oftwominds-Charles Hugh Smith

End of an Era: What Isn't Coming Back
March 16, 2009

Six conditions which underpinned the bogus prosperity of the past decade have changed for good. But the mainstream economists and media are still in denial, focusing on "freeing up lending" as if consumers are able to borrow more in an unsustainably debt-burdened economy.

For a snapshot of Mainstream Economist denial, please read this from Foreign Affairs:
The Japan Fallacy: Today's U.S. Financial Crisis Is Not Like Tokyo's "Lost Decade":
Summary -- The financial crisis of 2008 is not a replay of Japan’s “lost decade” of the 1990s. The current crisis is the result of correctable policy mistakes rather than deep structural flaws in the economy.

And there you have it in a nutshell: there is nothing structurally wrong with the U.S. economy that a few policy tweaks can't fix.

I beg to differ on these grounds:

1. Permanent decline of the assets which supported rampant consumerism. Having gleefully swallowed the fiction that real estate could rise indefinitely, and thus fund not only a plump retirement but a never-ending consumer binge, the American middle-class is now coming to grips with the reality that real estate valuations were a bubble which has burst. The bust is taking down the primary asset of the Baby Boom generation (housing) and the equity-extraction-machine of home equity lines of credit (HELOC).

We get a clearer picture of just how deep the rot of consumerism has reached in correspondent Jeff R.'s cogent commentary from this weekend:

Do you see the subtle parallel with what happened to the evangelism movement? It became something to serve our wants not address our needs. We need spiritual clarity and self-honesty; we also need informed people snooping around the workings of business and government. Both journalism and church transmuted into instruments for financial gain and market share. We simply pampered ourselves with the luxury to stay in big homes grossly uninformed and easily persuaded until we saw the raging grass fire headed toward our backyard. Some are still staring at it convinced it will get the neighbors house but not ours.

I have long said that the sophistication and ability of marketers outpaced our society's intellectual growth starting in the 60’s.

In other words, everyone from marketers to the evangelical movement perceived rising ownership of material goods as an "obvious" metric for "the good life." But the entire superficial surface of jewelry, lavish cruises, huge suburban homes, etc. was based not on a foundation of savings and productive real wealth but on astonishing increases in debt. It was never sustainable, and the fantasy that it was sustainable, and perhaps even "deserved," was always visibly absurd.

The mainstream economists seem to believe that everything will ramp right back up to 2005 as soon as those pesky banks start lending again. Oops, except that all the policy tweaks which these same economists are suggesting will restrict the very sort of insanely risky, unmoored lending which enabled a decade of wild consumer spending.

The entire edifice of consumerism is a "false god" which has now been toppled from its gold-leafed perch. Buying more and owning more did not create a sustainable, healthy happiness or a sense of self-identity; the insecurity and anxiety which were masked by shopping and prescription drugs have now been laid bare.

But it's not just housing which has plummeted; it's all assets classes. And that decline hasn't just shattered consumer borrowing, it's also wiped out much of the retirement wealth of the Baby Boomers. (Physical gold has risen in value, but other commodities have seen boom-bust cycles of appalling volatility.)

2. With their assets diminished, Boomers must now save rather than spend. The decimation of Boomer assets and retirement funding is documented in this report sent to me by longtime correspondent J.F.B., who has been presciently pointing out the risks to the Boomer retirement for some time:

The Wealth of the Baby Boom Cohorts After the Collapse (Center for Economic and Policy Research)

The median household with a person between the ages of 45 to 54 saw its net worth fall by more than 45 percent between 2004 and 2009, from $172,400 in 2004 to just $94,200 in 2009 (all amounts are in 2009 dollars). If the median late baby boomer household took all of the wealth they had accumulated during their lifetime, they would still owe approximately 45 percent of the price of a typical house1 and have no other assets whatsoever.

As a result of the plunge in house prices, many baby boomers now have little or no equity in their home. According to our calculations, of those who own their primary residence, nearly 30 percent of households headed by someone between the ages of 45 to 54 will need to bring money to their closing (to cover their mortgage and transactions costs) if they were to sell their home. More than 15 percent of the early baby boomers, people between the ages of 55 and 64, will need to bring money to a closing when they sell their home.

As if that isn't bad enough, then other assets like stocks and bonds held in 401Ks and public pensions have also been trashed. Even those like myself who foresee a stock market rally don't expect the market to shoot back to its 2007 highs anytime soon; stock valuations are correlated to profits, and in a global recession profits are unlikely to grow for most public companies.

As companies lose revenue they look for ways to trim expenses, and unsurprisingly, employee retirement benefits (matching 401Ks, etc.) are already on the chopping block. here is another article on the topic submitted by J.F.B.: Retirement funds in danger for millions of Americans

For millions of Americans, the deepening recession has meant a dramatic drop in funds put aside for their retirement. While many have seen the value of these accounts slashed in half, the pensions of others have been rendered virtually worthless as their employers file for bankruptcy. For others, a layoff in the family spells disaster, and saving for retirement is out of the question.

Many older workers have been forced to cash out their 401(k)s to cover mortgages and pay credit card debt and other expenses, with the amount withdrawn sharply reduced from their original investment. For other, particularly young, workers, the prospect of putting aside anything out of their weekly paychecks is out of the question.

Take away easy credit and rising assets and replace them with falling asset valuations and tight credit. Now add in a pressing need to save rather than spend, and it's easy to see why consumers cannot recover their free-spending ways.

3. Incomes for many in the middle class are in permanent decline due to the very structural changes the mainstream economists refuse to acknowledge. J.F.B. also sent me this sobering analysis of the erosion of jobs from the "middle" of the middle class: The middle-age, middle-income squeeze: Older workers taking lower-wage jobs due to broad-based market shifts, MIT study shows

Dramatic shifts in the U.S. labor market in the last 25 years are relegating older workers -- even those with a college education -- to lower-wage jobs, according to a research paper by MIT Economics Professor David Autor.

This trend appears likely to steepen in the current recession, as employers accelerate the rate at which they shed nonessential positions.

In a paper co-authored with graduate student David Dorn, "This Job is 'Getting Old': Measuring Change in Job Opportunities using Occupational Age Structure," which was presented last month at the American Economics Association conference, Autor analyzes a phenomenon that he refers to as the "hollowing out" of the U.S. job market from 1980 to 2005.

"One of the most remarkable developments in the U.S. labor market of the past two and a half decades has been the rapid, simultaneous growth of employment in both the highest- and lowest-skilled jobs," Autor says. European labor markets echo this shift.

Automation, computerization and offshoring are reducing the number of middle-wage, skilled occupations -- stock clerks, inspectors, telemarketers, payroll workers, sales agents and software programmers -- Autor finds. These jobs are particularly vulnerable to automation because their core tasks follow well-understood routines that can increasingly be codified in software and executed by machinery.

Ironically, many jobs that require less formal education -- such as construction workers, janitors, truck drivers, auto mechanics, home health workers and wait staff -- are more difficult to automate than these white-collar positions because they demand physical flexibility and rapid adaptation to unpredictable circumstances (e.g., oncoming traffic, unhappy customers). Humans excel at this form of flexibility while current technology falls short. Demand also remains high for high-wage, high-skill jobs, such as attorneys, physicians, engineers and top managers -- all of which perform analytic, interpersonal and problem-solving tasks requiring both expertise and intellectual flexibility.

Here are some recent entries on the structural demographic and employment challenges we face:
White Collar, Blue Collar, No Collar (February 9, 2009)
The European Model Is Also Doomed (February 7, 2009)
Endgame 3: The End of (Paying) Work (January 21, 2009)
End of Work, End of Affluence (December 5, 2008)

4. Much of the "wealth" of the past decade resulted from the velocity of money bouncing between new credit, financial legerdemain and millions of real estate transactions. The so-called FIRE economy (finance, real estate and insurance) thrived on three conditions which have now closed out: cheap, abundant credit, unrestricted financial legerdemain (risky assets labeled AAA, etc.) and a bubble-fueled peak of transactions.

The "average" house-flipper bought and sold up to 6 or even more properties at a time, creating stupendous fees for mortgage brokers, lenders, realtors, etc. Much of that velocity is gone, and without a bubble in credit and real estate, then it will never return to its bubble heights.

5. Interest rates will rise for the foreseeable future. As noted here many times, you can't borrow $3 trillion a year (or was it $9 trillion, or $13 trillion?) in a world of foundering profits and surplus capital and expect interest rates to stay low forever. This will further depress borrowing/debt and asset valuations like real estate which depend on low interest rates.

All of these forces are self-reinforcing; as interest rates rise, housing valuations will continue their decline, further lowering Boomers' assets and ability to borrow more, etc.

6. Selling big-screen TVs made in Asia at Best Buy is not a formula for national wealth. It's all well and good for every family to yearn for a big-screen TV made in Asia, but we as a nation have subscribed to the fantasy that charging the purchase of a big-screen TV is "wealth" when in fact it was only a simulacrum of wealth. Real wealth is making something others value enough to buy it from you at a profit, which then creates surplus capital which can be distributed and invested on a national scale.

If someone who created some of that wealth decides to use that surplus capital to buy a TV from Asia, fine; but charging the purchase on credit is not the same as deploying surplus/earned capital.

In other words, a consumerist economy based on ever-rising debt and trade deficits is completely unsustainable. The current "recession" might be called, "The Revenge of Reality."
There are many other structural flaws in the American economy, and rather than repeat myself, please glance at these recent entries:
The Middle Class Is Crumbling (February 3, 2009)
What Won't Change (February 2, 2009)

What's for dinner at your house? has been updated with a new recipe: Classic Chili and Cornbread.

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