Investing

The High Cost of High Prices

Instead of investing in the future of the U.S. with initiatives that seek a pay-off, recent bailouts and market manipulations will only hamper long-term growth. Is the U.S. heading toward Japanification?

By Chris Recker  ▪  May 14, 2020
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The shuttered U.S. economy has invoked a new wave of fiscal and monetary efforts that mirror three decades of past responses. As Americans revisit the eternal debate around government’s role during times like these, policymakers and power players have side-stepped the citizenry once again.

Instead of investing in the future of the U.S. with initiatives that seek a pay-off, recent bailouts and market manipulations will only hamper long-term growth.  

By some calculations, over 90% of recent fiscal and monetary efforts, or $8 to $10 trillion, will benefit a very small group—executives of large corporations and the wealthy top 0.1%. These resources are being used to support asset prices, with little to no sustained positive effect on the economy.

In our opinion, the long run consequences are quite negative, resulting in high total factor costs for most Americans and small business and subsidies, bailouts, and lower burdens for large corporations and the well-connected few. 

In sum, the absence of a level playing field and healthy policy is leading the U.S. toward economic stagnation known as Japanification. (Note that Japan’s benchmark Nikkei 225 stock index is lower today than it was in 1991.) 

The roots of modern Fed policy can be traced back to Alan Greenspan, former Chair of the Federal Reserve from 1987 to 2006. 

He steered the Fed toward market interventionism by flooding liquidity to save the stock market in 1987 and the organizing the bailout of hedge fund Long-Term Capital Management in 1998.  After the Fed induced Dot.com bubble, he lowered rates to 1% culminating in the Housing bubble, its collapse and subsequent bank bailouts.

Greenspan introduced an ethic that markets will not be allowed to fail no matter how incompetent Wall Street machinations were. For the past 35 years, markets in the United States have not been allowed to clear. But pointing only to Greenspan is not fair. There is plenty of blame to go around. 

For 50 years, United States regulatory, anti-trust, and trade policy have been captured to pave the way for almost unimaginable industry concentration and the decimation of the U.S. industrial base. Policies embraced and furthered by leaders of both political parties have allowed big corporations to get low prices through cheaper financing, cheaper labor, environmental arbitrage, and lower relative regulatory burdens.  

Consider the following culmination of events:

  • Decades of no anti-trust enforcement has resulted in sweeping consolidation. 
  • Tax reform in the 1980s crushed maverick Savings and Loans leading to the S&L crisis, which eliminated that competitive threat to the money center banks. 
  • The 1998 passage of the Gramm-Leach-Bliley Act effectively neutralized the 1933 Glass-Steagall Act and unleashed Wall Street to create financial weapons of mass destruction through derivatives and explosive debt levels. 
  • The Sarbanes-Oxley Act of 2002 and Dodd-Frank Act of 2010 reformed accounting and financial requirements that buried smaller public companies in compliance costs. 

In 1997 there were approximately 8,000 public companies listed in the United States. Over the next twenty years that number declined by over 50% to 3,600 companies. 

A recent OECD study documents the significant increase in U.S. industry concentration over the last 20 years and a correspondent decline in dynamism and competition. Lackluster GDP growth this century further confirms the finding.

We will not go into detail on the policies adopted vis a vis China and their impact over the past several decades. We will only say that the 50-year old military strategy employed by the People’s Liberation Army has used subsidies and subterfuge to lower costs for U.S. multinationals and resulted in higher prices for everyone else. 

Cheap products don’t advance a person’s purchasing power if one’s wages are falling and opportunities are disappearing. Between 1973 and 2019, real median earnings in the United States were essentially flat.

Zero growth over nearly 50 years! No society can achieve true wealth with these numbers.

At the family level, regulatory capture and government intervention have increased the cost of having children leading to lower population and economic growth. When housing, healthcare and education prices unrelentingly rise at multiples of official inflation for decades and real wages stagnate, households have to cut back. 

Headcount matters at the family level, as well as, the corporate level. Put simply, the large families of the Baby Boom generation are too expensive for 2020 America.

When savers invest at artificially high prices, returns are suppressed lower. It also means that the investment dollars do not stretch as far reducing future potential output, thus shrinking the future capital base of the country. We are made poor twice over.  

In the Global Financial Crisis, bailouts were directed at the big banks.  What happened? The largest banks now dominate holding nearly half of all banking system assets. Did this policy reduce risk or concentrate risk?  

Overly reliant on short term financing, General Electric was bailed out when the commercial paper market was rescued. Where is GE today?  In deep trouble after their CEO Jeff Immelt wasted billions on buybacks and a catastrophic acquisition of Alstom. Who was left holding the bag? GE shareholders, pensioners, and employees.

Goldman Sachs was bailed out when the U.S. government stepped in for AIG—reportedly Goldman’s largest counterparty at the time.  What is Goldman doing today? It’s CEO recently received a fat raise after green lighting the purchase of new Gulfstream jets. For deals to get done and financing to happen, does it really matter what the name on the door of the investment bank is?

As far as everyone else is concerned, we have experienced the weakest economic recovery in U.S. history. Millions of people lost their homes and their jobs. Statistics illustrate that, for all but the top 1%, income growth has been slight.

No senior executive went to jail for what some have documented to be the biggest control fraud in history. Infrastructure in the U.S. continues to crumble. In a national emergency, our industrial base has been found wanting and our relationship with China will prove deadly to over 100 thousand Americans—and that does not include those killed by fentanyl originating from Wuhan. 

And now we have the pandemic-related shutdowns.   Going into the shutdowns corporate debt in the U.S. was at an all-time high.  Speculative debt levels were extreme as well. Equity valuations were at all-time records. Global economic growth was already weak. In sum, prices in debt and equity were due to significantly correct regardless of the catalyst.  

But what has happened? When growth dynamics began to assert themselves, equity and debt markets began to price accordingly with a precipitous drop.  

Then the Federal Reserve stepped in with a thermonuclear monetary response. In a matter of weeks, the disclosed Federal Reserve Balance Sheet expanded by over $2.5 trillion. To put this in proper perspective, this is an amount that took years to deploy post-2008.  Our models expect the Fed balance sheet will expand an additional $5 trillion over the next year. 

Numerous and questionable lending programs, trillions in asset purchases, Fed Funds dropped to the zero bound and to cap it all off BlackRock was hired to do what? Bail out BlackRock ETF’s and junk bonds.  

The Treasury is stepping in with close to $500 billion levered up via the Fed to potentially $5 trillion in its own large corporate bailout program dwarfing unemployment and small business assistance. 

Poorly managed companies will not be allowed to fail, something that is essential in a capitalist system. Speculative hedge funds and leveraged offshore vehicles being bailed out in repo markets will not pay the price of unwise indiscretion.  

Those who took the conservative route of prudent decisions, the strong hands, will be shut out. The privatization of profit and socialization of loss is not sustainable. And another massive transfer of assets and resources will go to those who have already disproportionately captured wealth and power in the U.S.

And equity markets in the United States have moved back up to bubble level pricing. 

Between 1988 and 1998 Greenspan’s easy money drove stock market returns that average over 18% annualized. Since 1998, S&P 500 returns have been about 6% and it has taken the highest valuations in history and trillions in cheap-credit funded buybacks to achieve this meager result. 

Today, U.S. Treasury yields are between 0% and 1.5%. This is the bond market forecasting anemic economic growth. At current valuations, S&P 500 returns over the next decade are likely to be closer to 0% than 10%. That means it is more than likely that an entire generation of American savers are doomed to low single digit returns, while a select caste lives a new gilded age.

As the Fed has backstopped debt and equity markets, the largest of the large made hay issuing cheap debt while small and medium size enterprises are facing an apocalyptic scenario.

For the average person, unemployment has now eclipsed the peak of the Great Depression.  

The super-wealthy are counting their government and Federal Reserve given gains—negative costs. The rest of humanity faces the high prices of the terrible health and economic consequences of the pandemic and subsequent government responses.  

This has been and is a long depression. We are going into its third decade. It is a vacuum. A well-regulated capitalist system rewards virtue and punishes imprudence. We have the opposite and so this depression is a poverty of virtue and a product of corruption. 

In our history, we have experienced long depressions. They were cured by serious reforms and markets clearing. Could this help explain Warren Buffett’s ‘don’t bet against America’ proclamation?

Until we see fundamental change, we will pay the very high cost of high prices. 

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