The Market Ticker

Let’s talk about the economy – and the lack of jobs.

In the week ending July 31, the advance figure for seasonally adjusted initial claims was 479,000, an increase of 19,000 from the previous week’s revised figure of 460,000. The 4-week moving average was 458,500, an increase of 5,250 from the previous week’s revised average of 453,250.

Uh huh.  Note that the previous week was revised (again), but even so, the claims number is creeping ever-closer to the 500,000 level that marks “depressed”, and further and further away from the 300,000 level that marks “reasonably decent conditions.”

Why?

I’ll tell you why.

We have refused to address of the structural problems in the economy.  We have instead allowed our elected idiots to paper over those problems, and they have done so.

So Wall Street had a nice rally off the 666 lows to just over 1200.  A rally that is dissipating and sell-offs are now coming with increasing frequency and violence.

Just as they did in the early part of, and the summer of, 2008.

Everyone wants The Fed to come save the day.  It can’t.

Policy rates are at zero.

“Quantitative easing” doesn’t solve anything, as all you’re doing is debasing the currency, which in turn makes everything more expensive (or depresses wages – same outcome) and that in turn means that purchasing power decreases, which means that forward economic activity decreases as well.

It is exactly identical to giving a speed freak more meth.  Each dose produces not improvement, but pain avoidance.  But the cost of each dose is that the addict’s teeth become more rotted and their eyes more sunken.  The systemic damage accumulates with each bout of abuse.

While the addict seems to feel somewhat better for a short while with each dose he takes, he is in fact being systemically poisoned.  Eventually, bereft of teeth and with his body deprived of the ability to process nutrition, the addict will die irrespective of how much more drug he or she consumes.

The only solution for an addict caught in this spiral is to stop and take the pain of detoxification.  The pain is considerable – even excruciating.   Indeed, it feels even worse when the drug is stopped than it did in the depths of hell to which addiction had taken the sufferer.

Yet it is the only path out.

Such it is with the economy.

Barack Obama and Congress simply do not get it.  They think they, along with The Fed, can “prime the pump” with “stimulus”, just as the meth-head thinks he can “stimulate” recovery with “just one more hit.”

He’s wrong, as is Congress, Barack and The Fed.

The excess capacity in the economy cannot be sustained.  It simply doesn’t matter whether policymakers like this or not.  An economy that can only run at its former rate when mainlining speedballs cannot continue to operate in this fashion without killing the host.  Detoxification and a slowing of the economic metabolism to sustainable levels is the only way you survive.

Along the path to perdition we allowed a tapeworm to take up residence in the bowels of our economy: “financial innovation”.  It was not that long ago – indeed, within my lifetime and experience – during which bankers earned $50,000 a year and bank stocks returned 7% dividends – and no capital appreciation at all.  Banks made loans and held them to maturity, consuming the ~2% spread they needed to survive and paying out the entirety of the rest of it to shareholders in the form of dividends.  They were stodgy, old-school businesses that performed a vital intermediation function – and consumed ~5% of the economy in doing so.

Now financial innovation has gone from 5% of the economy to 20%.  But as the tapeworm grows larger, it consumes more and more of the fuel that the body takes in.  Soon the tapeworm not only consumes enough of the fuel to cause you to starve even though you’re eating like a horse, it in addition gets so large that it blocks the intestines – and can produce life-threatening stoppages and infections.

There is no way to reason with such a tapeworm.  It, like all organisms, will seek to survive, grow and reproduce – and it doesn’t care if you like it or not.  Your only choices are to kill it – or, if you don’t – die.

We as a nation must eradicate the tapeworm.  We must relegate the financial system to its former status as an intermediator – the old stodgy bank – and dismantle the complex and intertwined institutions that are sucking the economy dry.  We have refused for two decades to do this, believing in the Alan Greedscam and Turbo Tax Timmy mantra that a strong and diverse financial system is inherently necessary to a strong economy.

These statements are lies.  That they’re lies is trivially proved: financial innovation in all of its forms is inherently parasitic – that is, it produces nothing in the economy.  In it’s role of distributing risk it inherently must siphon off some portion of actual production to itself.

That means that the productive portions of the economy must produce more to feed the beast within.  But the beast inexorably grows – it reached 25% of the “earnings” in the S&P during the bubble years.

But that 25% wasn’t the bank’s earning power – it belonged to other actors in the economy and was stolen from them as a form of “tax”, just as the tapeworm steals your nutrition.

This in turn goaded CEOs to take on more and more leverage so they could “make their numbers” with that inherent 25% siphoned off.  And that, in turn, resulted in the market and economy as a whole levering to unsustainable levels.

Our error in 2007 and 2008, as I have repeatedly said, is that we refused to force these firms to face the music for their actions.  Actions that, in many cases, were outright fraudulent – and where they weren’t, they were unsound and unsustainable.

New York City has grown addicted to the tax and business revenue from these firms, but that doesn’t mean the rest of the nation can sustain New York City, any more than the rest of the nation can sustain California’s insistence on giving sanctuary to the 4% of our population that are illegal immigrants – who give birth to 8% of our babies, and who pay 0% of their hospital bills.

This is the result:

We’ve blown 14% of GDP in new debt to maintain the tapeworm, attempting to mainline speedballs into the arm of the economy.  It’s not working.  The reason is that the tapeworm is consuming nutrition faster than the economy can take it in, and as a consequence we are now in economic death spiral, exactly as I noted in 2007.

One way or another that parasite will be removed.  We either do it ourselves and suffer the pain required to heal or the market will do it for us with horrific and destructive results.

Those are the only two options folks.

The Fed cannot fix this.  Nor can Congress so long as the debate is focused on taxes.  We are running structural deficits of fourteen percent of GDP – nearly half of the federal budget is being borrowed.  This is akin to someone who is bringing home $2,500 a week but spending $3,800 – there is no reasonable way to increase one’s earnings by that amount – they must instead stop spending or they will go bankrupt.

I know that the government at all levels has made promises to people.  We don’t have the money.  It doesn’t matter if we want to keep the promises or not when we are physically unable to do so, and the tapeworm is continuing to eat more and more of the nutrition that flows past it.

The last speedball served to the Stock and Credit markets is about out of juice and we are headed for a future with a ticker on the market that looks like the masthead on The Ticker if we don’t cut this crap out – NOW.

Time’s up folks.

The Market Ticker

Amazing.  Simply amazing:

Aug. 11 (Bloomberg) — Let’s get real. The U.S. is bankrupt. Neither spending more nor taxing less will help the country pay its bills.

What it can and must do is radically simplify its tax, health-care, retirement and financial systems, each of which is a complete mess. But this is the good news. It means they can each be redesigned to achieve their legitimate purposes at much lower cost and, in the process, revitalize the economy.

Yep.  We’ve been over most of this before in The Ticker, but I’ll be happy to do it one more time.  But before I do, let’s get to this:

“The U.S. fiscal gap associated with today’s federal fiscal policy is huge for plausible discount rates.” It adds that “closing the fiscal gap requires a permanent annual fiscal adjustment equal to about 14 percent of U.S. GDP.”

Gee, where did I see that number before?  Oh yeah, right here:

14% eh?  Gee, that’s a suspiciously familiar number…. (look above, and then look below – there’s your output gap and the federal government’s attempt to cover it up!)

The fiscal gap is the value today (the present value) of the difference between projected spending (including servicing official debt) and projected revenue in all future years.

Got that?  Just like in the 2003-2007 time frame, the deficit that has been built into the economy by the actions of government has become STRUCTURAL.  This is exactly what I’ve been arguing now for THREE YEARS.

So the IMF is saying that closing the U.S. fiscal gap, from the revenue side, requires, roughly speaking, an immediate and permanent doubling of our personal-income, corporate and federal taxes as well as the payroll levy set down in the Federal Insurance Contribution Act.

Well, no.  The IMF is saying that this is what we’d have to do if raising taxes brought a dollar-for-dollar increase in revenue.  But it doesn’t.

Right now if you’re “rich” you get to keep about half of your income.  The rest is taxed away in some form or fashion.  A doubling on those people would mean that they would keep effectively none of their incremental earnings.

The problem with such a tax is that there’s no reason to earn that incremental dollar.  Imposition of such a tax causes an immediate avoidance move by those who earn such incomes – and if they can’t avoid the tax, they avoid the work – and the tax!

As someone who spent many years literally on-call 24×7 as the CEO of a moderate-size company (MCSNet), I can tell you this with certainty: If I had not been able to keep a very substantial amount of the money I earned, more than half, I would not have worked anywhere near as hard – there would be no reason to, when I was simply working for the government – and the people that I employed would have been UNemployed!

For this reason, irrespective of how you feel about the class-warfare game that many play with “tax the rich!” (even though the “rich” pay the majority of all federal income taxes) I can tell you that such a strategy is doomed to fail.  Indeed, The richest 1% of taxpayers pay 40% of all (yes, including FICA and Medicare) federal taxes, which is more than the entire bottom 95% pay – even with the Bush “tax cuts.”

(The next-top-slice, the 4% directly under the top 1%, pay the other 20% of federal taxes.  That is, the top 5% pay about 60% of all federal taxes.)

Many people say that the rich should pay “their fair share.”  To those I retort: What is their “fair share”, when the top 1% already pay 40% of EVERY tax dollar collected, and the top 5% pay 60% of it?  Are you truly going to argue that unless you’re super-rich you shouldn’t pay anything at all?

Such a tax hike would leave the U.S. running a surplus equal to 5 percent of GDP this year, rather than a 9 percent deficit.

Well, no, it’s worse than that.  The IMF is not counting the Social Security and Medicare tax theft.  I do.  This means that the real damage is about 4-5% higher, which means that the IMF’s numbers are low.  Congratulations.

Oh wait – you do get it.  Let’s continue….

Based on the CBO’s data, I calculate a fiscal gap of $202 trillion, which is more than 15 times the official debt. This gargantuan discrepancy between our “official” debt and our actual net indebtedness isn’t surprising.

Ah, there’s recognition.  Incidentally, that $202 trillion is materially higher than my numbers, but once you get into the hundreds of trillions do the rounding errors matter?  I think not.

Congress, of course, simply takes things “off balance sheet” it doesn’t want to count.  Incidentally, so does The Fed in their Z1 tables, which means that the graphs I present are somewhat-misleading, in that even the on-balance sheet portion of Social Security and Medicare aren’t counted.  The off-balance sheet forward liabilities, of course, aren’t counted at all, because legally they’re not “liabilities” – they’re political entitlement programs.  In economist-speak they’re “not really there” as a liability and in legal-speak (so said the Supreme Court repeatedly, from 1939 onward, with the latest being when Social Security’s retirement age was changed) both of these programs are, from a revenue point of view, nothing other than a bare tax.

That is, there’s no obligation to pay.  If you’re a senior, or about to become one in the next 40 years or so, you might want to think about that.  Carefully.

Some doctrinaire Keynesian economists would say any stimulus over the next few years won’t affect our ability to deal with deficits in the long run.

This is wrong as a simple matter of arithmetic. The fiscal gap is the government’s credit-card bill and each year’s 14 percent of GDP is the interest on that bill. If it doesn’t pay this year’s interest, it will be added to the balance.

Ding ding ding ding ding ding.  Notice that Mr. Kotlikoff didn’t resort to fancy math.  He in fact said arithmetic.

Well, to be more correct, exponents.

Back to basics:

The above is a (hypothetical) Ponzi Scheme.

That is a REAL (not hypothetical) Ponzi Scheme – our economic Ponzi Scheme.

All exponential growth functions – that is, “5% annual growth” – if projected out into the indefinite future – are Ponzi schemes.

IN EACH AND EVERY CASE.

The percentage increase dictates only when the Ponzi ultimately collapses.  It does not, however, determine if it will collapse.  That it will collapse is a mathematical certainty.

When I wrote the original business plan for MCSNet the five-year pro-forma financial statements made the following assumptions:

• Approximately 7 million people in the potential service area (greater Chicagoland)

• The first-year take-up would be on the order of 2,000 people (basically nothing), but that at the time organic growth, along with technology improvements, would cause growth well over 100%.

• By the end of that five year period, however, both competition and saturation would mean that growth would level off and reach a near-replacement state – further growth would come either through expansion of service areas or cannibalization of other provider’s customers.

That is, I recognized that ”forward growth estimates” that projected double-digit (or more) five-year growth rates were entirely unrealistic.  It was unrealistic because of the math, and nothing I wanted to do about this could, or would, change it.

As it turned out my projections were pretty accurate.  By the time I sold the company the technology was mature and growth rates were way down.  The “go go rah rah” 100%+ growth rates had abated to replacement + cannibalization + a bit more.  But the business was stable and crazy-profitable, because I had not committed to spending and financing activities that required those sorts of growth rates to make the payments!

Go find some old S-1s from some of the failed firms.  Look at their five-year projections.  Hell, look at the 5-year forward growth “estimates” for AMAZON (AMZN): 27%!  Worse, the SECTOR growth rate estimates on a five-year forward basis are 15.38%.

Not a snowball’s chance in hell folks.  And yeah, I know, the last five years were great on a annualized basis in sales.  But this sort of projection on a forward, permanent basis IS A PONZI SCHEME.

Unfortunately this is the premise of all such Ponzi schemers.  David Lereah and his “housing bubble” books was one such claimant.  Remember these?

Ponzi.  Why?  Because the projections made in those books required an ever-expanding price on a compound growth rate. It did not project an end to the growth rate, and a reasonable date and reasoning by which that end would occur.  Instead, it simply took the view that “for the foreseeable future” prices would continue to rise (and then went on to cite a bunch of “reasons”.)

So did the Internet Bubble.

And so do the projections that government and market analysts are making for forward growth rates, the stock market and the economy.

To solve these problems we have to do the following:

• Replace the tax system.  All taxes are paid by people.  We must both recognize this formally and make it transparent so that everyone knows what they’re paying, and where it’s going.  The Fair Tax is the only plan I’ve seen laid upon the table that will actually do this, and at the same time maintain a generally progressive system.

• Replace borrow-and-spend with save-and-form-capital. This has to happen both corporately and individually.  That means that real interest rates must rise so that borrowing for the purpose of speculation or consumption becomes expensive, and borrowing is thus only economically-justified if the intended use falls into the bucket of capital investment.
• Recognize that perpetual growth is impossible.  This means that those who project such things must be able to show their work, and the presumption against anyone who makes such a claim in the context of advice to a public official or private investor is that they are attempting to promulgate a Ponzi Scheme and be charged and tried for doing so – because they are.
• Recognize that there is no possible way to provide what was promised in Social Security and Medicare.  It is simply impossible – mathematically so.  These programs relied on perpetual growth in both tax receipts and population.  That is mathematically impossible out to the indefinite future as the land mass of this rock is fixed. We must therefore recast these programs to be fiscally solvent and isolate them so that they have no access to a general Federal backstop.  This will result in major curtailment of the promised benefits.
• Public pensions at the state and local level must be equally recast at the same time.  The simplest way is to put them under the auspices of the PBGC – all of them – right now.  The mechanism is already in place to do this.  That caps off pension payments in the ~$50,000/year range and stops the abusive double-dipping and other similar practices.  All public pension programs must be terminated at the same time existing pensioners are transferred to the PBGC.  The PBGC provides that all such pensions must be self-funding and reduces benefits automatically to the point that they are.  Public employee unions must live under the same rules as private ones - if you push the Ponzi to the point of breaking then your alleged “benefits” that can’t be funded mathematically won’t be – you’ll get only what the math in the form of the funded amount will support.  Period.  This mess is the primary cause of state and local government fiscal distress, and we must fix it, as we are on the verge of an all-out collapse in this regard.

The Fed appears to have recognized the above facts, but won’t come out and say it.  If they do the DOW goes down 5,000 points in about a week, and the SPX trades under the 666 low.

But refusing to say it doesn’t make it not happen, or change the facts.  It simply means that you don’t say it out loud.

And yes, this sort of recognition will result in a major economic contraction.  I’ve opined on this before – we are running a debt level some 60% above sustainable levels, and GDP 40% above.  Both must correct to sustainable levels, and the pain that this will bring to our society will be sizable.  Every “Big Bank” – all of them – are in fact insolvent, as all are relying on perpetual growth in the debt ponzi that cannot, mathematically, occur.  The depositors can be protected but nobody else can be, including the pension funds that own their paper.  The over-levered must be forced through resolution – bankruptcy – with the equity holders wiped out and the debt holders converted to equity.  Yes, this too will hit pension funds and individuals.  Prices must fall generally, especially in housing but also in all other asset classes, to the point where asset valuations reflect forward cash flows without the promise of an indefinite-forward growth rate that cannot occur.  This is not deflation per-se, it is reversal of the ponzi-based inflation that resulted from the fraudulent schemes foisted upon our society by the political and bankster classes.

(Incidentally, if we don’t cut this crap out right now the correction will be worse than 40%.  Thus far, from the above graph, it’s 9.7% + 11.6% + 12.35% – compounded, or 37.67%, and that’s just the distortions from the last three years.  The longer we let this go on the worse it will be – there is no way around the mathematics of this.)

Markets eventually suss out the truth.  The heroin high of credit expansion always feels real good at the time you take up the new credit, but the compound annualized growth rate of DEBT in the system, not including the off-balance-sheet Federal programs, has been 8.78% since 1953!

In the same time the compound growth rate of GDP has been 6.81%.

This is the definition of a Ponzi Scheme – the premise that one can growth GDP forever (and business plans are made and predicated on that) but also that credit can grow faster than GDP forever.

Neither of those premises is true, and having run this scam for sixty years we’ve now found the end of the rope – and it’s 20 stories up from street level.

For more than three years I have been banging this drum.  It is delightful to finally read these facts in a mainstream media publication, but at the same time rather sad that it took this long.

Buckle up folks.