In Plain View

There is superstition, writing on the wall
…in letters ten feet tall

–Stevie Wonder

If the market cracks big time (as you and I expect), every frickin’ economist on Wall Street will say, Nobody saw this coming! Really. When surveyed this past June, every single guy with a tie was incomprehensibly bullish. It’s ’07 redux.

My seven year old granddaughter could take one look at these charts and tell me a crisis was coming:

Debt: State and Local Government

Of Two Minds oneTax Receipts: State and Local Government

Of two minds two

Expenditures: State and Local Government

Of two minds three

Median Household Income in the U.S.

Of two minds four

Here’s how Charles Hugh-Smith (www.oftwominds.com) sorts it out:

  1. The bond market may choke if state and local governments try to “borrow our way to prosperity” as they did in the 2000s.
  2. If state and local taxes keep soaring while wages stagnate and household income declines, households will have less cash to spend on consumption.
  3. Declining consumer spending = recession.
  4. In recessions, sales and income taxes decline as households spending drops. This will crimp state and local tax revenues.
  5. This sets up an unvirtuous cycle: state and local governments will have to raise taxes to maintain their trend of higher spending. Higher taxes reduce household spending, which reduces income and sales tax revenues. In response, state and local governments raise taxes again. This further suppresses disposable income and consumption. In other words, raising taxes offers diminishing returns.

At some point, local government revenues will decline despite tax increases and the bond market will raise the premium on local government debt in response to the rising risks.

When borrowing becomes prohibitive (or impossible) and raising taxes no longer generates more revenues, state and local governments will have to cut expenditures. Given their many contractual obligations, these cuts will slice very quickly into sinews and bone.

If this doesn’t strike you a crisis, please check back in a few years. It is easily foreseeable, but very inconvenient. As a result, it too will be a crisis that “nobody saw coming.”

The frightening thing is that those clueless Brooks Bros. suits advise your advisors and your advisors advise you. Good luck!

Cheers,

Rod

 

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