Sunday, May 28, 2017

Will the Crazy Global Debt Bubble Ever End?

There are multiple sources of friction in the Perpetual Motion Money Machine.
We've been playing two games to mask insolvency: one is to pay the costs of rampant debt today by borrowing even more from future earnings, and the second is to create wealth out of thin air via asset bubbles.
The two games are connected: asset bubbles require leverage and credit. Prices for homes, stocks, bonds, bat guano futures, etc. can only be pushed to the stratosphere if buyers have access to credit and can borrow to buy more of the bubbling assets.
If credit dries up, asset bubbles pop: no expansion of debt, no asset bubble.
The problem with these games is the debt-asset bubbles don't actually expand the collateral (real-world productive value) supporting all the debt. Collateral can be a physical asset like a house, but it can also be the ability to earn money to service debt.
Credit card debt, student loan debt, corporate debt, sovereign debt--all these loans are backed not by physical assets but by the ability to service the debt: earnings or tax revenues.
If a company earns $1 million annually, what's its stock worth? Whether the market values the company at $1 million or $1 billion, the company's earnings remain the same.
If a government collects $1 trillion in tax revenues, whether it borrows $1 trillion or $100 trillion, the tax revenues remain the same.
If the collateral supporting the debt doesn't expand with the debt, the borrower's ability to service debt becomes increasingly fragile. Consider a household that earns $100,000 annually. If it has $100,000 in debt to service, that is a 1-to-1 ratio of earnings and debt. What happens to the risk of default if the household borrows $1 million? If earnings remain the same, the risk of default rises, as the household has to devote an enormous percentage of its income to debt service. Any reduction in income will trigger default of the $1 million in debt.
If a household earns $100,000 annually, how much can it borrow? The answer depends on the terms of the debt: the rate of interest and the percentage of principal that must be repaid monthly.
If the interest rate is 0% and the monthly payment is fixed at $1, the household can borrow billions of dollars. This is how the game is played: there is no upper limit on debt if the interest rate is effectively zero, or adjusted for inflation, less than zero.
Would you lend the household your savings, knowing you'll never get any interest and the principal will never be repaid? Of course not. Nobody in a functioning market for capital would throw their hard-earned savings away on a debtor who can't pay any interest or principal.
The only institutions that can play this game are central banks, which create money out of thin air at zero cost. As for risk--the way to manage defaults is to print more money.
But once again--printing money doesn't create collateral or income needed to service debt. As I have explained, printing money is akin to adding a zero to currency. Every $1 bill is now a $10 bill. Are you ten times wealthier once the central bank adds a zero to every bill? No, because the $5 loaf of bread is re-set to $50.
The other problem with this game is interest keeps ticking higher while earnings remain flat. Even at very low rates of interest, interest payments keep rising. This is not an issue if income rises along with interest payments, but if income is flat, paying higher interest costs eventually pushes the borrower into default.
The household that borrowed $1 billion at 0% paid no interest. But let's say the lender now demands 1/10th of 1% interest--nearly zero interest. The household now owes $1 million in annual interest. Oops! Even near-zero interest can generate crushing interest payments once the debt reaches the stratosphere.
The whole game is a bet that future income will rise faster than debt service.Unfortunately, we've already lost that bet: household income has been stagnant or declining for years (or for the bottom 90%, for decades), and tax revenues have a nasty habit of falling sharply in recessions and stagnating along with private-sector earnings.
Which leads to the second game: blowing asset bubbles. If the household's earnings are flat or declining, one magical fix is to inflate the household home's value from $100,000 to $300,000 in a few years.
Now the household has $200,000 in new wealth it can tap. Wow, was that easy or what? That's the easiest $200,000 we ever made!
Of course the house didn't actually gain any additional functional or utility value; it still has the same number of rooms, etc. It still only provides shelter for the same number of residents. The $200,000 in "wealth" that can now be borrowed or accessed via selling the house does not reflect an increase in the collateral's utility value--it's all financial magic leveraged off an unchanging utility value and household income.
These games look like a Perpetual Motion Money Machine. There is no cost, it seems, to expanding debt and assets bubbles; if future income doesn't rise enough to service the growing mountain of debt, we either print more money, lower the interest rate or create "wealth" with even grander asset bubbles.
But there is eventually a problem. At some point, even 0.1% interest becomes unaffordable, and adding zeroes to the currency devalues the currency faster than incomes rise. Asset bubbles run out of greater fools to buy at elevated prices.
Borrowers default, asset prices crash and everyone holding the currency is impoverished.
There are multiple sources of friction in the Perpetual Motion Money Machine.State-cartel inflation eats  away at stagnating incomes, rising interest payments eat away at stagnant incomes and tax revenues, and printing money eats away at the purchasing power of the currency. Eventually these sources of friction cause the Perpetual Motion Money Machine to grind to a halt and then shatter.
Put another way, the debt-asset bubble supernova consumes all the available fuel and implodes. I've employed the supernova analogy for many years, as it captures the expansion of debt and asset valuations and the resulting collapse once all the fuel in the system (i.e. earnings and real collateral) has been consumed.
State-protected cartels jack up prices with abandon, slashing disposable incomes. Get rid of competition and enforce a monopoly, and this is what you get:
Real earnings for the bottom 90% have gone nowhere but down for decades:borrowing from the future doesn't work if future earnings are lower.
While incomes stagnated, housing has ballooned into Real Estate Bubble #2.
Central banks have printed currency with abandon. Everybody loves free money--especially bankers and financiers.
Federal debt has tripled--no problem, let's triple it again, and then triple that.There is no upper limit on how much the Empire can borrow, right? "We are the ultimate power in the Universe now," etc.
All the games end badly. Tomorrow we'll examine the paths to impoverishment we can choose from.


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Thursday, May 25, 2017

Is Your Cost of Living Rising? Why the Elites Aren't Worried About Inflation

If you want to understand why we're fragmenting as a society, start by looking at the asymmetric burdens imposed by inflation.
In our household, we measure real-world inflation with the Burrito Index: How much has the cost of a regular burrito at our favorite taco truck gone up?
The cost of a regular burrito from our local taco truck has gone up from $2.50 in 2001 to $5 in 2010 to $6.50 in 2016.
That’s a $160% increase since 2001: 15 years in which the official inflation rate reports that what $1 bought in 2001 can supposedly be bought with $1.35 today.
My Burrito Index is a rough-and-ready index of real-world inflation. To insure its measure isn’t an outlying aberration, we also need to track the real-world costs of big-ticket items such as college tuition and healthcare insurance. When we do, we observe results of similar magnitude.
Our money is losing its purchasing power much faster than the government would like us to believe.
According to official statistics, inflation has reduced the purchasing power of the dollar by a mere 6% since 2011: barely above 1% a year. We’ve supposedly seen our purchasing power decline by 27% in the 12 years since 2004—an average rate of 2.25% per year.
But our real-world experience tells us the official inflation rate doesn’t reflect the actual cost increases of everything from burritos to healthcare.
The cost of a regular taco was $1.25 in 2010. By official standards, it should cost a dime more. Oops—it’s now $2 each, a 60% increase, six times the official rate.
The cost of a Vietnamese-style sandwich (banh mi) at our favorite Chinatown deli has jumped from $1.50 in 2001 to $2 in 2004 to $3.50 in 2016. That $1.50 increase since 2004 is a 75% jump, roughly triple the official 27% reduction in purchasing power.
So let’s play Devil’s Advocate and suggest that these extraordinary increases are limited to “food purchased away from home,” to use the official jargon for meals purchased at fast-food joints, delis, cafes, microbreweries and restaurants.
Well, how about public university tuition? That’s not something you buy every week like a burrito. Getting out our calculator, we find that the cost for four years of tuition and fees at a public university will set you back about 8,600 burritos. Throw in books (assume the student lives at home, so no on-campus dorm room or food expenses) and other college expenses and you’re up to 10,000 burritos, or $65,000 for the four years at a public university.
University of California at Davis:
2004 in-state tuition $5,684
2015 in state tuition $13,951
That’s an increase of 145% in a time span in which official inflation says tuition in 2015 should have cost 25% more than it did in 2004, i.e. $7,105. Oops—the real world costs are basically double official inflation—a difference of about $30,000 per four-year bachelor’s degree per student.
Here’s my alma mater (and no, you can’t get a degree in surfing, sorry):
University of Hawaii at Manoa:
2004 in-state tuition: $4,487
2016 in-state tuition: $10,872
Sure, some public and private universities offer tuition waivers and financial aid to needy or talented students, but the majority of households/students are on the hook for a big chunk of these costs. And remember that many students are paying living expenses, which doubles the cost of the diploma.
If you think I cherry-picked these two public universities, check out this article.
So the divergence between real-world costs and official inflation isn’t limited to burritos; it’s just as bad in items that cost tens of thousands of dollars.
As for healthcare: feast your eyes on this chart of medical expenses.
According to official inflation calculations, the $12,214 annual medical costs for a family of four in 2005 "should cost" around $15,000 today.
Oops—the actual cost is $25,826, $10,826 higher than official inflation, which adds over $100,000 in cash outlays above and beyond official inflation in the course of a decade.
So let’s add the $30,000 per university student above and beyond inflation for two college students over a decade and the $100,000 in healthcare costs that are above and beyond inflation over that decade, and we get $160,000.
Since deductions for education and healthcare don’t completely wipe out income taxes, the household has to earn close to $200,000 more over the decade to net out the $160,000 to pay typical college and healthcare costs above and beyond what education and healthcare “should cost” if inflation in big-ticket items had actually tracked official inflation.
$100,000 here, $100,000 there and pretty soon you’re talking real money in a nation in which median household income is around $57,000 annually.
So if a household’s income kept up with official inflation over a decade, that household would have to earn at least $20,000 more per year just to keep pace with real-world, big-ticket cost increases.
That’s the problem, isn’t it? If the household’s wages only kept up with inflation, there isn’t another $20,000 a year in additional income needed to pay these soaring big-ticket costs. So the shortfall has to be borrowed, burdening the household with debt and interest payments for decades to come, or the kids don’t attend college and the household goes without healthcare insurance.
Once again, real-world costs have soared at a rate that is almost six times higher than the official rate of inflation.
The reality is real-world inflation in big-ticket essentials is crushing every household that doesn’t qualify for government subsidies of higher education, rent and healthcare.
No wonder the political and financial Elites don't care about inflation: their incomes have soared far above mere inflation. When you're skimming millions, who cares about a mere $150,000 for a university education, or $25,000 for healthcare insurance?
Do you reckon the lobbyists for Big Pharma and the rest of the healthcare racket are spending millions lobbying politicians to slash the soaring costs of healthcare? Do you think all the universities collecting billions in government-guaranteed student loans are lobbying politicos to reduce loans to debt-serf students? Sorry, but that's not how pay-to-play "democracy" works.
In pay-to-play "democracy," the goal is to raise prices without improving service, and have the federal government enforce this racket on powerless debt-serfs.
If you want to understand why we're fragmenting as a society, start by looking at the asymmetric burdens imposed by inflation. The Elites aren't worried about inflation because they don't even feel it. And since they rule to benefit the top 5%, they don't really care what the bottom 95% are experiencing.
In other words, "Let them eat cake."


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Wednesday, May 24, 2017

Inflation Isn't Evenly Distributed: The Protected Are Fine, the Unprotected Are Impoverished Debt-Serfs

Welcome to debt-serfdom, the only possible output of the soaring cost of living for the unprotected many who are ruled by a hubris-soaked, subsidized Protected Elite.
The Consumer Price Index (CPI) measure of inflation is bogus on a number of fronts, a reality I've covered a number of times: though the heavily gamed official CPI is under 2% for the past four years, the real rate is 7% to 12%, depending on whether you happen to live in locales with soaring rents/housing and healthcare costs.
But the other reality is that inflation is not evenly distributed throughout the economy or populace: many people have little exposure to the crushing inflation of healthcare and higher education. For these people, inflation is a non-issue or a minor impact on their wealth, income and lifestyle.
Those fully exposed to the skyrocketing costs of healthcare insurance and higher education are being reduced to impoverished debt-serfs.
The key factor here that is missed in the official CPI is the relative size and impact of each cost input. Televisions, for example, have plummeted in price as LCD screens have become commoditized.
But how often does a household buy a new TV? Every four years? Every five years? And how big a difference does a $50 or $100 drop in the cost of a new TV make in their lifestyle?
Items that decline in price are modest slices of household budgets, while items that are soaring higher every year are big-ticket expenses that dominate household budgets. So a new TV drops in price by $100. If you buy a new TV every four years, that's $25 savings per year. Big Freakin' Deal: that deflationary price "bonus" means you can buy one extra pizza.
Meanwhile, households exposed to the actual cost of healthcare are absorbing increases of $5,000 or more annually. $5,000 increases every year add up: $5,000 + $10,000 + $15,000 + $20,000 = $50,000 was extracted from the household budget over the four-year period.
The household paying the unsubsidized cost of higher education is paying tens of thousands of dollars more for the same marginal-value education. Where a four-year college degree once cost the equivalent of a new car (i.e. $30,000), now it costs the equivalent of a house ($120,000 and up).
So a retiree with a small fixed-rate mortgage in a state with Prop 13 limits on property tax increases who qualifies for Medicare may complain about modest increases in co-pays for office visits and medications totaling a few hundred dollars annually, a young self-employed couple might be facing thousands of dollars in rent increases, healthcare insurance costs, childcare expenses and so on--each a big-ticket item with a crushing impact on household spending and debt.
Households protected from actual big-ticket inflation by subsidies or luck (i.e. buying a house 30 years ago when prices were a fraction of today's prices) have no experience of real inflation. Only the unprotected, unsubsidized households struggling to pay rising rents, soaring college tuition and fees and skyrocketing healthcare insurance premiums have an unmediated experience of the real inflation ravaging the the U.S. economy.
If you're on Medicaid, Medicare or your premiums are mostly paid by your employer, you have no idea of the system's actual costs. The self-employed aren't subsidized, so we are exposed to the full inflation rate of healthcare, in which the costs of medications are jacked up by 4,000% because, well, Big Pharma has a free hand, thanks to our pay-to-play "democracy".
Getting that often-worthless diploma now requires debt-serfdom, enforced by your private-profits-are-guaranteed, losses-are-dumped-on-the-taxpayers federal government. Needless to say, the government is here to help you--help you become a debt-serf whose serfdom enriches state-cartel cronies.
We're supposed to accept that because TVs are cheaper,the rate of inflation is near-zero. Meanwhile the unsubsidized costs of big-ticket items are rising by thousands of dollars annually.
My insightful colleague Lance Roberts prepared this devastating chart that shows how debt-serfs deal with soaring prices--they borrow more to fill the widening gap between what they earn (stagnating) and the cost of living (skyrocketing).
The inside-the-Beltway crowd that dominates Washington and the overpaid technocrats that dominate our financial skimming machine are both protected from the true ravages of inflation, so our corporate media never mentions the impact on the unprotected. Our job is to shoulder the higher prices by taking on more debt.
Welcome to debt-serfdom, the only possible output of the soaring cost of living for the unprotected many who are ruled by a hubris-soaked, subsidized Protected Elite.


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Tuesday, May 23, 2017

The Keynesian Cult Has Failed: "Emergency" Stimulus Is Now Permanent

Can we finally admit that eight years of following the Keynesian coloring-book have not just failed, but failed spectacularly?
What do we call a status quo in which "emergency measures" have become permanent props? A failure. The "emergency" responses to the Global Financial Meltdown of 2008-09 are, eight years on, permanent fixtures. Everyone knows what would happen if the deficit spending, money-printing, zero interest rates, shadow banking, asset purchases by central banks and all the rest of the Keynesian Cult's program stopped: the status quo falls apart.
Keynesianism Vs The Real World
Let’s start by reviewing the core contexts of the economy.
1. The dominant socio-economic structures since around 1500 AD are profit-maximizing capital (“the market”) and nation-states (“the government”).
2. The dominant economic theory for the past 80 years is Keynesianism, i.e. the notion that the state and central bank must aggressively manage private-sector consumption (demand) and lending via centrally planned and funded fiscal and monetary stimulus during downturns (recessions/depressions).
Simply put, the conventional view holds that there are two (and only two) solutions for whatever ails the economy: the market (profit-maximizing capital) or the government (nation-states and their central banks). Proponents of each blame all economic and social ills on the other one.
In the real world, the vast majority of Earth’s inhabitants operate in economies with both market and state-controlled dynamics in varying degrees.
The Keynesian world-view is doggedly simplistic.  The economy is based on aggregate demand for more goods and services.  People want more stuff and services, and as long as they have the means to buy more stuff and services, they will avidly do so (this urge is known as animal spirits).
The greatest single invention of all time in the Keynesian universe is credit, because credit enables people to borrow from their future earnings to consume more in the present. Credit thus expands aggregate demand for more goods and services, which is the whole purpose of existence in this world-view: buy more stuff.
But credit, aggregate demand for more stuff and animal spirits make for a volatile cocktail.  The euphoria of those making scads of profit lending money to those euphorically buying more stuff with credit leads to standards of financial prudence being loosened.  In effect, lenders and borrowers start seeing opportunities for profit and more consumption through the distorted lens of vodka goggles.
Lenders reckon that even marginal borrowers will earn more in the future and therefore are good credit risks, and borrowers reckon they’ll make more in the future (i.e. the house they just bought to flip will greatly increase their wealth), and so borrowing enormous sums is really an excellent idea—why not make more money/enjoy life more now?
But the real world isn’t actually changed by vodka goggles, and so marginal borrowers default on the loans they should never have been issued, and lenders start losing scads of money as the value of the collateral supporting the defaulted loans (used cars, swampland, McMansions, etc.) falls.
Oh dear! The hangover of credit expansion is brutal, as lenders go bankrupt, wiping out their owners, and borrowers go bankrupt as they are unable to make their payments or sell the collateral to pay off the loan.
Just as credit expansion feeds on itself—everybody’s making a fortune buying and flipping houses, let’s go buy a house or two on credit—the hangover is also self-reinforcing: the value of collateral falling pushes more marginal borrowers into insolvency, and the lenders who made the loans are pushed into insolvency as defaults increase and collateral melts like ice in Death Valley.
In the Keynesian universe, this self-reinforcing contraction of imprudent credit and widespread losses of speculative wealth are Bad Things. Very Bad Things.  Important, Powerful People tend to own issuers of credit (banks), and losses are not something they signed up for.
If all the Little People stop borrowing more money, the Powerful Owners of the credit-issuing machines (banks) can no longer reap enormous profits from issuing more credit, and that is a Very Bad Thing.
As a nasty side-effect of the credit hangover, businesses that depended on people borrowing more money to buy more stuff also shrink, and this contraction is also self-reinforcing: as sales decline, businesses must cut costs to stay solvent, which means laying off employees, abandoning under-utilized offices, closing factories, etc.
The euphoria of credit expansion turns to painful contraction.  Nobody’s happy in the hangover phase, and people naturally cry out, Somebody do something to stop the pain!
The Keynesian answer is simple: the government should borrow and spend lots of money to replace all the money that the private sector is no longer borrowing and spending, and the central bank should lower interest rates and create a lot of new money that private banks can borrow cheaply to loan out to private-sector businesses and consumers.
In the simplistic Keynesian Universe, the credit contraction is like a temporary drought: all the government and central bank have to do to fix the drought is release a flood of new money onto the parched landscape of the credit-starved private sector, and aggregate demand and new loans will blossom like spring flowers.
Horray for central states and banks! Given the power to borrow (or create out of thin air) as much money as they need to flood the private sector with fresh money and credit, the drought ends, animal spirits are revived, people get to buy more stuff by promising to give their future earnings to banks and Powerful Owners of banks are once again earning great gobs of cash from lending to the Little People (i.e. borrowers in danger of becoming debt-serfs, whose earnings go largely to service their debts).
In the crayon-coloring book of Keynesian ideology, this is The Way the Universe Works. The problem is always a temporary drought of aggregate demand caused by a temporary drought of private-sector credit, and the solution is always a state-central-bank issued flood of money and credit: the government borrows and spends more money to replace declining private spending, and central banks make it cheaper and easier for private banks to issue new loans to enterprises and Little People.
That this coloring-book ideology no longer describes the problem or solution is incomprehensible to the Keynesians.  That neither “the market” nor “the government” can solve the current set of problems is equally incomprehensible—not just to Keynesians, but to everyone who unthinkingly accepted that the market and/or the state can always fix whatever problems arise.
Oops! The Flood of Money and Credit Didn’t Fix the Economy
The post-credit/asset bubble crashes in 2000 and 2008 and the state/central-bank responses--fiscal and monetary stimulus, a.k.a. flood the land with borrowed money—seemed to confirm the Keynesian world-view: marginal borrowers, lenders and collateral all went south and the stimulus restored animal spirits, which promptly inflated a new credit/asset bubble.
But this time around, the drought never ended, no matter how much money was poured into the economy, and the earnings of borrowers stagnated or declined. (Recall that debt is borrowed from future earnings; if earnings decline, it becomes much more difficult to service existing debt, much less borrow more.)
Federal debt has more than doubled just since 2009 (and tripled since 2001) as the government flooded the land with fiscal stimulus:
Central banks have flooded the global economy with trillions of dollars, euros, yen and yuan, and continue to do so to the tune of $200 billion per month:
Central banks have dumped over $1 trillion in new monetary stimulus in the first four months of 2017—eight years after the “emergency” stimulus began:
Meanwhile, wages are stagnant or declining for the vast majority of wage-earners—even the highly educated:
Household income has fallen across the board:
Stagnating incomes is not a new issue for the bottom 90%; it’s a structural reality going back four decades:
Clearly, fiscal and monetary stimulus policies that were supposed to be temporary are now permanent.  That isn’t what was supposed to happen.
Earnings were supposed to rise once private-sector credit and consumption returned to expansion.  As we see here, bank credit and consumer credit have surged higher, but the incomes of the bottom 90% have gone nowhere.
Meanwhile, total debt—government, corporate and household—has rocketed higher, more than doubling from 280% of GDP in 2000 to 584% of GDP in 2016:
As if these weren’t bad enough, wealth and income inequality have soared during the era of permanent fiscal-monetary stimulus:
In sum: nothing has worked as the Keynesians expected.  Instead, state/central bank measures that were supposed to be temporary are now permanent, and the expansion of private-sector debt has failed to “trickle down” to earnings.
The Keynesian solution—borrowing from future earnings to “bring consumption forward”—has expanded consumption at the cost of enormous increases in debt throughout the economy, which has exacerbated income-wealth inequality and declining real incomes.
Can we finally admit that eight years of following the Keynesian coloring-book plan have not just failed, but failed spectacularly, and not just failed spectacularly, but made the economy even more vulnerable and fragile, as more and more future income must be devoted to service the skyrocketing debts?
Isn’t it obvious that there are deeply structural problems in the economy that inflating yet another credit/asset bubble won’t fix?
Clearly, the real-world economy does not function like the simplistic Keynesian coloring-book model.
What Comes Next: Contraction
Given the extraordinary failure of both Keynesian stimulus and private-sector credit growth to create a self-sustaining cycle of expansion whose benefits flow to the entire workforce rather than to the top few percent, what can we expect going forward? Can we just keep doubling and tripling the economy’s debt load every few years? What if household incomes continue declining? Are these trends sustainable?
In Part 2: Prepare For The Great Global Contraction, we detail why the economy’s structural problems languish unaddressed, and how the inflating of yet another speculative credit-asset bubble has not fixed these problems.  Instead, the current credit-asset bubble has dramatically increased the fragility of the economy by diverting capital from potentially productive investments to unproductive speculative gambles, and by increasing the unproductive burdens of soaring debt.
When the Great Reflation does finally roll over, there will be plenty of time to ponder what investments might do well—but only those who exit well before the rollover will have the cash to take advantage of the opportunities.
Click here to read the report (free executive summary, enrollment required for full access)
This essay was first published on Peak Prosperity.com under the title "How Long Can The Great Global Reflation Continue?"


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Check out both of my new books, Inequality and the Collapse of Privilege ($3.95 Kindle, $8.95 print) and Why Our Status Quo Failed and Is Beyond Reform ($3.95 Kindle, $8.95 print, $5.95 audiobook) For more, please visit the OTM essentials website.

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