Author: admin

Submitted by Adventures in Capitalism

Over the past few months, we’ve learned a lot about the psyche of the typical Ponzi Sector investor.

You see, Ponzi sector investors will ignore most red flags, even at a company like WeWork, with more red flags than a Soviet May Day parade;

• Super-voting stock – Zuck did that and it worked out in the end

• Accelerating losses – Look at all that revenue growth

• Zero possibility of profits – Hasn’t mattered for years

• Convoluted insider dealings on property leases – Property GPs always double dip somehow

• Sold the pronoun “WE” to the company – That man is a crook!!

Look, the average bagholder is braindead. However, it doesn’t matter how “woke” you pretend to be while promoting your stock scam, you cannot do something as egregious as sell 2 letters to a company you control 30% of. That is just blatant theft.

Ever since this transaction was disclosed, I’ve seen people attack the absurdity of it all. In fact, I saw so much coverage that I felt that I’d let this one pass—what else did I have to add? Then they failed to find buyers for the IPO. The valuation started a few months ago at $65b, then $50b, then $40b (…still no one?), $30b (…uhh guys, think of the kegerators?), $25b (does anyone care at roughly half of what SoftBank paid?), now $20b is looking like a long-shot.

It’s like one of those charity date-auctions in college where no one wants the fat chick. The price keeps dropping and everyone is looking at each other, seeing who’ll step up. “At least it’s for a good cause, right?” Well, the WeWork IPO does nothing other than prop up a Masayoshi Scheme (which is just a sophisticated Ponzi Scheme). Letting WeWork fail would actually be the “good cause.” It would stop innocent retail investors from getting hosed—while the scam artists take the beating for a change.

I’m not going to opine on the continued busting of the Ponzi Sector bubble, as I’ve done enough of that already and hopefully made my point (look at charts of TSLA, UBER, LYFT, etc. if you don’t know what I’m talking about). Instead, I want to talk about corporate governance. In today’s world where shares are increasingly owned through ETF mandate, investors often forget that behind the ticker symbol is an actual business and the guy in charge is king—particularly at a company like WeWork with super-voting stock. This king has incredible power over a pool of someone else’s money. There is literally no one to stop him from misbehaving and hardly anyone even watching closely. Abusing a key funding partner like SoftBank, really is something “special,” even in today’s era of corporate excess. Fortunately, CEOs leave paper trails which speak volumes as to how a particular CEO will treat minority shareholders going forward.

Let’s pivot to the smaller companies that I focus on. Corporate governance is everything to me. At a small growing company, your cost of capital or even access to capital (at any price), determines your ability to succeed. We all accept that a CEO needs to earn a salary so he can pay his mortgage and buy groceries for his family. Anything beyond a certain threshold seems egregious—particularly when the same CEO is tossing his hat around asking investors to buy shares so that the business can grow. You have no idea how many times I’ve avoided an attractive investment over excessive executive compensation. Why does a CEO need to earn 20% of EBITDA? This isn’t a hedge fund. That EBITDA has a multiple on it. The higher the valuation, the lower the cost of capital going forward. If a CEO with a pile of equity doesn’t understand this—I want nothing to do with that company.

Don’t CEOs need to profit too? Sure. Give them stock options. If you give stock options to a rapidly growing company, at worst, it’s a deferred capital raise when those options get exercised. More importantly, it retains cash inside of the company instead of giving it away as salary. Besides, the CEO is only making money on his options if I’m making money on my shares. I can accept a bit of dilution—especially if the cash salary component is on the lower side.

Of course, there’s a level of option compensation that is also egregious. Board members will agree to damn near anything for the CEO of a company that’s succeeding. It’s up to the CEO to recognize where the grey line is, then take 2 giant steps backwards and be shareholder friendly. It’s all about cost of capital. Over the past few years, where plenty of dubious companies have been able to raise capital, people seem to have forgotten this rule. Suddenly, a non-sensical $5.9 million payment (less than 2 days of losses at WeWork) has cut at least $20 billion off the company’s valuation. It may even prove fatal if they cannot list. Previously, WeWork was a loss-making real estate company masquerading as a tech business—now it’s simply WeFraud to everyone I know. Those were 2 expensive letters.

Watch your CEOs. Read the proxy statements. See who earns what. You’d be surprised at the dispersion of compensation levels, even at similarly sized companies. If cash compensation is egregious—run!! All businesses have a certain level of related party dealings—look closely at them—do they make sense? Does the company get a fair deal? Look for anything beyond the norm—look for transactions designed to take advantage of the company. The markets are rife with abuse. There’s a reason that owner-operator businesses tend to out-perform those with hired gun CEOs. Then there’s the exception to the rule; Adam Neumann owns roughly 30% of WeWork. Why is he destroying their cost of capital?

Last week, the Big Short’s Michael Burry sparked a fresh wave of outrage among the Gen-Z and algo traders (if not so much the handful of humans who have actually witnessed a bear market) on Wall Street, by calling the darling of modern capital markets – passive, or index/ETF, investing – the next CDO bubble. Echoing what many skeptics before him have said, Burry argued that record passive inflows, coupled with active fund outflows which suggest passive equity funds will surpass active by 2022 according to BofA…

… are distorting prices for stocks and bonds in much the same way that CDOs did for subprime mortgages. Eventually, the flows will reverse at some point, and when they do, “it will be ugly.”

“Like most bubbles, the longer it goes on, the worse the crash will be,” Burry told Bloomberg.

This nascent passive bubble is also why Burry had avoided large caps and was focusing entirely on small-cap value stocks: to Burry, they tend to be underrepresented in index funds, or left out entirely, which is why they are i) cheap and also why ii) when the passive bubble bursts, they will be the few names left standing.

To be sure, Burry’s strategy is hardly new: we first profiled that exact threat in April 2017, when we quoted One River’s Eric Peters who warned to “expect enormous losses in the next correction”… as “there is no such thing as price discovery in index investing”… either on the upside, or on the downside, and as a result “the stocks that have been blindly bought on the way up will be blindly sold.” He continued:

“When these markets do finally have a correction there will be no bid for many of these stocks…. “The people who are indexing now are the same ones who were selling in 2009,”

“I just spoke at a conference filled for wealth advisors from all the major players. They say the same thing – today’s buyers are not long-term investors.” They’re guys who put $1mm into index ETFs.

His dire conclusion preceded Burry’s by more than 2 years:

“I don’t know when the next major crisis will hit, no one does,” admitted VICE. “But I do know that even in the next normal correction, the market’s losses will be amplified enormously by this move away from active management.”

At roughly the same time, we also reported that “the world’s most bearish hedge fund”, Russell Clark’s Horseman Capital had revealed a new “investing” strategy using ETF flows as a catalyst for positioning and bets.

Citing the transition from active to passive as a catalyst that makes markets increasingly more inefficient, Clark lamented that there “are complaints from some quarters about it being harder to short sell as flows of money push up stocks.” So what is his new shorting philosophy? This is how he explained it, using his biggest short at the moment, retail REITs:

The biggest short sector in the fund are REITs. In the US, they are mainly retail REITs, and there are two reasons for this. One is that we have guaranteed sellers in the Japanese US Reit fund. The other reason is the appalling performance of the major tenants. However, as an aside, I like them as a short area as they have the highest exposure to ETFs of any sector.

Bloomberg allows you to find the biggest ETFs and open ended funds which are invested in US Real Estate Sector. The top 28 funds have total assets of 187bn USD, of which 13.3bn USD invested in Simon Property Group, that is 24% of Simon’s market cap. However, Real Estate passive funds are not the only passive fund invested in Simon. When all passive funds weights are added together I get over 50% of Simon Property Group shareholders are passive. I wonder who will become the buyer if all these funds start to see redemptions if there are some problems in US commercial real estate?

His conclusion:

The long bull market in passive investment has made them wilfully blind to the liquidity risk that they are running. Passive investments are concentrated in the US market…

And if Eric Peters is right, “when these markets do finally have a correction there will be no bid for many of these stocks”, so all Clark has done is tighten the universe of ETF unwinds from the entire market to a market sector or subset of stocks, in this case the retail REIT space.

Fast forward to today, when this idea of selectively trading ETFs received a much needed refurbishment courtesy of SocGen’s Andrew Lapthorne, who writes that the French bank’s ETF Research team – which monitors ETF stock ownership and the potential for overcrowding – looked at overcrowding in Bond ETFs and more recently updated their analysis of overcrowding in equity ETFs.

According to the SocGen observations, the greatest risk of crowding in ETFs is with non-market cap weighting schemes (i.e. Nikkei 225) and where there is significant liquidity in the ETF relative to the underlying (US Smallcaps and Gold ETF are two areas they highlight). However “despite getting the usual pushback from ETF providers on this topic” on the whole the bank does not see significant overcrowding risk, although we will let readers look at the chart below and make their own conclusions.

Meanwhile, as Lapthorne adds, the more interesting point of Michael Burry’s comments related to cheapness in smaller, less liquid stocks that were less likely to be included in a passive index. The SocGen strategist reminds readers that he highlighted in July “that there is an ever increasing cohort of cheap but small global stocks, but we also know from experience that whenever we create systematic equity strategies we leave significant “alpha” on the table through an inability to easily trade these names.” Of course, to Burry this misplaced alpha – the result of a liquidity mirage – is precisely the reason why one should be buying these stocks, if perhaps not so much for the upside, as much as the lack of downside once the next correction hits and all ETF constituents are liquidated at the same time as the bath water.

The result is visualized in the chart below which creates portfolios of roughly 500 names, based on a decile ranking of their average daily traded volume over the prior 6 months. As Lapthorne concludes, “the liquid portfolio performance has been easily outstripping the illiquid over the last couple of years and there is a clear valuation discrepancy.” The bottom line: “for those with genuinely patient capital, globally illiquid small caps are increasingly an interesting fishing ground.”

As a reminder, the reason why the world remembers the name of Burry is not so much his insight into the last financial crisis – many others had also warned about the coming Global Financial Crisis – it was his ability to remain patient in the face of client redemption demands as his thesis was bleeding to death, only to be validated overnight.

For now, the real question is which contrarian will have a similar patience this time around? While our money is on Horseman, the fund’s AUM is starting to drop to existentially dangerous levels as we observed just two weeks ago. It will be painfully ironic if when the market finally does crash there are no shorts left to finally profit.

Authored by Charles Hugh Smith via OfTwoMinds blog,

Either we root out every last source of rot by investigating, indicting and jailing every wrong-doer and everyone who conspired to protect the guilty in the Epstein case, or America will have sealed its final fall.

When you discover rot in an apparently sound structure, the first question is: how far has the rot penetrated? If the rot has reached the foundation and turned it to mush, the structure is one wind-storm from collapse.

How deep has the rot of corruption, fraud, abuse of power, betrayal of the public trust, blatant criminality and insiders protecting the guilty penetrated America’s key public and private institutions? It’s difficult to tell, as the law-enforcement and security agencies are themselves hopelessly compromised.

If you doubt this, then please explain how 1) the NSA, CIA and FBI didn’t know what Jeffrey Epstein was up to, and with whom; 2) Epstein was free to pursue his sexual exploitation of minors for years prior to his wrist-slap conviction and for years afterward; 3) Epstein, the highest profile and most at-risk prisoner in the nation, was left alone and the security cameras recording his cell and surroundings were “broken.”

If this all strikes you as evidence that America’s security and law-enforcement institutions are functioning at a level that’s above reproach, then 1) you’re a well-paid shill who’s protecting the guilty lest your own misdeeds come to light or 2) your consumption of mind-bending meds is off the charts.

How deep has the rot gone in America’s ruling elite? One way to measure the depth of the rot is to ask how whistleblowers who’ve exposed the ugly realities of insider dealing, malfeasance, tax evasion, cover-ups, etc. have fared.

America’s ruling class has crucified whistleblowers, especially those uncovering fraud in the defense (military-industrial-security) and financial (tax evasion) sectors and blatant violations of public trust, civil liberties and privacy.

Needless to say, a factual accounting of corruption, cronyism, incompetence, self-serving exploitation of the many by the few, etc. is not welcome in America. Look at the dearth of investigative resources America’s corporate media is devoting to digging down to the deepest levels of rot in the Epstein case.

The closer wrong-doing and wrong-doers are to protected power-elites, the less attention the mass media devotes to them.

As for Corporate America’s fraud and corruption: No Wrongdoing Here, Just 6,300 Corporate Fines and Settlements (May 2015). Prosecutors no longer indict bankers, CEOs or top executives. Wrist-slap fines are deemed adequate punishment, even when corporate managers have reaped billions of dollars in profits selling highly addictive and dangerous drugs while claiming they’re safe and non-addictive.

The tens of thousands of Americans who’ve died from these drugs suggest this was never true.

All this rot–corruption, fraud, abuse of power, betrayal of the public trust, tax evasion, blatant criminality and insiders protecting the guilty–has consequences. As I explained in Crony Capitalism Is Kryptonite to Democracy and the Real Economy (October 6, 2014), When the machinery of governance is ruled by the highest bidders, democracy is dead. (Hmm, why is Facebook suddenly spending $100 million on lobbying?)

Or as correspondent Simons C. recently put it: “The ethical dimension underpinning the whole system is this: what’s moral is what’s legal and what’s legal is for sale.”

Here are America’s media, law enforcement/security agencies and “leadership” class: they speak no evil, see no evil and hear no evil, in the misguided belief that their misdirection, self-service and protection of the guilty will make us buy the narrative that America’s ruling elite and all the core institutions they manage aren’t rotten to the foundations.

Either we root out every last source of rot by investigating, indicting and jailing every wrong-doer and everyone who conspired to protect the guilty in the Epstein case, or America will have sealed its final fall.

*  *  *

Pathfinding our Destiny: Preventing the Final Fall of Our Democratic Republic ($6.95 ebook, $12 print, $13.08 audiobook): Read the first section for free in PDF format. My new mystery The Adventures of the Consulting Philosopher: The Disappearance of Drake is a ridiculously affordable $1.29 (Kindle) or $8.95 (print); read the first chapters for free (PDF). My book Money and Work Unchained is now $6.95 for the Kindle ebook and $15 for the print edition. Read the first section for free in PDF format. If you found value in this content, please join me in seeking solutions by becoming a $1/month patron of my work via patreon.com. New benefit for subscribers/patrons: a monthly Q&A where I respond to your questions/topics.

Will US media label him a pro-Putin stooge as it would surely do if Trump said it? French Foreign Minister Jean-Yves Le Drian has called for an easing of tensions with Russia as a delegation of top French ministers met with officials in Moscow on Monday.

“The time has come, the time is right, to work towards reducing distrust,” Le Drian said at a press conference. He described Saturday’s historic prisoner swap between Russia and Ukraine, which included 24 Ukrainian sailors detained in the Kerch Strait incident last November, as presenting a “window of opportunity” that could open a lasting peace between Kiev and Moscow.

It was the first meeting between Russian and French officials in the so-called “2+2” format since tensions soared over the 2014 Crimea crisis, according to the AFP. Defense Minister Florence Parly accompanied Le Drian for the talks with their Russian counterparts. 

“We have come to suggest, in the name of the president of the republic, a new agenda of trust and security,” Le Drian said. Parly added also that “it is important to talk to each other, to avoid misunderstanding and friction.”

“We need to act together toward progressive restoration of strategic stability in Europe in order to lay ground for this new architecture of trust and security, as the European continent will never be stable, will never be secure if there is not utmost clarity in relations with Russia,” Le Drian said at a joint press conference with Russian Foreign Minister Sergey Lavrov.

Russian Foreign Minister Sergei Lavrov responded by saying the rebuilding of ties was “possible and necessary” — this after French President Emmanuel Macron hosted President Vladimir Putin in southern France last month for talks. 

However, Le Drian stopped short of saying EU sanctions related to Russian action in Ukraine should be lifted: “Minsk process should progress for the stabilization of the situation in Ukraine, then the sanctions will be lifted,” he said early this week on a French broadcaster.

He further acknowledged recently elected Ukrainian President Volodymyr Zelensky’s desire to end the conflict in eastern Ukraine and east tensions with Russia “led to the prisoners’ swap”.

Russia and Ukraine exchanged several dozen prisoners Saturday as they moved to dial down tensions in a swap that included captured Ukrainian sailors and a suspect in the 2014 downing of a Malaysia Airlines plane. https://t.co/BeQLrIPW6W

— Stars and Stripes (@starsandstripes) September 7, 2019

Paris has of late been at the forefront of European countries seeking to renew high-level diplomatic contacts with Russia after the still stalemated war in Donbass and Crimean status referendum, or what the West describes as Russian annexation of the peninsula, brought Moscow’s relations with Europe to their lowest point over the past years. 

In the latest resignation announcement from a key figure in the UK government, Commons Speaker John Bercow, who has faced scrutiny and even an attempt by some of his fellow Tories to oust him , said Monday afternoon (London Time) said he would stand down as Speaker by the end of October.

Bercow’s announcement prompted the pound to soften against the dollar.

Source: Bloomberg

The pound started to weaken earlier after the Queen assented to a law prohibiting a no deal Brexit.

Source: Bloomberg

Bercow said that if the Commons votes for an early general election, his tenure as Speaker and as an MP will end when this Parliament ends. And if MPs do not vote for an election, Bercow has concluded that the least disruptive option for him would be to stand down at the close of business on Oct. 31, according to the Guardian.

The votes on the Queen’s Speech are taking place early this week, and Bercow said it would make sense to have an experienced Speaker in the chair for those votes.

Via S&P Platts’ “The Barrel” blog,

Globalization of natural gas markets, OPEC’s struggle to balance oil supply and price, and platinum coming to the fore as an investment vehicle are all covered in this week’s selection of essential charts from S&P Global Platts editors.

1. Global gas price differentials keep tightening…

What’s happening? Gas spot prices across regions have converged in recent weeks due to the continued gas glut in an increasingly globalized gas market, with surplus LNG cargoes struggling to find homes amid subdued demand in Asia. With limited European storage demand, coal-to-gas switching in Europe maximized and the global LNG surplus growing all the time, prices are now within a small $2/MMBtu range.

What’s next? With more US LNG set to come online over the next 12 months, the global gas glut could become even more severe, with a likely continuation of the gas price convergence into 2021 unless there is a significant supply disruption of some kind. And even then, prices could move together rather than diverge given the interconnected nature of the gas markets.

2. …and US LNG export economics start to favor Europe over Asia.

What’s happening? For prompt US Gulf Coast-loading spot LNG cargoes, price signals from Northeast Asia, represented by the Platts JKM, overtook those from Southwest Europe last month, as represented by the Platts SWE marker. US Gulf Coast netback price calculations take into consideration the cost of shipping to destination markets. In recent days, the trend has started to flip, favoring Europe.

What’s next? With six major US terminals now operating – four on the Gulf Coast and two on the East Coast – offtakers will be looking for the best bang for their buck heading into the fall and winter.

3. China steel prices suggest squeeze on manufacturers’ profits

What’s happening? Look out for the release of China’s producer price index (PPI) on Tuesday. In August, factory prices compared to the previous year fell for the first time in three years last month due to weaker domestic and export demand as a result of a slowing economy and no sign of respite in the ongoing trade tensions with the United States. Steel prices have historically been a good leading indicator and proxy for producer price inflation. If the past if any guide to the future, PPI data could show a further decline in August which is likely to be harbinger of weakening corporate profitability going forward.

What’s next? The Chinese government is determined to avoid the long term risk to the economy of excess credit. That means it’s unlikely we will see a major stimulus to boost demand. However, a modest credit injection in the coming months to offset the impact of weaker external demand, supporting domestic consumption and stabilizing factory gate prices, is a possibility.

Go deeper – China downstream steel segment outlook

4. OPEC struggles to lift oil prices despite cuts discipline

What’s happening? OPEC crude oil production edged up higher in August to 29.93 million b/d but is still 2.34 million b/d lower year on year. The cuts, along with US sanctions on OPEC members Iran and Venezuela, have contributed to tightening supplies, particularly of heavier and sour crudes. But the bloc is still struggling to move oil prices higher, with the market wary of a global economic slowdown.

What’s next? Several key OPEC members and their allies, including Russia, will gather Thursday in Abu Dhabi for a Joint Ministerial Monitoring Committee meeting, where traders will be watching closely for signals on potentially deeper cuts. OPEC, Russia and nine other oil producing countries are in the midst of a 1.2 million b/d in production curb agreement that runs through March 2020.

5. Platinum prices surge as investors look to new safe haven

What’s happening? Platinum has received a boost in recent weeks from the surge in gold prices, with spot bids around $940/oz on September 6. Negative interest rates have bolstered demand for gold and pushed prices sky-high in the process, driving investors towards platinum. In the first half of 2019, investment demand in platinum amounted to 855,000 oz, driven by a surge in exchange traded fund (ETF) holdings, which gained 720,000 oz, the World Platinum Investment Council said last week. That interest comes on top of a market that is much tighter than it was six months ago.

What’s next? Platinum’s fortunes may be closely tied to the outlook for palladium, which faces glaring deficits. In a 10 million oz palladium market, there was an 800,000 oz shortfall this year, and more than a 1 million oz potentially expected next year, according to WPIC. The metal is currently trading at more than $1500/oz The organization believes platinum will be considered as a serious substitute for palladium in ICE vehicles. That could mean there is potential for platinum prices to be pulled upwards.

6. German clean energy targets at risk as wind projects stall

What’s happening? German wind capacity additions have plunged after a record 20 GW was added over the past four years. Onshore wind is at a standstill with 10 GW of projects stuck in the permitting process due to aviation, military or ecological planning restrictions. Local opposition is growing in some regions, while coastal areas are already saturated causing grid bottlenecks.

What’s next? Germany targets a 65% share of renewables in the power mix by 2030 as coal is slowly phased out. Current growth trajectories lag behind that target, with market actors in crisis talks with the government ahead of climate policy decisions September 20. These could see offshore wind targets boosted, planning restrictions eased and the 52 GW solar ceiling cancelled.

President Trump shredded former South Carolina Governor and congressman Mark Sanford, who announced his bid for the Republican presidential nomination on Sunday.

“When the former Governor of the Great State of South Carolina, @MarkSanford, was reported missing, only to then say he was away hiking on the Appalachian Trail, then was found in Argentina with his Flaming Dancer friend, it sounded like his political career was over,” tweeted Trump. 

“but then he ran for Congress and won, only to lose his re-elect after I Tweeted my endorsement, on Election Day, for his opponent. But now take heart, he is back, and running for President of the United States. The Three Stooges, all badly failed candidates, will give it a go!“

…but then he ran for Congress and won, only to lose his re-elect after I Tweeted my endorsement, on Election Day, for his opponent. But now take heart, he is back, and running for President of the United States. The Three Stooges, all badly failed candidates, will give it a go!

— Donald J. Trump (@realDonaldTrump) September 9, 2019

Sanford made headlines in 2009 after it emerged that he had an extramarital affair with an Argentinian woman, which he and his wife, Jenny Sanford, attempted to cover up by fabricating a story that he was “hiking the Appalachians.”

The now-divorced father of four, who announced his run on “Fox News Sunday” with host Chris Wallace, became the third Republican challenge to Trump in 2020. The “Three Stooges” may find it tough sledding however after South Carolina and Nevada canceled their GOP primary contests for 2020, and committed all Republican delegates to Trump. 

“We have a storm coming that we are neither talking about nor preparing for given that we, as a country, are more financially vulnerable than we have ever been since our Nation’s start and the Civil War,” Sanford wrote, adding “We are on a collision course with financial reality. We need to act now.”

Trump’s tweets on Monday morning targeting Sanders came minutes after the candidate concluded an interview on MSNBC’s “Morning Joe,” during which he defended his decision to take on the president.

Sanford declined to say whether he believes Trump is a Republican, pointed to polls he said showed roughly half of party members eager for a challenge to Trump, and claimed a robust primary debate would strengthen the GOP ahead of the general election. –Politico

 “This is the equivalent of saying within the Republican Party, to all of those high school football teams across America, ‘Tell you what, guys: We are not going to scrimmage this week. We’ll be stronger by not scrimmaging. We’re just going to play on Friday night,” said Sanford. “And the coach would say, ‘Are you completely out of your mind?’ The American way is premised on competition.”

Authored by Lance Roberts via RealInvestmentAdvice.com,

In 2016, I first touched on the impacts of hiking the minimum wage.

“What’s the big ‘hub-bub’ over raising the minimum wage to $15/hr? After all, the last time the minimum wage was raised was in 2009.

According to the April 2015, BLS report the numbers were quite underwhelming:

‘In 2014, 77.2 million workers age 16 and older in the United States were paid at hourly rates,representing 58.7 percent of all wage and salary workers. Among those paid by the hour, 1.3 million earned exactly the prevailing federal minimum wage of $7.25 per hour. About 1.7 million had wages below the federal minimum.

Together, these 3.0 million workers with wages at or below the federal minimum made up 3.9 percent of all hourly-paid workers. Of those 3 million workers, who were at or below the Federal minimum wage, 48.2% of that group were aged 16-24. Most importantly, the percentage of hourly paid workers earning the prevailing federal minimum wage or less declined from 4.3% in 2013 to 3.9% in 2014 and remains well below the 13.4% in 1979.’”

Hmm…3 million workers at minimum wage with roughly half aged 16-24. Where would that group of individuals most likely be found?

Not surprisingly, they primarily are found in the fast-food industry.

“So what? People working at restaurants need to make more money.”

Okay, let’s hike the minimum wage to $15/hr. That doesn’t sound like that big of a deal, right?

My daughter turned 16 in April and got her first summer job. She has no experience, no idea what “working” actually means, and is about to be the brunt of the cruel joke of “taxation” when she sees her first paycheck.

Let’s assume she worked full-time this summer earning $15/hour.

• $15/hr X 40 hours per week = $600/week
• $600/week x 4.3 weeks in a month = $2,580/month
• $2580/month x 12 months = $30,960/year.

Let that soak in for a minute.

We are talking paying $30,000 per year to a 16-year old to flip burgers.

Now, what do you think is going to happen to the price of hamburgers when companies must pay $30,000 per year for “hamburger flippers?”

Not A Magic Bullet

After Seattle began increased their minimum wage, the NBER published a study with this conclusion:

“Using a variety of methods to analyze employment in all sectors paying below a specified real hourly rate, we conclude that the second wage increase to $13 reduced hours worked in low-wage jobs by around 9 percent, while hourly wages in such jobs increased by around 3 percent.Consequently, total payroll fell for such jobs, implying that the minimum wage ordinance lowered low-wage employees’ earnings by an average of $125 per month in 2016.”

This should not be surprising as labor costs are the highest expense to any business. It’s not just the actual wages, but  also payroll taxes, benefits, paid vacation, healthcare, etc. Employees are not cheap, and that cost must be covered by the goods or service sold. Therefore, if the consumer refuses to pay more, the costs have to be offset elsewhere.

For example, after Walmart and Target announced higher minimum wages, layoffs occurred (sorry, your “door greeter” retirement plan is “kaput”) and cashiers were replaced with self-checkout counters. Restaurants added surcharges to help cover the costs of higher wages, a “tax” on consumers, and chains like McDonald’s, and Panera Bread, replaced cashiers with apps and ordering kiosks.

A separate NBER study revealed some other issues:

“The workers who worked less in the months before the minimum-wage increase saw almost no improvement in overall pay — $4 a month on average over the same period, although the result was not statistically significant. While their hourly wage increased, their hours fell substantially. 

The potential new entrants who were not employed at the time of the first minimum-wage increasefared the worst. They noted that, at the time of the first increase, the growth rate in new workers in Seattle making less than $15 an hour flattened out and was lagging behind the growth rate in new workers making less than $15 outside Seattle’s county. This suggests that the minimum wage had priced some workers out of the labor market, according to the authors.”

Again, this should not be surprising. If a business can “try out” a new employee at a lower cost elsewhere, such is what they will do. If the employee becomes an “asset” to the business, they will be moved to higher-cost areas. If not, they are replaced.

Here is the point that is often overlooked.

Your Minimum Wage Is Zero

Individuals are worth what they “bring to the table” in terms of skills, work ethic, and value. Minimum wage jobs are starter positions to allow businesses to train, evaluate, and grow valuable employees.

• If the employee performs as expected, wages increase as additional duties are increased.
• If not, they either remain where they are, or they are replaced.

Minimum wage jobs were never meant to be a permanent position, nor were they meant to be a “living wage.”

Individuals who are capable, but do not aspire, to move beyond “entry-level” jobs have a different set of personal issues that providing higher levels of wages will not cure.

Lastly, despite these knock-off effects of businesses adjusting for higher costs, the real issue is that the economy will quickly absorb, and remove, the benefit of higher minimum wages. In other words, as the cost of production rises, the cost of living will rise commensurately, which will negate the intended benefit.

The reality is that while increasing the minimum wage may allow workers to bring home higher pay in the short term; ultimately they will be sent to the unemployment lines as companies either consolidate or eliminate positions, or replace them with machines.

There is also other inevitable unintended consequences of boosting the minimum wage.

The Trickle Up Effect:

According to Payscale, the median hourly wage for a fast-food manager is $11.00 an hour.

Therefore, what do you think happens when my daughter, who just got her first job with no experience, is making more than the manager of the restaurant? The owner will have to increase the manager’s salary. But wait. Now the manager is making more than the district manager which requires another pay hike. So forth, and so on.

Of course, none of this is a problem as long as you can pass on higher payroll, benefit and rising healthcare costs to the consumer. But with an economy stumbling along at 2%, this may be a problem.

A report from the Manhattan Institute concluded:

“By eliminating jobs and/or reducing employment growth, economists have long understood that adoption of a higher minimum wage can harm the very poor who are intended to be helped.Nonetheless, a political drumbeat of proposals—including from the White House—now calls for an increase in the $7.25 minimum wage to levels as high as $15 per hour.

But this groundbreaking paper by Douglas Holtz-Eakin, president of the American Action Forum and former director of the Congressional Budget Office, and Ben Gitis, director of labormarket policy at the American Action Forum, comes to a strikingly different conclusion: not only would overall employment growth be lower as a result of a higher minimum wage, but much of the increase in income that would result for those fortunate enough to have jobs would go to relatively higher-income households—not to those households in poverty in whose name the campaign for a higher minimum wage is being waged.”

This is really just common sense logic but it is also what the CBO recently discovered as well.

The CBO Study Findings

Overall

• “Raising the minimum wage has a variety of effects on both employment and family income. By increasing the cost of employing low-wage workers, a higher minimum wage generally leads employers to reduce the size of their workforce.

• The effects on employment would also cause changes in prices and in the use of different types of labor and capital.

• By boosting the income of low-wage workers who keep their jobs, a higher minimum wage raises their families’ real income, lifting some of those families out of poverty. However, real income falls for some families because other workers lose their jobs, business owners lose income, and prices increase for consumers. For those reasons, the net effect of a minimum-wage increase is to reduce average real family income.”

Employment

• First, higher wages increase the cost to employers of producing goods and services. The employers pass some of those increased costs on to consumers in the form of higher prices, and those higher prices, in turn, lead consumers to purchase fewer goods and services.

• The employers consequently produce fewer goods and services, so they reduce their employment of both low-wage workers and higher-wage workers.

• Second, when the cost of employing low-wage workers goes up, the relative cost of employing higher-wage workers or investing in machines and technology goes down.

• An increase in the minimum wage affects those two components in offsetting ways.

  • It increases the cost of employing new hires for firms

  • It also makes firms with raise wages for all current employees whose wages are below the new minimum, regardless of whether new workers are hired.

Effects Across Employers.

• Employers vary in how they respond to a minimum-wage increase.

• Employment tends to fall more, for example, at firms whose sales decline when they raise prices and at firms that can readily substitute machines or technology for low-wage workers.

• They might  reduce workers’ fringe benefits (such as health insurance or pensions) and job perks (such as employee discounts), which would lessen the effect of the higher minimum wage on total compensation. That, in turn, would weaken employers’ incentives to reduce their employment of low-wage workers.

• Employers could also partly offset their higher costs by cutting back on training or by assigning work to independent contractors who are not covered by the FLSA.

Macroeconomic Effects.

• Reductions in employment would initially be concentrated at firms where higher prices quickly reduce sales. Over a longer period, however, more firms would replace low-wage workers with higher-wage workers, machines, and other substitutes.

• A higher minimum wage shifts income from higher-wage consumers and business owners to low-wage workers. Because low-wage workers tend to spend a larger fraction of their earnings, some firms see increased demand for their goods and services, which boosts the employment of low-wage workers and higher-wage workers alike.

• A decrease in the number of low-wage workers reduces the productivity of machines, buildings, and other capital goods. Although some businesses use more capital goods if labor is more expensive, that reduced productivity discourages other businesses from constructing new buildings and buying new machines. That reduction in capital reduces low-wage workers’ productivity, which leads to further reductions in their employment.

Don’t misunderstand me.

Hiking the minimum wage doesn’t affect my business at all as no one we employee makes minimum wage. This is true for MOST businesses.

The important point here is that the unintended consequences of a minimum wage hike in a weak economic environment are not inconsequential.

Furthermore, given that businesses are already fighting for profitability, hiking the minimum wage, given the subsequent “trickle up” effect, will lead to further increases in automation and the “off-shoring” of jobs to reduce rising employment costs. 

In other words, so much for bringing back those manufacturing jobs.