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Archive for the ‘Fiscal Cliff’ Category

The last-minute fiscal cliff deal reached by congressional leaders and President Barack Obama cuts only $15 billion in spending while increasing tax revenues by $620 billion—a 41:1 ratio of tax increases to spending cuts.

The House now has until 1:00 pm ET to read the proposed Bill.  Representative Mick Mulvaney (R-SC) is reporting that so far, no one has found ANY cuts whatsoever.   And I suppose he should know, since he’s on the House Finance Committee.

This is a 41:1 ratio of tax increases to spending cuts (provided the cuts can even be found).

In 1982, President Reagan was promised $3 in spending cuts for every $1 in tax hikes. The tax hikes went through, but the spending cuts did not materialize. President Reagan later said that signing onto this deal was the biggest mistake of his presidency.

So we’ve gone from 3:1, which Reagan thought was catastrophic to 41:1. So, what’s this? Apocalyptic? Nuclear? Suicidal?

I’d say all of the above and a black hole.  Let’s be real clear.  If this passes, this will be the largest expansion of US government EVER in the history of this country.   Yes, this beats FDR’s ‘New Deal’ and Johnson’s ‘Great Society.’

 Happy f*%king New Year.

There’s a much bigger cliff than the so-called fiscal cliff. The absolute worst result of the fiscal cliff would be a moderate uniform tax increase at a bad time, resulting in a moderate contraction. It is an obvious — but ultimately rather cosmetic — stumbling block on the so-called “road to recovery”.

The much bigger cliff stems from the fact that the so-called recovery itself is build on nothing but sand. This is a result of underlying systemic fragilities that have never been allowed to break. I have spent the last year and a half writing about this graph — the total debt in the economy as a proportion of the economy’s output:

This is the bubble that won’t go away. This is the zombified mess that the Federal Reserve won’t let dissolve (as happened regularly in the 19th century and early 20th century each time there was an unsustainable debt bubble). This is the shifting sand — preserved by the massive monetary stimulus programs — that the so-called recovery is built upon. During the 1980s and 1990s and 2000s cheap money pumped up the debt level in America. In 2008, the bubble burst, and the hyper-connective fragile financial system was set to burn. Then central banks around the world stepped in to “stabilise” (or as Nassim Taleb puts it, overstabilise) the financial system. The unsustainable reality of debt vastly exceeding income was put on life support.

A high pre-existing residual debt level makes growth challenging, as consumers and producers remain focussed on paying down the pre-existing debt load, they are drained by pre-existing debt service costs, and they are wary about taking on debt or investing in a weak and depressed environment. It’s a classic Catch-22. The only true panacea for the depression is growth, but the economy cannot grow because it is depressed and zombified. That’s where a crash comes in — the junk is liquidated, clearing the field for new growth. That is what Schumpeter meant when he talked of “the work of depressions”, something that many mainstream economists still fail to grasp. (In fairness, a similar effect can probably be achieved without a depression through a very large scale debt relief program.)

Japan has been stuck in a deleveraging trap for twenty years, to no avail, all that has really occurred is that the private debt load has been transferred onto the central bank balance sheet —there has been very little net deleveraging) and while the Japanese central bank has completed round after round of quantitative easing — sustaining and preserving the past malinvestment and high debt load — the Japanese economy is still depressed.

That is the road America and most of the West are now on. And just as Japan’s bank stocks did multiple times even after the Japanese housing bubble burst, American banking stocks — even in spite of a year of fraud, abuse, mismanagement and uber-fragility — have been shooting up, up, up and away:

The zombie financial sector is the real cliff — as interconnective as ever, as corrupt as ever, and most importantly, nearly as leveraged as ever:

This is a reinflated bubble built on foundations sand. I don’t know which straw will break the illusion (middle eastern war? Hostility between China and Japan? Chinese real estate and subprime meltdown? Student debt? Eurozone? Natural disasters? Who knows…) but this bubble poses a far greater threat in 2013 than the fiscal shenanigans and the Boehner-Obama “Boner-Droner” snoozefest.

Azizonomics

Facing reality is positive. That’s the upside to the fiscal cliff.

There are two definite upsides to the fiscal cliff:

1. We are finally starting a national discussion of spending-taxation trade-offs

2. We are at last starting to (grudgingly) accept there is no free lunch, what I call the Free Lunch Fantasy of limitless borrowing at near-zero interest rates: taxes for upper-income wage-earners will revert to previous levels while those drawing Federal dollars must accept reductions in spending.

The last decade’s fantasy that we could borrow our way to prosperity while lowering taxes on upper-income earners (because it’s so cheap to borrow trillions at near-zero interest rates) is finally running into reality-based resistance: interest on all that debt is starting to squeeze the spending everyone wants, and long-term rates might rise despite the Federal Reserve’s constant intervention.

That would eventually raise interest costs paid by the Federal government.

How can interest rates rise if the Fed is buying much of the Federal Debt?

The first part of the answer is to accept the fiscal consequences of the Baby Boom entering Social Security and Medicare at the rate of 10,000 retirees a day: Federal spending will rise far faster than tax revenues, dwarfing the relatively minor spending cuts being discussed.

Notice how unprecedented the Boomer generation is demographically:

As correspondent Michael Goodfellow explained in Where There Is Ruin II: Social Security(July 25, 2006):

Now of course, retirees are also dying, so you might think this is only half the story. However, the people who die are, on the average, 15 years older than the new retirees. So when the number of retirees surges in 2011, the number of deaths is still from the pre-boomer group, and stays roughly constant.In other words, Social Security and Medicare outlays continue to increase for 15 years, until the number of retirees dying rises to match the number of new retirees.

Simply put, the retirement and healthcare systems were not designed to match the nation’s demographics, nor was Medicare designed to limit costs, which continue to rise faster than inflation, despite various cost-saving measures.

Combine these trends with stagnating wages and employment and you get a triple-whammy: soaring number of retirees, rising Medicare costs per retiree and a stagnating tax base.

Federal spending and thus borrowing will rise unless the promises made are slashed.

This sets up an increasingly unstable dynamic: the Federal deficit of $1.3 trillion will continue to rise, forcing the Fed to increase its balance sheet as it buys hundreds of billions of dollars of newly issued Treasury bonds. Is there no upper limit on the Fed’s purchases of Treasury bonds? Even if there is no financial limit, there is a political limit, as the Fed’s policies will be recognized as counter-productive failures as the 2013 recession kicks in.

The Fed’s political room to maneuver is shrinking, and its policy of keeping interest rates at near-zero by buying unlimited quantities of mortgages and bonds has limits. Once the markets sniff these limits, yields on long-term bonds will rise, pushing up borrowing costs. The Fed can play around with yields by selling long-term bonds and buying short-term bonds, but these Operation Twist manipulations also have limits.

The Fed’s purchases of Federal debt enabled the Free Lunch fantasy. Rather than let the market price Federal debt higher, which would have set limits on Federal borrowing, the Fed’s purchases of Treasury bonds suppressed the recognition that there was a cost to essentially unlimited Federal borrowing.

All these policies that enabled the Free Lunch Fantasy are reaching financial and/or political limits. The fiscal cliff is one expression of this recognition, and it is very positive that Americans are finally facing up to the personal costs of dealing with reality: higher taxes and lower Federal spending are no longer abstractions to be borne by others. We will pay more taxes and we will get fewer benefits/Federal contracts, and these reductions in income will negatively impact the economy.

Facing reality is positive. That’s the upside to the fiscal cliff.

Charles Hugh Smith – Of Two Minds

I don’t know about you, but I’m already sick of the so-called “Fiscal Cliff” battle in Congress. That’s the mandatory concoction of tax increases and spending cuts that kick in January 1st if Republicans and Democrats can’t reach a compromise.   Comedian Jon Stewart gave his perspective recently on The Daily Show.  He makes it very clear who is to blame for all this.

Raising taxes is the “solution.” Too bad incomes are declining. What will raising taxes do to household savings, spending and the economy?

We all know cutting Federal spending is politically impossible, so that leaves raising taxes as the only “solution” to the “fiscal cliff.”

Since most income tax revenues flow from household income, let’s look at some charts of the workforce and household income:

As a percentage of the population, the workforce has contracted to levels of the late 1970s.

As a percentage of national income, labor’s share is in a free-fall:

Hourly earnings have been trending down for years:

Income for every age group other than 65+ seniors has declined sharply:

The income of those in their peak earning years 45-54 have been slammed:

Household debt loads have soared far above wages:

Meanwhile, government expenditures are up, up and away:

Yes, I know: the solution is to “tax the rich.” The Problem with “Tax The Rich”: It Won’t Work (May 28, 2010)

Will “Tax the Rich” Solve Our Deficit/Spending Crisis? (December 28, 2011)

Do the Parasitic Elite Pay Any Taxes? (June 13, 2012)

The parasitic Elites should certainly pay as much as the heavily taxed middle class (The Real-World Middle Class Tax Rate: 75% (July 5, 2012), but since the parasitic Elites have captured the machinery of governance, the chances of Congress actually raising taxes on the top 1/10th of 1% are nil.

There will be noises made, of course, for perception management and public relations, but when April 15th rolls around we will find tax revenues are stagnant: loopholes and tax breaks will have blossomed like mushrooms, magically enabling the parasitic Elites to escape any serious reduction in their income.

Even if we were able to squeeze some additional taxes out of the parasitic Elites, their income stream is dwarfed by the Federal spending that looms ahead: The Fiscal Cliff and Demographic Drag. The top 1/10th of 1% cannot pay the rapidly expanding Federal benefits of the 99.9%, even if we confiscated every dollar of their incomes.

How can tax revenues increase when household incomes are declining? Transfer more of the national income to taxes and that leaves less for savings, investment and consumption. The economy contracts, reducing the workforce and wages further.

If that isn’t a death spiral, it is a close approximation of one.

Charles Hugh Smith – Of Two Minds