Financial topics

[Higgenbotham]

Now onto Ben Bernanke who is my favorite subject of discussion.

Ben said that he could turn lead into gold with his helicopter, or what he really said is that a fiat electronic currency can be created in unlimited amounts, just like dropping regular paper currency out of helicopters, and therefore deflation can always be stopped.

One thing Ben forgot about is profit and the fact that corporations can become reliant on Ben's helicopter to the point that they can't be profitable without it. It would also be apt to say at this point that profit is a measure of wealth, but money is not.

Looking at the stock market, we now have two possible scenarios.

Ben can keep running the helicopter and channel free money to corporations so they can claim profits. Say a corporation operates at a $1 billion dollar loss without the helicopter drop. He can channel $2 billion to them so they can claim a profit while they continue losing money in their operations. They can keep their excess reserves on deposit at the Fed and earn 0.25% interest but have no other use for the money. in many cases, for the corporation to use the money to expand, make loans, and so on, they would only end up compounding their losses and needing even bigger bailouts.

The other option is that Ben can stop running the helicopter. If that happens, investors will soon realize that they bought Tulip Bulbs in many cases instead of stock in profitable corporations.

But in either case, I think it's too late because he ran the helicopter too long. The least painful option would be to stop running it but he's been running it for so long that the damage will likely be very severe if he stops. Under the wrong conditions, slowing the helicopter down or even not increasing the rate at which it runs could have the same effect as shutting it down.

The above 3 posts are all way oversimplified.

[Higgenbotham]

This post will explain to some extent why the above posts are oversimplified. Basically, the economy is a dynamic process and none of the above covered that.

If the government cuts back spending and corporate revenue gets cut, there wil be a dynamic process that takes hold. The dynamics of that process will cause revenues to fall further but profit margins to improve, eventually.

Under present conditions, the last dollar of revenue that a corporation takes in is at the highest profit margin because for a currently profitable corporation the previous revenue has covered all the overheads. So that's why eliminating the deficit spending of $1.5 trillion, which is 10% of GDP, could wipe out more than 10% of corporate profits. At the same time, nothing will stay static, overheads will be reduced, and that will have knock on effects of further reducing spending as unprofitable divisions have to be shut down, unprofitable stores closed and consolidated, etc.

There's no reasonable way that I know of to do a quantitative variable versus time estimate of how all this will turn out as the dynamics wear on. If the budget were to be balanced tomorrow, all at once, which is an unrealistic assumption anyway, I'd guess corporate profit margins would drop at least 50% immediately. Then it would become difficult to know exactly how the markets, the consumer and the corporations would respond.

Mean reversion would say that corporate profit margins are going to stabilize toward perhaps 2% at best, on average, at some point in the future and stay there for a few years. Before stabilizing, there will probably be an enormous amount of pain.

[John]

I'd guess corporate profit margins would drop at least 50% immediately.

Do you really believe this? I would expect them to go negative, wouldn't they?

[Higgenbotham]

I'd guess corporate profit margins would drop at least 50% immediately.

Do you really believe this? I would expect them to go negative, wouldn't they?

I think within 3-6 months they would go negative. I'm not sure how long it would take (could be more or less) but at some point I would expect profit margins to go negative like they did in the 4th quarter of 2008, then creep back up toward 2%. Reading over my previous posts I see it wasn't clear how I think margins will stabilize around 2%, but I see no chance of a soft landing at 2% - I think the only question is how far below and for how long.

[OLD1953]

Higgs, you've expressed that issue very well. It's exactly why I've said many times that current "capitalism" cannot continue and must collapse.

Just MHO, but continuing on this course of printing money in lieu of price increases is going to lead to heads on pikes if it continues much longer.

Perhaps we'll actually get some control over Madison Avenue. We can hope. I cannot believe that the first amendment protects someone's "right" to attempt to immerse me in unwanted commercial images 24/7.

[Higgenbotham]

Higgs, you've expressed that issue very well. It's exactly why I've said many times that current "capitalism" cannot continue and must collapse.

It's difficult to express it simply, concisely and accurately all at the same time. As such, there are holes and inaccuracies but to fill all that in would cause most readers to get lost in the volume and complexity. Thanks for letting me know that what I wrote agrees with your thinking.

Just MHO, but continuing on this course of printing money in lieu of price increases is going to lead to heads on pikes if it continues much longer.

I agree.

Perhaps we'll actually get some control over Madison Avenue. We can hope. I cannot believe that the first amendment protects someone's "right" to attempt to immerse me in unwanted commercial images 24/7.

If there's a deflation, the advertising and public relations industry will nearly disappear in my opinion.

[Trevor]

If there's a deflation, the advertising and public relations industry will nearly disappear in my opinion.

It didn't disappear during the last depression. Granted, the industry was nothing compared to what it was during the 1920's, but as long as anyone is selling anything, you're going to have advertisements.

[Higgenbotham]

If there's a deflation, the advertising and public relations industry will nearly disappear in my opinion.

It didn't disappear during the last depression. Granted, the industry was nothing compared to what it was during the 1920's, but as long as anyone is selling anything, you're going to have advertisements.

I was reading a speech by the new head of the Wisconsin Dept of Tourism that I think was right on target. The gist of part of it was in an era of tight budgets, how do we get the word out that Wisconsin is a great place to vacation. Her solution was that, whenever possible, she needs to get the word out without paying for it, through free interviews or whatever means.

Another part of the equation is going to depend on who takes market share as the Depression deepens. Private label is known for not advertising to keep costs down and probably the question is how much market share they take. The same would be partly true of local manufacturers.

Having worked for a global consumer products manufacturer (Frito-Lay), I knew how much they were spending on advertising and every component of their cost structure. As private label and local manufacturers take market share, advertising is the area where global consumer products manufacturers are going to have to cut in order to survive. They won't have an option.

As far as other industries that rely heavily on advertising, I have no expertise to speak of.

Thinking of it from the macro point of view, it'll depend on how deep the trend against globalization goes and how local our lives become. Part of my assumption in making those statements is that the trend against globalization will go very deep, deeper than it did during the Great Depression. That's only a guess though and may not be correct.

One last point I should add to close the loop. In the Internet/computer era, any bozo who has some time on their hands should be able to pick up the formula for something like Tide laundry soap either by finding a contact who knows a lot about laundry detergents or by finding a contact who has the formula and will sell it. I had a job once where I had access to every formula for every product that a major consumer products manufacturer had on the store shelf. I had it because the government required them to divulge their formulas, which was not required during the Depression. That's just one avenue. Another would be hacking, which also didn't exist during the Great Depression. Once someone has a formula like that, they can mix the product and take it around to flea markets, put it in bulk areas of local businesses, advertise it on craigslist and so on.

[Trevor]

Attitudes have changed for a few people, but for many, they're spending every dollar as soon as they earn it, necessary or not. They're not even trying to save anything. I can't begin to explain this kind of behavior, considering the weakness of the economy and the fact that we're sliding back into recession.

[Higgenbotham]

I think your observation is right on. As I typed my last response my thought was/is that while these things can happen and surely would have happened in the "Old America" of even 25 years ago, I'm not sure the American Spirit of thrift and entrepreneurship exists to the extent that these things will happen. Surely they can. Surely they are not to any great extent. The woman who is running the Wisconsin Dept of Tourism is either a leader for the future or an anomaly and I'm not completely sure which.