The robo-machines suddenly barfed their breakfast this morning when a Fed head said it might not be time to cut interest rates just yet. And that came upon the heels of an ostensibly Republican President’s newest nominee to the Fed calling for a 50 basis point rate cut—even as he described the tepid December increase to 2.4% as “inexplicable”.
Inexplicable, my eye!
We have apparently reached the point of such abject monetary stupidity on both ends of the Acela Corridor that virtually nobody any longer even knows that money can’t be free; and that after the Fed has spent 10 consecutive years shoveling essentially free carry trade money into the canyons of Wall Street, the place is rife with dangerous speculation that will eventually implode in another fiery crash—even as it continues to incentivize the corporate C-suites to strip-mine their balance sheets and cash flows to fund stock buybacks and M&A deals rather than invest in productive assets.
Stated differently, we are at the point where everyone fears an itsy-bitsy interest rate, and therefore peddles bogus theories as to why that which is inexplicable by all traditional canons of sound money is supposedly perfectly rational and appropriate at the present time.
In that vein, the Keynesian central bankers palaver endlessly about an invisible benchmark called r-star or the neutral rate of interest; supply-siders like Moore batter a bogeyman called the Phillips Curve with a rhetorical stick until it is bloody; and the gamblers in the casino gravely warn about “tightening” monetary conditions, which boils down to an aversion to widening risk spreads and falling stock prices.
But the facts mock all of those self-serving rationalizations.
After all, the current 2.40% funds rate being assessed by the traders as 60% likely to be cut before year-end is just 25 basis points above the 2.15% inflation rate (CPI less food and energy) of the last twelve months; and after Stephen Moore’s wacky 50 bps cut, it would be back in negative real yield territory, where it had been for 123 months running before November 2018.
The truth is, there is not a snowball’s chance in the hot place that a money market rate just 25 basis points above the inflation rate could possibly harm the main street economy.
For instance, if the December increase were fully passed through to borrowers it would amount to a hairline difference in the current 4.71% average rate on a 60-month auto loan. And the same would be true of its impact on the current average 30-year home mortgage rate of 4.08%, the average prime rate on business loans of 5.5% and the average credit card rate of 17.7%.
As to the latter, it would cost shop-until-they-drop consumers just 1.4% more to use their plastic. So we are quite certain it would not slow down hits to the “order” button on Amazon by one bit.
In short, when we are talking about the cost of money to real borrowers on main street the December increase was a rounding error; and so would be another 50 or 100 basis point rise in the money market rate on top of that.
For crying out loud, during the seven years over 1994-2000 the federal funds rate averaged far higher. In fact, at 4.80% it exceeded the average core CPI (less food and energy) rate of 2.55% by fully 225 basis points.
That is, the money market spread over inflation, or the real rate, averaged 10Xgreater than what Moore claimed to be the “inexplicable” level resulting from the December increase, and from which the day traders were also stomping their feet and pouting loudly for relief.
Yet back in the 1990s a meaningful return on liquid savings over and above the cost of inflation and taxes did not bring down the economic house. Real GDP growth, in fact, averaged 3.5% during the period.
So here, again, is the Fed’s sugar bowl. The fast expanse between the brown line (trend CPI inflation less food and energy) and the purple line (effective Fed funds rate) amounted to speculators’ heaven because it permitted Wall Street traders to put on margined or optioned positions with 90% or better leverage—borrowings which cost less than the going inflation rate.
In a word, the policy embedded in the chart below was a massive subsidy for speculation, and that’s exactly what happened.
In this regard, here is one example of the resulting speculative madness, which was noted yesterday by Wolf Richter. Upon the disclosure by WeWork that it had managed to post a loss greater than its entire revenue during 2018, Richter summarized:
The four standout numbers that were reported:
Revenues in 2018 doubled to $1.82 billion
Losses in 2018 more than doubled to $1.93 billion.
Occupancy rate in Q4 fell to 80% from 84% in Q3, meaning it expanded its spaces faster than it could fill them.
The average revenue per “member” per year fell to $6,360, and is down 13.5% from the start of 2016.
For a nine-year old global company, generating larger operating losses than revenues is an art, takes some doing, and requires full connivance of the investors whose money this is – but really all they want to do is sell the thing to the public at a huge valuation and wash their hands off it.
Needless to say, its recent VC valuation of $47 billionamounted to 26X revenues, which, in turn, generate $2 of cost for every dollar of sales!
That would be called going for volume to make up for profit margin with a vengeance—if its business model could stand the ramp, but it can’t. To wit, WeWork has contracted for upwards of 10 million square feet of office space on long-term leases (7-20 years), which it rents out one desk at a time on a monthly basis to some 100,000 tenants.
The skunk in the woodpile, of course, is that a big share of these tenants are “burn babies”. That is to say, start-ups paying the rent with VC cash, not earned revenue.
So when the great financial bubble finally implodes and the VC cash dries up, WeWork’s occupancy rates will plummet, leaving behind a great smoldering pile of defaulted leases.
But that’s not all. Nearly half of the proposed $47 billionvaluation a few months back was attributable to the company’s main sponsor—the $100 billion “Vision Fund” of a Japan based high-flyer called SoftBank.
The latter has managed to bamboozle the sovereign wealth funds of Saudi Arabia, the UAE and others to invest $50 billion of capital in its Vision Fund, which SoftBank has topped up with layers of preferred stock and debt to fashion one of the greatest VC gambling pots in recorded history; and from which it snags fees, carried interest gains and greater fool realizations on stock sales to pad its own financial statements.
But here’s the thing. WeWork was valued at $47 billion because SoftBank said it was worth that in order to mark up its own previous investments in this absurd scheme.
Yet SoftBank itself should know all that is possible to know about today’s speculative mania in the financial markets. That’s because its stock is currently valued at $102 billion, which comes on top of $160 billion in debt and long-term leases.
Even when you give allowance for its $30 billion of cash and short-term investments, it sports a TEV (total enterprise value) of $230 billion. That happens to equal 20Xits 2018 EBITDA ($22 billion) less CapEx ($10 billion), which is a pretty frisky valuation even for a normal operating company.
But SoftBank is anything but normal—since a large share of its profits come from essentially hedge fund and VC speculations. That’s evident, in fact, in its operating free cash flow figures.
To wit, it has none. During the last five years it has generated $51 billion of operating cash flow but spent $56 billionon CapEx. We’d call that a Ponzi if there ever was one, and fittingly, it is the largest investor in Uber, which is now valued at $120 billion— even as it’s losing $1 billion per quarter.
So when the third great central bank bubble of this century comes crashing down, it will be SoftBank and its portfolio of egregiously over-valued Unicorns which will be at the center of the bonfire.
Hopefully, however, none of the four-legged clients of its $300 million investment in Wag will get caught up in the inferno:
About a week before SoftBank announced a $300 million investment in Wag at the end of January, The Information reported that the Vision Fund’s interest in backing the dog-walking companyhad caused other investors to back away. Venture capital mainstays including NEA and Kleiner Perkins were considering participating in a $100 million round, but SoftBank reportedly indicated that it would only partake if it totaled $300 million. The other investors dropped out, SoftBank dropped in, and the $300 million deal was completed.
A Wag dog-walker with an adorable client
We understand, of course, why Wall Street wants to keep the free money flowing. And we also realize that making up an idiotic idea like “r-star” gives our Keynesian central bankers something to do.
That is to say, if there is such a thing as the natural rate of interest there is absolutely no reason to believe that the 12 members of the FOMC have any more competence to discover it than the bids and offers of millions of market participants intermediated by today’s high tech trading technology.
But the real stunner is the fact that the last bastion of financial rectitude—the Republican party—has now seen fit to put a whack-job on the Fed who wants to add kerosene to the fire.
