Wednesday, July 01, 2009

Interlocking Traps

A number of lethal traps hobble structural reforms to the failing Status Quo.
NOTE: I apologize for the delays in responding to reader email; yesterday I was away from my desk all day and today our Internet service was down.

While I often refer here to cycles, trends and feedback loops, there is another class of forces called traps which are self-explanatory: once entered, traps are difficult or impossible to escape due to their inherent (ontological) nature. While all the traps have conceptual elements, each is very much grounded in the real world.

For example: once a nation misallocates its capital into unneeded malls, office towers and exurban housing which now sit vacant and decaying, that capital can never be recovered.

Here are few such traps:

1. Stagnation Trap. A pernicious positive feedback loop is at work as the Plutocracy and State continually increase their share of the national income: their power and influence increase proportionately, which then enables even more wealth acquisition and ever greater influence.

The primary consequence of this widening gap between the ever-poorer middle class taxpayers and the ever wealthier State and Plutocracy is a structural divergence between the interests of the Plutocracy and the State and those of the middle class. This widening structural imbalance of power and share of the national wealth creates an ontological (inherent) cynicism and profound political disunitywhich is reflected in the blocking of any structural solution by the State and Plutocracy.

Since the structural problem is State and Plutocracy over-reach, any real solution will necessarily reduce their shares of the national income and limit their joint powers. Loathe to accept even the smallest reduction in their income and power, both the Plutocracy and the State (including all those dependent on its various fiefdoms) resist all structural change with every force at their command.

The inevitable consequence is a profound structural stagnation in which real reform is betrayed in the name of compromise, the same simulacrum "solutions" which leave the powers and income of the State and Plutocracy fully intact are trotted out under new Orwellian names ("Save the American Homeowner Act," etc.) and all discussions of truly structural solutions are ruthlessly eliminated from the mass media or belittled/undermined in classic propaganda manner.

Thus the State and Plutocracy prefer stagnation and eventual collapse to any present-day reduction in their income and power. This is the stagnation trap: in resisting structural change, the State and Plutocracy guarantee a stagnation which inevitably leads to collapse of the very system of privileges and powers they seek to maintain.

2. Scalability Trap. This is a way of describing the inevitability of job losses in any industry as it scales up to technologically optimum (automated) production. correspondent K.D. (who coined the term Scalability Trap, as far as I can tell) termed this process a "modernity tax," or the cost of modern productivity.

Iit might be also be considered a "technology/trade tax on employment." That is, if an economy refused technological production then it could not trade such expensively produced products profitably. Even the lowest-cost labor is more expensive than machines because machinery does not get sick, does not need to be trained, does not spoil production with errors, does not riot when idled, etc.

Just as the agricultural workforce of the U.S. has fallen to 2% from 50% as mechanization scaled up, any work which can be largely automated (not just manufacturing, but software coding, tax preparation, etc.) will fall into a scalability trap once the technology is available to automate production.

3. Capital Trap. In my lexicon, there are three distinct applications of this term:

A. Banking/finance capital trap. As bank assets fall in value (mortgages on foreclosed homes and commercial real estate, credit-default derivatives, mortgage-backed securities, etc.) then banks' capital requirements increase dramatically. Additional reserves are simply trapped capital as the capital constraint will lead to a downward spiral of higher interest rates for borrowers (as banks try to "earn their way out of insolvency"), a slowdown in borrowing (due to higher risk management/qualification standards), more loan defaults (as those who planned to roll over old debt find they no longer qualify to do so), and thus more erosion of bank capital as bad-debt/impaired loan losses keep mounting.

B. National investment trap. The U.S. as a nation has poured staggering sums of its national wealth into speculatively built, rapidly depreciating real estate: malls nobody wants to rent or own, roads to weedy subdivisions, 20 million empty homes, office towers with 90% vacancy rates, empty storefronts, etc. The capital in all this unnecessary real estate is trapped because it cannot be sold--it is illiquid except at fire-sale prices, at which point the remaining shards of capital are finally freed but the owners have to book catastrophic losses in the capital.

Rather than be declared insolvent, the owners (often the banks holding foreclosed properties) leave the capital trapped, hoping for some magical rescue via a new real estate bubble.

This misallocated capital hurts the owner and the nation in another way: trapped in impaired and unneeded real estate, it cannot be invested elsewhere where it might earn a real return. Unfortunately, America's suburbs, malls and office parks are now "capital traps" of national savings.

C. Homeowner's capital trap. The housing bubble attracted many buyers who either sought a low-down/no-down speculative investment (i.e. buy a super-leveraged house to "flip" for a quick profit) or who were unqualified by prudent pre-bubble standards but qualified via "liar loans" (no-document mortgages) and fraudulent appraisals and mortgages applications. As prices plummeted, the value of their houses soon fell far below the mortgage and these speculators exited via foreclosure, walking away, etc.

Since these speculators put up little or no capital, there is no capital to be trapped. But those who put down 20% cash or who already owned a home found themselves in a capital trap. When an asset starts depreciating rapidly, the smart investment decision is to sell it quickly and preserve whatever capital you still have--unless it's illiquid, in which case your capital is trapped.

That is the situation facing homeowners in markets where prices tumbled so far and fast that only fire-sale prices attract buyers--and for the vast majority of mortgage holders, that means they receive none of the capital back.

In the housing bubble glory days, these homeowners with capital (equity) could extract it via refinancing or HELOCs (home equity lines of credit). But those credit lines have all but dried up, leaving the capital well and truly trapped.

Though the cliche is that "housing always comes back," the owners of homes in Detroit and other depopulating, de-industrializing locales have found that to be misleading; in hard-hit cities and jobless, service-poor exurbs, house values are dropping toward zero. In these unfortunate situations, the homeowner's capital isn't just trapped; it has vanished entirely.

In many other locales, the capital in housing will remain trapped for years as sellers refuse to accept less than bubble-era valuations and buyers refuse to pay bubble-era prices. This illiquidity stasis requires either a loss of capital (selling at low prices) or trapping the capital (illiquid assets).

4. Value Trap. A value trap occurs when an asset such as a stock or house drops to a level which seems to offer a compelling value. But no sooner does the unwary buyer commit capital to the asset than it starts falling in value again.

The seemingly attractive value caused the buyer to step into the trap. Once snared, the unhappy new owner, drawn to the hope that values will rise again, refuses to sell. As asset values keep slipping, the owner falls into a capital trap: either sell for a stupendous loss of capital or leave the capital trapped in the depreciating asset.

5. Stranded Debt Trap. As assets fall in value, the debt (mortgages, etc.) cannot be repaid. The debt is stranded/trapped and cannot be sold except at fire-sale prices which require the owner to book stupendous losses. In the case of lenders/bankers, accepting/recognizing such losses would generally lead to a formal recognition of insolvency.

6. Saturation Trap. A saturation trap occurs when a product or service deemed essential and backed by a large sunk-cost (i.e. already paid for) infrustructure hits a saturated market: there is simply far too much supply and declining demand. Yet the pressure to keep providing the service or product is immense as so many jobs, enterprises and governmental agencies depend on the market's existence. Examples include homebuilding, mortgages, commercial space, retail, hospitality/lesiure/travel, etc.

In a saturation trap, every attempt to create demand fails as the market is well and truly saturated; there are too many homes for sale, too many mortgages going begging, too many empty hotel rooms, too many garage sales, etc. and the cycle of cutting prices to attract the few remaining customers only extends the losses from weak participants to all participants.

On the supply side, production or capacity is relentlessly trimmed to no avail; the entire edifice must either be carried at a loss with no end or shuttered at a complete loss since there is no market for either the assets or skills.

Advanced capitalist economies are replete with over-indebtedness, overcapacity and thus with saturation traps.

7. Quantification Trap. In many cases, quantifying the situation leads to clarity and thus on to insights. Observation and the accurate logging of quantifiable data is the heart of science.

But economics, finance and human behavior are not always illuminated by choosing a quantifiable metric and then logging data. In some cases, quantification serves to obscure the actual forces and causal mechanisms at work. For instance, almost all economic activity in advanced economies stem from so-called "animal spirits" or the internal state of confidence which triggers some financial or economic decision.

If all the economic field's massive data collection and quantification were actually useful, then economists would be empowered to make more accurate forecasts. As it stands, the overwhelming majority of financial downturns are "unexpected" by economists.

A quantification trap opens when data of questionable value is deployed as an "empirical metric" to support a policy or forecast which then serves to mislead policymakers, enterprises, buyers and sellers. Examples include costly public transport systems justified and constructed with borrowed money based on quantifications which mask the inherent unknowns and risks behind a falsely confident facade of data.

Another classic example is the data presented on the enormous profits to be gained by the purchase of a building, plant, etc.

In other cases, well-meaning researchers seek to quantify situations in which data is inherently incoherent, ambiguous or only marginally relevant.

In other cases, the State or other powerful enterprise presents ginned-up deceptively packaged quantifications which support its policies or propaganda: for instance, the birth-death model of job creation, which magically creates hundreds of thousands of jobs each month in the depths of the current Depression.

8. Skillset Trap. Similar to a saturation trap: the sunk costs of training and the awarding of degrees creates a force akin to a mighty river behind skillsets for which there is no market. We may find that MBAs now classify as skillset traps as countless business schools seek to milk candidates for tuition even as the market for middle managers dries up. We might even find that the entire college/university degree industry is largely a skillset trap as the skills being taught have no analog in the job market.

At the lower end of the employment scale, "computer repair" training continues to attract funding even as it becomes ever cheaper to simply replace defective computers with new ones. Such functionally obsolete skills qualify as skillset traps.

9. Trend Extrapolation Trap. While it can be argued that this is merely a cognitive bias, not a trap, in cases such as the "accidental demographics" behind Social Security then I think it qualifies as a trap, as there is no way out of a policy based on a false trend extrapolation.

The Social Security system (and indeed, all "pay as you go" entitlements) was founded on a worker-retiree ratio of about 20-to-1 and an average lifespan of about 64 years. The trap was the extension of these demographic trends into the distant future.

Now the worker-retiree ratio has slipped to about 2.5-to-1 and the average lifespan has risen to 80+ years even as the retirement age has dropped to 63 and numerous other entitlements such as SSI have been added to the once barebones Social Security program.

Despite official assurances (which ring increasingly hollow), the reality is these programs will go broke far sooner than is politically convenient. Please read The Coming Generational Storm: What You Need to Know about America's Economic Future and Fewer: How the New Demography of Depopulation Will Shape Our Future.

Another trend extrapolation is "economic growth is only way to expand prosperity." While this trend has the appearance of a permanent "law," never before has humanity been so numerous or so dependent on a dwindling, easily portable high-energy resource, i.e. petroleum for that growth and its attendent prosperity.

As several billion people aspire to the high-energy consumption lifestyle enjoyed by the advanced economies, we can anticipate an end to the trendline of ever higher energy consumption and ever higher growth based on resource exploitation.

While it certainly possible that the world's population will enjoy a high-energy consumption lifestyle in 20 years (based on bioengineered algae, or some other "miracle technology" which is scaled up at enermous expense to planetary supply levels) but it certainly won't be enjoying cheap, abundant petroleum-based growth.

For it is also true that the world faces not just Peak Oil but Peak Coal (anthracite), Peak Uranium, and peak rare metals. Technocrat cheerleaders essentially promise that new technologies will seamlessly arise to replace not just fossil fuels but every material facing depletion, but the more one knows about a specific field the more sustained one's skepticism. Thus it seems that lithium-ion batteries cannot be scaled due to materials limitations. Will some battery emerge which is made from sand (silicon) or salt or some other abundant mineral? If not,then the reality is more sobering--we cannot evade one Peak by substitution because the Peaks are not just in oil but in minerals and metals as well.

Thus the idea that some new scalable technology will certainly emerge from some obscure lab to rescue the planet from peak Oil, peak uranium, peak iridium, etc., is, evidence to the contrary, a trend extrapolation trap.

10. Preservation of Institutions Trap. As the payoffs from ever-larger investments and borrowing continue to decline (marginal returns), those bureaucratic institutions which depend on "economic growth" find their own resources shrinking. In defense, each institution and the public unions and technocrats which thrive within its stout walls raise a clarion call that society and the economy will certainly collapse should their institution (or their salaries and benefits) suffer any degradation or diminishment.

Since such institutions, their dependent suppliers/contractors and their symbiotic unions wield tremendous lobbying powers, their cries of anger and despair will be heeded until the public coffers has been completely drained.

There are many pernicious reasons why "preservation of institutions" is such a trap. Consider the "early retirement" or other "buyouts" which are offered to reduce head count; the most competent and experienced will quickly accept the offers, knowing they can pocket the settlement and then seek other employment, while those with few other employemnt options will cling to the safety of the institution, leaving the organization weaker and ever more prone to produce ever more marginalized returns on investment.

Those left behind will be even more strident and desperate in their demands to "save our vital institution" and will thus redouble their lobbying efforts to funnel more of the dwindling tax revenues to their fiefdom. As morale sinks and leadership weakens, the public grows ever more disgusted and dismayed that their taxes are producing such mrginal returns.

Thus an unresolvable conflict arises: those left within the institutional fiefdom will fight for their entitlements with the zealousness of the resentful and desperate, while the taxpayers will rise up in rebellion against paying such high taxes which produce such pathetic returns.

There are other forces at work other than self-reservation and myopic entitlement. In many cases those bound up in the institution's bureaucracy suffer a failure of imagination: they literally cannot imagine the institution without endless staff meetings, various layers of management, and all the other trappings of an enterprise which has lost its way but which remains viable because its source of income is no longer accountable to the market or to its output/results.

Rather than undertake the radical reform all sclerotic, overly complex institutions need, those employed by the fiefdom (or profiting from it indirectly via contracts) will fight to preserve not the institution's purpose but their own entitlements and perquisites. To attempt to preserve the institution in its present high-cost, marginal-returns decline is a trap which will result in complete insolvency/dissolution.

11. Growth Via Credit Trap. In a previous incarnation of capitalism, wage earners were encouraged to save money, thus creating pent-up demand for products and a pool of capital which couldbe lent to private enterprises.

In the current incarnation of neoliberal capitalism, consumption requires ever greater borrowing and debt to sustain ever more mrginal growth. Due to Saturation Traps, basic needs are oversupplied in advanced economies, and thus ever more marginal demand must be manufactured via marketing and low-cost credit. "Growth" in GDP has thus become entirely dependent not on savings and what I call organic demand but on marketing and debt-based consumption.

But as demand and sales rely to an ever-greater extent on ever-increasing borrowing and debt, the trap opens: any reduction in borrowing will cause a near-collapse in demand as the simulacrum of demand falls to organic demand--a level far below what is needed to sustain "growth"as measured in production and consumption.

This trap deepens with every State attempt to prod the over-indebted and over-indulged consumer (once a proud citizen, now nothing but a debt-serf "consumer") into further borrow-and-spend binges; like all alcoholic/addictive-type traps, this cycle of ever more extreme State stimulus-funded-by-debt campaigns has only one end-state: self-destruction.

12. Exemption from Free/Transparent Market Trap. As noted earlier, a key defense against erosion of the Plutocracy/State/high-castes' increasing shares of the national income is the Elites mechanism of "innoculating" themselves against disruptive market forces via the political construction of protected fiefdoms (public unions, private risks being backstopped by socialized guarantees, no-bid contracts with parasite firms, etc.)

The trap is that as each Elite observes another Elites' success is dodging the market forces of change/risk/efficiency/productivity, then its own shrill lobbying efforts to strengthen its own protected fiefdom increase accordingly. The end-state of this process is the Elites' avoidance of market forces except as a simulacrum promoted in officially sanctioned propaganda to persuade the middle class that the destruction of its own wealth and security was the result of "eternal laws" (the invisible hand, etc.) rather than from the complete transfer of risk from the Elites to the middle class taxpayers.

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