88% Probability We Just Entered Recession & The Broken Monetary Mechanism That Got Us Here

My last piece “The Matrix Exposed” generated a bit of a stir.  And as per usual the PhD’s had some fairly colourful things to say to me regarding the notion that more money and more credit may actually stall an economy.  But look I’m not trying to be offensive to anyone.  I’m simply making a case that when consumer credit becomes the basis of growth, well you have a real problem.  And that is a pretty reasonable argument even without the hoards of data backing it up.

But so allow me an attempt to mend some bridges.  Let’s start by looking at the various existing frameworks that drive economic policy.  We have Monetary policy (the banks), Fiscal policy (Congress), Microeconomic policy (Corporations).  So let’s look at each.

Let’s begin with Fiscal policy.  The very first issue that should jump out to everyone is that Congress has been utterly ineffective for almost 2 decades now.  That is because the partisanship has become so intense that there simply seems no room for compromise in an effort to get any reasonable piece of legislation done.  What we are left with is a slew of outdated fiscal policies.  Perhaps most detrimental is a corporate tax rate nearly twice that of many other developed nations.

The problem with relatively (to other nations) high corporate tax rates is it means that any domestic investment, everything else equal, has a significantly longer breakeven point.  Said another way, the return on domestic investment is much lower than the return on foreign capital investment (ceteris paribus).  This is a very intuitive concept, easily digestible by all.  The implication is that the relative level of corporate tax rates here in the US incentivize corporations to invest elsewhere.

And corporate tax is now a catch 22 because government transfers have become such a robust part of the societal fabric.  We need the high corporate tax level for the transfers but the transfers are in part a result of the high corporate tax level.  This quickly becomes a highly sensitive political point of dispute.  And again with Congress completely locked down by partisanship there is essentially zero probability of any significant legislation (either tax cuts or spending initiatives) being passed anytime soon.  And so Fiscal policy is off the table.

Now let’s look at Monetary policy and the Fed.  If you follow my research and writing you’ll know that I’m not the Fed’s biggest fan.  That said, if we are going to have a Fed it should do what it can to be beneficial to the economy.  But so how does the Fed affect the economy?  Well it does so through interest rates and money supply.  Now the major problem with monetary policy is that it attempts to stimulate economies by incentivizing capital allocators (corporations) to be productive.  It does so by essentially dictating the cost to borrow, which flows through to breakeven point and thus return on investment.  It also increases the effective money supply in the economy (through credit i.e. fractional reserve) in an effort to kickstart a demand side that then incentivizes capital allocators (corporations) to be productive.

By being productive I mean initiating domestic capital investment, which should lead to jobs and thus demand via improved incomes; and the boom cycle begins.  And the Fed had some success historically.  But Fed/Monetary policy has been ineffective during its latest recovery program post financial crisis.  Why?  Well when we look at things like corporate debt levels we see that Fed easing did incentivize corporations to borrow but what they did with that capital countered the Fed’s objective and this is the main problem with monetary policy.  It is indirect and requires allocators to play along and this time they didn’t.

And so when we look at what corporations did with that money we find the broken mechanism of monetary policy.  Rather than initiating productive domestic investments a significant amount of those funds went to dividends, buyback and foreign capital investment.  None of which hit on the Fed’s objective for easing monetary policy.  And so while the Fed may have been genuine in its attempt to stimulate the domestic economy, it was reliant on corporate microeconomic policy to follow suit.  And that simply didn’t happen.  Let’s visualize this story with real data.

Here’s the Fed’s implemented monetary easing post financial crisis.screen-shot-2016-09-15-at-1-17-32-pm

Next chart shows that Fed policy did incentivize capital allocators (corporations) to borrow.screen-shot-2016-09-15-at-1-12-07-pm

Next chart shows that corporations have been increasing dividends as their borrowing increased.screen-shot-2016-09-15-at-12-52-40-pm

Next chart shows that corporations have taken buybacks to record levels as borrowing increased.  If you summate divs and buybacks you’ll note it is more than 100% of net income.screen-shot-2016-09-15-at-12-53-29-pm

Next chart shows the increased debt is used almost exclusively to buy back shares (cash distribution – the most inefficient use of capital). screen-shot-2016-09-15-at-1-20-35-pm

Next chart shows that real private domestic business investment peaked in Q1 ’15 at a much lower level than where it was in the late 1990’s and has again been contracting for the past year despite the most extreme monetary easing in the history of the Fed.screen-shot-2016-09-15-at-1-01-37-pm

This means that the significant increase to borrowing that was incentivized by Fed policy in order to stimulate productive domestic investment actually went to the most inefficient use of capital, i.e. cash distributions.  And that means the Fed’s monetary policy objectives failed to be realized.

Notice in the above chart that a recession (grey verticals) immediately followed every sharp drop in real net domestic business investment (recession was delayed in the 80’s but we ultimately succumbed to recession before increasing). However, today we are asked to believe record equity valuations are warranted based on near/medium term expectations despite an 88% probability that we have just entered a recession?  Well that’s a topic for another day.  Now what happens at the microeconomic level when capital is misallocated?

Next chart tells us exactly what happens.  Return on investment  and balance sheets deteriorate.  So we add risk while reducing return.  An investing 101 No – No.  screen-shot-2016-09-15-at-1-21-30-pm

The result of perpetually misallocating capital is that everyone dies in the end.  And look I have sympathy for CEO’s.  In fact, I’ve given CEO’s a pass on criticism.  It is because CEO’s are simply pawns in the system.  They are beholden to what investors demand.  And investors want returns.

Investors today, with median holding periods now less than 60 days, don’t care if a CEO can provide return through expansion of operations or contraction (raiding the balance sheet).  For the past 8 years CEO’s have only been able to provide investors a return through contraction (as a result of a damaged demand function) and so they have done so.  The problem is that while this is generally ok on a short term basis as an individual firm awaits its demand universe to correct, things are different this time.  Demand isn’t coming back because all firms have implemented the same survival policies, which become destructive to both demand and productivity on the macro level.

The result is that these corporate microeconomic policies of capital misallocation (implemented in an attempt to appease investors) are negating all of the intended benefits of Fed policy.  This means we are fully reliant then on fiscal policy which, as we already discussed, is off the table for as far as the eye can see.

And so even if we accept that all existing economic policy frameworks (fiscal, monetary, microeconomic) really do have the very best of intentions we are still effectively dead in the water.

So then what in the hell do we do?  Well there is a real and viable solution that would require no central banker, legislator or CEO involvement by creating a fourth policy framework.  Let me know if you’re interested in hearing more.

 

 

The Matrix Exposed

I define corporatism as an economic model, such as our existing, that prioritizes short term profit maximization above everything else even consuming all other aspects of society to attain that goal.  Now I try not to simply opine on matters I discuss but attempt to substantiate my claims with objective quantitative analysis.  And yet it amazes me the number of ‘experts’ and otherwise out there that don’t just disagree with me but quite aggressively take exception to my claims.

What is really fascinating to me is that so many stringent supporters of corporatism honestly believe they are proponents of capitalism.  And it is for them that I’ve set out to unleash the iniquitous truth with such clarity so as to finally sever their misplaced loyalties to those false authorities who would have them not only believe but defend that the system is, in fact, what ‘They’ say it is.

Now before we go on, I must warn you there is a potential risk lying somewhere between jest and certainty that you will never see the world the same way again.  And so if this is something that will cause you a sense of unending doom then perhaps best to click over to CNBC.  And so….

“This is your last chance. After this, there is no turning back. You take the blue pill—the story ends, you wake up in your bed and believe whatever you want to believe. You take the red pill—you stay in Wonderland, and I show you how deep the rabbit hole goes. Remember: all I’m offering is the truth. Nothing more.”

Recently I provided some charts that show Wall Street profits up some 800% over the past 30 years while over that same period median weekly earnings for the American worker have risen about 9%.  The point of this was not to make a moral judgement about central bankers (I’ll leave that to you), but to highlight the fact that policy objectives are best understood through policy results.  Now in today’s world of continuously updated news, facts and figures it becomes almost impossible to gauge real progress.  We rarely ever hear about YoY results anymore let alone 5 year or 10 year results.

Our standard of measure is relative to yesterday or at most last quarter.  This allows the artistic freedom of seasonality adjustments.  You see YoY results don’t require seasonal adjustments and that means the raw figures would have to be exposed.  And well, that is a dangerous proposition for any government office or agency.  But by keeping us focused on a new individual leaf each day they have prevented us from noticing the forest has burned down around us.

So take a step back with me and let’s look at the long term results to see exactly what the policy objectives have and continue to be.  What we are about to see is that for those not already in retirement and especially for those just entering the real economy today the economic future is menacing and most will not survive it.

Now the subject of trade agreements always seems to elicit some very intense opposition to my own views.  My claims have focused around the concept that so called Free Trade Agreements are anything but.  These international trade agreements have two basic objectives.  First is to create a cost arbitrage while negating the high risk proposition of undeveloped economies that naturally exists in a free market.  Second is to protect the cost arbitrage from tariffs when targeting consumers back in developed economies.  That’s really it.  If you could lock those two objectives up on the back of a napkin the corporate interests would be happy for our legislators to sign it.

I’m about to prove that these trade agreements are the very essence of corporatism and together with fiat money have destroyed the natural self sustainment of capitalism through the requirement of private and public debt.  In doing so corporatism has sabotaged the vast majority of American households thereby eradicating the capacity for economic growth.  Leaving a tremendously precarious situation for those whose futures are not yet secured by fortune.

Note that labour cost arbitrage is not a real competitive advantage because it only works if government legislates away the naturally occurring free market risk.  That is by definition, not a free market concept.  So please, let’s stop calling these trade agreements ‘Free Trade’.  And now think about a true capitalism cycle – Investment/production requiring profit, profit requiring consumption, consumption requiring income and income requiring investment – with only those parametres could firms profit if all firms implemented a labour cost arbitrage strategy?  Well let’s quickly run through it.

Imagine all CEO’s replace their domestic workers with cheap foreign workers in hopes of increasing profit.  A trade agreement is put in place to negate the higher risk of their foreign capital investment and to ensure no tariffs are placed on products when they sell back into the domestic consumer market.  So all firms build products overseas, ship them back to the US and put them on the shelves of Walmart.

So far everything is looking good.  We have the Investment/production stage and now just require the consumption stage to realize profits so we can start the cycle over again.  However, in our capitalism cycle it appears that consumption requires income yet all CEO’s replaced domestic income with cheap foreign income in an effort to increase profitability.  And so how do corporations realize profits if there is no income for domestic consumers to consume?

This is the absolute heart of the problem and helps to clarify the difference between capitalism and corporatism.  Corporatism strategies (trade agreements and economic cannibalism) necessitate credit and welfare (private and public debt) whereas capitalism is self sustaining.

Please understand the above is a logical syllogism because corporate profit requires a transaction to take place.  If no transaction then no profit is possible.  The transaction is a necessary (but not sufficient) process for corporate profit.  The transaction we call a ‘sale’.  The sale we call ‘consumption’.  So profit necessitates consumption.  Consumption can only come by way of three means, namely, income, credit and welfare.  Therefore by decreasing income in an effort to increase profit (on a macro scale, which is exactly what trade agreements do i.e. push microeconomic strategies on a macroeconomic scale) firms must assume the lost consumption from the lost income will be made up by credit and/or welfare.  And in our current system it is.  And I’m about to prove that to you beyond any shadow of a doubt.

If my claims are correct, then by implementing a labour cost arbitrage on a macro scale (trade agreements) you would end up with current account deficit inflection points following major trade agreement events.  The most recent trade agreement events for the US were NAFTA and the Tokyo round of GATT (which increased corporatism benefits by more the 500% over all other rounds combined).  The reason is that domestic consumption would increase materially relative to domestic production (i.e. production shipped offshore while selling that production back in the domestic consumer market).  So let’s have a look at at the data.

Screen Shot 2016-08-31 at 5.48.47 AM

The chart depicts total current account balance (black line) and 5 Yr moving average (red line).  What we find is that following both trade agreement events we had significant increases to the imbalance of domestic consumption and production.  Notice the balanced current account prior to Fiat money because you can’t run deficits on a gold standard.  Notice a bit of fluctuation in current account after Fiat but prior to Gatt Tokyo.  And then notice the major deficit move post Gatt and the massive deficit post NAFTA.  Essentially Fiat allowed for deficits but the trade agreements unleashed the deficits.

Now the above chart shows that our existing model post trade agreements (necessarily) integrates perpetual imbalances between consumption and production (and remember gdp = gni) so this means that the imbalance must be ‘balanced’ by some input.  And my claim is that exogenous input has to be credit and welfare.  You’ll notice I included the point at which we moved from a quasi gold standard to a full on fiat currency.  The reason is that we couldn’t implement labour cost arbitrage agreements without the ability to print endless private and public debt and so that was a necessary part of corporatism.  So Let’s have look at private and public debt.

Screen Shot 2016-08-31 at 10.33.20 AM

The above chart depicts changes in consumer credit + welfare as a percent of changes in personal consumption expenditures.  Essentially this is tracking how much of the growth in corporate revenues is coming by way of increases to credit and welfare.  What we find is that while there were ebs and flows over time there was a major shift immediately following NAFTA.  The shift moved the ceiling of 37% of consumer sales growth coming from credit and welfare increases before NAFTA to 37% being the floor after NAFTA.  In fact in 2015 a staggering 76% of consumer sales (PCE) growth came from growth in credit and welfare.

By now I must have your spidey senses tingly but I’m about to blow your mind with this next chart.  I’m going to prove to you with absoluteness that these trade agreements that create perpetual trade deficits have a direct requirement for consumer credit.

Screen Shot 2016-08-31 at 10.11.35 AM

The above chart simply adds total real consumer credit per capita / total real salaries and wages per capita (blue line) to the first trade deficit chart above.  It is useful to think in terms of per capita because ultimately the macro is just the aggregate of individual circumstances and choices. The above chart has a correlation of -.9 and highly statistically significant regression results.  While correlation is not causation we have our theoretical basis that predicted this very relationship and the tightness of that relationship is truly striking.

It tells the story that these trade agreements force the economy to subsidize income (i.e. consumption) per consumer with credit.  That is, the trade deficits are a result of the trade agreements as depicted in the deficit charts above.  And the deficits are then directly subsidized by consumer credit, which must make up the relative shortfall in income.  Note the blue line is an almost perfect mirror image of the black line in the chart above, validating the hypothesis that the subsidizing credit is a direct requirement of the ‘free’ trade agreements.

Yeah, I know… colours are getting a bit brighter and things are starting to look much sharper than before.  Truth can be so cleansing.

Now each of these above charts are highly supportive that the logical syllogism I discussed above is in fact absolute.  It’s logical and mathematical; two things that most have very little success debating.  And remember, I’m not suggesting that international trade is necessarily bad.  I’m saying we irresponsibly develop trade agreements with corporate objectives that can only be supported by private and public debt.  The antithesis of capitalism.

Corporatism embodies the worst aspects of both capitalism and socialism to form a uniquely destructive economic framework.  So let’s look at the destructive nature of corporatism.  What we’ll find is that it isn’t only destructive to the average American but to the profiters themselves.

As I’ve discussed previously credit and welfare are a function of income and if income is stagnant then as credit and welfare increase we are moving toward their limit.  And this means we are heading to a maximum level of consumption (which can only be achieved by way of income, credit and welfare).  But not only does credit have a limit relative to income but as it increases for the sake of consumption it actually reduces the flow of consumption over the medium and long term because of interest.

Now without getting too philosophical, when one researches the concept and history of interest (usury, ribbit, riba) one finds that most ancient religions (which were the basis of law) going back to the ancient Vedic Texts prohibited interest either absolutely or in some form (this includes Christianity, Judaism and Islam).  And this to me is fascinating because it suggests that these ancient civilizations were wise enough to understand the potential destructive nature of interest bearing debt.  Some writings actually specifically ban the concept of consumer debt.

What this means is that at some point in even more ancient history some society or societies must have collapsed under the weight of indebtedness because ancient laws were based on generational experience.  Putting this in context with the plight of most great societies in more modern history we see the old lessons were lost on us.  The irresponsible expansion of money and debt being the fatal common denominator of so many great societies in recent history.

So let’s look at the destruction of our modern society by way of corporatism, which is synonymous to the expansion of interest bearing private and public debt.

Screen Shot 2016-09-01 at 4.47.55 PM

The above chart is pretty self explanatory.  What it suggests is that we are only about 5 – 10 years from moving beyond the now 45 year period of deceleration and into actual contraction.  Growth in incomes, credit and population are all below 1% on a 10 year average.  Consumption and welfare growth are around 4% on the 10 year average.  What’s concerning is that this trend, while softening during the 1990’s has again intensified post 2008.  One thing to note is that income, credit and consumption growth rates all peaked immediately following Gatt Tokyo.  What I’m telling you is that this is not a coincidence but a consequence.

And so I guess the point here is that you no longer have to take my word for it or for that matter the word of Moses, Plato, Aristotle, Cato, Cicero, Seneca, Aquinas, Muhammad, Jesus, Philo or even Gautama Buddha, all of whom condemned the concept of usury.  An economic model that is built around interest bearing private and public debt is a form evil in that it necessarily ends in the destruction of society.  Do comprehend that evil presents itself not as repulsive but nefariously seductive and credit is nothing if not seductive.

This is no longer about theory or opinion.  The facts define how this will end.  If you continue to deny these absolutes then you are technically irrational i.e insane.  And so I see this as an end to the debate.

The policy objectives have not been what you were told.  None of the economic policies were intended for your benefit.  Monetary policy is not about you or your well being.  Fiscal policies have not had your interest in mind.  This is not to conclude  that those who control your world maliciously intended you direct harm.  But in the very best case you were and are simply irrelevant in this economic model of Corporatism.

Ironically, however, the solution is your relevance and will be the subject of discussion very soon.

Hidden Agenda Perpetrated by Congress and the Fed in One Chart

I like to say policy objectives are invisible ink and policy results are the coloured glasses that expose them.  You see, policy makers always tell us how they design and implement policies targeted at middle class America.  However, time after time after time, the only segment of society that fails to realize any benefit from any policy is middle class America.  Yet for some mind boggling reason we continue to allow these policy makers to carry on with this skullduggery.  The following chart really tells you everything you need to know about economic policy objectives for the past three decades.

Screen Shot 2016-08-25 at 9.56.24 PM

The above chart depicts Wall Street real profits (black line), non-financial corporate real profits (red line) and real median weekly wages and salaries (blue line) all indexed back to 1982 (this is an important period where antitrust policies broke down under the Reagan admin).

What we find is that while median wages and salaries have increased by a paltry 9% over the past 35 years, corporate income is up 250% and Wall Street income is up almost 800%.   And so over the decades this story line about policies targeting the middle class is absolutely, in every way, a total and complete fabrication.  This chart doesn’t happen by accident nor could it be the result of honest mistakes.

The above results expose the hidden agenda perpetrated by Congress and the Fed.  The American middle class is a patsy in a system designed to do exactly what it has done.  International trade agreements and excessive money printing do help Wall Street and Corporate America but do not help the middle class.  This is made absolutely clear in the above chart.  And if you are one of those typically shallow regurgitators of the theories you’ve been told, well tell it to the facts above.