Monday, March 30, 2020

Pandemic Pandemonium: The Tides of Globalization and Financialization Reverse

Central bank free money doesn't create collateral or creditworthy borrowers, and without those foundations, the decayed, rotted shack will collapse.
In terms of consequential trends, the pandemic is not a cause, it's an accelerant of shifts already under way before the emergence of Covid-19. Put another way, the tide had already reversed, but now it's visible to all.
The twin drivers of neoliberal inequality, globalization and financialization, are now ebbing, much to the dismay of central banks and the elites that neoliberalism's golden twins enriched at the expense of everyone else.
Globalization ceased expanding some time ago, as diminishing returns set in. The low-hanging fruit had long been picked, and Wall Street's relentless arbitrage of labor costs, environmental laxity and corrupt governance had long since stripped the globalization tree not just of fruit but of bark and foliage.
Wall Street's equally relentless commoditization of assets, debt and leverage had also reached diminishing returns, unsurprising as financialization is the core driver of globalization's ruthless exploitation.
While the conventional media has long focused on offshoring of jobs and factories, the truly monumental profits were raked in by commoditizing assets, debt and leverage on a global scale.
Thus guaranteed-to-default subprime mortgages were deceptively bundled as "low-risk" securities and sold to pension funds in Norway in 2008, this being a mere tip of the iceberg of fictional capital sold off to marks and rubes globally.
The collateral is gone, baby--if there was anything other than fictional collateral to start with. All those collateralized debt obligations (CLOs), neatly bundled auto loans, junk debt based on illusory future returns from fracking companies--it's all gone, and the bagholders are looking to the central banks to bail them out by buying all the putrid sewage of financialization.
The problem with financialization, of course, is that it creates no real goods or services. It is nothing but an elaborate skimming of value produced by others, a looters' paradise that siphons most of the gains into the hands of a few financial puppet-masters.
Globalization's gains were also sluiced into the hands of the few, while neoliberalism's propaganda machine spewed the bogus benefits of globalization: cheaper jeans and TVs, and toasters that might last a year if you're lucky. The nation's essential industries were sent overseas with one goal and one goal only: maximize profits for corporate insiders, their political lapdogs and the top 5% who own most of the shares.
The pandemic has done nothing but knock down the brightly painted facade, revealing the decayed, rotted shack of reality. Globalization and financialization always served one goal: maximizing the profits of the few, by any means available, at the expense of the many.
Now that the collateral is gone and the tree of globalization has been stripped bare, there's nothing left to exploit except the unlimited largesse of predatory finance's best buddies, central banks.
Only chumps, rubes and marks think they can get something for nothing, yet here we are, rubbing our hands with glee at the Fed's trillions in free money. Yee-haw, free money for everyone, but especially for the most exploitive and predatory of financialization's looters.
Sorry, but there is no free lunch. Every dollar of the Fed's freshly printed trillions will eventually be taken out of the purchasing power or collateral of the holders of Federal Reserve currency.
Just as the way of the Tao is reversal, the tides of globalization and financialization have reversed. Central banks are shoveling sand against the tide, and in their hubris-soaked delirium, already declaring victory.
Central bank free money doesn't create collateral or creditworthy borrowers, and without those foundations, the decayed, rotted shack will collapse. The pandemic has released a tightly coiled pandemonium that will play out in the years ahead.
Money and Work Unchained $6.95 (Kindle), $15 (print) Read the first section for free (PDF).


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Posted by Charles Hugh Smith at 7:26 PM

Sunday, March 29, 2020

What Happens as State and Local Tax Revenues Crater?

We can anticipate a federal bailout of pension funds and one-time aid to state and local governments, but bailouts won't repair the eroding foundations of tax revenues.
As we all know, the federal government can "print" money but state, county and city governments cannot. The Treasury can sell bonds to fund deficit spending, and the Federal Reserve can create currency out of thin air to buy the bonds, so federal spending can increase even as tax revenues crash.
State, county and city governments do not have this printing press. Yes, states and counties can sell municipal bonds for infrastructure projects, but they can't sell bonds to support General Fund (i.e. everyday government services) expenditures.
As a result, massive declines in State, county and local tax revenues are already baked in as sales and payroll taxes drop and capital gains taxes--an essential source of revenues for many states--are set to collapse along with the stock market.
Longer term, the other primary source of tax revenues--property taxes--will fall off a cliff as the commercial real estate bubble and Housing Bubble #2 implode later this year. Lower sales, lower employment and lower profits all undermine the fundamentals of real estate, and the institutionalization of remote work and education will gut demand for commercial space.
Real estate transactions are also sources of transfer taxes and capital gains, and as values plummet so will transfer taxes and capital gains.
Every locale has a different mix of tax revenues, but since all sources will fall sooner or later, no state or local government will escape the decline in revenues. Sales (excise) and payroll tax revenues will fall first, and capital gains will vanish as stock market losses replace gains.
In states like California that depend heavily on capital gains taxes, the holes being blown in budgets will be catastrophic. Roughly 10% of all General Fund revenues in California flow from capital gains--over $15 billion in the previous fiscal year. As noted in the California State Revenue Estimate 2019-2020:
"The amount of capital gains revenue in the General Fund can vary greatly from year to year. For instance, in 2007, capital gains contributed $10.9 billion to the General Fund. By 2009, the contribution from capital gains had dropped to $2.3 billion. For 2018, capital gains are forecast to contribute $15.7 billion to General Fund revenue--the highest amount ever."
Were this to drop to previous recession-era lows, that would open a $13 billion hole in tax revenues, completely erasing the state's $8 billion "rainy day fund" and leaving a $5 billion deficit--a sum that will only increase as sales and payroll taxes decline.
Once Silicon Valley Unicorns, Big Tech and zombie corporations start laying off highly paid staff, income tax revenues will crater as well. As the California State Revenue Estimate 2019-2020 explains:
"The highest-income Californians pay a large share of the state's personal income tax. For the 2016 tax year, the top 1 percent of income earners paid just under 46 percent of personal income taxes. This percentage has been greater than 40 percent in 12 of the past 13 years. Consequently, changes in the income of a relatively small group of taxpayers can have a significant impact on state revenues."
Many states and counties are increasingly dependent on a dominant revenue source which may well prove to be an Achilles Heel. California has increasingly come to depend on income taxes from high earners (who also garner most of the capital gains as well):
"In 1950-51, sales tax revenue made up over 50 percent of General Fund revenues while personal income tax revenue made up just more than 11 percent. That relationship has changed dramatically over time, and, for 2019-20, personal income tax makes up 68.8 percent of all General Fund revenues."
A steep decline in tax revenues isn't the end of the pain for local government. Public-sector pension funds heavily invested in stocks are absorbing shattering losses that will have to be compensated by higher contributions by cash-strapped taxpayers. If bond yields rise despite central bank interventions, bond holdings could crash along with stocks.
We can anticipate a federal bailout of pension funds and one-time aid to state and local governments, but bailouts won't repair the eroding foundations of tax revenues. Sales: down. Income: down. Capital gains: down. Vehicle sales: down. Fuel taxes: down. Property taxes: down, once bubble valuations crash to earth.
Cash-strapped taxpayers, many of whom may have lost their jobs, will be in no mood to absorb enormous tax increases to fund insiders, cronies and vested interests.
The gravy train of state and local government spending has just been derailed. The declines in tax revenues will be too steep and too enduring to support the magical-thinking hope that a V-shaped recovery will make all the blown budgets whole next quarter, much less next year.
Money and Work Unchained $6.95 (Kindle), $15 (print) Read the first section for free (PDF).


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Posted by Charles Hugh Smith at 5:38 PM

Saturday, March 28, 2020

The New (Forced) Frugality

There are only two ways to survive a decline in income and net worth: slash expenses or default on debt.
In post-World War II America, the cultural zeitgeist viewed frugality as a choice: permanent economic growth and federal anti-poverty programs steadily reduced the number of people in deep economic hardship (i.e. forced frugality) and raised the living standards of those in hardship to the point that the majority of households could choose to be frugal or live large by borrowing money to enable additional spending. Either way, rising income and net worth would raise all ships, frugal and free-spending alike.
For everyone above the bottom 20%, frugality was viewed as a sliding scale of choice: if you couldn't increase your income fast enough, then borrow whatever money you needed. If you chose to be frugal, in moderation (i.e. clipping coupons and shopping for the cheapest airline seats, etc.) this was viewed as admirable fiscal prudence; if pushed beyond moderation then it was dismissed as counter to the American spirit of everlasting expansion: tightwad is not an endearment.
Thus none of us immoderately frugal folks ever fit in. Our frugality raised eyebrows and drew derogatory exhortations from indebted free-spenders to "get out there and live a little," i.e. blow hard-earned money on aspirational gewgaws or status-enhancing fripperies, including the oh-so-precious "experiences" that have now replaced gauche physical markers of status-climbing.
We are now entering a new era of forced frugality in which incomes and net worth stagnate or decline while the cost of living rises and borrowing is no longer frictionless.
To say that these changes will shock the system is putting it mildly. Here's the key dynamic in forced frugality: income can drop precipitously without any ratcheting to slow the decline, but costs only ratchet higher, or decline by nearly imperceptible degrees; that is, costs are "sticky" and refuse to slide down as easily as income.
The second key dynamic in forced frugality is the tightening of lending and the rising cost of borrowed money. When lenders could assume that almost every household's income would increase as a byproduct of ceaseless economic expansion, and assets such as stocks, bonds and houses would always increase in value (any spots of bother are temporary), then the odds of a nasty default (in which the borrower stiffs the lender--no monthly payments to you, Bucko)--were low.
But once incomes and asset valuations are more likely to fall than rise, the door to lending slams shut. Why would lenders extend loans to households and enterprises that are practically guaranteed to default? Any lender that self-destructive would soon be stripped of their capital and solvency.
The general assumption is that since central banks are buying bonds, interest rates for borrowers can only go down. This assumption is misguided. The base assumption of all lenders is that a very thin layer of borrowers will default. Once this layer thickens, it makes no sense to lend to everyone who can fog a mirror.
Unwary lenders are about to learn a very painful lesson about the creditworthiness of supposedly solvent middle-class households: since income isn't "sticky," households that had high credit scores for years can quite suddenly default on their loans once their incomes plummet.
As for the borrower's assets, those too can plummet in value, leaving the lender with zero collateral or an asset for which there is no buyer, regardless of the appraised value.
The income/assets slope is greased while the cost slope is on a resistant ratchet. Income can slide down effortlessly while costs stubbornly refuse to fall.
The net result of this dynamic is forced frugality. For the first time in decades, households and enterprises cannot count on a resumption of growth in a few months and higher incomes and asset valuations.
To the dismay of living-large-on-debt households and enterprises, the only way to get more than you have now will be to save, save, save cash. Earning more from one's labor will be difficult, as will reaping easy speculative gains from simply owning assets.
The debt-free frugal may be forgiven for indulging in a bit of schadenfreude toward those who scorned frugality in favor of living large in the moment. Now who's living large? Not the extremely frugal, because squandering money gives them no pleasure, and they prefer the anti-status "status" of old cars and trucks, tools that have lasted decades and assets that look like everyone else's except they're debt-free.
As for income--those who control and invest their own capital and labor, the class I've long called mobile creatives--will have far more opportunities than those chained to the monoculture plantations of corporate cartels and government agencies squeezed by collapsing tax revenues.
A great many people who reckoned moderate frugality was more than enough will discover it no longer suffices. A great many other people who reckoned they were rich enough to spurn frugality will discover their income no longer covers their expenses and so expenses will have to be slashed and burned to the ground.
And many frugal people who did the best they could with limited income will find that even extreme frugality can't fix a decline in income.
An economy-wide reckoning of what's essential is just starting. Netflix subscription? Gym membership? Fast food takeout a couple times a week? No, no and no. A thousand no's as there are only two ways to survive a decline in income and net worth: slash expenses or default on debt. Both are toxic to "growth" in spending and debt.
Money and Work Unchained $6.95 (Kindle), $15 (print) Read the first section for free (PDF).


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Posted by Charles Hugh Smith at 9:19 AM

Wednesday, March 25, 2020

The Pandemic Is Accelerating the Breakdown That Began a Decade Ago

The feedback loop has reversed: by saving more, people will spend, borrow and speculate less, draining the fuel from any broadbased expansion.
In eras of confidence and certainty, people save less and spend more freely. When we're confident that good times are not only here but will continue, we not only spend more freely, we're more inclined to borrow money and speculate on the shimmering promises of more good times ahead.
In eras of uncertainty, people save more and spend, borrow and speculate less. There is an obvious feedback loop here: if people feel confident about their future prospects and have a measure of certainty about the general economic trend, they spend more, borrow more and speculate more, all of which feed the expansive mood that then encourages further spending, borrowing and speculating.
If their confidence collapses and the future is deeply uncertain, people save more as a hedge against bad things happening in the economy that could trigger hardships in their own household.
With this in mind, it's interesting to look at a long-term chart of the U.S. savings rate, courtesy of the St. Louis Federal Reserve database (FRED). It's easy to discern the waxing and waning of confidence / certainty in the decline or expansion of savings.
The broadbased prosperity of the 1960s is reflected in the high savings rate as cheap oil and real-world growth (as opposed to financial trickery and speculation) fattened paychecks while real-world inflation (cost of living) remained low.
The uncertainties of stagflation--oil shocks, recessions and soaring inflation and interest rates-- pushed savings higher in the early 1970s. As purchasing power and speculative gains fell, so did the savings rate as households struggled to keep up with soaring costs of living.
Once inflation and speculative excess were wrung out, the stage was set for a 25-year expansion of "good times" powered by the financialization of the entire economy, the rise of high tech and the first stages of de-industrialization and offshoring, a.k.a. globalization.
Note that the savings rate popped higher after the 1991 oil-shock / Desert Storm recession and again after the dot-com bubble burst in 2000-02.
But the trend to save less and spend/speculate more continued until the the housing bubble burst, triggering the Global Financial Meltdown of 2008-09. When the dot-com bubble burst, the effects were largely confined to the tech sector and those who had speculated in the frenzy. But the housing bubble bursting had far wider consequences, as housing is the bedrock of household wealth and mortgages are the largest category of household debt.
The primary trick of financialization is to turn previously low-risk assets such as home mortgages into high-risk financial instruments that can be traded globally as "low-risk" assets. This fiction--greased by rampant fraud and institutionalized misrepresentation of risk--nearly brought down the global financial system when it finally unraveled.
This globalization of financialization went hand in glove with the rapid expansion of offshoring and the hollowing out of real-world economies as the purchasing power of labor (wages) stagnated for all but the top tiers (top 5% and to a lesser degree, the top 10%) of technocrats, managers and entrepreneurs who rode the wave of globalization and technology.
To save the financial system from a well-earned collapse, central banks pushed monetary policies to unprecedented extremes, lowering interest rates and flooding the system with liquidity / stimulus. These extraordinary monetary policies boosted assets while leaving the real-world economy in decline as globalization stripmined local economies that could not compete with global corporations feasting on low interest rates, a steady decline in quality and quantity designed to increase profits and cheap overseas labor.
Despite the thin gloss of "growth" this hyper-financialization generated, the stagnation of wages and real-world economy are reflected in the savings rate which has been steadily rising since 2009. The erosion of the real-world economy and the purchasing power of wages has sapped confidence in future prospects and ushered in an era of rising uncertainty.
The economic-financial fallout from the Covid-19 pandemic is accelerating the loss of confidence and the rise of uncertainty that has been trending higher for over a decade.
The feedback loop has reversed: by saving more, people will spend, borrow and speculate less, draining the fuel from any broadbased expansion. This is one reason why monetary policy extremes won't revive growth, real or fictitious: the uncertainty that was launched in 2009 is only deepening.
Money and Work Unchained $6.95 (Kindle), $15 (print) Read the first section for free (PDF).


If you found value in this content, please join me in seeking solutions by becoming a $1/month patron of my work via patreon.com.
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Posted by Charles Hugh Smith at 10:24 AM
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