Blog Archives

What’s the Real Meaning of the Stock Market Swoon?

There’s no shortage of explanations on the whys and wherefores of the US stock market’s recent swoon / swan-dive / plummet. Here’s a few of the many credible explanations:

— the economy has reached peak earnings so there’s no fundamentals-driven upside left;

— bond yields are now high enough to dampen enthusiasm for inherently risky stocks;

— central banks curtailing / ending their quantitative easing programs have reduced liquidity in the financial system;

— US markets are catching up to the rest of the world’s market slump;

— the US market is overvalued by just about any measure;

— uncertainty about the mid-term election;

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America 2018: Dicier by the Day

If we look beneath the cheery chatter of the financial media and the tiresomely repetitive Russian collusion narrative (that’s unraveling as the Ministry of Propaganda’s machinations are exposed), we find that America in 2018 is dicier by the day.

The more you know about the actual functioning of critical subsystems, the keener your awareness of the system’s fragility, reliance on artifice and an unceasing flow of “free money.” Keynesian economics boils down to a very simple premise: a slowing or stagnant economy can be goosed by distributing plenty of “free money” which can be freely blown on either speculation or goods and services.

The “free money” (either created out of thin air or borrowed into existence at rates of interest so low that they’re less than zero when adjusted for inflation) dumped into speculation gooses assets higher, generating the “wealth effect” beloved by Keynesians, and the “free money” dumped into goods and services gooses consumption, tax revenues, hiring and so on.

The catch is “free money” is never actually free. Creating trillions out of thin air reduces the purchasing power of all existing currency, and pretty soon you’re following Venezuela into “our money has lost all its value” territory.

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Beware the Marginal Buyer, Borrower and Renter

When times are good, the impact of the marginal buyer, borrower and renter on the market is often overlooked. By “marginal” I mean buyers, borrowers and renters who have to stretch their finances to the maximum to afford the purchase, loan or rent.

In bubble manias, buyers of real estate reckon the potential appreciation gains are worth the risk of buying a house they really can’t afford with the intention of flipping the home for a profit.

Workers moving to high-rent cities reckon they’ll either make more money going forward or find a cheaper flat later, so they pony up the high rent.

When there’s steady overtime or generous tips adding to the household income, buying a new car or getting a new auto lease looks do-able.

It’s difficult to assess how many recent buyers, borrowers and renters are marginal, but given the stagnation in household incomes and rising debt loads, it seems reasonable to guess that a substantial number of recent buyers, borrowers and renters are one lay-off or one missed bonus or one unexpected expense away from being unable to pay their mortgage, loan payment or rent.

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Systemic Uncertainty, Meet Fragility

Life is inherently uncertain, but systems that were once considered certainties have increasingly become uncertain. Social Security is one example; recent polls reflect widespread doubts among Millennials and Gen-Xers that there will be any Social Security benefits left for them by the time they reach retirement age.

This doubt is fact-based; as the number of retirees swells, as Medicare costs soar ever higher and the number of full-time jobs paying into Social Security/ Medicare stagnates, these pay-as-you-go programs break down; Social Security is already paying out billions more than it collects from employers and employees.

Uncertainty is one thing, fragility is another. The socio-economic systems we rely on are also becoming increasingly fragile and prone to failure, for an entirely different set of reasons than those driving uncertainty.

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When We Can No Longer Tell the Truth…

When we can no longer tell the truth because the truth will bring the whole rotten, fragile status quo down in a heap of broken promises and lies, we’ve reached the perfection of dysfunction.

You know the one essential guideline to “leadership” in a doomed dysfunctional system: when it gets serious, you have to lie. In other words, the status quo’s secular goddess is TINA–there is no alternative to lying, because the truth will bring the whole corrupt structure tumbling down.

This core dynamic of dysfunction is scale-invariant, meaning that hiding the truth is the core dynamic in dysfunctional relationships, households, communities, enterprises, cities, corporations, states, alliances, nations and empires: when the truth cannot be told because it threatens the power structure of the status quo, that status quo is doomed.

Lies, half-truths and cover-ups are all manifestations of fatal weakness.

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How Systems Break: First They Slow Down

The reality that cannot be spoken is that all the financial systems we believe are permanent are actually on borrowed time. One way we can judge this decline of resilience is to look at how long it takes systems to recover when they are stressed, and to what degree they bounce back to previous levels.

Another is to look at the extremes the system reaches without returning to “normal”: for example, interest rates, which rather than normalizing after seven years of suppression are being pushed to negative rates by increasingly desperate central bankers.

The key insight here is that financial systems and indeed economies function as natural systems. Central planning/central banker manipulation appears to control the system, but this control masks the reality that the system is increasingly fragile and prone to collapse, not just from internal dynamics but as a direct result of central bank manipulation.

The warning signs of fraying resilience are all around us.

Nature’s Warning Signal: Complex systems like ecological food webs, the brain, and the climate all give off a characteristic signal when disaster is around the corner.

“The signal, a phenomenon called ‘critical slowing down,’ is a lengthening of the time that a system takes to recover from small disturbances, such as a disease that reduces the minnow population, in the vicinity of a critical transition. It occurs because a system’s internal stabilizing forces—whatever they might be—become weaker near the point at which they suddenly propel the system toward a different state.”

Recent email exchanges with correspondent Bart D. (Australia) clued me into the Darwinian structure of this critical slowing down and loss of snapback (what we might call a loss of reslience).

The dominant systems do not operate in a vacuum; beneath the surface dominance of one system are many other systems that are suppressed by the dominant system.

As the dominant system weakens/slows down, these largely invisible systems quickly expand to occupy more of the ecosystem. An example in the financial realm is barter: in a system dominated by central bank/state issued money and digital transactions, barter still exists but on a very modest scale.

When central bank/state currency loses its value and utility (due to devaluation of the currency, hyper-inflation, etc.), then barter expands rapidly to fill the vacuum left by the demise of the dominant system.

The ecosystem example illustrates is how critical transitions occur: as the dominant system slows down, other systems fill the ecosystem niches that are opened up by the weakness of the dominant arrangement. At some point, the equilibrium of the ecosystem is disrupted and a new balance of other dynamics become dominant.

In the realm of currencies, the rise of crypto-currencies is an example of a nascent new system gaining ground as the dominant system slows/decays.

In financial systems, this process can be at least partially conscious: we can see the dominant paradigm weakening, and start developing other systems that can compete for the coming openings in the financial/social ecosystem.

Alternatively, we can cling to a state of denial, and the dominant system will be replaced by arrangements that are not necessarily positive. Conscious development of alternatives that can compete transparently for dominance as the status quo decays is the most effective avenue to more resilient, sustainable systems.

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The Increasingly Fragile Upper-Middle Class

Since the top 10% takes home 50% of all household income, it follows that this top slice has most of the discretionary cash, i.e. net income left after taxes, servicing debt and paying for essentials such as food, utilities and housing.

It also follows that the discretionary spending of the top 10% is supporting much of the economy that is dependent on discretionary spending: tourism, eating out, personal trainers, etc.

The top 10% includes the thin slice of Financial Oligarchy (top .01%) and the top 1%. This skews the income and wealth of the top 10%. But if we set aside the top 1%, the next 10% still earns the lion’s share of household income.

The top .1% can prop up Maserati sales and buy $5 million vacation homes, but there simply aren’t enough super-wealthy to support the U.S. economy. As for the top 1%, they can prop up the local Porsche dealership and pay dock fees at the yacht club, but there aren’t enough of them to support the entire economy, either: around 1.5 million qualify as top 1%.

So that leaves the upper-middle class, the roughly 12 million households that earn a disproportionate share of household income, with the task of spending enough discretionary cash to prop up an economy that depends heavily on consumer spending.

Many of these upper-middle class households are far more financially fragile than their substantial incomes suggest. The vast majority of these high-income households depend on two earners, each making substantial salaries, bonuses and benefits such as 401K retirement contributions.

Many of these apparently high incomes are completely absorbed by high-cost upper middle class expenses. $250,000 a year may look like a lot until you throw in a couple of kids attending private prep schools or college, healthcare costs that aren’t covered by insurance, an enormous mortgage and sky-high property taxes.

The upper-middle class includes many people with wealth, but it also includes many people who have saved very little, and what they do have is in IRAs and 401Ks trapped in the stock market. Their slide to insolvency can be very quick once one high-earner loses their job and can’t find another equally lucrative position in a few months.

Many of these people are vulnerable to a downturn because they own/operate small businesses in discretionary spending sectors–the ones that will get creamed as people cut discretionary spending. Others are sandwiched between kids in college and elderly parents, and their seemingly big incomes are fully allotted to essentials and the generations they are sandwiched between.

One job loss will crumble the entire house of cards. As local government revenues start crumbling along with corporate profits, many high-cost jobs in both thr public and private sectors will suddenly be vulnerable as managers are forced to seek the largest possible savings from job cuts.

The upper-middle class that’s supported the “recovery” with massive discretionary spending is far more vulnerable to implosion/insolvency than is generally appreciated.

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What’s America’s Fragility Score?

By this measure, the U.S. scores very poorly: 4 out of a possible 5 on the Fragility Index.

There is a certain logic to the idea that stability is a good predictor for future stability: if a nation’s economy and governance are stable and devoid of disorder, this trajectory of stability will be durable, right?

Well, actually, no. Nassim Nicholas Taleb and co-author Gregory F. Treverton argue in their essay The Calm Before the Storm: Why Volatility Signals Stability and Vice Versathat “the best indicator of a country’s future stability is not past stability but moderate volatility in the relatively recent past.”

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The Three Acronyms That Best Describe This Era: TINA, TANSTAAFL and FUGAZI

TINA and the complacent belief in free lunches strip the resiliency from a system and leave it vulnerable to collapse.

It’s tough to select three acronyms that best capture the current perfection of central planning, central banking and centralized propaganda. FUBAR (f**ked up beyond all repair) is tough to beat, and for those with a taste for absurdist humor, ROTFLMAO is equally appropriate–especially when “official” economic data is issued by various Ministries of Truth.

After long deliberation, I’m going with TINA, TANSTAAFL and FUGAZI as best defining our era: there is no alternative, there ain’t no such thing as a free lunch, and f**ked up, got ambushed, zipped in (to a body bag).

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