“Taxes are not paid on profits not made on sales of products never produced by workers not working, truckers not trucking, and buyers not buying. And we are just at the beginning.” – Bill Bonner

The Stock Market Collapse, and What We Can Learn About Economics

I have been thinking positively.

Maybe, when all of this is over, we will all have a better understanding of how economies work. Perhaps, after we get through all the naming and blaming, we will realize that the cause of the collapse was not the coronavirus but the overspending, the speculation and the accumulation of mountainous debt that which have been at the root of just about every economic collapse in history.

If, as is likely, the government’s current bail-out package doesn’t help, and all the follow-up bail-out bills don’t work either, perhaps we will realize that our government cannot solve financial problems, large or small, unless it can tap into the only source of wealth available: the profits of private enterprise.

We are on the verge of what could be a recession as great as that of the Great Depression. If the virus subsides quickly and businesses are allowed to reopen quickly, our economy may survive. Not in months, but perhaps in a year or two or five.

But if we continue to have our businesses shut down for months into the future, what we will likely see is a collapse of the economy followed by a collapse of the tax base followed by a collapse of the government’s ability to do much of anything.

Let’s hope not. Right now, governments all over the world are passing relief programs costing trillions of dollars.

Let’s hope things get back on track before we run out of money.

The ABCs of Economics 

The cause of the current financial crisis is the same as every financial crisis we’ve ever had. What’s different is this widespread government shutdown of businesses. This didn’t happen in any of the other virus outbreaks. It didn’t happen in 1987 or 2000-2002 or 2008. It didn’t even happen in 1929.

What happens when you have a widespread shutdown of private enterprise?

The answer is pretty obvious: You have a widespread shutdown of revenues and profits, which causes a domino effect that spreads throughout the economy with alarming speed. Just like a virus can.

A local restaurant shuts down. The owner can’t pay the bills and lets his staff go. All those companies that the owner is no longer paying – the cleaning company, the maintenance company, the suppliers of not just food and beverages but everything from paper towels to light bulbs – go without their revenues.

This is now happening with thousands of small private businesses all over America (and the rest of the world).

And many large businesses, too.

US unemployment rates a month ago were at all-time lows. Today, they are skyrocketing. It’s quite possible that they will soon be at 20%.

Yes, this is a real economic meltdown. And things are likely to get worse before they get better. But one day, things will get better and the economy will recover.  The question I’m asking is: Will we have learned anything from all of this? Will this help us understand the basic fundamentals about economics – i.e., how an economy works?

Government Intervention 

The current remedy in the USA – the $1.5 trillion bailout that is being argued about as I write this – will soon be passed. Will it help?

Certainly, government checks for $400, $800 ,and $1200 will give short-term relief to millions of unemployed tax payers. But unless the virus subsides very soon (possible, but not likely) and the economy revives quickly (unlikely), the future value of this relief to individuals will be naught.

One could argue that the proposed bailouts to businesses will have a longer-term positive effect. If these subsidies allow businesses to stay profitable during the duration – and if these companies use the aid to continue production and employment going –there would be a longer-term benefit.

But that won’t be the case with most companies that are bailed out. Many of them will use the relief to protect their shareholders. And many of them, even doing the right things, will fail.

But the bottom line is that our government – no government – can solve large and extended financial crises, because governments themselves do not create wealth. The wealth they acquire comes to them in the form of taxes. And tax revenues come from personal and corporate earnings. And all of those earnings are dependent on business profits.

This is Lesson One in the Economics of Business: All wealth ultimately comes from private enterprise – the profits generated by private businesses. Governments are not designed to create profits. They are designed to tax profits and distribute them to social enterprises like fighting wars and policing crimes and social welfare. Whenever governments have tried to run businesses, those industries have failed.

But when governments allow businesses to grow their profits, their economies expand and so does the tax base. With a growing tax base, governments can provide more of those services. This is what happened with the US and other Western economies in the Industrial Revolution, in the post-WWII expansion, in the Information Revolution in the late 1990s. And it is how Denmark and other Scandinavian countries were able to pay for their lauded social welfare nets.

But this can only happen if there is a tax base that is growing. When a tax base shrinks (as happens during recessions), the ability of a government to do its basic work shrinks too.

And if you have a situation where a large portion of an economy’s businesses become unprofitable – either because of the nationalization of industries or because of forced shutdowns like we are having now –  the government’s revenues dry up very quickly.

What options do governments have, then?

There are only two: They can borrow money (from their citizens or from businesses or from other countries) or – if they are not on a gold standard – they can print paper money and spend that. But the second rule of the ABCs of Economics is that every dollar of fake money decreases the value of the currency by the same one dollar. Quantitative easing and its economic siblings is just another form of borrowing – i.e., borrowing today that will be paid back later by inflation or recessions. But the debt will always be paid. And the payment must be made by real losses in the real income and real net worth of the entire population. Except those people and those businesses that refused to overspend and speculate and saved their profits for a rainy day.

The USA has more debt than any country in the world. The same is true for American consumers. Right now, the stock and bond markets are crashing, oil prices are falling, and even gold is moving down. (Though this will eventually reverse.)

You cannot increase your debt forever. Sooner or later, lenders will stop lending. The Chinese have been the USA’s largest lenders in recent decades. Will they come to our rescue? Can they?

As for the current bailout, it will, at best, be temporary relief. And temporary relief can work if the recession is temporary. But when businesses are not making profits for an extended period of time, the dominoes will start falling.

So if businesses can’t get back into profits in the next month or two, we will likely see a second bailout in weeks or months, and perhaps a third later on this year. But none of that will fix the real problem – that our credit system is collapsing on its foundation. Sooner or later, the twin towers of federal and consumer debt will collapse on themselves.

I’m hoping this doesn’t happen. I’m hoping the virus will soon slow down and our businesses will be allowed to operate again. Recovery won’t be immediate. It may take a year or five or 10. In the meantime, I’m hoping that the nature of this crisis – accelerated by the closing of so many thousands of businesses – will make it clear to every Americans this simple truth: All real wealth comes from the profits of private enterprise –  and without those profits, our government cannot be of any help.

This is such a simple fact that you’d think everyone with a high school education would understand it. (Ironically, it seems that the more education one gets, the less likely he is to comprehend.)

Another way to grasp this fundamental truth of economics is to understand that no government can forever provide what nature is not willing to guarantee. And nature guarantees nothing.

So that’s what I am hoping – that we will all come to understand this simple truth.

But I’m not holding my breath.

Most of my liberal friends have decided that the crisis we are living through is the fault of Donald Trump. And when they lose their jobs, they will blame that on him, too.

My conservative friends will point out that the delay in testing kits was the fault of regulation. That instead of using the kits that were available, the CDC decided we needed to use FDA-approved kits, so they tried and failed to create one of their own.

All of that is beside the point. The fact is that Black Swan events do happen. And when they create recessions, thousands of businesses go belly-up and millions of workers lose their jobs. The only survivors are those people and businesses that have not allowed themselves to overspend, speculate, and get into debt.

If we do move into a major and extended recession, I’m hoping that we will come out of it with the recognition that no government can guarantee its citizens anything that nature itself doesn’t guarantee. And nature guarantees nothing.

The silver lining would be a general recognition of the reality that we – each country, each company, and each person – are responsible for our own financial well being. And that to achieve financial security, we must work hard at jobs that create profits and save those profits for a rainy day.

A Challenge That Every Business Owner in the World Is Facing Right Now 

JS has a dilemma.

“Right now,” she writes, “I strongly believe in self-isolation… which brings me to a question about the young woman who cleans my apartment. I want to tell her to stay home. And I want to tell her that I will pay her even if she doesn’t clean. But for how long? I don’t want her to think that this ‘offer’ (if I make it) is open-ended. What is the right thing to do? I don’t really know. What do you think?”

This is what I told her…

You are a caring employer. You have decided that she shouldn’t continue working for you because of the potential dangers. You are taking responsibility for that decision (which she may not agree with) by offering to continue to pay her salary – thus transferring the financial burden from her to you. But you cannot afford to gift her salary indefinitely.

Recognize this: Tens of millions of business owners, large and small, have to grapple with the same problem. Some have more in the treasury than others. Some can afford to hold out longer than others. But none can afford to do so forever.

The advantage you have is that this is not a business but a personal service. You aren’t risking ruining your business by giving away too much. If it were a business, it would likely be a much tougher question. You’d be faced with “firing” her, knowing that she can’t get another job. And knowing that any check she gets from the government isn’t going to help her for very long.

I’m in that same situation – both as a business owner, the principal donor of a charitable foundation, and as the employer of several dozen people that maintain my properties (that are not income-producing properties).

As a business owner, my partners and I are doing everything we can to keep our employees employed. How long we can do that depends on sales. If sales crash, we will be laying people off in a matter of months. If they continue at a reasonable pace, they will stay employed.

As a donor of a charitable foundation, I have a responsibility not only for the several dozen people that work for us, but for the thousand or so people we provide assistance to. I will continue to support that foundation as long as I possibly can. But that depends on the income I get from my businesses. If that dries up, all these people will be negatively affected.

The people that work on my non-income-producing properties are in the same situation that your house cleaner is in. My plan there is to keep paying them as long as I can.

In every case, I am willing to reduce my net worth to help these less fortunate people survive. But the limit to that is the responsibility I feel for my family and friends. So there is a limit there too.

For the moment, I don’t have to make the decision you have made, because I have the opinion (from everything I’ve read)  that social distancing is more effective than isolation.

Were I in your shoes, I would continue to provide that assistance for as long as you can… but let your cleaning lady know that your largesse may end at any time in the future and that she should do whatever she can to prepare for it.

What everyone is discovering these days – I hope – is that there is a limit to how much charity all of us are willing to provide out of our own pockets. This is a very important realization. In accepting the truth of that, we must also recognize that this is true for everyone else.

All those who feel virtuous for taking the position that other (wealthier) people and the government should take care of wealth and income inequality will hopefully see the hypocrisy in that position. And perhaps (although it may be doubtful) that all wealth and therefore all financial charity comes not from the government but from the profitable efforts of private enterprise.