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The Great Disconnect
The following article was published on June 4, 2020. It is being republished now because it remains just as relevant, since the current situation is even more exaggerated.
What happens when the government chooses to preserve “return on capital” over the plight of working people?
Major stock market averages have been advancing, unabated, since the panic bottom in March. The NASDAQ, home of most major tech stocks, just hit a new all-time high and market valuations of leading companies (price to earnings ratios on forward earnings) have never been higher, even in 2000, when the tech bubble burst. On Wednesday, June 3rd, the market set the record for the biggest rally in a 50-day period in the history of the stock market. Some financial analysts are even starting to comment that this is the new normal, going so far as to say that equity valuations have reached a permanently higher plateau.
This is all happening against a backdrop of a global pandemic and historic social unrest, when unemployment is reaching stratospheric levels (US government statistics say 40 million unemployed, which means it’s more like 50 million), when 100,000 small businesses have closed their doors, forever, when more than 44% of Americans say they are in danger of not being able to feed themselves or afford healthcare and 44% also don't even make enough money to have to pay income tax, and consumers and corporations are drowning in debt.
How can this paradox exist?
One explanation is that interest rates are at historic lows and will stay there indefinitely, which may actually be true. But low interest rates are a sign of underlying economic weakness not strength, so that’s a curious reason for robust confidence in risk markets.
Another explanation is that the Federal Reserve and the US Treasury are now committed to spending/printing as much money as it takes to keep the country working and consuming, even if they have to resort to buying shares of common stock in private companies. The so-called “moral hazard” of this precedent setting action aside, with so much of our “prosperity” now beholding to stock market prices, do they really have a choice?
Still, this argument is also based on the questionable premise that economic weakness, socioeconomic dysfunction, and increasing “functional” poverty for a growing percentage of Americans are good reasons to invest in the markets.
Then there is the argument is that there is nowhere else for all the money the government’s assistance money to go but into the stock market, which means there’s really no risk at all. After all, almost all other investments are suffering--bond yields are negligible, real estate investments are having trouble getting tenants to pay rent, and so on, so stocks are the only game in town.
The message of the markets
The message of the markets is that none of the dysfunction, inequity, or inequality and unequal treatment under the law in our society, not to mention our growing environmental deficits, matters or will have any economic cost associated with them in order to correct them. But, the market is betting that the protests will come and go, wages will not rise (though everyone knows that working people in a major metropolitan area need $25 an hour to live), that business taxes and fees will not go up, that corporate responsibilities and liabilities won’t increase, that corporate costs of training workers won’t rise, deflationary price pressures won’t matter, zero interest on savings won’t hurt consumption, social security will not have to be saved, universal healthcare won’t ever happen in our lifetimes, and building affordable housing will not cost the government, corporations, or taxpayers, anything.
All of these events would cut into profits and hurt forward earnings, which, theoretically, are supposed to impact stock valuations.
However, the market is not just saying that there will be no significant economic impacts from the pandemic or these systemic challenges, but that things will actually be a lot better, going forward, than they were before Covid-19. For example, Tesla, which predominately makes products for the wealthy, is now trading at almost twice the valuation it was trading at in January (measured by its PEG). I have nothing against Elon Musk. He's an amazing genius. But that's not the point.
The financial media’s interpretation of the message of the markets is that the virus is behind us, the suffering of fellow citizens doesn't matter, and the future will be just like the past: nothing is going to change. Expanding profits are assured… forever.
But, what if the historic rise in stock prices has nothing to do with any of this or our normal definitions of “value?” Maybe the “markets” are now just a gigantic video gaming contest, with a relatively small group of money managers and hedge funds playing with highly sophisticated algorithms, trading in milliseconds to the point that the whole system is a self-feeding momentum machine that no longer even needs reality to support its so-called “values.”
Or, conversely, what if the market’s rise is real? What if rising stock prices are a reflection of the dollar losing value, worldwide, and in anticipation of massive inflation in the US, caused by the government flooding the economy with money in a time of frozen production—a classic case of too much money chasing too few goods and services (and too few shares), so stocks are inflating and not changing in real relative value? Or what if the threat of Covid-19 turns out to have been far less than anticipated?
Or maybe it’s a little of all of these.
At the end of the day it really doesn’t matter. What is clear is that the government has made the choice to preserve returns on investment capital over the plight of working people, just as the government made a choice in 2008 to protect bank shareholders over the interests of homeowners (mortgagees).
But it’s capitalism
Okay, I get it. The concept is that by preserving returns on capital, we backstop the kind of fear and uncertainty that could cut off capital to even worthy borrowers and equity issuers: capital that feeds the returns needed by all those banks, pension funds, insurance companies, and other market participants that backstop and stabilize our system. So again, the government can legitimately argue, did we really have a choice? And, certainly, programs like PPP will save jobs and maybe even create some.
But overall, fewer and fewer Americans are participating in the “game” or benefiting from those insurance policies, rising IRAs, and retirement funds we are saving, because they can’t afford to participate.
It’s hard to be a capitalist if you can’t accumulate some capital.
Perhaps more poorly run companies should be allowed to fail, or should be taken over, recapitalized by the government in exchange for public equity, so taxpayers might see some of that return on investment, someday. It’s a question worth asking because as it is, what the Fed and Treasury are doing looks like just another version of the trickle-down theory we’ve “enjoyed” since the 1980s, which said the benefits would flow down to everyone: a belief that has failed so miserably since 2008.
What I do know is this. If you wanted to be sure to sow the seeds of divisiveness, discontent, protest, and ideological extremism, you couldn’t pick a better method than preserving our combination of corporate socialism and trickle-down capitalism.
So, what happens if “the market” is just wrong? In California, with its massive government expenses, a lot is riding on the outcomes of our current grand economic gamble.
The “New” Corporate Consciousness
America’s largest corporations have recently been making a big deal about “social responsibility.” Jamie Dimon, CEO of JP Morgan, Wall Street’s largest bank, and chairman of the US Business Roundtable, is the poster child of this new “consciousness.”[1] Robert Reich, former Secretary of the Labor during the Clinton Administration, has been writing about that.
In a recent piece, he wrote,
“The Business Roundtable—an association of CEOs of America’s biggest corporations – announced with great fanfare a “fundamental commitment to all of our stakeholders” and not just their shareholders. They said “investing in employees, delivering value to customers, and supporting outside communities” is now at the forefront of their business goals — not maximizing profits.
“One Business Roundtable director is Mary Barra, CEO of General Motors. Just weeks after making the Roundtable commitment, and despite GM’s hefty profits and large tax breaks, Barra rejected workers’ demands that GM raise their wages and stop outsourcing their jobs. Nearly 50,000 GM workers then staged the longest auto strike in 50 years. They won a few wage gains but didn’t save any jobs. Barra was paid $22 million last year.
“Another prominent CEO who made the Business Roundtable commitment was AT&T’s Randall Stephenson, who promised to use the billions in savings from the Trump tax cut to invest in the company’s broadband network and create at least 7,000 new jobs. Instead, even before the coronavirus pandemic, AT&T cut more than 23,000 jobs and demanded that employees train lower-wage foreign workers to replace them.
“Let’s not forget Jeff Bezos, CEO of Amazon and its Whole Foods subsidiary. Just weeks after Bezos made the Business Roundtable commitment, Whole Foods announced it would be cutting medical benefits for its entire part-time workforce.”
Let’s face it, by and large, most corporations will never address any of our socioeconomic challenges (aside from some charitable donations to their own private foundations—translation: "Good PR") unless they are forced to, and even then, if a state’s requirements get too close to their bottom line, they’ll simply move elsewhere.
That’s what capitalism does.
But, social injustice, income inequality, lack of education and skills to do 21st century jobs are problems that are not going away. Correcting them will come at a price. Similarly, reversing environmental destruction will also come at an increasingly high price. Being blind to both will eventually extract a penalty, if not financially, then from our democracy, our health, our physical and mental, or certainly from our humanity.
Fixes won’t just happen, magically. These problems are not self-correcting. There is no “app” for this and no tech-nerd genius can save us.
California Dreaming
California is now the fifth largest economy in the world, essentially tied with France. The San Francisco Bay Area has been the epicenter of that 21st century, innovation-driven economy, for decades. Although there is no doubt that the tech boom that started here has transformed the world in amazingly good ways, there can also be too much of a good thing.
However, in California, regardless of the magnitude of the financial challenge, the belief in Sacramento remains that our state is so desirable to live in, our economy is so strong, and our tax base is so deep that nothing can stop us and none of the state’s plans need to defer to looming socioeconomic realities. The argument is that we have the most vital industries, the best weather, the smartest population, and everything that ensures that our future is bulletproof.
New York City held similar beliefs in the 1970s a few years before it ended up on the verge of declaring bankruptcy, as businesses and wealthy individuals began to flee in droves to avoid excessively high taxes and regulations.
The stock market’s recent action is affirming California’s over-confidence.
For Californians, the market’s behavior implies that unfunded pension debt doesn’t matter (because their stock investments will bail them out), that local and state government can ignore rising costs of providing public services, and that they can continue to float debt and raise taxes and fees without limits to spend on financial boondoggles (e.g., SMART in Marin County) and other things that inefficiently waste taxpayer dollars.
So, it’s very likely that California politicians will continue down the path they are on. Reassured that business as usual is the right way forward, they will continue to do everything they can to avoid facing systemic challenges or if they do confront those challenges in realistic ways, they will continue to put the financial burden on the working middle class and cities, if not just financially, in terms of their rights and powers.
All this adds up to California continuing to attack middle-class and lower-class family values and lifestyles, along with the concept of “community values” and “neighborhood character,” via an endless maze of taxation, fees, and financial penalties, all of which will end up being counter-productive in the long run and none of which will help the poor and those who are really most in need of help with housing, education, and opportunity.
Pure Capitalism
If we accept that capitalism is not about a society’s real world concerns but is just about maximizing return on capital, regardless of the means or outcomes, then there’s logic to everything we’re seeing in the public markets (the current definition of "good," in our system, seems to be synonymous with being rich).
Capitalism--seeing things through a lens of maximizing efficiencies and return on investment--is after all, a great thing. It taps into our nature in very positive and productive ways. But sex is also a great thing. However, seeing all personal relationships as simply as an opportunity for physical, self-gratification or seeing all business relationships as nothing more than the opportunity to extract maximum profits is pathological.
Rather than discounting the prospects for a prosperous future, perhaps the markets are in the act of reinforcing our socioeconomic pathologies: the systemic problems we refuse to face up to.
This is not a matter of what we believe or don’t believe, or what we would like to see happen or not happen, or what is just or unjust. It’s simply math. A society that is increasingly unequal—in assets, income, education, justice, and opportunity—is an earthquake waiting to happen. History has repeated itself on this over and over. The system can only get too disconnected from the greater good before it unravels and ultimately fails everyone.
But apparently, at the moment, the markets are saying, none of this matters.
Is the "market" right that we'll be back to business usual before we know it and our present concerns about justice, inequality, and equal opportunity will all just be a faint memory?
It seems a risky bet.
[1] Dimon lobbied Congress personally and intensively for the biggest corporate tax cut for the rich in history.
Bob Silvestri is a Marin County resident and the founder and president of Community Venture Partners, a 501(c)(3) nonprofit community organization funded by individuals and nonprofit donors. Please consider DONATING TO CVP to enable us to continue to work on behalf of California residents.