“Credit is a system whereby a person who can not pay gets another person who can not pay to guarantee that he can pay.” – Charles Dickens

K and I were in LA for two weeks at the end of February. We were visiting two of our three kids and our four grandkids. If you’ve ever spent time with toddlers and preschoolers, you know they are always drooling, sneezing, and coughing. And often their parents are too. (Well, not the drooling.)

This is because young children are incredibly good at catching colds and the flu, and very good at spreading them. Typically, they infect their parents, who are also relatively young and healthy. Then their parents spread the cold or flu to everyone they come in contact with.

Thus, it didn’t surprise us to be showing symptoms of the flu when we returned to Florida early in March. We spent a week with symptoms. Normal for me. K usually recovers more quickly. And we thought nothing of it.

Two weeks later, when I began researching the coronavirus, I wondered if we might have caught it. But we had been in LA several weeks earlier than it was said to have started there. So I ruled out that as a possibility.

At the beginning of April, I was reading articles suggesting that the virus might have come to America significantly earlier than the experts had been saying. I speculated that it could be true. We now know it was.

Two recent autopsies proved that the virus was in LA in January, as the victims died on or about February 5. And several more reports confirmed it, with cases identified in late January and early February.

That is good news for everyone. It means that the actual lethality rate of COVID-19 is, indeed, much less than the case fatality rate. In fact, a recent antibody study suggests that 5% or more of the LA population is or has been infected. And that means, as I’ve been saying from the beginning, the lethality rate is just a fraction of 1%.

And this is hopeful news for me and K. Those flu symptoms we had in early March might just have been a dose of coronavirus that our adorable grandkids were kind enough to give us. I’ll let you know after my serology test next week. Meanwhile, back to my exploration of the Corona Economy…

The Corona Economy, Part III

What the Media and Our Representatives Don’t Understand 

Last Monday and Friday, we talked about the general state of the US economy. We took a look at its P&L and balance sheet and concluded it was a bankrupt enterprise that is losing money at an astonishing pace.

2020 will be a watershed year for the US. In terms of the usual data points that measure economic health, it has already neared or surpassed numbers that are as bad as we’ve seen in 100 years.

Unemployment is as high as it was in the Great Depression. The GDP is shrinking quickly. Government spending is at historic highs. Tax revenues are tumbling by the trillions. The federal debt is $24 trillion and will grow by $6 trillion to $10 trillion by the end of the year.

Those are scary statistics. And not just for Americans. Notwithstanding efforts by some countries to achieve economic independence in energy and other vital resources, the global economy is inextricably connected. When any country in the world sneezes, the rest of the world catches cold.

Few in Washington or in the mainstream media are alarmed about this. The attitude seems to be: We’ll deal with it after we defeat the coronavirus.

In fact, an ethos has spread that is disturbing. Being worried about the economy means you don’t care about human life. I see a parallel to the way they responded to the threat of the virus in its early stages. “It’s nothing to worry about,” they said. “We should go about our daily lives without concern.” (It was not just the administration that took this position in January and February. It was the pols and reporters from both sides of the aisle.)

It’s only gotten worse since then. The reportage of the pandemic has been politicized. The right presents hopeful new data as reasons to open up the economy. The left interprets the data darkly and insists that the closure should continue.

One hopes a crisis would bring people together. The Corona Crisis seems to have done that in Italy and Sweden and some other European countries.  But in the US, the divide is wider now than ever. And the animosity is higher.

So we stay in lockdown to slow the virus and, therefore, insure a second and possibly third outbreak. And we spend trillions of dollars we don’t have to “protect” American businesses and workers, even though all the spending is putting us on the brink of an economic collapse.

And yet, economic collapse (which is happening at an exponential rate) is not being discussed with the alarm it deserves – particularly among left-leaning pols and the mainstream media. Some of that is surely due to political animosity. But I think a bigger problem is the widespread ignorance of the way our government gets and spends money. This is true generally of the population at large. But what’s disconcerting is that the ignorance is widespread among the politicians that do the spending and the media that report on it.

A Simple Question 

This takes us back to where we left off on Friday. We know that our government is broke. We know it doesn’t have huge stockpiles of gold and silver or even dollars. So is it able to pay for the $6 trillion to $10 trillion deficit we are putting ourselves into right now?

It’s a simple question. I recently posed it to a few of my smart and educated friends. I’m talking about doctors, lawyers, business executives, and college professors. None of them had any idea.

That’s understandable. In most colleges, economics (let alone government fiscal policy) is not a required course. But you’d think that government officials that vote on spending bills and reporters and columnists that write about government spending would be well-versed on the subject.

I don’t think they are. In fact, I believe most of them haven’t the foggiest idea about how our fiscal and monetary policies work.

But you don’t need to understand these things to be a politician, a political reporter, or a columnist. Nor do you need to understand them to be able to function in almost any career.

I believe I could have had pretty much the same career I’ve had as an entrepreneur and business consultant without a background in fundamental economics. But I do think that the experience of running a business and trying to squeeze a profit from it for many years has given me a good understanding of some of it. Such as:

* There are several ways to make money: You can earn it, you can steal it, or you can be given it. The first is the best of the three because it won’t land you in jail and because it’s not dependent on the kindness of strangers. You are in control of how much money you make.

* The only way to earn money is to exchange something for it – your time, your expertise, or something you own.

* The best way to have that exchange is on a voluntary basis, with everyone free to buy or sell as they wish. This is called a free market. A free market, therefore, is the best way to create economic growth.

There is one more way to make money: You can borrow it and invest it and have the investment pay off the loan and leave you with a profit.

This is a standard practice of at least half the businesses in the US and the rest of the world. Some make the borrowing (debt-financing) work for them. Some don’t.

The trick to making debt-financing work is to invest the money in something that has a good chance of being profitable. That’s why investing in infrastructure generally makes sense for businesses and for economies. But spending borrowed dollars to pay for spending is generally a terrible idea.

You know this from your personal experience. You have friends and family members that are always maxed out on their credit cards, always hiding from their creditors, always getting into more and more debt because they borrowed money they couldn’t possibly pay back.

This is the core problem with the solvency of America right now, and it’s why it’s so important to understand how our government spends the trillions of dollars it doesn’t have.

The Idiot’s Guide to Monetary and Fiscal Policy in the US 

I’m hardly an expert in economics. And my understanding of fiscal and monetary policy has come very slowly over many years. In fact, before writing these Corona Economy essays, I asked Tom Dyson, a colleague who understands this subject much better than I do, to give me a refresher course. “Explain this to me as if I were one of your children,” I said. “Actually, no. Your kids are super-smart. Explain it to me as if I were a really dumb version of your kids.”

And he did.

Tom began by pointing out that there are two federal systems that operate together: the fiscal policies of the government and the monetary policies of the Federal Reserve, our central bank.

The fiscal system is what I was talking about on Friday. It’s how our government gets and spends its money. On the get side is tax revenue. On the spend side is everything our representatives vote for to get themselves elected: military spending, social spending, spending to support our businesses, foreign aid, etc.

If, in any particular year, the government spends more than it gets from taxes, it creates a deficit. If it spends less than it gets from taxes, it creates a surplus. (This is the fiscal counterpart of profit and loss.) In theory, we should want the fiscal system to balance the budget every year – or, in good years, to create a surplus.

In fact, since WWII, we’ve had a lot more years with a deficit than a surplus. I’ll get to that in a moment.

The Mechanics of Debt 

When the government runs a deficit, it has to cover that deficit somehow. The way that’s normally done is with debt. The Treasury posts a sign saying, “We need dollars. Anyone out there want to lend us some?”

This is done through Treasury bonds, which are basically loan contracts. [See “Did You Know?” below.] The person who buys the bonds is the lender. The government is the borrower. And as with most loan contracts, the borrower (government) promises to pay back the lender (bond purchaser) the amount of the loan plus interest.

If, for example, the government spends a billion dollars more than it makes in taxes, it must sell a billion dollars’ worth of Treasuries to make up the difference.

And if the government continues to runs deficits and sell bonds to cover them, it’s going to get deeper into debt.

The problem with growing debt is the same for the government as it is for businesses and consumers. The government has to pay interest on it. If the debt is great and the interest it has to pay is high, the government can find itself in a position where it’s forking over a large percentage of its income (from tax revenues).

A Potentially Catastrophic Problem… or Is It? 

This is a crude example, but it is essentially the problem that the US government has right now. It has been deficit spending almost every year for the past 70 years, and at the rate of more than a trillion dollars every year for at least 10 years. It has a debt of $24 trillion now and a loss in tax revenues of maybe $4 trillion. Add to that another $4 trillion to $6 trillion that it will be spending on the Corona Crisis, and its overall debt is likely to be $30+ trillion over the next few years.

But is that really a bad thing?

Common sense would tell you it is. But there are economists that will argue it’s nothing to worry about. At an interest rate of 1%, it’s “only” $35 billion. Our tax revenues can easily cover that.

Maybe. But what if our lenders – all those people, businesses, and countries that have been lending us that money (buying Treasury bonds) for so long – decide they don’t like the fact that the US has so little collateral. What happens if our credit dries up?

In fact, that’s already happened. You’ve probably read about it. It happened in what they call the repo market.

We’ll pick up on that next time.

“Performance is better than promise. Exuberant assurances are cheap.” – Joseph Pulitzer

The Corona Economy, Part II

Will America Survive It? 

Alec writes:

Today marks the 29^th day in a row that I have worn pants with a drawstring.

I went into Rand’s room this morning and woke him up. I said, “Rand, you have to get up.”

He raised his head up from his pillow and said, “Why?” Then he went back to sleep.

My wife is running a business with 10 restaurants and goes to work every day. She is busier than ever… as other restaurants gradually close, they are filling a growing number of carryout orders for breakfast, lunch, and dinner.

Her text this morning read, “Has at Costco $1.49.”

How she had time to text me, or what the text meant, I didn’t know. But thinking it might be vital information, I texted back, “WHAT??”

Her reply was, “G gas.”

I thought, “Wow, gas, $1.49 a gallon. I can’t remember when gas was that cheap. I’d better rush to Costco to get gas before they run out.”

I jumped into my car and backed out of the driveway. Then I realized: I hadn’t gone anywhere for 29 days. My gas tank is still full!  (Later, I did the math and I am driving an average of 0.7 miles a day. I may not need gas until the middle of June.)

But America will soon be “opening up again.” Not because Donald Trump wants it to.  Nor will it happen because we’ve passed the peak of the contagion. (There will be a second wave.) State governors will have lots to say about it, but they won’t actually make the important decisions. America’s people – its entrepreneurs, professionals, corporate executives, and employees will.

“Opening up” is  bit of hyperbole. Our economy was never truly shut down. It was regulated into a crippled gait. In six short weeks, the US has experienced a financial collapse it hasn’t experienced in a hundred years.

As I write this, for example, more than 22 million American workers have filed for unemployment. Millions more will surely be filing in May and June. Both Treasury Secretary Steven Mnuchin and the Fed’s James Bullard have said they believe that unemployment will bypass 20% and could end up higher than it was during the Great Depression of 1929.

The unemployment rate hit a record of 25% in 1933 – 4 years after the Great Depression – and remained over 14% during the entire decade of the 1930s. The highest rate since then was 10.8% in 1982.

Another concern: The 2008 financial collapse was triggered by mortgage defaults. What is happening today is just as serious – rent defaults. According to Rent Payer Tracker, as of April 19, one-third of the 13.4 million renters surveyed hadn’t yet paid their April rent, ordinarily due on April 1. An increase in rent defaults isn’t likely to collapse the economy by itself, but it reflects a trend I’ve seen even among friends and colleagues that are financially secure: People are reluctant to pay bills they don’t have to pay.

The big picture is the gross domestic product (GDP), the total output of the US economy. With so many businesses, large and small, inactive or unprofitable, Goldman Sachs projects that GDP could decline by 24% by the end of June.

Think about that. Total GDP output in 2019 was about $21.4 trillion. If it drops 24%, that’s an annual loss of over $5 trillion of economic activity. And that’s on top of the macroeconomic factors we covered in Part I of this series:

* The US government is currently in debt to the tune of $24 trillion.

* It’s been running at a $1 trillion annual loss for years.

* The Treasury itself is broke. Its bills exceed its revenues by several trillion dollars.

* The government recently spent $2.5 trillion it didn’t have.

* On the other side of the ledger, federal tax revenues will be at least $2 trillion less than they were last year.

Add it all up and you have an already broke government increasing its deficit by as much as $10 trillion in a single year!

The government is working furiously to avoid a total collapse. Their strategy is to give away trillions of dollars in paper money. They have already given half a trillion via the Payroll Protection Program and have committed to another half-trillion more. And that’s not counting the 1.5 trillion that went to bail out Wall Street.

As you remember from Monday’s essay, the US government doesn’t really have any wealth to distribute. It’s broke and is getting broker every day by billions of dollars. If, as I suggested, our government were a business, only a fool would invest in it or lend it money. But that’s how it’s been surviving these past several years – by selling Treasury bonds to the likes of China, Saudi Arabia, and Europe.

That’s of no apparent concern to some of our legislators and public thinkers. They are criticizing the giveaway so far for being too conservative.

Regarding the 20% to 24% projection of GDP loss, a NYT columnist said, “This time, with government deliberately shutting down commerce, it could well fall faster.

Only a World War II-scale response can make up that difference.”

And where will government get the money?

His answer: “At a time when inflation is close to zero and the government can borrow for 30 years at less than 2%, this is precisely the moment to borrow to underwrite a recovery that also modernizes the economy.”

Never before in US history has so much money been doled out so quickly and with so little understanding of or regard for consequences. Rarely have so many politicians from both sides of the aisle favored such a level of spending.

As Bill Bonner recently pointed out, the Small Business Administration giveaway is forcing banks to review and approve loans at a surrealistic rate.

“Every half a second,” he writes, “they’ve had to check out the facts… verify the value of collateral… and assure themselves that everything was on the level – after all, they were giving out as much as $2 million per application!”

“Who gets the money?” Bill asks. We can’t be sure. But when money is being given away so fast and furiously, there’s a good chance that much of it will be unproductive. “Like subprime mortgages in 2007,” Bill says, “All you need [to qualify] is a pulse. Even hedge funds are eligible.”

The millions that have been fired or furloughed will be getting a few hundred dollars a week while the shutdown continues. Meanwhile, the hundreds of US senators and representatives and their thousands of aides will continue at full pay while they try to spend our way out of all this mounting debt.

“Don’t worry,” they assure us. “We are going to take care of this.” Assurances from people that have never run a business and have little to no understanding of how a real economy actually works.

So what is it they don’t understand? We’ll talk about that on Monday.

“Economics is a subject that does not greatly respect one’s wishes.” – Nikita Khrushchev

The Corona Economy, Part I: Will America Survive It?

New York City is losing billions in tax revenues, and Mayor Bill De Blasio is going to have to lay off thousands of city workers. He is upset about this. He’s calling on the Trump administration to bail out the city. “We can’t do anything about this,” he pleaded. (I’m paraphrasing.) “Only the federal government has the power to help us.”

Many in my family feel that we should keep the economy shut down “for as long as it takes.” They also say that the federal government should keep cranking out financial aid “for as long as it takes.”

“Human life is more important than money,” they say.

The trouble with mixing ethics and economics is not that they are incompatible. Quite the contrary, they are inextricably linked. The problem is that if you talk about them simultaneously, you never get anywhere.

Both subjects are important. Neither is dispositive or scientific. But economics has the advantage of a vocabulary of facts and a language of numbers. Thus, if you want to have the conversation about both, it’s better to start with the facts and numbers.

So let’s do that.

* As of April 13, 1.1 million small business loans had already been approved, totaling $253 billion in bailout money. By the time you read this, the federal government’s $350 billion small-business relief fund will be nearly exhausted.

* The total “relief package” already enacted will cost about $2 trillion. There is good reason to believe that we will have a second and perhaps a third one at that same level.

* On April 17, we learned that more than 5.2 million Americans had filed for unemployment benefits that week – which means that the virus put more than 22 million out of work in less than a month.

* There are about 127 million households in America earning, on average, about $150,000. (That’s the mean, which counts the rich people. The median income is $60,000.) Ten million unemployed, multiplied by, say, $100,000, is $10 trillion. At an average tax rate of 20%, that’s $2 trillion in lost federal tax revenues.

* Tens of thousands of small businesses, representing hundreds of billions of dollars in tax revenues, have been shut down. Many of them will not reopen.

* For some years now, the federal government has been running at a deficit of about $1 trillion a year.

* Total US debt is nearing $24 trillion and rising fast.

Would You Invest in This Company? 

Think of the federal government as a business. I know that it’s not a business, nor is it intended to be. But hear me out.

You are an investor, trying to decide whether you want to buy this company.

The first thing you do is look at a spreadsheet of the financials – a P&L (profit and loss) statement and a balance sheet (assets minus liabilities).

You look first to the bottom line of the P&L, which tells you how profitable this company is. Hmm. Can that possibly be true? Is this company really losing $1 trillion a year?

Maybe they are investing for future growth, you tell yourself. Maybe, like Amazon in its early days, the Feds are spending money they don’t have in order to acquire income in the future. But when you look at the company’s projected income, it’s going the wrong way. Projected tax revenues are going down. Way down!

And what about its balance sheet? What about the company’s net worth? You glance at the liabilities and what do you see? You see $24 trillion in debt!

Surely, the company’s assets must offset this figure. You check that side of the ledger, and you see about $500 billion worth of gold (by today’s prices). Okay. You also see that the company has a great deal of valuable property (national forests and monuments and buildings and so on). But that property is  encumbered. It can’t be sold.

From this perspective, the US looks like a terrible business opportunity, right? It’s big-time broke and losing billions of dollars every day.

And thanks to the Corona Crisis, that debt and those losses are going to pile up faster than ever. The current bailout package is estimated to cost $2 trillion, bringing the projected loss for 2020 to $3 trillion. But to make matters worse, tax revenues are crashing. As I said above, it’s likely that they will drop by as much as $2 trillion this year.

Meanwhile, Mayor De Blasio is facing a fiscal crisis. Tax revenues are down more than $8 billion. And even with firing thousands of city employees, New York will still be short more than $6 billion by the end of this year… just to pay its upcoming bills.

That’s why he is complaining about Trump. He knows he doesn’t have a magical way to create the dollars he needs to solve his problem. But the federal government does.

The government has the Treasury, which issues Treasury bonds (IOUs), and it has the Federal Reserve (the central bank) which, among other things, decides how much interest it will charge US banks to borrow money from it. But the Fed can also, if it wants, put “liquidity into the system.” What that means is that someone that has access to a database that keeps track of the money supply (how many dollars are out there) hits a button and billions (or trillions) of dollars that never existed before appear out of nowhere. This is what most economists mean when they say “printing dollars.” (We’ll get into that in more detail in Part IV of this series.)

This is why some people are worried about the economy now. The federal government is in crazy debt and is losing money faster than it ever has before. Millions of people are out of work and tens of thousands of small businesses are dead in the water. That means a lot of pain and suffering. And the possibility of a deep depression like we haven’t seen in 100 years.

You may be thinking, as my brother-in-law said last night, that these facts and numbers must be false. After all, everyone knows that the USA is “the richest country in the world.” It can afford a shutdown of three to six months. You may be thinking, as some have said, that the economy will bounce back to full strength as soon as we get past this pandemic.

Maybe. But I doubt it. If I’m going to bet, and I probably will have to, I’m going to bet that things will get worse before they get better.

I’ll tell you why I am pessimistic on Friday, in The Corona Economy, Part II

Update on My Investment Portfolio:

Why I’ve Just Sold Most of My Stocks 

“Be fearful when others are greedy, and be greedy when others are fearful.” – Warren Buffett

I’ve just sold about 75% of my stock portfolio. I’ll tell you why…

The Economic Outlook Is Scary

At a macro level, our economy is fragile. For one thing, the US has never been in so much debt. The national debt has been growing pretty much non-stop for 20 years, but it accelerated significantly under Obama and Trump. It is currently $26 trillion. That is 107% of our GDP. The last time the debt-to-GDP ratio was that high was in 1948, at the end of WWII.

And then there is our consumer debt: the debt private citizens carry on mortgages, loans, and credit cards. That hit $14 trillion in March, a record high, surpassing by almost $1 trillion the record set at the height of the 2008 financial crisis.

This level of debt is scary. But what’s scarier is that there are only two or three elected officials left that believe in balanced books and sound money.

The business outlook is bleak. Since January, US GDP has dropped nearly $3 trillion, from $21.8 trillion to $19.2 trillion. Thousands of small and medium businesses, employing millions of medium- and low-skill workers, have been shut down. The economists I trust are prognosticating that as many as half of them are closed for good.

By these and many other metrics, the US economy today resembles that of the economy after the real estate bubble collapsed in 2008, except for debt, which is worse. Given that, it seems reasonable to believe that we are looking at an attenuated recession and a feeble recovery.

Longtime readers know that I don’t buy or sell stocks based on macro analysis. But I don’t ignore it either.

The Upcoming Election

This is the main reason I converted 75% of my stock portfolio to cash.

The pollsters and their pundits are predicting that Trump will be ousted in November and the Democrats will sweep the House and perhaps even the Senate. The Democratic agenda is for higher social spending, $500+ billion on infrastructure, and higher taxes for businesses and high-income earners. But I’m even more concerned with the talk about eliminating the cap on the Social Security tax.

Wall Street doesn’t respond well to the threat of higher taxes. So as we approach the November elections, if it looks like Biden will be elected and the Democrats will win both houses of Congress, it’s very likely that we’ll see a big drop in stock prices. A 30% to 50% drop wouldn’t surprise me.

So those are the three reasons I decided to sell most of my stock portfolio: I have a continuing concern about US debt, a suspicion that we have entered into another extended recession, and a strong hunch that if it becomes apparent that the Blues will dominate the November elections, the stock market will take a dive.

Longtime readers will rightly be surprised to know that I’ve sold off 75% of my stock holdings. They will remind me that my investment philosophy has always been to buy world-dominating companies and hold them long-term. They will further remind me that as recently as April 6, I repeated that viewpoint in explaining why I did not sell any of my stocks as the markets were tumbling from the Corona Crisis.

Yes, I’m violating that rule now. Let me take you through my thinking process…

I “lost” millions in March and April. The loss was just on paper, but it still didn’t feel good. Because I didn’t panic and didn’t sell then, I was able to see the market climb back up this “wall of worry.” And now I’ve regained (again, on paper) all that I had lost.

The balance of my stock portfolio is at an all-time high. But there is a fair chance that the market will take a dive sometime between now and November. And if it does, it could be, as I said, a steep dive – 30% to 50%.

So I did what I sometimes do when I’m in a confusing situation like this. I interviewed the three parts of my brain.

First, I asked my limbic brain, the part that’s in charge of my emotions: “How would you feel if that happened?”

And Limbic Brain answered: “Like horse shit. Like a fool. But I would blame-hate you for keeping our money in the market.”

Then I asked my reptilian brain, the part that’s in charge of my instincts: “What would you do if Limbic Brain felt like that?”

And Reptilian Brain answered: “I would definitely panic. I would be afraid the market would drop even further. I would take flight. I would tell Limbic Brain to sell everything – all of our stocks – immediately and eat the loss.”

And finally I asked my rational brain: “What do you think of all this?”

And Rational Brain said: “Normally, I’d tell you to ignore Limbic Brain. I’d say that Reptilian Brain is bluffing. But in this case, why take the chance?”

“What do you mean?” I asked.

Turning to Limbic Brain and Reptilian Brain, Rational Brain said: You have told us how badly you would react if our portfolio dropped again by 30% to 50%. How good would you feel if we held on to our stocks till November and they went up in value?”

“Like by how much?” they asked.

“Say, 10% to 15%,” Rational Brain said. “Which, I might remind you, would be an unprecedented three-month climb, considering where they are now.”

Limbic Brain and Reptilian Brain went into the corner, as they always do when confronted by Rational Brain, and conferred. After a few minutes, they emerged.

“So how would you feel about our making another 10% to 15% on top of our current gains?” Rational Brain asked.

Limbic Brain shrugged. Reptilian Brain, lacking shoulders, said, “Meh.”

Rational Brain turned back to me. “As you can see,” he said, “my less intelligent but immensely muscle-bound siblings don’t really care if our stock portfolio goes up. But they really, really are going to go nuts if it goes down again.”

“Yes, I can see that,” I said.

Rational Brain leaned forward and stared into my eyes. “You know what you should do,” he intoned. “Sell all or most of your stocks right now and wait until November. You will be giving up the unlikely possibility of getting modestly richer over the next three months. But you will be safe from the more likely possibility of becoming considerably poorer.”

“That makes sense,” I said to Rational Brain.

He winked. “That’s what I’m here for.”

And that’s why I sold 75% of my stock holdings. If you are having some of the same concerns regarding your investments, conduct an interview. Your brain parts are yours, formed by your own knowledge and experience. See what they have to say. And then do what your Rational Brain advises.

 This essay and others are available for syndication.
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Every day, more people are walking the sidewalk alongside the beach across the street from my house. A month ago, someone would pass by every three or four minutes. A week ago, it was a steady trickle. Now, it’s a light but continuous stream.

The rules haven’t changed. The shelter-in-place mandate is still active. But as each day passes, more and more of my little city’s self- imprisoned population have decided to ignore the extremes of social distancing and get back out into the sunshine and fresh air.

I’ve not been interviewing them, so I can’t say why. But from the way they walk and even greet one another, I’m thinking they just don’t believe we are in the midst of a plague. Some no doubt think we’ve passed the peak and the threat of the virus is no longer serious. Others, like yours truly,  probably never thought it was that serious to begin with. Still others, probably don’t think at all.

But their numbers are increasing, and I don’t think it will stop. For whatever reason, we haven’t seen the body counts the media teased us with in January and February. Most of us haven’t seen any dead bodies at all.

As of today, I’ve finished my two-month-long exploration into the virus and the shutdown and its economic repercussions. I’m looking forward to resuming my morning walks and thinking about other things.

The Corona Economy, Part V

What Will America Look Like in 2021? 

“Unemployment is sky-rocketing; deflation is [here] for the first time since the Great Depression. I don’t care whose fault it is. It’s the truth.” – John Mellencamp

As I said on Wednesday, US fiscal history is a history of borrowing money to fight wars.

During the country’s first eight decades of existence, our wars were relatively small and inexpensive. That was chiefly because the Treasury’s income was small then – restricted to what it could get from sales taxes and import duties.

To finance the Civil War, which cost $2.7 billion ($42 billion in today’s dollars), Lincoln introduced the income tax – which made increasing debt and fighting expensive future wars that much easier.

WWII cost us more than 10 times as much as the Civil War ($323 billion or $5.8 trillion in today’s money). It also gave birth to the wealth- and life-destroying machine that Eisenhower warned us against: the military-industrial complex.

The atomic bomb deprived that machine of the ability to produce carnage on a global scale, so it fed on proxy wars (Korea, Vietnam, Afghanistan, and Iraq).

Then, in 1964, President Johnson launched the first of a succession of social and ideological battles – the wars on poverty, drugs, and terrorism.

And now we have the War on COVID-19.

Like the spectral enemies we fought before it, COVID-19 is a formidable killer of human beings. And like the wars against poverty, drugs, and terrorism, the cost of the War on COVID-19 is immense and will be ongoing. What irks me is that most of the perfectly intelligent people I speak with have no idea how expensive it will be. The fact is, it will likely eclipse the cost of all previous wars.

Let’s add up the damage so far:

* $10 trillion in lost production (GDP) – that can never be recovered

* $4 trillion to $6 trillion in “bailout” distributions – that will produce no sustained benefit to anyone

* $5 trillion in stock losses – that may take years to recoup

* And some trillions more in pork barrel legislation that will likely follow in the next few years

With that kind of damage on the country’s P&L statement, it’s inevitable that  the Treasury’s balance sheet will soon be in the red by more than $30 trillion. That would be 150% of our GDP – the highest debt-to-GDP ratio in our nation’s history. (Higher even than the previous WWII record of 119% in 1946.)

You might be wondering: How is it possible for an economy to get into that much debt without collapsing? How is it possible for the US to escape the fate that felled the Romans, the Germans, the Chinese and – most recently – the Venezuelans?

In those cases, the mechanism for economic collapse was hyperinflation. Gradually at first, and then accelerating as the national debt mounted, the world’s faith in the solvency of each of these countries eroded.

That is what many of my historically attuned colleagues believe is going to happen again here in the US. And to be fair to their viewpoint, all the markings are there.

So how is inflation an answer to excessive debt?

It’s because inflation reduces the onus of debt by making each owed dollar less valuable. At an inflation rate of 10% a year, each trillion dollars of debt is effectively reduced by $100 billion. At an inflation rate of 50%, the debt would effectively shrink to next to nothing in just a few years.

And if you think an inflation rate of 50% is unlikely, you need to spend 15 minutes researching inflation in the countries mentioned above. There have been plenty of times in the past when over-indebted economies saw annual inflation rates of 50%, 100%, and even 200%. In Germany, Zimbabwe, and Venezuela, inflation rose to 1000% and even more!

An inflation-diminished dollar would be good news for the Treasury’s balance sheet, but it would be terrible news for the rest of the country. It would mean the purchasing power of every dollar earned would decrease by that amount. At 50%, the loaf of bread that costs $2 today would cost $10 in 2021, $50 in 2022, and so on.

Likewise, the cost of tools and raw materials and energy typically rises and falls alongside inflation. And those costs make it more expensive for businesses to produce the goods and services they provide. But they can’t increase their fees at the same rate and, thus, take a beating, with many of them going out of business permanently.

I don’t think we have an immediate threat of hyperinflation. In fact, what we’ve been seeing so far is deflation (a reduction in prices) of oil and gasoline and most commodities and equities, and most bonds. But deflation cannot cure the debt disease, which is why it’s normally short-lived (and followed by inflation).

The Great Recession of 2008 was caused, as all recessions are, by debt and speculation. Banks, brokerages, and insurance companies had leveraged up with sub-prime real estate debt and were on the verge of bankruptcy when the Fed, under Ben Bernanke, descended from the skies and attempted to save the economy with quantitative easing (flooding the bond markets with fake dollars).

That effort, from 2009 to 2014, saved most of America’s largest financial institutions (that irresponsibly created the debt), but it did not save the economy.

The economy entered into a period in which many middle- and working-class Americans lost their homes and got considerably poorer. At the same time the Wall Street was getting richer – much ricer – and awarding multimillion-dollar bonuses to its brokers. When all was said and done, the US economy had experienced the largest transfer of wealth in its history – with $10 trillion passing from Main Street to Wall Street.

In retrospect, it’s easy to see that the 2009 bailout was a bad idea. But the corona bailout could be worse.

The big difference is this: Back then, the bailout was optional – a “grand experiment,” as Tom Dyson put it. But the corona bailout is being done out of necessity. Because of everything we’ve talked about in the last few days, the government has no choice: Bail out the Treasury or risk going bust.

Nobody is against the current bailout. Not our trading partners, not our politicians, not the CEOs of big business, not the owners of mom-and-pop shops, nor the 26 million unemployed Americans. They are all depending on the US central bank to bail them out and, along with them, the entire world’s economy.

Think about it. For the first time since Obama was elected, Republicans and Democrats have come together to embrace a massive spending spree larger than any in our history. The only differences among these traditionally competing groups in this case is how much to overspend: whether the bailout should stop at $4 trillion or $6 trillion or $10 trillion or more.

The Problems With Free Money 

Free money, as I’ve said a hundred times, is never a good idea. And it’s an especially bad idea when it’s the federal government giving it out to foreign countries, domestic corporations, and to its populace through blanket giveaways like this one.

When money is given freely, it is often wasted. And it always creates dependency and entitlement. When fake money – dollars created out of thin air by an entry ledger in the Fed’s books – is given away freely, the net effect is reduced productivity, greater social and corporate dependency, and a weakening of faith in the US dollar. The first of these damages, reduced national productivity – has already happened on an enormous scale. The second is happening now. And the third is almost sure to follow. The only question is when.

I’ve no doubt that a portion of the productive sector of the economy will recover strongly after America opens up its economy next month. But I’m quite sure that it will not fully recover, as thousands – perhaps tens of thousands – of businesses will not be reopening and millions of Americans workers will remain unemployed.

How long the Corona Recession will last is anybody’s guess. Trump is hoping it will be short-lived and the economy will be firing on all cylinders by election time. His opponents would rather have America endure another bout or two of lockdown to ensure public discontent till then.

Nobody can possibly know what’s coming. We’ve never been in this sort of situation before. But it would be foolish to presume that we can replace the $10+ trillion we’ve lost these last three months by simply resuming our old work lives.

I’d say we enjoyed a good economy last year, but the fact is it wasn’t very good at all. The recovery after the crash of 2008 was a tepid one, with growth averaging a measly 3% a year. And the debt, as I explained Wednesday, mounted strongly during the Obama years and then skyrocketed once Trump took office. The $30 trillion of federal debt we’ve incurred will have to be dealt with sooner or later.

So how will America deal with this humongous debt?

Will we follow the historical pattern of inflation leading to hyperinflation leading to debasement of the currency and then total economic collapse?

Or is there another way?

A Bit More History 

From 1933 to 1939, President Franklin Roosevelt instituted the New Deal – a series of large-scale reforms and programs meant to stimulate the economy and end the Great Depression. (See “Did You Know,” below.)

The New Deal was popular. It put the Democrats into power for nine administrations, from 1937 to 1964. And it is credited with bringing the American economy back from near collapse to the strongest in the world.

Many good programs were launched through the New Deal, including the Reciprocal Tariff Act of 1934 (which opened up international trade) and the regulation of the worst practices of banks, insurance companies, and brokerage houses (which, till then, had been basically free to bamboozle and swindle their customers).

But one thing that wasn’t good about the New Deal was a series of executive orders that suspended the gold standard, unlinking the value of the dollar to the price of gold. This changed US monetary policy forever by allowing the amount of dollars in circulation to be a decision made by a handful of central bankers, rather than millions of businesses and consumers that make decisions by prices, which are controlled by supply and demand.

What some New Deal fans don’t talk about was that in 1937, during Roosevelt’s second term, there was a significant downturn in the economy. Production and profits declined sharply and unemployment jumped from 14.3% in May 1937 to 19.0% in June 1938. This proved to some the faults in the New Deal. (Maynard Keynes, for ones, was a doubter. He attributed the eventual recovery to the efforts of the private sector up to and through WWII.)

Whether it was the New Deal or private enterprise or both, there is no argument that what made America the leading economic power after WWII was the expansion of the gross national product.

The halcyon days of the 1950s and early 1960s were the consequence of the enormous expansion of capital enterprise that took place during those years. Growth in production eradicates debt and creates prosperity by virtue of added authentic economic value. That and the population explosion married to an expansion of consumer consumption were the true driving forces of America’s economic ascension.

Could it happen again?

Could America be first again? That’s a question that will be answered in the next 10 years. Can American enterprise innovate its businesses to lead the world? Or will faith in the US economy and its dollar crumble and send America down the path of the collapsed empires of the past?

You can ponder that question, if you will. But if your goal is to get yourself and your family into recovery mode, you’ll have to put your energies into building wealth the old-fashioned way: producing and selling value for a profit, and saving that profit for the future.

I’ll be talking about how you can do that in future blog posts as, after today, I’ll be back to talking about something I don’t need Wikipedia for – personal productivity, business growth strategies, personal finance, and the well-lived life.

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When I first started making more money than I was spending, I asked my partner to recommend someone to help me do my taxes. “You should speak to Sid,” he told me. He does my taxes and he’s good. Plus, he got rich as an accountant, and that’s not easy to do.”

Sid was his father-in-law. He must have been in his 60s back then, in the early ‘80s, but he looked older. He was tall and gaunt with an angular face and thin gray hair. He was shocked when he discovered how little I knew about money.

Perhaps for that reason he adopted an avuncular attitude towards me. He advised me on taxes, but that was just the beginning. He quizzed and lectured me on sales and marketing and business communication. And he advised me on investing, too.

“Why are you spending all that money on art?” he would exclaim. “It’s just decoration! Just pictures on the wall!”

He failed to dissuade me from collecting art, but he was a big influence in helping me develop a philosophy of wealth building. “You’re making good money now, kid,” he said after I received my first big dividend. “But if you’re not smart, you can lose that much and more with a single stupid move.”

Sid had been a very aggressive businessman (as was his son-in-law). But when it came to investing, he was a conservative as one can be. He bought for himself and recommended to me only two asset classes: triple-A municipal bonds and Treasury bonds.

“What about stocks?” I frequently asked him.

“Stocks are for shmendriks and schmucks,” he’d howl. “Bonds! Buy bonds!”

The Corona Economy, Part IV

War, Debt, and the Eve of Destruction 

“I found this national debt, doubled, wrapped in a big bow waiting for me as I stepped into the Oval Office.” – Barack Obama

In Part I of this series, we looked at our government’s financial situation the way an investor would look at the financials of a business. The conclusion: From a P&L and balance-sheet perspective, it looks awful.

In Part II, we saw how much worse those financials are going to be at the end of this year: a bigger deficit (by $6+ trillion), a smaller GDP (by about 20%), a much larger debt (around $30 trillion).

In Part III, we rued the fact that these facts are not understood by 98% of the voting public, and are misunderstood and/or ignored by 80+% of our elected officials and the media that report on what they’re doing.

And in case you’d want to be one of the 2% of the population that does have at least a basic understanding of how money works at that level, we provided an introduction to US fiscal and monetary policies (as we understand them). Today, we continue where we left off.

The Idiot’s Guide to Monetary and Fiscal Policy in the US (continued)… 

When our government spends more money than it takes in, it covers the difference (the deficit) by borrowing money. It does that through its Treasury, which sells bonds (government IOUs) for the dollars it needs for its overspending.

Treasury bonds are attractive to savers and investors for two good reasons. (1) They are generally considered risk-free because they are “backed by the full faith and credit of the US government. And (2) as “fixed-income securities,” they provide the investor (bond buyer) a guaranteed return paid out on a predetermined basis.

Guaranteed returns by the world’s largest and “strongest” economy? Of course there will be a big demand for T-bonds. Individuals want them. Banks want them.  Pension funds want them. Even foreign countries want them. Not necessarily as a primary investment, but as an asset they can count on when everything else is in flux.

Whether the bond buyer is a retired plumber or a sovereign nation, Treasury bonds promise a solid foundation for any portfolio, providing a sense of security that’s the next best thing to gold. Think about it. Holding T-bonds is like owning a share of America! So long as America doesn’t declare bankruptcy, those IOUs will pay off.

A Wee Bit of History 

The history of US debt is the history of its wars. Before the Civil War, the national debt was relatively modest, because before then there was no income tax. Wars were funded with sales taxes and the like.

The Civil War changed that. Between 1860 and 1866, the debt rose from $64.8 million to more than $2.7 billion, approximately $42 billion by today’s standards. To keep the nation whole, President Abraham Lincoln pushed debt to nearly 30% of gross domestic product and introduced the first income tax in American history.

After that, every war led to ever-higher debt levels. WWI elevated the national tolerance for federal debt, bringing it to $27 billion. More importantly, Woodrow Wilson changed the way debt was approved. Congress’s previous approach was to approve each bond sale individually. Wilson introduced the “debt ceiling,” whereby the US Treasury was told how much it could borrow overall and the administration was allowed to manage the sale of individual rounds of debt. This law has remained in place ever since.

President Franklin Roosevelt made a big “contribution” to raising our debt through the New Deal, elevating borrowing to over $40 billion to fight the war against the Great Depression — nearly doubling the national debt when he took office.

WWII was the next big step in the history of US debt, with the government spending more than $323 billion ($5.8 trillion in today’s money) to defeat Germany and Japan. Much of that money was borrowed. And between 1940 and 1946, US debt climbed from $42 billion to $269 billion, much of it held by individual Americans in the form of Treasury bonds.

But between 1965 and 1978, two more “wars” dramatically boosted the national debt. One of them, from 1965 to 1975, was the Vietnam War. The other one began in 1966 when Lyndon Johnson signed the Medicare program into law. Like the Vietnam War, it was a battle we would not win. But unlike the Vietnam War, the costs of fighting it have never ended or even diminished.

Since then, the national debt has not stopped growing. It grew under President Reagan and under George H.W. Bush and Bill Clinton. (Although the rate of growth slowed considerably after Clinton got Congress to enact tax increases early in his first term.) In the year 2000, our government went into the new millennium with a debt of $5.65 trillion.

Debt slowed a bit in the 1980s and 1990s. Then, on Sept. 11, 2001, President George Bush Jr. spearheaded yet another war – the war on terror. But the invasions of Afghanistan and Iraq were not funded by additional taxes. They were funded by debt, growing at a rate of $400 billion to $500 billion per year.

The Great Recession of 2008 brought deficits beyond the $1 trillion mark. And under Obama, that continued, although it did diminish by more than half during the second half of his presidency.

Then, in 2018, Donald Trump was elected president. Many hoped he would reduce spending, but that didn’t happen. Instead, he oversaw a deficit increase to $1.3 trillion during his first full year in office.

And now we have the war on COVID-19.

Bartering for Dollars 

All of these wars since the Civil War have been funded by government debt. Initially, it was private citizens and businesses (and wealthy industrialists) that bought that debt. But in recent decades, it was foreign countries – countries like Germany, Japan, Saudi Arabia, and China – that were producing budget surpluses and looked at Treasury bonds as a safe haven for their extra dollars.

Germany was an early buyer of bonds. Japan became one soon thereafter. As the years passed, other countries became big buyers. When Saudi Arabia discovered it was sitting on an ocean of oil, it could think of no better way to save its excess dollars than by parking them in T-bonds, backed by the full faith and credit of the USA. After China abandoned government ownership of all businesses, it rapidly became a net surplus economy as well. And it, too, invested its extra dollars in US Treasury bonds.

Which is why you’ve probably heard some people say that the US dollar (and, actually, the American economy) has been supported in the last two decades by Germany, China, and Saudi Arabia.

But surpluses come and go. And about 6 years ago, China changed its priorities vis-a-vis saving its surplus wealth. It continued to buy Treasury bonds, but it also began to buy large amounts of gold. And perhaps more importantly, it began a massive investment in its own infrastructure and overseas ambitions.

“Luckily” for our government, large financial institutions (and particularly hedge funds) began buying (and trading) billions in US debt at the time. This increased the supply of dollars bidding for the T-bonds and, thus, kept the rates down to reasonable levels.

But in the last year, this supply of dollars diminished. That, and the continuing reduction in demand from China, put the Treasury in a terrible situation. If the supply got too small – less than the demand for dollars (our deficits) –  it was possible that the Treasury couldn’t keep up with its payments. That would mean a literally bankrupt USA. And that would mean the end of the world’s economy, as we know it.

In Greek tragedy, the hero is sometimes saved by a deus ex machina – i.e., an intervention by the gods. For America, that came in the form of the Federal Reserve. To make up for the reduced demand from bonds from our traditional buyers, the Fed began buying bonds itself.

Now you may be wondering how the Fed can afford to buy bonds. After all, it is a semi-autonomous central bank that is required by law to balance its books.

Here’s how Tom Dyson explains it:

“The Fed doesn’t ‘inject’ money supply into the economy. Instead, it ‘trades’ it or ‘swaps’ it via transactions with the entities it’s giving the money to. So, for example, if the Fed wants to give the government some fresh money, the government must give it some Treasury bonds. If the Fed wants to give a bank some fresh money supply, the bank must give it something in return.”

It’s called “quantitative easing.” And that’s how the Fed balances its books. It sits on a pile of collateral representing every dollar it has printed and “traded” for something.

Tom again: “Basically, the Fed is a bank that makes huge loans and takes collateral. And the collateral serves as its capital base.”

That is all good and dandy so long as the Fed can unwind these trades when the economy has stabilized by returning the collateral and receiving the dollars back. But recently, the Fed has moved into uncharted territory – making loans whose collateral is questionable, at best. For example, the Fed has recently started accepting the equivalent of junk bonds as collateral. There’s even talk of the Fed purchasing equities with its printed money.

Quantitative easing, as it was done after 2008, was a way for the Fed to help the banking system and lift the stock and bond markets. Back then, the Fed was giving dollars to banks and helping them grow. This was great for the banks and for Wall Street, but it wasn’t good for the economy because the great majority of those QE dollars remained within Wall Street.

About a year ago, the Fed began doing something it hadn’t done since April 1942. It agreed to monetize the government debt. The government’s need for dollars was at all-time highs. But because the usual buyers of T-bonds (foreign countries and, more recently, hedge funds) were reducing their buying, a crisis developed in the Repo Market – a critical market where the government finances itself with short-term loans. There was a “shortage of dollars,” as many analysts put it. A dangerous thing.

So what the Fed did was step into the gap and start buying T-bonds. Billions and billions of T-bonds daily to prevent interest rates from skyrocketing, which would then skyrocket US debt payments and put the Fed on the verge of bankruptcy.

As Tom put it:

“There are no more lenders. So the Fed is now being forced to assume the role of ‘lender of last resort’ to the Treasury… financing the US twin deficits and monetizing the Treasury’s debt. All with printed money!”

Quantitative easing is problematic for many reasons, but it didn’t erode the value of the dollar after 2008 because the stock market went bullish and stayed bullish until this year. The world and its economists, its politicians and its journalists took the rise of the stock market and the modest (3%) rise in GDP as a sign that the US economy could be trusted again. But what the Fed is doing now is different. It is not trying to save Wall Street. It is trying to save the Treasury itself. As Tom put it, this new strategy is “Project Argentina.” [See “Worth Reading,” below.]

On Friday, I hope to finish this series of essays on The Corona Economy. I’ll talk about how this new desperately-seeking-recovery strategy will put our government in an impossible situation that can only be resolved by a miracle or a long and devastating economic depression. And how you can both gird yourself against economic disaster and, at the same time, invest in the miracle that could be.

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