of the super-wealthy: the bids will soon vanish and yachts will be set adrift to avoid paying the dock fees.

Regards,

Charles Hugh Smith
for The Daily Reckoning

The post It’s Over appeared first on Daily Reckoning.

The Economic Cataclysm

This post The Economic Cataclysm appeared first on Daily Reckoning.

To understand the economic cataclysm ahead, do the math. Those expecting the Covid-19 pandemic to leave the U.S. economy untouched are implicitly making these preposterously unlikely claims:

1. China will resume full pre-pandemic production and shipping within the next two weeks.

2. Chinese consumers will resume borrowing and spending at pre-pandemic rates in a few weeks.

3. Every factory and every worker in China will resume full pre-pandemic production without any permanent closures or disruptions.

4. Corporate America’s just-in-time inventories will magically expand to cover weeks or months of supply chain disruption.

5. Not a single one of the thousands of people who flew direct from Wuhan to the U.S. in January is an asymptomatic carrier of the coronavirus who escaped detection at the airport.

6. Not a single one of the thousands of people who flew from China to the U.S. in February is an asymptomatic carrier of the coronavirus.

7. Not a single one of the thousands of people who are in self-quarantine broke the quarantine to go to Safeway for milk and eggs.

8. Not a single person who came down with Covid-19 after arriving in the U.S. feared being deported so they did not go to a hospital and are therefore unknown to authorities.

9. Even though U.S. officials have only tested a relative handful of the thousands of people who came from Covid-19 hotspots in China, they caught every single asymptomatic carrier.

10. Not a single asymptomatic carrier caught a flight from China to Southeast Asia and then promptly boarded a flight for the U.S.

I could go on but you get the picture: an extremely contagious pathogen that is spread by carriers who don’t know they have the virus to people who then infect others in a rapidly expanding circle has been completely controlled by U.S. authorities who haven’t tested or even tracked tens of thousands of potential carriers in the U.S.

These same authorities are quick to claim the risk of Covid-19 spreading in the U.S. is low even as the 14 infected people they put on a plane ended up infecting 25 passengers on the flight.

These same authorities tried to transfer quarantined people to a rundown facility in Costa Mesa CA that was not suitable for quarantine, forcing the city to file a lawsuit to stop the transfer.

Do these actions instill unwavering confidence in the official U.S. response? You must be joking.

Do the math. The coronavirus is already in the U.S. but authorities have no way to track it due to its spread by asymptomatic carriers. People who don’t even know they have the virus are flying to intermediate airports outside China and then catching flights to the U.S.

None of the known characteristics of the virus support the confidence being projected by authorities. The tests are not reliable, few are being tested, carriers can’t be detected because they don’t have any symptoms, the virus is highly contagious, thousands of potential carriers continue to arrive in the U.S., etc. etc. etc.

The network of global travel remains intact. Removing a few nodes (Wuhan, etc.) does not reduce the entire network’s connectedness that enables the rapid and invisible spread of the virus.

Second, what authorities call over-reaction is simply prudent risk management. When an abstract pandemic becomes real, shelves are emptied and streets are deserted. It doesn’t take thousands of cases to trigger a dramatic reduction in the willingness to mix with crowds of strangers. A relative handful of cases is enough to be consequential.

Human psychology is exquisitely attuned to risk once it moves from abstraction to reality. Why take a chance unless absolutely necessary? For many people, the first handful of local cases will be enough to cancel all exposure to optional public gatherings: cafes, bistros, theaters, concerts, etc.

But many of the new jobs created in the U.S. economy over the past decade are in the food and beverage services sector, the sector that is immediately impacted when people decide to lower their risk by staying home rather than going out to crowded restaurants, theaters, bars, etc.

Many of these establishments are hanging on by a thread due to soaring rents, taxes, fees, healthcare and wages. Many of the employees are also hanging on by a thread, only making rent if they collect big tips.

All the official reassurances won’t be worth a bucket of warm spit. After being assured the risk of the virus spreading in North America was “low,” the arrival of the virus will destroy trust in official assurances. People will awaken to the need to control their own risk factors themselves. And as empty streets and shelves attest, people taking charge of risk has dire economic consequences.

Central banks can borrow money into existence but they can’t replace lost income. A significant percentage of America’s food and beverage establishments are financially precarious, and their exhausted owners are burned out by the stresses of keeping their business afloat as costs continue rising. The initial financial hit as people reduce their public exposure will be more than enough to cause many to close their doors forever.

As small businesses fold, local tax revenues crater, triggering fiscal crises in local government budgets dependent on ever-higher tax and fee revenues.

A significant percentage of America’s borrowers are financially precarious, one paycheck or unexpected expense away from defaulting on student loans, subprime auto loans, credit card payments, etc.

A significant percentage of America’s corporations are financially precarious, dependent on expanding debt and rising cash flow to service their expanding debt load. Any hit to their revenues will trigger defaults that will then unleash second-order effects in the global financial system.

The global economy is so dependent on speculative euphoria, leverage and debt that any external shock will tip it over the cliff. The U.S. economy is far more precarious than advertised as well.

The economic storm hasn’t passed; the false calm is only the eye of the financial hurricane.

Regards,

Charles Hugh Smith
for The Daily Reckoning

The post The Economic Cataclysm appeared first on Daily Reckoning.

Why the Fed Won’t Save the Market

This post Why the Fed Won’t Save the Market appeared first on Daily Reckoning.

A very convenient conviction is rising in the panicked financial markets that the Federal Reserve will “save the market” from a COVID-19 collapse. But they won’t.

“Buy-the-dip” punters are placing bets on the belief the Fed can’t possibly let the current bubble pop.

Oh yes they can and yes they will. Why?

It’s about control. Here’s what I mean…

Just as the Fed gets panicky if interest rates start getting away from its control, the Fed also gets nervous when its speculative bubbles get away from it, even though it causes them in the first place.

When speculators no longer fear a downturn because of their faith in eventual Fed “saves,” the Fed has lost control. And that’s not what the Fed wants.

The COVID-19 pandemic is actually a godsend to the Fed.

To reestablish control, the Fed must let the current euphoric faith in its “guarantee” to rescue markets crash to Earth.

The Fed’s foolish but not stupid. They understand speculative bubbles always pop, so the COVID-19 pandemic is just the excuse they needed to let the air out of the current grossly unsustainable bubble.

All bubbles pop. That leaves the Fed with an unsavory choice: Either be viewed as responsible for the bubble bursting or engineer some fall guy to take the blame and give the Fed cover for its incompetence.

It’s also instructive to note, as many have, that the Fed enters this global recession with very little policy ammo.

Interest rates are so near zero already that a couple of rate cuts will do very little good in the real economy.

Panicky punters expect the Fed to blow its wad on saving their hides, but what would that leave the Fed for the real recession that’s just getting underway? Nothing. If the Fed starts cutting now, it’ll have nothing left.

Would the Fed be so shortsighted and stupid as to blow their last ammo just to save speculatively insane punters from the inevitable bursting of a moral hazard-driven bubble?

In a word, no.

What about the possibility of negative interest rates?

Japan and Europe have effectively proven that negative interest rates do essentially nothing to boost spending in the real economy.

All negative interest rates accomplished was further boosting speculative bubbles and wealth inequality, which threatens to destabilize the social order — something the Fed cannot control.

The reality is the COVID-19 pandemic promises to be much more consequential than the run-of-the-mill financial excesses of the past 20 years, but we already know one important thing:

All bubbles pop.

We also know this: The greater the excesses, speculative euphoria and moral hazard, the greater the reversal.

Regards,

Charles Hugh Smith
for The Daily Reckoning

The post Why the Fed Won’t Save the Market appeared first on Daily Reckoning.

Will MMT Trigger the Collapse of “Money”?

This post Will MMT Trigger the Collapse of “Money”? appeared first on Daily Reckoning.

Dear Reader,

If the supply of money in an economy is $1 billion, each unit of currency buys X (the purchasing power of each unit of currency).

If the money supply is doubled without any expansion in the consumers’ pool of goods and services, the purchasing power of each unit of currency falls in half. This reduction in the purchasing power of each unit of currency is called inflation.

Governments facing soaring demands and limited tax revenues are naturally tempted to meet these demands with “free” new currency, since the political and financial pain caused by skyrocketing taxes leads to governments being tossed from power.

This temptation explains the regular occurrence of hyperinflation and debt default, as the temptation to over-borrow and pile up interest payments leads to governments defaulting on their debt. In both cases — hyperinflation and debt default — there’s a currency/ governance/ financial crisis that upends the status quo.

This is one common objection to MMT: the freedom to issue new currency is difficult to limit, as there will always be more demands for government spending. Without some “governor” to limit the issuance of new currency to align with the expansion of goods and services, then governments tend to issue new currency far in excess of what the real economy is creating.

This generates inflation, which impoverishes everyone using the currency.

MMT advocates claim that since MMT generates goods and services, it won’t generate inflation. But rebuilding a bridge doesn’t actually create any new goods and services, or increase productivity: it generates wages and consumes materials and energy.

Since it doesn’t generate more consumable goods and services, the expansion of wages and demand for materials will drive prices higher.

The core difficulty here is that the democratic political process is intrinsically skewed to short-term, politically expedient dynamics: politicians focus by necessity on winning re-election, and they will naturally approve new issuance of currency and new spending to placate the demands of constituents, lobbyists and campaign donors.

I honestly don’t see any intrinsic limit on political expediency. Politicians need to be forced to say, “I know your need is legitimate, but the money’s simply not there.”

Without some real-world limit on the issuance of new money, money will be issued in surplus because the issuance isn’t an economic process, it’s a political process.

This is a fatal flaw in MMT. Relying on politicians to impose limits on their own desire to win re-election is to deny human nature.

A second concern is the entire notion of “slack” in the economy — untapped capacity.

Have you noticed the “help wanted” signs in every Home Depot and many other retail outlets and restaurants? We read about millions of people who aren’t working, but if they wanted to work, or had to work, why are there so many unfilled positions?

The answers are complex: the wage being offered isn’t sufficient incentive, the unemployed don’t have the requisite skills, etc.

In other words, in some important ways, the economy appears to be very close to full capacity. New programs such as The New Green Deal will basically be poaching experienced workers from existing projects, driving up wages (good for workers) which can generate a wage-price spiral (bad for everyone who can’t demand higher incomes).

My third concern: as someone with 45 years of construction experience, I am keenly aware that the vast majority of the infrastructure and New Green Deal spending many people see as socially beneficial requires skilled labor.

Rebuilding bridges, electrical grids, etc. all require highly specialized labor. Installing solar arrays also requires trained workers with physical stamina.

The process of training a large new workforce is time-consuming and expensive, and doesn’t necessarily generate new goods and services.

In other words, it’s inherently inflationary as it puts new money into the economy but doesn’t increase the goods and services — at least until the newly trained workforce starts generating goods and services.

My fourth concern is related: ultimately, “wealth” (as measured in new goods and services generated by capital and labor) is generated by increasing productivity, via investment in greater efficiencies.

Much of the spending people want — repairing bridges, supplanting natural gas electrical generation with solar or wind, and so on — are not necessarily increasing productivity: the repaired bridge carries the same number of vehicles as it did before, so there is no increase in productivity.

In other words, efficiency and productivity are core dynamics, yet the MMT process is fundamentally political, and politics has little interest in efficiency or productivity. It is, as noted above, politically expedient, with a default setting to put off tough decisions into the future.

In the private sector, return on capital and the productivity of labor and processes are the core dynamics. These rationalize decisions to prioritize efficient use of capital, labor and resources. Absent this rationalization, resources can be squandered for politically expedient reasons.

In other words, capital, resources and labor can be mal-invested, which brings up the opportunity cost: all the capital, labor and resources squandered on “bridges to nowhere” and other pork-barrel projects are no longer available for truly productive use.

The key question here is: How do we harness our intrinsically scarce capital, labor and resources to increase productivity and socially/ecologically beneficial investments in a sustainable way?

MMT’s diagnosis is that a lack of currency is the primary problem. The MMT solution assumes the new currency can be efficiently invested within the existing political system without disrupting the increasingly precarious existing financial system.

While the appeal of MMT is self-evident, it seems to me that both the financial and political systems are broken in ways that MMT, no matter how it’s managed, cannot fix.

The problem is we’re misallocating capital, resources and labor on a vast scale. That’s the problem. Adding more currency and capacity/”growth” doesn’t fix this problem, it actually makes it worse.

If we look around at the trillions of dollars in recently issued currency floating around the world looking for a yield, the trillions poured into asset bubbles that only benefit the few at the top, the gargantuan waste of capital, it’s hard not to see MMT as a “green” Band-Aid for a profoundly broken, wasteful, unsustainable system.

MMT leaves the existing status quo essentially untouched and adds a new layer of newly issued currency and spending, and a new layer of “growth” and consumption, consumption that no matter how socially beneficial is still an additional burden on resources.

In effect, MMT is another attempt to preserve a dysfunctional status quo by adding another layer of newly issued currency and “growth.” More “growth,” even the sort envisioned as “Green,” is simply adding to a destructive system.

What’s needed is a radical reduction in consumption and a diversion from a consumerist Landfill Economy to one driven by incentives other than “more of everything” in the name of “growth.”

As my longtime readers know, I see a new system of private-sector currency, DeGrowth and decentralization and the institutionalization of a more sustainable (i.e. less perverse and destructive) set of incentives as the only set of solutions that can fix what’s broken in the current socio-economic model.

But that doesn’t mean MMT won’t be tried, as the three engines of “growth” over the past 20 years — soaring debt, financialization and globalization — all falter.

To sum up: MMT is presented as the solution to the “problem” of insufficient government funding, but that’s not the real problem:

The real problem is the purchasing power of the fiat currency that will be issued in the trillions of dollars.

It’s a recipe for the collapse of money as we know it.

Regards,

Charles Hugh Smith
for The Daily Reckoning

The post Will MMT Trigger the Collapse of “Money”? appeared first on Daily Reckoning.