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Musings Report 2018-37 9-15-18 Why Inflation Will Arise and Eat Us All Alive
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Why Inflation Will Arise and Eat Us All Alive
Let's see if we can't tell the story of our economy and inflation in a distilled-down narrative.
Energy defines our global industrial economy. Without it, everything stops. If it's expensive, the system can no longer expand.
Each barrel of oil (5.8 million BTUs) contains the energy equivalent of more than a decade of one human's labor.
That decade represents $400,000 in human wages, hence each $40 barrel of oil is the equivalent of $400,000 in human labor.
When oil hits $80/barrel, it's the equivalent of $200,000 in human labor. No wonder the global economy sinks into recession when oil prices spike higher.
The fracking boom is an artifact of technology and cheap credit: without billions of dollars in cheap credit, the fracking boom would not have happened. The fracking industry lost $5 billion in the past few years.
In effect, the Federal Reserve has subsidized fracking to push down the cost of energy.
Why? The incomes of the bottom 80% of households have stagnated for a decade (or two). Since every product / service in the industrial economy requires energy, higher energy costs push the price of everything higher.
How can consumers maintain the high levels of discretionary spending the economy needs for growth when costs are rising but their incomes are stagnant or actually declining when adjusted for inflation?
They can't. To enable the bottom 80% to keep consuming, the Fed suppressed the cost of energy by subsidizing a money-losing industry (fracking) with dirt-cheap credit.
Super-low interest rates also enabled households to fill the widening gap between their incomes (flat) and costs (steadily higher) by borrowing: student loans, credit cards, auto loans, home equity lines of credit, etc.
Super-low interest rates enabled homeowning households to refinance their mortgages, freeing up hundreds of dollars for spending/consumption.
Super-low interest rates mean super-low yields on safe investments such as Treasury bonds.
Pension funds, insurers and other institutional owners of assets cannot meet their obligations if they earn 1%-2% annually. So the Fed's repression of yields has pushed these institutions into risk-assets such as stocks, high-yield (junk) bonds and commercial real estate.
In response, the Fed has backstopped risk assets with unprecedented purchases of assets--Quantitative Easing. This has inflated bubbles in stocks, bonds and real estate as investors understood the Fed would never let assets drop, since any decline would wipe out pension funds, insurers, etc.
But these expedient policies have unexpected consequences.
Inflating assets has greatly widened wealth-income inequality, as only a few households and corporations own the majority of the risk-assets. (See Musings on the Economy below for more). Those who don't own meaningful amounts of productive assets have lost ground while those who own the assets have seen their wealth skyrocket.
This has generated social discord, which has manifested political revolt (nationalism, etc.). Central banks no longer have the political leeway to bail out banks and the super-wealthy.
In addition, the boom generated by central bank stimulus has removed central banks' excuse for keeping interest rates low and buying assets: now that the economy is growing smartly, interest rates should move higher and return to historic norms, and the Fed should reduce its balance sheet (selling assets instead of buying assets).
These moves put the asset bubble at risk, since the fundamental drivers were 1) corporations could borrow cheaply and buy back their shares and 2) institutions and investors were driven into risk assets to earn a yield, i.e. chasing yields but at the cost of taking on much higher risks. Once yields rise, the incentive to lower risk by selling risk assets in favor of safer assets strengthens.
Rising interest rates threaten to derail the fracking industry unless energy prices are allowed to rise.
Rising interest rates also increase the borrowing costs of households, decreasing income available for discretionary spending.
In response to higher interest and ever-higher costs, those left behind are calling for QE for the People, i.e. central bank largesse should be distributed directly to households via Universal Basic Income (UBI) or equivalent (a $1,000 monthly stipend issued to each adult).
The political class views UBI as politically expedient: as Fed-induced asset bubbles have pushed wealth inequality to the danger zone of social instability, the easy fix is to borrow $2 trillion a year and distribute UBI to everyone.
All the money creation of the past decade has flowed into assets, inflating bubbles in stocks, junk bonds, housing and commercial real estate.
These bubbles have pushed rents higher, as new owners need high rents to cover their costs. Easy credit has also enabled higher education to keep pushing costs higher, forcing students to borrow more to attend college.
Healthcare costs have also soared. Those exposed to rent, higher education and healthcare are experienced inflation far above the official rate of 2% to 2.5%.
Now interest costs are rising, too, adding another inflationary pressure.
QE for the People/UBI will pump trillions of borrowed dollars directly into the economy. This will generate inflation, unless energy costs drop significantly.
Energy is the forgotten factor of inflation. If energy is abundant and cheap, new money flowing into the economy can boost productivity and output. This dynamic is not inflationary, as the pool of goods and services expands along with the money supply.
But if energy is scarce and costly, new money isn't able to meaningfully increase productivity (hence stagnating productivity as energy costs have risen). New money chases the existing pool of goods and services, pushing prices higher.
To summarize: cheap abundant energy, cheap goods and credit from overseas (globalization) and cheap abundant domestic credit funded by savings are non-inflationary.
Higher cost energy, rising costs of goods/credit from overseas, higher-cost credit domestically and vast injections of newly issued currency (i.e. UBI) are all inflationary.
Add these dynamics up and the only possible output is inflation that will start slowly but soon accelerate to the point of severe financial pain and beyond.
Highlights of the Blog This Past Week
Massive Deficit Spending Greenlights Waste, Fraud, Profiteering and Dysfunction 9/14/18
The Next Financial Crisis Is Right on Schedule (2019) 9/12/18
How Things Fall Apart: Extremes Aren't Stable 9/10/18
Best Thing That Happened To Me This Week
We were gifted 15 dryland taro plants which are now in our newly cleared garden.
Musings on the Economy
IRS data from tax returns are one of the most reliable sources of financial data because there are stiff penalties for not filing accurate returns, and there are no "adjustments" or massaging of the statistics: they are what they are.
Here's the primary page with numerous Excel spreadsheets for download: Individual Statistical Tables by Size of Adjusted Gross Income.
Adjusted Gross Income is reported on line 37 on form 1040, income after major deductions such as moving expenses, self-employed health insurance, etc.
Each spreadsheet is a trove of information on wealth and income--distribution, inequality, sources of income, etc.
Consider Returns with Income or Loss from Sales of Capital Assets Reported on Form 1040, Schedule D.
This spreadsheet consolidates all tax returns that reported capital gains or losses.
Out of 150 million total individual tax returns, 11 million reported capital gains/losses, and 9.3 million were taxable returns.
1.26 million taxpayers reporting adjusted gross income of between $50,000 and $75,000 (middle-middle class) reported average capital gains of $6,187.
3 million taxpayers reporting adjusted gross income of between $100,000 and $200,000 (upper-middle class) reported average capital gains of $16,000.
250,000 taxpayers reporting adjusted gross income of $1 million or more reported average capital gains of $1,600,000.
So those earning 10 times a middle-class income of $100,000 reaped (on average) 100 times the middle class average of capital gains.
It's worth noting that only 6% of tax returns reported taxable capital gains, and of these 9 million returns, the lion's share of the capital gains flowed to the top 0.0016% of all returns--the 250,000 reporting incomes of $1 million and higher.
If we want to understand wealth and income inequality, this spreadsheet provides a solid foundation.
Earned income (from labor and enterprises) is much larger-- $9.6 trillion distributed over 150 million taxpayers, compared to $634 billion in capital gains--but those gains are highly concentrated: 63% of all capital gains flows to the top (those earning $1 million and up).
From Left Field
Asian plastic is choking the world's oceans: More than 80% of marine plastic pollution comes from Asia
How does recycling work? (not very well if China refuses our low-quality, unsorted recycling...)
The Turkish financial crisis-- the model for future crises globally?
Prof. Robert Jensen: “There Clearly Is No Decent Human Future Possible in Capitalism”
Crazy Poor Asians: There is no poverty in Singapore because I’m not poor
EIA chart of Oil Imports and Exports--just the facts... hey, we're still importing millions of barrels a day....
How Tourists Are Destroying the Places They Love: Travel is no longer a luxury good. Airlines like Ryanair and EasyJet have contributed to a form of mass tourism that has made local residents feel like foreigners in cities like Barcelona and Rome. The infrastructure is buckling under the pressure.
Tencent - A Total Rethinking (via Maoxian)
Fall of the 'Frack Master': apostle who briefed parliament lands in Texas jail (via Joel M.)
Japan's Debt Problem Visualized (6:45 min video) (via John F.)
Scents and Senescence: "Old Person Smell" Is Real, but Not Necessarily Offensive (via Moaxian) Yikes! Something else to worry about as I age....
7 Steps You Can Take So You Don’t Smell Like an Old Lady as You Age (via Moaxian) -- open the windows...
'Monster' Turns Our Farmers into Serfs and Sharecroppers: The Grapes of Wrath and its vision of enslavement to big agribusiness isn't just our past--it is our present too.
"It is not the unknown we fear, but the known coming to an end." Krishnamurti
Thanks for reading--
charles |
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