Corporate Taxes Set To Triple

 Looking at the Federal Budget data documents directly is always revealing because it avoids being blindsided by political blah blah and media spin.  Just the facts, no BS.

I looked at corporate tax revenue from 2014 to now and the projections for the immediate future. Then I made the following chart. This is what the current government is planning to do:

• Triple corporate tax revenue from $212 billion to $648 billion in FY2024
• Corporate tax revenue is budgeted to rise from 1% to 2.5% of GDP
  

(In case you are wondering about individual income taxes, they are also budgeted to rise from $1.61 trillion to $2.29 trillion, or from 7.7% to 9.0% of GDP)

Looking at corporate taxes from a longer perspective, the budgeted 2.5% of GDP for FY2024 is the highest since 1979 - excluding 2006-07 when the financial sector had record profits during the Great Credit Bubble (that didn't end too well...).

The era of low taxes is over, clearly. This is the Biden administration's plan, anyway.

Corporate Tax Revenue As Percentage Of GDP

Given that the effective tax rate is currently at 14%, the lowest level in history, the Biden budget is effectively calling for it to at least double, taking it back to the levels of the early 1990's.

Right now S&P 500 is trading at 35 times after tax earnings. The only time P/E was higher was when financial sector earnings collapsed during the Credit Bubble implosion (ie huge losses dragged down average earnings)  and at the top of the dotcom madness - see below, notice the scale is logarithmic.

 

  S&P 500 12-Month Trailing P/E

So... equities trading at record P/Es at the time when the government is budgeting a tripling of taxes. Hmmmm....

Show Me The Money

The Fed’s reverse repo just hit another new all time high at $1.33 trillion (that’s trillion with a T not billion with a B, let that sink in). Since the interest rate is 0.05% annualized, the Fed pays $665.000.000 annualized to banks and funds who park their money there. Not exactly spare change, eh? And why does the Fed do that, pray tell, since it is still pumping out $120 billion per month in QE? The mind boggles.

The Fed (ie basically the taxpayer) is giving out money for free and then allows those who receive it to give it back at a guaranteed markup. Oh, but it gets better (umm… worse, actually). The way you get the Fed to give you the money in the first place, is that you put a bunch of mortgages together, create an MBS (at a mark-up, of course) and sell it to the Fed.  The whole operation is, of course, chock full of fees accruing to you and, essentially, risk free. Hey, nice work if you can get it, no? 

And oh, yeah, there’s so much demand for this nice little money-making machine that the Fed just doubled the amount it will accept per counterparty for the reverse repo. And the QE keeps pumping… it’s nuts!!

But that’s not my main topic today. Keep reading..

The Fed’s Reverse Repo Hits Yet Another All Time Record

The government borrowed a bunch of trillions in the past 12-18 months and stuck them into its account at the Fed, called Treasury General Account. It has now spent almost the entire cash pile, taking the TAG balance down from $1.8 trillion to a mere $200 billion - see below. The two charts are, quite obviously, reverse images of one another.

The Treasury’s General Account Drops To $200 Billion

Let that sink in, too: the government’s cash reserves are now just $200 billion. We know that its monthly deficit is an average of ca. $150-160 billion (outlays minus receipts), of which some $25-30 billion is interest on debt alone.  

 

Where’s the money going to come from?  Show me the money!! Normally, the government just borrows by selling bonds - but the debt limit has now been reached; so, no more bonds for now.

Therefore, unless the debt limit is raised rather immediately - as in now! - the US federal government is going to shut down next month and stop paying  Democrats and Republicans are at complete loggerheads on the issue.

 

The Republicans are swearing up and down that they won't vote to raise the limit because the Democrats want to attach an amendment to increase social spending by at least $1 trillion. This requires at least 60 votes in the Senate, where the Democrats only have 50 votes. Gridlock..

The Democrats could vote it in by themselves with 50+1 votes (the VP vote), but only if the Republicans don't filibuster.

 

Hmmmm…. Maybe read again yesterday’s post on US defaulting?

Maybe We Should Rethink What We Know For Sure

The Evergrande crisis is bringing back memories of 2006-08 and comparisons with Lehman’s collapse. Since I had a front seat to the Great Credit Bubble, I have a few observations.

The Credit Bubble of 2006-08 and the crash that followed were pretty easy to identify and to predict. I did it, and I’m no genius. All it took was some common sense and a bit of research. Not serious scientific research - finance is not quantum physics - just data put together from sources easily accessible to everyone.  So, I looked; it was immediately obvious that residential mortgage lending had gone from a boring workaday business to a free-for-all, involving piles of obscure ultra leveraged derivatives.

The immediate culprit, over-leveraged real estate, led to a collapse that was easily understood and affected  the wider public. I mean, everyone understood real estate and mortgages, even if they had no clue about MBS. CMO, CDS, CDO and the rest of the derivative alphabet soup. 

The collapse immediately spread to the banking/financial system for a very simple reason: everyone trusted that a AAA or AA rated CMO or CDO meant it was gild-edged. In fact, it was an artificial construct that depended on very spurious assumptions.  Basically, most of them were little pieces of mortgage bird$#it that were put into a pot, stirred vigorously and…. Voila, they were magically transmuted into foie gras. It was called structured finance and financial engineering; in fact, it was greedy loony alchemy.

Mark Twain said “it ain't what you don’t know that gets you into trouble. It's what you know for sure that  just ain’t so”. In 2006-07 everyone knew for sure that they were buying expensive duck liver. 

Before the Credit Bubble collapsed, everyone knew for sure that residential mortgages just didn’t default much - right? But then, defaults soared - see chart below.  The assumption upon which all those alphabet soup securities were based was wrong, so they all came crashing down like blocks in a Jenga game.

 

 Delinquency Rate Of House Mortgages

Today, despite Evergrande’s troubles it is not really possible to point a finger to a single overpriced and over-leveraged asset class. Yes, there are NFTs and meme stocks that are priced absurdly, but they are not going to produce a systemic shock on their own. A can of “trading sardines” selling for $1 million won’t create a domino effect (see bottom of today’s post for an explanation). I think that while Evergrande may be in big trouble, it is pretty isolated. Crucially, it has not generated hundreds of billions in ultra leveraged credit derivatives which could annihilate bank and insurance company balance sheets all over the world. Evergrande is not Lehman. But something else may be an even bigger problem. 

Back to the present: what is the biggest assumption that we make in markets? What is it that we all know for sure?

The US is rated AAA/AA+ and will never default, right? 

The US government has never defaulted. Its bonds are considered ultra safe and act as the foundation of our global dollar-based monetary system. We know that they are safe, so we use them everywhere, from banking to pension fund assets. We also use them, one way or another, as benchmarks for just about every other financial product in existence. Treasurys are very, very deeply and widely interconnected with our global economic system. We take them for granted.

So, how safe are Treasurys, really?

Let’s start with the basics. Proper debt service is based on two things: 

1. The ability to easily cover interest payments.
2. The ability to easily refinance.

Highly indebted borrowers are riskier and  must pay higher interest rates and/or borrow less than they need. How is the US doing? Federal debt is now at 125% of GDP, just about the highest ever. But that by itself is not enough to spell trouble. 

Let’s look at interest payments as a percentage of tax receipts. They have varied in a tight range between 5-7% for the last 20 years. But, today's 5% is not really as comfortable as it may seem because  interest rates are near zero - see below.  The US is still paying a chunky piece of tax revenue to cover interest payments, even though interest rates are near zero. What will happen if/when interest rates go up?

Point A: The US is very vulnerable to an interest rate increase

US Annual Interest Expense As % Of Total Tax Receipts (blue line)

Two Year Treasury Note Interest Rate (red line)

Another way to assess debt viability is to look at the ratio of total debt to annual tax receipts. It started rising in 1980 from 2.5x to around 7x in 2005, but then soared to 10x in 2010 as the government borrowed heavily to salvage the economy from the 2006-08 Credit Bubble. Dealing with the pandemic has now taken the ratio even higher to around 12x. If the government was a business, we would say that its debt load is 12 times its EBITDA, a very high multiple, indeed. For example, the S&P500 is around 2-3x, although that's nor a very relevant comparison; still, it provides a sort of yardstick.

• Point B: The US federal govt. is very highly indebted versus its income
  

Federal Debt/Annual Tax Receipts

Another way to look at US debt service is how much money is left over to cover interest payments after basic expenses are paid, eg salaries. For Fiscal Year 2022 the government projects receipts of .$4.12 trillion and outlays of $6.01 trillion. The budget deficit is thus estimated at $1.89 trillion. It was much worse for FY2020 due to COVID, but even so the 2022 deficit will be enormous by historical standards.

US Federal Budget Balance

Salaries and national defense outlays for 2022 are budgeted at $4.86 trillion.  In other words, just paying for those two wipes out all revenue: $4.12-4.86 trillion = - $740 billion. The US is running a huge deficit before interest payments, ie it has a very large primary budget deficit. Outlays for interest for FY22 are estimated at $305 billion and will obviously have to be covered by more debt. Again, if this was a business banks would be very leery to lend.

• Point C: The US cannot cover interest without going deeper into debt, or slashing expenses and/or raising taxes significantly
  

Finally, are investors taking all of the above into account when lending to the US? Yes, to a limited extend they are getting more cautious. The "purest" way to look at default risk is through Credit Default Swaps (CDS). As of yesterday, the US is ranked #9 as a credit risk, below even Belgium and just a notch above Ireland (higher CDS prices equal higher default risk).

 

5 Year Sovereign CDS 

 

 

It is interesting to note that US CDS prices have come up 32% in the last month alone.

Putting it all together....

Never mind Evergrande, maybe what we know but just ain't so is that the US cannot default. Or at least, that its debt is priced at a level that does not adequately reflect the risk of default. Given the upcoming debt limit process and the highly polarized political scene in Washington, we should maybe rethink what we know for sure.

————————————————-

The following was posted originally on Nov. 2, 2009

The Trading Sardine

Andy convinces Billy to buy a can of sardines at a high price by telling him how wonderful they taste. Billy, being greedy, decides to resell them to Charlie for a profit at an even higher price by convincing him, too, about how great these sardines are. The process is repeated several times until the last buyer, let’s call him Zebediah, pays a million bucks to Yorick for a can of the “world’s absolute best sardines – EVER”.

Well, Zebediah decides to open the can and eat the sardines, only to discover they are ordinary, plain sardines. Furious at being swindled, he yells at Yorick: “You crook! You liar! I paid you a million bucks for plain ordinary sardines. They were not the greatest tasting sardines - EVER”, yells Zeb.

Yorick shrugs and replies…

“Hey Zebediah, you are such a schmuck. Those were not eating sardines – them were trading sardines!"

Evergrande As Lehman? No, But…

 Is Evergrande China’s Lehman? No, it isn’t. But it may very well be its Countrywide Financial.  

Countrywide rose spectacularly on the back of the US real estate bubble by writing an enormous amount of home mortgages that were packaged by Wall Street into all kinds of MBS (mortgage backed securities). At the top of the bubble, lenders couldn’t care less about the creditworthiness of the borrowers. 

Countrywide’s collapse was one of the first signs that the Credit Bubble had burst. Its stock started plunging in mid 2007 and the company was bought out by Bank of America in January 2008 (BOA has regretted it ever since). 

Lehman, on the other hand, filed for bankruptcy much later, in September 2008.

Evergrande is one of China’s largest real estate developers, concentrating on building and financing huge residential properties. It finances its projects through… did you guess it?… bond-type investment products sold to retail and institutional investors. So, no, Evergrande is not Lehman. But it looks awfully similar to Countrywide.

Sudden Debt Limit

 The US debt limit now stands at almost $29 trillion and has already been exceeded by a tad, with the Treasury employing emergency-type funding techniques to keep paying its bills (mostly wages). 

Congress needs to vote an increase on the limit, but Democrats want a moratorium on the limit until the end of 2022 (ie no debt limit until then), while Republicans want no increase whatsoever. In other words, they are polar opposites.

Looking at the chart below I can’t really blame the Republicans…. On the other hand, I see the need for immediate investment in infrastructure, particularly in the sustainable energy sector. 

How about this radical idea: BALANCE THE BUDGET! It’s not rocket science, just make sure taxes are raised back to a sustainable level. Trump pushed corporate and individual tax rates to record lows, so there is plenty of room to raise revenue.

Here’s a compromise: a small debt limit increase to tide things over now combined with an immediate significant tax increase on corporate, individual and capital gains income at the high brackets, plus a modest annual tax on large wealth.

It is high time for the US to understand it can’t print its way out of trouble ad infinitum..  

The Demise Of Casino Capitalism

Banking, finance and markets exist to make the economy run smoothly. From money transfers and currency exchange, to raising capital for new or existing companies, their role is supportive and secondary. Finance is like a dog’s tail: basically useless except for maintaining balance. And, like I’ve said many times before, in the US the tail is now wagging the dog.

Finance, insurance and real estate (the FIRE tail) accounts for an enormous 22.3% of America’s total GDP, nearly double professional services, the second largest sector.  If we add Government, another sector that acts as an economic facilitator as opposed to being a primary producer, the total rises to an astonishing 35% of GDP. (Keep this in mind, I’ll revert to it at the end).

By stark contrast, Manufacturing which was once America’s proud creator of the currently evaporating middle class, has shrunk to fourth place at a mere 10.8%..

Looking at financial businesses alone, their share of GDP has quadrupled to nearly 9%.

The “financialization” of the economy may produce enormous and quick rewards for those select few who can take advantage of it, but it does absolutely nothing for all the rest. I mean, hedge fund managers are making $1+ billion per year, but employees at the companies whose stocks he/she is trading often need food stamps to survive (keep this in mind, too).

Like all bubbles, the finance economy has gone to extremes. While you may dismiss some crazy instances like GameStop, DogeCoin and “art” NFTs as one of a kind aberrations, you can’t ignore what is happening to the overall stock market.  Its total capitalization now stands at an all time high 200% of GDP, well above the 140% reached during the dotcom mania (1999-2000) and double the level of 2007, right before the Debt Bubble burst.

Is this casino capitalism economy sustainable? Of course not, the tail can’t keep wagging the US dog, particularly when there are other much less waggy dogs out there nipping at its heels (eg China, as Biden himself put it, “is having our lunch”).

=============

Final thoughts: the US won the Cold War when the USSR collapsed, seemingly within days. At the end, USSR was spending almost 20% of its GDP on defense while its middle class had to scrounge to find even basic necessities. It’s not a perfect parallel to the US today, of course, but it sort of rhymes, just substitute finance for defense.

There is one major difference: unlike the USSR, in the US the average Joe can dream of hitting it big by hard work, guts and brains, even if his/her chances of success are actually minimal. Americans, however, have (finally?) come to realize that the American Dream is now pie-in-the-sky, a situation creating huge dissent and class division. Never before  have mainstream American politics been so decisively shaped by polar opposites like Trump and Sanders. 

Here’s a question: could America’s version of Casino Capitalism collapse almost overnight (in a historical time scale)? 

The Mother Of All Bubbles - Are We In For An Unprecedented Crash? (Part V)

 ….continued from previous posts…

Part V - Thought Is Faster Than Light

On Part II of the series I laid out six concerns that could produce an unprecedented crash. Number two:

Speed: computers have made everything faster. Communications, transactions, manufacturing, transportation, logistics, decision making. Reaction to anything is nearly instantaneous.

I would like to expand on this a bit more, though from a non-technological perspective. 

While algorithmic and high frequency (flash) trading are still very prevalent in today’s markets, I’m not looking at them today. Instead, I want to focus on the one thing that seemingly travels faster than light: thought, including the subcategories of memory and feelings. (Yeah, ok, the brain, too, works via electrical impulses, but you get my point).

In my opinion, most everyone active in markets today, amateur or pro, individual or institution, knows (ie thinks, feels) that the US stock market is currently driven by momentum alone, completely detached from all fundamentals such as price to book, price to earnings, dividend yield, etc. The basic reason everyone mentions when asked “why buy or own stocks right now?” is: “because they are going up.”  

You don’t have to go far for proof, just look at the wildly popular SPACs. People are willing to subject themselves to an immediate loss of their capital (due to SPACs origination fees, commissions and expenses) to invest in nothing  tangible, just a promise that whenever the SPAC merges with whatever, the result will be something that will go certainly up. Speculation on momentum, and nothing else. 

Since everyone knows this, that the market is hanging on momentum alone, how quickly will everyone jump ship once momentum shifts? How quickly will the thought of exuberance transform to panic?  Remember, retail speculators today don’t even have to call a broker to place a sell order (he/she may change a speculator’s mind), it’s all a button on an app on a phone. There are no brakes in the system.

Today, market information is disseminated instantly to all, and the thoughts/feelings it produces, ranging from greed to panic are also transformed into action instantly. The classic KAL cartoon below sadly belongs to another era…there’s too much of a delay.

All right, maybe an old cartoon isn’t exactly convincing to you. How about what happened today to a Chinese property developer’s stock trading in the Hong Kong exchange, down 95% in one day - see chart below. Fast enough transmission of fear for you? (On the heels of Evergrande… sounds like Souza’s USMC march, doesn’t it?)

The Mother Of All Bubbles - Are We In For An Unprecedented Crash? (Part IV)

….continued from previous posts…

Part IV - It’s Only Money

Some years ago a gentleman I worked with at an investment bank had a saying: “It’s only money”. John K. was at least 20 years my senior, having started his career in the early 1960s. At the time, I thought he was merely being sentimental, as in “money can’t buy you love”.  It took me a while to realize that John was being literal and was referring to markets.

Market prices are marginal, ie they are determined by incremental, instead of total, supply/demand and, since they float on a sea of money they rise and fall along with its ebb and flow. John was right: it’s only money. Emphasis on only.

It’s even more so with stocks, since unlike, say, wheat, they have no tangible underlying physical demand and are therefore priced at multiples of other markers like earnings, sales, assets, etc. You can’t eat stocks or, these days, use them as wallpaper; furthermore, their prices are derived from a consensus view of the future, since just about everyone ignores the past. 

Therefore, tongue in cheek, how are stocks any different from Papal indulgences? After all, you pay a given price for a stock today because you believe it to be a fair representation of the future. We call it a discount mechanism, but it is merely one more article of faith in the Permagrowth religion. The more you believe, the more you pay. 

But, wait a minute… what about “it’s only money”? Show me the money, cries the unbeliever - so voila: the connection between money/more money/much more money and share prices is obvious, as you can see in the charts of M3 and S&P 500.

Lest we forget, I’ll end today’s post with a reminder: money is debt. More money is more debt. Much more money is much more debt. 

Why the reminder? Two reasons:

1. Some will argue that more money/debt is a natural consequence of higher GDP and therefore there is nothing to worry about. False: Debt/GDP is now the highest in US history. Today it takes four times more debt dollars to produce a dollar of GDP than it did in 1980. Debt to GDP has soared from 30% to 125%.
2. Bubbles initially thrive on debt (leverage) but are eventually poisoned by an overdose of it.The bigger the leverage, the bigger the crash once the bubble is popped. Unprecedented debt therefore will, by default (pun intended), result in an unprecedented crash.

And there you have it…. I may write one more post in this series to include the other elements mentioned in the second post, not sure yet.

 

The Mother Of All Bubbles - Are We In For An Unprecedented Crash? (Part III)

 …. continued from previous posts…

Part III - Permagrowth As A Runaway Reaction

Continuing from yesterday’s post, let’s put together all six points and apply them to our dominant Permagrowth socioeconomic model. (If you haven’t read my posts before, Permagrowth is my term for the incessant expansion of everything, from population and consumption to money supply and debt.)

Permagrowth is much more than an economic model. Above all, it is a way of life where “more is better” has become rigid and unquestionable dogma. It comes closer to the unshakeable faith in Heaven and Hell dominant in 16th Century Catholic Europe than, say, the economic theories developed by Adam Smith, Keynes, Friedman, or even Marx. In other words, Permagrowth is now a religion. If you don’t believe me, ask anyone why they buy the latest iPhone.

The Pope sold indulgences so that sinners could get into Heaven by paying a steep price in cash. Likewise, Permagrowth devotees are fundamentally convinced that everyone will be “saved” with more money, higher prices for assets, more wealth on paper. Our sins of raping the environment, depleting precious habitats and unleashing natural disasters (eg COVID) are all washed away by … higher stock or real estate prices.

Then came Martin Luther’s Ninety-Five Theses and within just one day in Wittenberg the world changed.

Only Faith In God Decides Who Is Saved, Not Money 

(Only You Can Change The World, Money Can’t 😜)

Change can occur with lightning speed when conditions are right. But it comes as a shock to those lulled into apathy by what they perceive as “normality” in the period immediately preceding change. It was “normal” for the Catholic Church to sell indulgences since the Pope ex cathedra was infallible and God’s sole representative on Earth. It was “normal” for the USSR to produce thousands of nuclear warheads but not enough toilet paper. Dogma and apathy trump common sense every time - until they don’t.

How “normal” is Permagrowth today? My thesis is that it is utterly untenable, that constant expansion has become a runaway reaction that can no longer be contained in its reactor vessel. Think Union Carbide and Bhopal, India writ on a global scale. Its deleterious products are spilling over: not only climate change and habitat destruction, but socioeconomic and geopolitical dislocations are just as rampant. And it’s happening fast - very, very fast.

I could give dozens of examples, but if you’ve been reading this blog you can easily identify them. The most ardent acolyte of the Permagrowth religion is the stock market, particularly in the anything-goes US. 

I’ll be focusing on that in the next post.

…. to be continued…

The Mother Of All Bubbles - Are We In For An Unprecedented Crash? (Part II)

 …continued from Part I. 

Hopefully I didn’t bore you with ancient history and you are now reading …

Part II - The Big Six 

The basic idea behind this series of posts is that I have never before experienced such extreme conditions in the economy, geopolitics and markets in 40 years as a finance professional. Same holds going back further in history.

In my opinion, these are the most worrisome underlying fundamentals today:

1. Scale: everything is larger and bigger. Global population, GDP per person, debt, consumption, pollution.
2. Speed: computers have made everything faster. Communications, transactions, manufacturing, transportation, logistics, decision making. Reaction to anything is nearly instantaneous.
3. Climate change and habitat destruction: we are destroying our human habitat at an unprecedented scale and speed.
4. Risk appetite is at an all time high: Stocks in the US and EU are trading at heroic multiples and interest rates are zero or negative. Even recent bankrupts (eg Greece) and companies with junk ratings are borrowing at near zero interest. Central banks’ gusher of money is completely obscuring the dangers.
5. Generation gap: young people who grew up with game and chat apps view markets as just another game. Their heavy participation in daily “meme” trading is very apparent and defies all common sense ideas on investing.
6. End of Empire: the US was the undisputed global Empire for the past 100 years. This is no longer the case, as a resurgent China is now more determined and ready than ever to claim primacy, whilst America is riven with internal political, social and economic divisions. The previous switch of Empires created WWI and WWII - and it didn’t even involve a direct confrontation between the old Empire (British) and the new (USA). It was just Germany and Japan who thought they could squeeze into at least some of the vacuum left by Great Britain. Today, the confrontation is direct: China vs USA.

….. to be continued…