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Musings Report 2023-47 11-18-23 Goodbye To All That: The Demise of Speculation
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Goodbye To All That: The Demise of Speculation
The title refers to Robert Graves' classic account of his experiences on the battlefields of France in World War I--left for dead in triage due to his horrific wounds, but clinging on until he was discovered alive--and more broadly, to his life after the war and the demise of the pre-war era's confidence in Progress as bourgeois, rational and inevitable.
This loss of confidence led to the Roaring 20s loosening of social restrictions and the go-go euphoria of soaring real estate and stock markets driven by new technologies (radio, autos) and new financial innovations (leverage and credit available to the masses). This speculative frenzy reached an apex in 1929, and millionaires famously sold all their stocks when they heard taxi drivers and shoe-shine boys swapping hot stock tips.
My sense is that we've reached a similar apex of rampant speculation that will collapse in on itself as a result of unsustainable excesses that have become normalized, i.e. we now take rampant speculation as not only normal but "the way the world works." Beneath this normalized frenzy of speculation, the world is changing in ways that no longer support the engine of speculation: the endless expansion of credit and consumption managed by omnipotent central banking.
What's changed?
1. The era of financialization, globalization and digitization is giving way to an era in which materials will dominate the global economic, social and political orders. Life will revolve around obtaining the basics of life rather than around marketing to consumers with discretionary income/credit to spend.
2. The material world is ruled by physics, chemistry and cost, not finance or politics. Humanity has already consumed / depleted the cheap, easy-to-get resources, from coal and oil to topsoil, wild fisheries and fresh water aquifers. The net result is that all resources will cost more to extract, process and transport, and these systemically higher costs manifest as inflation / loss of purchasing power: it will take more units of labor / money to buy the essentials of life, leaving fewer units of money for discretionary spending in the consumer economy and fewer units available to support additional debt.
3. The status quo solution was the financialization of the world: everything is now collateral for an expansion of credit, and so everything is an income stream or collateral that is awaiting monetization. This vast expansion of credit sparked a global bubble in all assets, as trillions of new units of currency began chasing higher returns. This fueled speculation and an appetite for risk.
4. Risk was reduced to near-zero by central bank interventions, which have shifted from responses to rare panics to permanent interventions of increasingly stupendous scale. This has fed the belief that you simply can't suffer any real losses if you follow the central bank stimulus ever higher: don't fight the Fed is the no-risk mantra of the age.
These trends are already visible.
The problem for the status quo is this happy arrangement of ever-expanding credit, consumption and asset valuations is all based on credit being low-cost, preferably less than background inflation.
Once inflation is structural due to higher costs of extracting the resources needed to fuel the global economy, then interest rates cannot remain near-zero, as capital eventually demands a return above inflation, and at some point it also demands a premium for the risk that the whole shebang might collapse due to central bank interventions failing to inflate the value of collateral, i.e. assets.
Once credit isn't cheap and assets are no longer soaring in value, increasing the collateral to support more debt, the arrangement implodes. The first asset class to manifest this reversal is commercial real estate (CRE), which was overbuilt due to the incentives of financialization. Now buildings that sold a few years ago for $120 million are selling for $60 million, or $40 million, or even less.
These declines in collateral mean the outstanding loans are much larger than the value of the asset, and so somebody has to take the losses.
Since lenders are highly leveraged due to the structure of fractional reserve banking--every $1 of cash can be leveraged into $10 of new loans--massive declines in collateral lead to lender insolvencies, which then tighten credit as the insolvencies work their way through the entire financial system.
Global debt now exceeds $300 trillion, roughly 10X the GDP of the US. As a significant percentage of this debt is written down due to defaults and insolvencies, it reduces both the income from loans that are no longer generating interest and it reduces the collateral to support more credit.
The debtors are free of the burden, but every debt is someone else's income-generating asset. The income and asset both vanish into thin air.
5. There is one more change in the works: how governments respond to higher costs of credit and the resulting stagnation of the credit-based global economy. For the past century, the Keynesian dogma has held that the proper response of governments is to spend more to keep their economies afloat by borrowing money, generally by selling government bonds to private investors. This is deficit spending.
This works when the cost of money is low, but it quickly become untenable when rates and debt both rise: much of the government's tax revenues are going to pay interest on the debt--mostly owned by the wealthy-- rather than flowing through to the bottom 90% who subsist on wages, not income from capital.
The government can cut spending, further pressuring a weakening economy and risking political disorder, or it can raise taxes. Borrowing more is no longer a solution once the interest payments are consuming much of the tax revenues.
The wealthy famously buy political influence to reduce their taxes, but since they're the only segment who can afford higher taxes, push comes to shove: if political survival demands higher taxes, then what happens next?
Let's look at some other dynamics and a few insightful charts.
Let's consider what happens as inflation / interest rates rise and credit tightens due to higher risks of default: stocks start looking much riskier than Treasury bonds. This is what happened in the 1970s as structural inflation took hold: as this chart shows, the percentage of household wealth in stocks plummeted. Brokerages became quiet and speculation dried up. Adjusted for inflation, stocks lost 40% in the decade. (Dividends reduced the losses of course, but stocks went up and down and ended up at the same nominal level.)
The tax rates on capital gains were once higher than taxes on most wages. The neoliberal dogma held that favoring capital over labor would boost growth, and so capital gains tax rates fell to 20%, far below the tax burden on wages of Social Security/Medicare and income tax rates up to 35%.
These two charts show that capital gains are almost entirely concentrated in the top 1%.
Capital gains flow from trading securities: stocks, bonds, derivatives, options, futures, etc.
A generation ago, before online trading, buying $1,000 of a stock cost $50 in brokerage commission. Trading in and out thus cost 10%, negating any gain less than 10%.
In the early days of online trading, $9.99 commissions were a revolutionary bargain. A friend who worked at Oracle in the late 1990s told us employees were day-trading just to make lunch money.
Now trading is essentially free.
Returning to the normalization of rampant speculation: in the pre-financialization era, a 10% annual gain was considered handsome. Now anything less than a 5-bagger (5X gain) is chump change. Politicians always managed to skim off favors and wealth, of course, but they were not buying $50,000 of options or minting millions from trading stocks (the Pelosi Portfolio etc.).
Housing developers were once satisfied with a 10% gain, now every investor expects a 50% within a few years.
Investing once meant giving cash to an enterprise to invest in exchange for shares in its stock. Now "investing" means gambling / trading in the casino.
I date this inflation of speculative expectations to the late 1990s dot-com frenzy, when 40% leaps in stocks in a day became common, and ten-bagger entered the lexicon as the gold standard of speculation: the stock you bought for $1 is now $10. Low-level employees cashed in their stock options and retired in their late 20s.
This speculative fever never died; rather, it was boosted to new heights as meme stocks and Federal Reserve interventions fueled outsized gains. That all this was ultimately the result of central banks pushing rates to zero while globalization crushed the cost of resources and manufactured goods was generally ignored.
Putting this together, what can we expect?
The demands to impose transaction fees on all trading have been around for years, and it seems likely they will eventually be viewed as a painless way to raise revenue. This will make day-trading and front-running retail trades much less lucrative. Once it actually costs money to trade, accounts will be eroded even as nominal gains are notched.
Capital gains are the obvious place to raise tax rates, along with incomes above whatever level is considered upper-middle class: $300,000, etc.
We can also expect a predictable reversion to the mean in speculative animal spirits: the extremes of speculation we now consider normal will decay back to previous levels, volumes will fall as transactions will cost money and the stagnation of the drivers of speculation--zero-cost credit and ever-expanding collateral--reverse.
The above chart of stock ownership in the 1970s is instructive. Traders tried to play the wild swings up and down in the early 1970s and then they gave up in 1974 and sold out, reducing the percentage of their wealth in stocks by half.
In other words, speculation of the current intensity won't expire overnight. It will cling on in the zeitgeist for years, as the muscle-memory of scoring huge gains will drive traders to attempt to catch each swing and exit one meme story for the next hot trend.
But over time, the tides will be running with increasing vigor against this feverish churn. Inflation and interest rates won't go back to zero and stay there for another decade, and central bank interventions will no longer have the desired results; diminishing returns will set in across the entire global financial system.
It's already in motion, but nobody's ready to give up the idea that Progress as measured in ever-rising credit and profits is already in the past. Nobody's saying "goodbye to all that" yet, but nothing is more ephemeral than speculative manias, and yet nothing feels so enlivening and forever as speculative manias.
Highlights of the Blog
What's It Take To Be Middle Class Now? 11/17/23
Check All That Apply: Artifice, Suppression, Deceit, Denial, Delusion 11/15/23
Can We Reverse America's Distemper? 11/13/23
The Original Song That Came To Me in a Dream 11/12/23
Best Thing That Happened To Me This Week
Gave away / shared 80+ breadfruit with family, friends and neighbors, roughly 200 pounds of highly nutritious, high-fiber carbo. Here is our tree, planted as a 2-foot sapling 5 1/2 years ago. For scale, the bamboo stick is five feet in length.
A breadfruit on the tree.
On the kitchen scale.
From Left Field
NOTE TO NEW READERS: This list is not comprised of articles I agree with or that I judge to be correct or of the highest quality. It is representative of the content I find interesting as reflections of the current zeitgeist. The list is intended to be perused with an open, critical, occasionally amused mind.
Many links are behind paywalls. Most paywalled sites allow a few free articles per month if you register. It's the New Normal.
Vitamin B12 May Lower Inflammation, Study Suggests
Home, studio, a way to sell abandoned items: the many uses of self-storage
Going ‘delulu’: being delusional is the new manifesting
Fika, four-week holidays – and zero overtime: Sweden’s stunningly healthy work culture
I Moved Out Of The U.S., People Hate Me For It
7 Steps to Move Out of the U.S.
How ‘Calculated Misery’ and Capitalism Increasingly Go Hand in Hand
Has The US Lost Its First-World Status?
Focus: A second life for EV batteries? Depends how long the first is
Court jester hypothesis (via Ryan K.)
The Japanese Word That Expresses Melancholy and Joy at the Same Time
20 years of tech has made life easier, not better.
Musical mysteries: the unlikely album cover stars who became modern pop enigmas
"Dogs and philosophers do the greatest good and get the fewest rewards." Diogenes
Thanks for reading--
charles |
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