The stock market spiral. It may not be what you are being told

Stock market downturn august 2011

The broadcast media loves a good, tight narrative. Here is the narrative for the stock market downturn for the recent events happening on Wall Street.

Congress squabbles over debt ceiling, Tea Party was obstinate about debt and deficit, we came close to default, S&P drops rating, stock market reacts. Package that up with some pundits, repeat over and over and it becomes fact. Next story.

Only part of this is true.

Here is what I think is happening with the stock market. It is about as simple as the narrative, but admits that human behavior is behind all the numbers so that is always scary territory for economists. But we’ll give it a go anyway.

In 2008, the economy came to a grinding halt. Millions of people lost their jobs, many were on their way to losing their homes and since poor people don’t spend money, millions of businesses quit stocking inventories.

Corporations shed jobs and cut expenses and immediately became more productive and profitable just in the way we measure these things. When the economy started growing slowly, they did not re-hire people; they replaced them with technology that shows up every day, do not need a medical plan and will never saddle the corporation with a pension plan. Investors like that so they buy more of that company’s stock. And they bought a lot in the past two years, pushing stock prices higher. Investors were getting richer.

But you can not cut your way to long-term profitability. The life span of a “cost-cutting to profitability” plan is about 18-24 months. After that, if you are not growing revenues, your profitability will start to decline. Business knows that but they also know that the average “dip” between recessions is about 18-24 months. After that, people get tired of austerity, they start spending, jobs get created and the economy kick-starts itself into gear.

Investors also know this, but they never know exactly when they should be selling the stock. But the smart ones know they will sell the stock eventually because companies will start hiring based on product/service demand and their stocks will take a hit before going back up. Investors hate when companies hire; it means lower short-term profitability and long-term obligations. They like to sell before that “hit” happens.

The underlying reason businesses are not hiring is because they have no need to hire. There are few customers on the horizon. Regardless of what the GOP spins about tax cuts and regulations, the number one — and only reason — businesses are not hiring is because they do not see any customers. Period.

Taxes and regulations are things to either comply with or figure out how to get around when you really, really want to get to the dollars on the other side. To date, I have not met a businessperson who does not believe that in his/her heart. Have you?

We are at about the 24 month mark when the economy should be swinging upward. Only it isn’t and the only organization with the will and means to spend money to get things kick-started — the US Federal Government — is now in a Tea Party-forced cost-cutting frenzy. Even if the President were to introduce a jobs bill, he could never get it funded. What the market heard during the debt ceiling debate and Mitch McConnell’s comments afterwards is the government is going to keep cutting way past the 18-24 month window. Way, way, way past.

“Holy crap!” think investors who are looking at history and know they are at or near the end of the “cost-cutting to profitability” plan of most corporations. “I’m not going to lose my butt in the private sector. I’m going to buy the most secure stuff that exists; US Treasuries.”

Standard & Poor’s did the only thing they knew how to do; lowered the rating for the US Government. Not entirely the best strategy, but they could do little else. S&P also gave a narrative as to why they did something, anything. But neither side heard the rationale. I’m not a fan of S&P as they have been wrong more often than right, but this time, I think they got it right, even if their math was off.

The problem does not lie in the math; it lies in the human assumptions behind the math.

And that is exactly what is going on, regardless of what rating Standard & Poor’s gives the US Government.

Now, all we need to do is package that in a nine-second sound byte.

*Sigh*

The debt ceiling discussion as a household family meeting

Friday, Standard & Poor’s downgraded the rating on the United States of America from AAA to AA+. Regardless of how you spin this or what you believe in the reputation of S&P’s ratings in light of their performance during the housing bubble with their ratings on the derivatives, the fact is that the markets depend on the ratings for investment decisions and it will matter. Let’s not dance around that fact.

But that is all for the media and politicians to argue about. We’re going to examine this in a slightly more pedestrian way.

It seems like the GOP loves to talk about the US economy in terms of a household. To keep in step with that metaphor, let’s peek in on the secret tapes of a family meeting that just adjourned at one of my neighbors down the street.

Dad: Ok, is everyone here? Mom, kids? The mortgage loan officer and credit card card companies? ….. do you want more tea?

Mom: Can we just get on with this meeting? I have a blog to write….

Dad: Ok, ok. As you know, 42% of our budget is dedicated to the mortgage. Since we’re cutting spending, we’re going to quit paying that. We might just send in the interest payment but we’re gonna have to crunch those numbers. And we’re going to further devalue the collateral value of our house by not repairing that gaping hole in the roof or patch the driveway. We’re probably not going to pay the credit cards, though.

And we’re spending far too much in food, so we’re cutting way back on everything….

Kids: But daaaaaaddddddd….

Dad: Hey, we have to cut the spending. The malnutrition that will set in may affect your ability to learn in school and I may get weak and fall down on the assembly line, but we have to cut that spending.

We’re also cutting off our medical insurance so if anyone catches anything, you’re just gonna have to ride out the symptoms. If it kills you, well, you just should have had stronger genes. Cable and telephone is going, to…

Mom: But what about emergencies? We’ll have no way to know if a tornado is coming or have 911 to call…

Dad: That is all in God’s hand now. If God wants us to survive a natural disaster, His hand will move us out of harm’s way.

…….

And the mortgage officer goes back to the bank and immediately draws up papers to call in the mortgage and the credit card companies cut the credit limit and raises the interest rate on the existing balances and any future spending.

Are we surprised that Standard & Poor’s lowered our credit rating in light of the people who claim to be the most responsible members of Congress were publicly debating whether or not the United States should pay its bills? That the GOP front-runner for the presidency publicly claimed to support default as a viable action? That the president who has been widely regarded as being able to win re-election in 2012 is now being reported by the media as having a plummeting approval rating and this challenger could win?

If you were a creditor of the United States, would you sit by and wait to see what happens?

Yeah, me neither.

There is no right or left, only power. The real debt ceiling crisis

us constitution article one

Before I begin, I would like to disclaim that I am not a Constitutional lawyer nor do I pretend to be. But I am an avid reader, one who has read a lot of literature surrounding the pre-Civil War through Reconstruction period. The “mood” of the country, including its values about government, is richly portrayed in these works. I can also read the Constitution, especially the plain language parts that have not been seriously mangled by case law.

Since the end of the mid-term elections last year, the media and Tea Party have been debating this issue of the debt ceiling, mostly as a taunting device against the Tea Party debt and deficit ideology. It made for a good story line of hypocrisy. Most Americans had never heard of such a thing before this, but it sounded bad. Real bad. And for the Tea Party, it also sounded like something that could be used for political leverage.

But since few Americans have ever read the Constitution, fewer still have any idea what the issue is really about. The issue has nothing to do with debt or deficits; it has everything to do with the separation of powers. Congress needs to avoid forcing the Supreme Court to “fix” a glaring hole that House Speakers have been successful at covering over since 1787.

John Boehner knows that. So does president Obama. And by sending a letter to the Speaker in January asking for a clean debt ceiling vote, Timothy Geithner demonstrated that he also supected how the markets would react if it were ever seriously brought to their attention.

And the Tea Party has done just that. Oops. Really, really big oops.

The Constitutional issue:
Article I, Section 8 gives Congress the “Power To lay and collect Taxes, Duties, Imposts and Excises, to pay the Debts” and “To borrow Money on the credit of the United States.” In short, it gives Congress and Congress alone the power to tax, pay debts and borrow. Despite what the Republicans would like all of us to believe, the president has no taxation, spending or borrowing power. Zip, nada, nothing.

Article 1, Section 9 says specifically, “No Money shall be drawn from the Treasury, but in Consequence of Appropriations made by Law.” That means that not even one dollar can be spent that is not appropriated by Congress. The president may have a discretionary budget for the various executive branches, but all of them exist and get paid for through the laws Congress passes.

The US Treasury is responsible for managing the money and cutting the checks, but it can only do so under the authority of the Congress. Blaming the president for spending is like beating up the newspaper boy for bringing me a paper with bad news in it. It is dumb and misdirected. But, since he is right there, he’s smaller than me, and there is only one of him, not 535, it is easier to focus my rage. The bottom line is the president has no legal authority to spend money the Treasury does not have.

Or does he?

The Constitution makes no mention of what to do if the Federal Government has run up bills because of laws enacted by Congress for which there is no money to pay. The Constitution says that only Congress can borrow money, but it does not obligate them to make sure money is there.

But then along came the Fourteenth Amendment that cemented the obligation of the United States to pay its bills for laws enacted by Congress. “The validity of the public debt of the United States, authorized by law, including debts incurred for payment of pensions and bounties for services in suppressing insurrection or rebellion, shall not be questioned.” Still, it does not spell out specifically what to do if the United States Treasury runs out of money.

That, specifically, is the glaring hole raising the debt ceiling covers over and has for a very long time. Neither the Congress nor the President really wants the Supreme Court to decide how to fix this Constitutional issue. For each branch, it would be ceding power to the third branch; something that is even more loathsome to Republican legislatures (actually, all of them regardless of their party) than taxes.

More than likely, the Supreme Court would rule to compel Congress to act by either raising taxes or borrowing money to cover the shortage. And the debt ceiling approval from Congress would be lost forever as leverage. The House does not want to risk that.

But the Supreme Court could also rule that the Treasury Department can continue cutting checks without the approval of Congress, adopting the Gephardt Rule that had long been in place as law. Basically, the Gephardt Rule says by default, Congress is authorizing an increase in the debt ceiling when it enacts a new law. (More complicated than that, but you get the general notion. Google has more info.) That would put the president in the undesirable position of being responsible for increasing the debt and deficit of the United States of America. No more blame game. It would also destabilize the “borrow” powers, much like “declare war” and “wage war” is right now. Congress does not want to risk that.

The effect of pledges
I always found it somewhat perplexing that George W. Bush did not advocate to raise taxes after 9/11 to fund the War in Afghanistan when he clearly had the political capital to do so. Instead, Congress opted to borrow the money, mostly by selling US Treasuries to China. As it turns out, since most Representatives and Senators signed Grover Norquist‘s Taxpayer Protection Pledge, raising taxes was not politically possible. But borrowing money was. The pledge allowed for drunken spending by incurring unsustainable debt, but not increased taxes.

That was the first major step in plunging the United States into the debt it now finds itself. Add another unfunded war, Iraq and Medicare Part D on borrowed funds coupled with revenue reductions that Bush tax cuts created , the largely unregulated banking and mortgage industries and in short order, you clearly have a growing debt issue that is not easy to hide.

Follow the money
The first Secretary of the Treasury, Alexander Hamilton understood the United States of America was only as powerful as its ability to pay its debts. As a new country, the States could bluster all they wanted about life, liberty, pursuit of happiness, blah, blah, blah, but if it could not pay its debts, none of that mattered. The policy has held up well throughout history. We are after all, a market-driven race, sprinkled here and there with altruism. Sparingly.

But times have changed. The stock markets have gotten more global. There is no patriotism in corporations, only profit. The goal is to make money, whether you bet on or against the US Government. From what we have learned with the collapse in 2008, a lot of people can make a lot of money betting against the United States.

What has held and made Congress blink first in years past when the debt ceiling card was played with the threat of the Constitutional hole being exposed and the ability of the president to be able to clearly articulate the issue to the American people. Newt Gingrich tried it and quickly learned how skilled Bill Clinton was in talking plain language with ordinary folk. George Bush was never really challenged on raising the debt ceiling as he operated mostly with a GOP Congress, bound by the Norquist pledge.

But Barack Obama was something new. The GOP leadership — while apprehensive about going to the mat on the the debt ceiling issue — gambled that Obama would not be able to articulate the issue clearly enough to get the American people on his side. And they are kinda right. But what the “mature” GOP leadership did not understand fully is how cancerous and ideological the Tea Party would be.

I’m not sure if the legislators the Tea Party got elected are oblivious on the Constitution, are singularly focused on debt, deficit and taxes to the exclusion of their other responsibilities or are just stooges for the greater monied bosses that got them elected. I don’t believe in conspiracy theory, but I do believe in the power of mobs and the infectious contagion of simple ideology in favor of nuanced, reasoned thought. We are, after all, the country of fast food, the sound byte, CNN Headline News, Twitter and Snooki.

But the markets have become spooked, whether by sheer stupidity brought on by ignorance of the Tea Party-backed legislators or a long-formulated master plan I don’t know. And since we have ceded power of our credit over to the world-wide credit rating agencies (and kinda pissed them off with things like Dodd Frank) the great power of the United States of America is no longer really in charge of its own destiny.

What I do know is to follow the money and to ask who is likely to profit exponentially from the credit downgrading of the United States of America. I’m sure that is where we will eventually find our answer to what is really motivating the Tea Party, whether they are complicit or not.

The financial education of Eric Cantor

After listening to Eric Cantor talk one too many times about how rich people and small business create jobs as a result of keeping their taxes low, I feel it is my duty as an American citizen to give him a short lesson on how poor and rich people spend money differently. It’s not very complicated or that long of a lesson, so he can even read this blog post on his iPad while the president is talking during the meeting tomorrow. Really, nobody will notice.

How a poor person spends money
For purposes of this post, let’s say a poor person is someone making $10.00/hour at a full time job, even though there are many more people making far less at minimum wage ($7.25/hr just to refresh your memory. It was an issue the last election.) Besides, the math is easier at $10.00/hour.

Working a full day will gross this person $80.00 each day or about $67.00 net after payroll taxes (that is the Medicare and Social Security contribution in addition to income tax, which they are likely to get back as a refund at the end of the year, so we won’t count that.) At the end of the week, that is $400.00 gross, $335.00 net.

That is the income part. Now, let’s look at how they think about their paycheck.

Rent is usually seen as “Can I cover this month’s rent with one paycheck?” If the answer is yes, that is good. Most often, though, it is a week and a half, maybe two. But poor people never do a percentage of income calculation. They don’t see that housing is costing them 25-50% of their net pay. They just look at weekly paychecks.

Let’s take a look at one more example; buying lunch. If a poor person goes to McDonald’s during lunch and it cost $8.00 it never occurs to him that he just spent 12% of his net pay and has worked a whole hour to pay for a lunch that took ten minutes to consume. Poor people just simply do not do this math; it is too scary. It would paralyze them and make them unsuitable for the cheap labor capitalism needs to maintain productivity.

If you gave a poor person a $1,000 check, he would go spend it on something like a television or toys for his kids or some material thing that some company made and hopes to sell. Most likely he would treat his family to a steak dinner at the Roadhouse and maybe buy a tshirt at the next soccer tournament his kid plays in. I’m not perpetuating a stereotype here, just making an observation about how most poor people would spend a “windfall.” You can do the math about how many televisions you need to sell for companies to make more, and hire more sales people to help people buying sets, etc, etc. to get to a real stimulus number. In short, poor people circulate money which gets the economy going.

How rich people spend money
I’m going to skip the income part of rich people and say that they make way more than $80.00/day gross, $67.00 net. Let’s say that is their per minute rate. The difference lies in their awareness of how much things cost as a percentage of their income and how much return they can make on a dollar invested. They are aware of their housing costs, their health care costs and the rate they paid in taxes last year. They are also aware of the rate of return on their portfolios and whether it makes sense to spend or invest money received as a windfall.

If you give a rich person $1,000, they won’t need it for anything. Instead of buying something or creating a job, they will simply turn it over to their portfolio that invests in companies that are rewarded for keeping head counts and the wages for those they need low. The money is not circulated into the economy; it is just parked in a stock market where gains and losses are recorded in some computer. The money is doing the exact opposite of what the economy needs. Sure, it contributes to creating wealth, but all wealth really is is money someone didn’t spend.

$1,000 to a rich person or a company is nothing. A tax break is seen as that $1,000; not enough to actually do anything like create a job but large enough to not just throw away. It goes into the bank or the portfolio. For a company to create a job, it needs to either see a lot of demand for its goods and services or it needs to have very, very large incentives. In all instances, it will take the former.

Mr. Cantor, your theory of business people creating jobs by cutting their taxes just doesn’t mesh with the way they think. I know this because I is one of them. I was also once a poor wage earner so I know how they think. The rich are hoping you keep saying your line because they are accumulating wealth a little bit each year and the poor don’t really understand finances all that much to know that your line is crap.

But you know the difference. And to continue perpetrating your perverse logic under the banner of fiscal responsibility is anything but.

*I should disclaim my motivation for trying to educate Mr. Cantor on how poor people spend money. My business is going to need a lot of poor people spending money irresponsibly on their kids in the near future, so if given the choice, I’d much rather have 10 million poor people with an extra $1,000 in their pockets than 400 really rich people socking money away in the stock market.