Blog Archives

How Do We Create Value When Knowledge Is Almost Free?

How do we create value in an economy that is increasingly dependent on knowledge? The answer is complicated by the reality that knowledge is increasingly digital and “unownable” and therefore almost free.

Financialization as a substitute for creating value has run its course.

The crony-capitalist answer is always the same, of course: bribe the government to create and enforce private monopolies. This process has many variations, but a favored one is to deepen the regulatory moat around an industry to the point that competition is virtually eliminated and innovation is shackled.

(more…)

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The Disaster of De-industrialization

By now, we all know what’s happening in Venezuela: hyperinflation, empty stores, a regime in denial. The Trajectory of Venezuelan Hyperinflation Looks Frighteningly Familiar… (Zero Hedge)

My contacts in Venezuela tell me that merely posting the black market exchange rate of bolivars to USD can get you arrested. So yes, Venezuela’s regime has gone full Orwell-1984: whatever is true is outlawed.

Venezuela is imploding not because of hyper-inflation, but as a result of policies that led to hyper-inflation: policies that generate perverse incentives, disincentives to produce goods and services and incentives to depend on government subsidies.

But one of my correspondents nailed a key cause that is rarely discussed: Venezuela has been effectively de-industrialized. Capital that should have been invested in the electrical grid and the oil industry has been diverted to other pet projects (and the pockets of regime insiders).

There’s no food in the markets because government-set prices don’t make it worthwhile to grow anything. Farmers take their produce to neighboring countries if they can, where they can actually get paid for producing food.

But de-industrialization is the result of more than perverse policies. De-industrialization results when a citizenry is denied access to the tools and capital needed to produce goods, and when government subsidies sap the will to take the risks that are part and parcel of making real stuff.

De-industrialization is also the result of currency exchange and trade policy.When it becomes cheaper to import goods and services from other nations, the domestic populace loses the will and the skills needed to produce goods and services.

But a funny thing happens when a nation loses its capacity to produce real goods in the real world: when the currency and trade policies that made importing everything financially sensible blow up, there’s nobody left to actually make essential goods, grow food or maintain critical infrastructure.

De-industrialization is a gradual process. The loss of key industries is gradual; the loss of supply chains is gradual; the loss of local suppliers and jobbers is gradual; the loss of skilled workers is gradual; the decline of local capital is gradual; the loss of the willingness to get out there and take risks to make real goods in the real world is gradual.

This is a chart of industrial production in the United Kingdom. many nations share the same basic trajectory: given a strong currency and restrictive policies, it no longer makes sense to produce goods, food, transport, etc. Financialization and free-spending governments borrowing billions create the illusion that a nation that was once a nation of makers can become a nation of takers with no downside.

Once a nation no longer produces essential goods and services, and depends on financial games or commodities to pay for industrial goods and food produced elsewhere, it becomes vulnerable to a collapse in the financial games and the commodity markets that made it all too easy to succumb to de-industrialization.

A Radically Beneficial World: Automation, Technology and Creating Jobs for All is now available as an Audible audio book.

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Work Won’t Be Scarce–It’s Paid Work That Will Be Scarce

All the media chatter about work disappearing due to automation fails to draw the critical distinction between useful but unpaid work and profitable work.Since value (and profits/wages) flow to what’s scarce, what matters is not the decline of useful work–there’s plenty of that even in a society that has automated production–but the supply of paid work–work that is profitable and hence worthy of wages.

Mark Jeftovic and I discuss work, profit and new models of paying for useful work(44:47) in a free-ranging podcast on my book A Radically Beneficial World.

The great fantasy that many are depending on to solve the decline of paid work is taxing the robots and software that ate all the jobs. These taxes are supposed to pay for the Universal Basic Income that everyone will enjoy once work is automated and jobs become scarce.

The problem with the fantasy is that profits only flow to what’s scarce, and as the tools of automation are commoditized, they will no longer be scarce. Once anyone can buy the same robots/software you own, where is your competitive advantage? If anyone on the planet with some capital can buy the same robots and software, where is the pricing power that is essential to reaping big profits?

Commoditization and globalization push profits down to near-zero. In a world of ever-cheaper, ever more abundant commoditized tools and software, it becomes much more difficult to generate increases in productivity and profits.

Those who dream of the the end of work forget that robots will only be purchased to perform profitable tasks. Much of human life is not profitable. For example, maintaining dedicated bikeways is useful work that serves the health and transportation needs of the community and economy.

There is no way to make this work profitable unless you charge bicyclists for using the bikeways, which defeats the purpose of the bikeways.

The typical response is that governments will pay for robots to maintain bikeways.But that leads right back to the decline of profits and paid labor: since government depends on profits and paid work for its revenues, as those decline, where will government get the revenue to make good all its vast promises for pensions, services, healthcare etc., and buy and maintain robots to do unprofitable but useful work such as maintain bikeways?

Take a look at these charts of productivity and income. Ultimately, increases in jobs, wages and profits flow from increases in productivity, which typically rises as a result of investments in better tools, training and processes.

Productivity struggles when investment stagnates, external costs (such as paying to remediate industrial pollution) reduce the available pool of capital/profits to invest, and new technologies are either limited in scope or do not scale well.

All these factors played a role in the 15-year stagnation of productivity from 1966 to 1980.

As computer/digital technologies improved and dropped in price (i.e. scaled up to impact the entire economy) and financialization (i.e. abundant credit and leverage, and the commoditization of financial assets) provided new sources of profits, productivity increased from 1981 to 2005.

Since then, growth of productivity has been in a freefall: financialization has reached diminishing returns, the technologies of automation have been commoditized, and globalization has opened up a vast new labor force and new places to invest capital.

In sum: what was once scarce is now abundant, and thus it no longer generates value or profits.

When new productivity tools were scarce (unique to American factories and workplaces) and required a growing labor force, productivity growth translated into higher wages. But when productivity growth relied on financial capital and processes and higher-level technical/managerial skills, the gains flowed only to those who owned these processes and skills: generally speaking, the wealthy owners of productive capital and the highly educated technocrat/managerial class (the top 5% and to a lesser degree, the top 20%.)

All of which is to say the model of paying wages for profitable work (or collecting taxes from profits and profitable work to pay government workers) is broken: not slightly broken, but fundamentally broken.

We need a new economic model that recognizes the value of useful work that isn’t necessarily profitable, an economic system that creates money to pay those doing useful work at the bottom of the pyramid rather that creating money only for banks, corporations and financiers at the very top of the pyramid.

There is plenty of work that is useful but not profitable. Work won’t disappear; it’s paid work and profits that will become increasingly scarce. We need a new system that enables an abundance of paid work. This is the topic of my book, which Mark Jeftovic and I Discuss in this podcast (44:47).

A Radically Beneficial World: Automation, Technology and Creating Jobs for All is now available as an Audible audio book.

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We’re in the Eye of a Global Financial Hurricane

The Keynesian gods have failed, and as a result we’re in the eye of a global financial hurricane.

The Keynesian god of growth has failed.

The Keynesian god of borrowing from the future to fund today’s consumption has failed.

The Keynesian god of monetary stimulus / financialization has failed.

Every major central bank and state worships these Keynesian idols:

1. Growth. (Never mind the cost or what kind of growth–all growth is good, even the financial equivalent of aggressive cancer).

2. Borrowing from the future to fund today’s keg party, worthless college diploma, particle board bookcase, stock buy-back, etc. (oops, I mean “investment”)–a.k.a.deficit spending which is a polite way of saying this unsavory truth: stealing from our children and grandchildren to fund our lifestyles today.

3. Monetary stimulus / financialization. If private investment sags (because there are few attractive investments at today’s nosebleed valuations and few attractive investments in a global economy burdened with massive over-production and over-capacity), drop interest rates to zero (or below zero) to “stimulate” new borrowing… for whatever: global carry trades, bat guano derivatives, etc.

Here is my definition of Financialization:

Financialization is the mass commodification of debt and debt-based financial instruments collaterized by previously low-risk assets, a pyramiding of risk and speculative gains that is only possible in a massive expansion of low-cost credit and leverage.

That is a mouthful, so let’s break it into bite-sized chunks. (more…)

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The Destabilizing Consequences of Globalization

It is not possible to coherently discuss the “New Normal” economy without discussing financialization–the substitution of credit expansion and speculation for productive investments in the real economy–and its sibling: globalization.

Globalization is the result of the neoliberal push to lower regulatory barriers to trade and credit in overseas markets. The basic idea is that global trade lowers costs and offers more opportunities for capital to earn profits. This expansion of credit in developing markets creates more employment opportunities for people previously bypassed by the global economy. (more…)

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No Wonder We’re Poorer: Wages’ Share of GDP Has Fallen for 46 Years

The majority of American households feel poorer because they are poorer. Real (i.e. adjusted for inflation) median household income has declined for decades, and income gains are concentrated in the top 5%:

Even more devastating, wages’ share of GDP has been declining (with brief interruptions during asset bubbles) for 46 years. That means that as gross domestic product (GDP) has expanded, the gains have flowed to corporate and owners’ profits and to the state, which is delighted to collect higher taxes at every level of government, from property taxes to income taxes.

Here’s a look at GDP per capita (per person) and median household income.Typically, if GDP per capita is rising, some of that flows to household incomes. In the 1990s boom, both GDP per capita and household income rose together. (more…)

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The Root of Rising Inequality: Our “Lawnmower” Economy (hint: we’re the lawn)

After decades of denial, the mainstream has finally conceded that rising income and wealth inequality is a problem–not just economically, but politically, for as we all know wealth buys political influence/favors, and as we’ll see below, the federal government enables and enforces most of the skims and scams that have made the rich richer and everyone else poorer.

Here’s the problem in graphic form: from 1947 to 1979, the family income of the top 1% actually expanded less that the bottom 99%. Since 1980, the income of the 1% rose 224% while the bottom 80% barely gained any income at all.

Globalization, i.e. offshoring of jobs, is often blamed for this disparity, but as I explained in “Free” Trade, Jobs and Income Inequality, the income of the top 10% broke away from the bottom 90% in the early 1980s, long before China’s emergence as an exporting power.

Indeed, by the time China entered the WTO, the top 10% in the U.S. had already left the bottom 90% in the dust.

The only possible explanation of this is the rise of financialization: financiers and financial corporations (broadly speaking, Wall Street, benefited enormously from neoliberal deregulation of the financial industry, and the conquest of once-low-risk sectors of the economy (such as mortgages) by the storm troopers of finance.

Financiers skim the profits and gains in wealth, and Main Street and the middle / working classes stagnate. Gordon Long and I discuss the ways financialization strip-mines the many to benefit the few in our latest conversation (with charts): Our “Lawnmower” Economy.

Many people confuse the wealth earned by people who actually create new products and services with the wealth skimmed by financiers. One is earned by creating new products, services and business models; financialized “lawnmowing” generates no new products/services, no new jobs and no improvements in productivity–the only engine that generates widespread wealth and prosperity.

Consider these favorite financier “lawnmowers”:

1. Buying a company, loading it with debt to cash out the buyers and then selling the divisions off: no new products/services, no new jobs and no improvements in productivity.

2. Borrowing billions of dollars in nearly free money via Federal Reserve easy credit and using the cash to buy back corporate shares, boosting the value of stock owned by insiders and management: no new products/services, no new jobs and no improvements in productivity.

3. Skimming money from the stock market with high-frequency trading (HFT): no new products/services, no new jobs and no improvements in productivity.

4. Borrowing billions for next to nothing and buying high-yielding bonds and investments in other countries (the carry trade): no new products/services, no new jobs and no improvements in productivity.

All of these are “lawnmower” operations, rentier skims enabled by the Federal Reserve, its too big to fail banker cronies, a complicit federal government and a toothless corporate media.

This is not classical capitalism; it is predatory exploitation being passed off as capitalism. This predatory exploitation is only possible if the central bank and state have partnered with financial Elites to strip-mine the many to benefit the few.

This has completely distorted the economy, markets, central bank policies, and the incentives presented to participants.

The vast majority of this unproductive skimming occurs in a small slice of the economy–yes, the financial sector. As this article explains, the super-wealthy financial class Doesn’t Just Hide Their Money. Economist Says Most of Billionaire Wealth is Unearned.

“A key empirical question in the inequality debate is to what extent rich people derive their wealth from “rents”, which is windfall income they did not produce, as opposed to activities creating true economic benefit.

Political scientists define “rent-seeking” as influencing government to get special privileges, such as subsidies or exclusive production licenses, to capture income and wealth produced by others.

However, Joseph Stiglitz counters that the very existence of extreme wealth is an indicator of rents. Competition drives profit down, such that it might be impossible to become extremely rich without market failures. Every good business strategy seeks to exploit one market failure or the other in order to generate excess profit.

The bottom-line is that extreme wealth is not broad-based: it is disproportionately generated by a small portion of the economy.”

This small portion of the economy depends on the central bank and state for nearly free money, bail-outs, guarantees that profits are private but losses are shifted to the taxpaying public–all the skims and scams we’ve seen protected for seven long years by Democrats and Republicans alike.

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What Killed the Middle Class?

Everyone knows the middle class is fading fast. I’ve covered this issue in depth for years, for example: Honey, I Shrunk the Middle Class: Perhaps 1/3 of Households Qualify (December 28, 2015) and What Does It Take To Be Middle Class? (December 5, 2013)

This raises an obvious question: what killed the middle class? While many commentators try to identify one killer cause (for example, the U.S. going off the gold standard in 1971), the die-off of the middle class is more akin to the die-off in honey bees, which is the result of the interaction of multiple causes (factors that increase the toxic load dumped on bees and other pollinators by modern agriculture).

Longtime collaborator Gordon T. Long and I discuss the decline of the middle class and other key topics in a new 29-minute video How did that work out for you?

So where do we begin this detective story? With the engine of all real prosperity, productivity. This chart reveals that wages stopped rising with productivity around 1980.

Here’s another look at the same phenomenon:

Productivity has been slipping since around 2003: Alan Greenspan:”Productivity is Dead”

Cause #1: declining productivity, which means the pie of real wealth is no longer expanding.

Exhibit #2: middle class wage earners have not received any of the gains.Wages as a percentage of GDP have been falling for decades, with occasional blips up in tech/housing bubbles:

Inflation-adjusted household income has dropped back to levels first reached in the 1980s:

More recently, wages have actually declined, regardless of educational attainment:

Income gains have all flowed to the top 10%, with most of the gains being concentrated in the top 5% and top 1%:

If the middle class didn’t receive any of the gains, who did? Corporate profits have soared to unprecedented levels:

Cause #2: all the gains in the economy have flowed to corporations and the top 10% of financiers, managers and technocrats.

But wait a minute–hasn’t the rising stock market enriched the middle class?Short answer: no. Middle class household wealth has absolutely cratered since the top of the housing bubble in 2007, and hasn’t recovered.

Why? Middle class wealth is based not in stocks but in the family home. The middle class does not own enough financial assets to have participated in the latest stock market bubble, while the majority did not recover the wealth lost in the housing bubble bust. This is the cost of allowing the financial sector to financialize housing and mortgages in the 2000s.

Cause #3: the middle class doesn’t own the “right” assets to benefit from systemic financialization and financial speculation.

How about rising costs? The federal agencies tasked with measuring inflation assure us inflation is near-zero. But these measures underweight big-ticket costs like healthcare and higher education, where costs have exploded higher, greatly increasing the burden on the middle class:

Cause #4: soaring costs of big-ticket expenses such as higher education and healthcare. Saving $10 on cheap jeans imported from Asia does not make up for 135% jumps in tuition and college fees, and $100 decline in the cost of a laptop computer does not make up for healthcare insurance and out-of-pocket expenses in the tens of thousands of dollars per household.

Correspondent Kevin K. submitted this article and accompanying note: Colleges with the biggest tuition hikes (my ala mater University of Hawaii-Manoa clocked in with an increase of 137% since 2004.)

“It looks like the article linked above didn’t do much research since:
University of California Davis
2004 in-state tuition $5,684
2015 in state tuition $13,951
Percentage increase 145.44 percent”

There is no way middle class households with declining real incomes can pay soaring costs imposed by state-enforced cartels and gain ground financially. If the four structural trends highlighted above don’t reverse, the middle class is heading for extinction, the victim of financialization, the glorification of financial speculation via central bank-central state policies, the decline of productivity and rising costs imposed by state-enforced cartels.


We need a new system, one we control from the ground up:
A Radically Beneficial World: Automation, Technology and Creating Jobs
for All
. The Kindle edition is $8.95 and the print edition is $20.82.

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“Free” Trade, Jobs and Income Inequality: It’s Not As Easy As We Might Think

Globalization (a.k.a. “free” trade) has become an election issue for two reasons: many voters blame “free” trade with China and other nations for job losses in the U.S. and rising income inequality as globalization’s “winners” in the U.S. outpace its far more numerous “losers.”

A recent article in the New York Times looks at the issue from the perspective of recent economic studies: On Trade, Angry Voters Have a Point (via Lew G.)

The case for globalization based on the fact that it helps expand the economic pie by 3 percent becomes much weaker when it also changes the distribution of the slices by 50 percent.

Before we dig into this complicated set of interconnected macro-dynamics, let’s stipulate that there is no such thing as “free” trade. Every trade agreement defines winners and losers by the very design of the agreement.

Also, other issues that are outside the confines of the actual trade agreement can have outsized influence on trade’s winners and losers.

For example, trade between the U.S. and China cannot possibly be “free” because China pegs its currency to the U.S. dollar (USD). This peg enables China to arbitrarily keep its products cheaper than they might be if the market set the value of China’s yuan.

We must also keep in mind that the owner of the reserve currency, the U.S., must export its currency in size, i.e. run a permanent and substantial trade deficit. I’ve explained Triffin’s Paradox many times; please read (or re-read) these essays if you want to understand why trade deficits are integral to the reserve currency and are not a feature of any particular trade agreement:

Understanding the “Exorbitant Privilege” of the U.S. Dollar (November 19, 2012)

The Federal Reserve, Interest Rates and Triffin’s Paradox (November 19, 2015)

Many overlook the fact that central bank interventions play an enormous role in establishing globalization’s winners and losers. By lowering interest rates to zero (or less than zero) and flooding the banking sector with credit/liquidity, central banks encouraged an explosion of global carry trades, in which financiers borrow cheap in one currency to buy high-yielding assets in another currency/nation.

The central-bank fueled explosion in credit also threw gasoline on speculative investments in emerging market nations, distorting currencies, markets and trade. The point here is that globalization, financialization and central bank interventions are tightly bound together. We cannot talk about any of these drivers in isolation; together, they form one system we loosely call “global trade.”

Let’s move on to globalization’s impact on jobs, income and income disparity.The article linked above notes that one study found trade with China erased 2.4 million jobs in the U.S. Other studies have found an offsetting consequence: the purchasing power of middle-class and working class households rose by 26% due to globalization’s relentless reductions in the cost of imported goods.

We must take all such estimates with a grain of salt, as there are many dynamics in play. The U.S. economy has been roiled by deep structural changes since the late 1960s; there has been no let-up in systemic turbulence: the end of the Bretton Woods stability in foreign exchange markets; the rise of Japanese and Asian imports in the 1970s and 80s; oil shocks and stagflation in the 1970s; the cost of dealing with industrial pollution of our air, water and soil; the tech boom–the cost of processors and memory have fallen while advances in software and robotics accelerate; the explosive changes wrought by the Internet; the rise of China and the Asian Tigers as the world’s low-cost workshop, and various speculative debt/fraud bubbles that burst with catastrophic consequences for participants and non-players alike.

At the risk of overloading you with data, let’s look at a few key charts and mark the rise of China’s influence, the rise of financialization and income inequality and the explosive rise in U.S. corporate profits.

Here are the charts we’ll be reviewing:

— Civilian employment-population ratio (the percentage of the population who are employed in some fashion, including self-employed and part-time)

— Productivity (and income disparity)

— Income inequality

— U.S. Financial profits

— U.S. Corporate profits

On the face of it, the U.S. experienced a multi-decade boom in employment from the early 1980s to 2008. Many have noted that the key demographic driver of this rise in employment was the mass entry of women into the work force. Many believe the loss of purchasing power in the stagflationary 1970s pushed women into the work force as the only means of maintaining household buying power. There were other drivers, of course; nothing this structural reduces down to one single cause.

This chart looks like a giant head-and-shoulders pattern that correlates with the rise and fall of financialization, which is the commodification of previously safe assets such as housing and the explosive rise in debt, derivatives and financial gaming (which quickly morphs into fraud if regulatory agencies fall asleep at the wheel).

It’s difficult to separate China’s rise and the bursting of the tech bubble, as both occurred in the same time frame; undoubtedly both negatively impacted employment.

The disconnect between productivity and wages really took off with the rise of financialization and cheap technology tools in the early 1980s. This is not coincidental, and can’t be pinned on globalization or trade with China, which occurred much later.

As we see in this chart of income inequality, the top 10% (the “winners” in financialization and tech) had already pulled away from the bottom 90% when China entered the WTO in 2001. Clearly, the disparity began before China’s trade was large enough to impact the U.S. economy; the dramatic increase in trade with China post-2001 had little impact on the disparity between the top 10% and the bottom 90%.

This chart of financial profits and debt/GDP shows the dramatic expansion of debt from the early 1980s and the explosive rise in financial profits as interest rates were pushed to zero and the debt/housing bubble #2 took off.

Could globalization have been a factor in this monumental expansion of financial profits? As noted above, it’s clear that the globalization of finance–carry trades, the expansion of financial markets in emerging nations–gave U.S. financiers, corporations and banks an enormously expanded field for skimming fees and profits via debt, derivatives and speculation.

Total U.S. corporate profits soared once trade with China and the financial free-for-all of housing/debt/fraud took off. This chart makes it clear that the winners from 2001 on were financiers and corporations exploiting two dynamics: offshoring production to China and maintaining product costs to reap outsized profits, and borrowing cheap money to expand overseas and skim profits from carry trades.

What do we get if we add these charts up?

1. Offshoring of production jobs to China et al. undoubtedly slashed jobs for the bottom 90%, but these losses were offset (or masked) by the rise of housing/debt/fraud bubbles that boosted employment in the FIRE sector (finance, insurance, real estate).

2. Financialization and central bank intervention greatly rewarded those with the skills and sociopathologies needed to participate in the resulting debt/fraud booms.

3. U.S. corporations reaped the gains from offshoring jobs, and these gains flowed to top management and those who own corporate shares, i.e. the top 5%.

4. The trend of rising income disparity started long before China’s trade was significant enough to impact the U.S. economy, and correlates with the rise of financialization and cheaper technology tools.

5. These trends rewarded management, finance and technology expertise, which are concentrated in the top 10% of the work force.

6. Cheap imports, offshoring of production and the global expansion of financial markets have driven U.S. corporate and financial profits to unprecedented heights. Since these profits largely flow to top management, financiers, technocrats and owners of corporate capital–roughly speaking the top 10% or even top 5%–it’s no wonder wealth and income disparity is rising: there is no other output possible in the current system.

Slapping fees on imports (which by the way is illegal in treaties such as the WTO) will not solve the larger problems of reduced employment, stagnant wages and rising income inequality. To make a dent in those issues, we’ll need to tackle central bank and central-state policies that have pushed finance and speculative churn to supremacy over the productive economy.


We need a new system, one we control from the ground up:
A Radically Beneficial World: Automation, Technology and Creating Jobs
for All
. The Kindle edition is $8.95 and the print edition is $20.82.

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A Profitless Recession

The basic idea of a balance sheet recession (attributed to Richard Koo) has been well-publicized: when the liability (debt) side of household and business ledgers reach danger heights, stakeholders respond by reducing debt and increasing savings rather than increasing spending and debt.

The result is a slowdown, a balance sheet recession.

What do we call a recession triggered by a collapse in profits? Corporate profits have soared to unprecedented heights in the “recovery” of 2009-2015: it’s certainly been more than a recovery in terms of corporate profits:

What’s left to push profits even higher? The mainstream answer is: just more of the same: more global growth, more expansion in emerging markets (EM), renewed monetary and fiscal stimulus in the developed markets (DM), and the tailwind of lower energy costs.

The possibility that the era of unprecedented profits might have been an aberration and is now drawing to a close does not register in the mainstream financial media. If we look at the red line I drew on the chart, it’s easy to see the incredibly abnormal rise in corporate profits in the era of rapid globalization and financialization, both driven by cheap-money policies of central banks.

Note that profits literally exploded once central banks opened the credit spigots, and lending standards were loosened to the point there were no real standards (2002 onward).

This globalized flood of nearly-free money pushed asset valuations to absurd heights everywhere. These insanely high asset valuations supported additional debt, which then fueled higher asset prices, a virtuous cycle of expanding debt pushing asset prices higher, when then enabled more debt, and so on.

The problem with bubble valuations is revealed when participants must sell to pay down debt. When the debt-monkey can’t be dislodged from the debtor’s back, assets must be sold. And in the thin, rarefied air of most markets, any real selling quickly crashes valuations, which were predicated on more buyers, not more sellers.

The initial wave of selling assets to pay down debt has already crushed emerging markets. Relatively modest selling in developed markets pushed many markets into Bear territory (down 20% or more).

Since stock markets are ultimately underpinned by corporate profits, let’s ask: What factors could crush profits in 2016?

1. stronger U.S. dollar: as many of us foresaw, the stronger USD has pummeled U.S. corporate profits, much of which are earned overseas in other currencies:

The USD Bull in the Global China Shop (February 4, 2015)

Anyone who thinks the USD will give up its gains is dreaming:

Why the Dollar May Remain Strong For Longer Than We Think (September 17, 2014)

2. Emerging markets consumption is weakening. Crush a nation’s currency and stock market, and spending atrophies. When spending sags, so do profits.

3. Oil exporters are reducing their spending. Tightening belts means fewer imported luxury goods and fewer profits for exporters who feasted off oil-exporting wealth for years.

4. China. Imports to China are cratering. Profits will crater, too.

5. Diminishing returns on cost-cutting. All the low hanging fruit has been plucked; shipping manufacturing overseas–done. Reducing head-count: done. Buying software to increase productivity: done. What’s left: slash payroll (again), cancel company 401K contributions, etc.–in a word, devastate employment.

6. Diminishing returns on lower interest rates. Refinancing old debt at super-low rates boosted profits wonderfully the first time around, now, not so much: rates have been low for so long, there’s no juice left in that lemon.

7. Energy savings have been banked. Airlines have feasted on record profits resulting from plummeting fuel costs, but the big gains have already been banked. If oil drops below $30/barrel, a few dollars can be picked up, but they won’t match the gains reaped when oil fell from $100 to $30/barrel.

8. Risk-on borrowing is drying up. The global booms from 2002 – 2008 and 2009- 2015 were both driven by trillions of dollars of new (borrowed) money being dumped into risk-on assets–real estate development, stocks, junk bonds, shadow banking loans, etc.

This tide is now receding.

9. Much of the profit was accounting gimmickry. Jim Quinn recently dismantled the illusory nature of corporate “profits,” drawing upon John Hussman’s analysis:Corporate Profits Vaporizing: (excellent job, John and Jim):

Elevated corporate profits since 2009 have largely reflected mirror image deficits in the household and government sectors, as households have taken on debt to maintain consumption despite historically low wages as a share of GDP, and government transfer payments have expanded to fill the gap, with 46 million Americans now on food stamps – a five-fold increase in expenditures since 2000.

Essentially, corporations are selling the same volume of output, but paying a smaller share in wages, with deficits in the household and government sectors bridging the gap. As households and government have shoveled themselves further into the hole, corporate profits have climbed higher on the adjacent pile of earth. Deficits of one sector emerge as the surplus of another.

If you think all this is a solid foundation for ever-higher profits, by all means go buy stocks with all four feet. But don’t be surprised if the rest of the market disagrees at some point–for example, when even flim-flam accounting can’t hide the fact that profits are in a free-fall back to “normal” levels 60% below current levels.

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2015: The Last Christmas in America

If we define Christmas as consumer spending going up while earnings are going down, 2015 will be the last Christmas in America for a long time to come. In broad brush, Christmas (along with all other consumer spending) has been funded by financialization, i.e. debt and leverage, not by increased earnings.

The primary financial trick that’s propped up the “recovery” for seven years is piling more debt on stagnating incomes. How does this magic work? Lower interest rates.

In a healthy economy, households earn more money (after adjusting for inflation, a.k.a. loss of purchasing power), and the increased earnings enable households to save, spend and borrow more.

In an unhealthy, doomed-to-implode economy, earnings are declining, and central banks enable more borrowing by lowering interest rates to zero and loosening lending standards so anyone who can fog a mirror can buy a new pickup truck with a subprime auto loan.

The problem with financialization is that it eventually runs out of oxygen.

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Why Even a Modest Disruption Will Shatter the Status Quo

Consider this clipping from the August 1932 San Francisco Chronicle newspaper:

“Reduction of salaries of municipal employees and limitation of city positions to only one member of a household will be sought by (Supervisor) Adolph Uhl in two amendments to the San Francisco charter. The salary reductions would run from 2.5% for the lowest bracket to 25% on salaries of $500 a month or more.”

Thanks to the handy BLS Inflation Calculator we know that $500 a month in 1932 is the equivalent of $8,680 per month (about $104,000) a year.

Imagine the tempest of fury and outrage that would arise should this be proposed the next time local governments run short of funding. Nowadays, the calls would not be for sacrifices from the highly paid public servants but for tax increases of 25% to maintain public-servant wages and benefits while the private sector economy implodes.

 

This unwillingness to sacrifice for the greater good is now endemic. This is the result of two powerful social forces:

1. The loss of any shared sense of purpose or social good worthy of sacrifice.

2. The ascendancy of maximizing private gain by whatever means are available as the primary purpose and goal of the Status Quo.

The dominance of maximizing private gain by whatever means are available leaves the Status Quo brittle and fragile. Since everyone reckons any sacrifice should fall on someone else, the only possible result is disunity and bitter conflict over modest sacrifices that are too inconsequential to save the system from collapse.

Wishful thinking, mindless optimism and blind adherence to failed ideas also make the Status Quo brittle and fragile. As Michael Grant noted in his book The Fall of the Roman Empire:

There was no room at all, in these ways of thinking, for the novel, apocalyptic situation which had now arisen, a situation which needed solutions as radical as itself. (The Status Quo) attitude is a complacent acceptance of things as they are, without a single new idea.

This acceptance was accompanied by greatly excessive optimism about the present and future. Even when the end was only sixty years away, and the Empire was already crumbling fast, Rutilius continued to address the spirit of Rome with the same supreme assurance.

This blind adherence to the ideas of the past ranks high among the principal causes of the downfall of Rome. If you were sufficiently lulled by these traditional fictions, there was no call to take any practical first-aid measures at all.

A dependence on debt, low interest rates and financial legerdemain also render the Status Quo extremely fragile when the debt become unpayable and low interest rates no longer boost additional borrowing.

The wishful thinking is that we can borrow limitless sums and leave the debt burden on our children and grandchildren with no consequences. But once the system is dependent on massive borrowing, it becomes acutely sensitive to default, as consumption collapses once consumers can no longer borrow to consume, and asset bubbles engorged by debt-assets (bonds, student loans, mortgages, subprime auto loans, etc.) burst.

Lest you think this implosion from a modest decline in debt and new borrowing is preposterous, please examine this chart of total credit: that tiny wobble in 2008 very nearly collapsed the entire global financial system.

Any modest reduction in debt, tax revenues, consumption or new borrowing will bring the entire Status Quo crashing down. This is the bitter fruit of rampant financialization and the ascendancy of maximizing private gain by whatever means are available.


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