End of Work, End of Affluence
December 5, 2008

As headlines announce jobs are being lost (Employers shedding jobs as recession deepens), several inter-related questions arise: is this the end of work, or just the end of affluence--or both?

These are indeed separate questions. Near the end of the long postwar Bull market in the late 1960s, the utopian possibility that we could have both affluence and leisure seemed not only possible, but perhaps even inevitable.

In post-industrial America circa 1968, a huge surplus of food was grown by a mere 2% of the workforce. The cornucopia of manufactured goods was produced by about 20% of the workforce (hence the phrase "post-industrial"), and other than essential government services like the Armed Forces, police and the courts, the rest of society's work was either service-oriented paper-pushing relating to affluence (insurance), do-good selfless work (Peace Corps, churches) or leisure-related: entertainment, films, travel, amusement parks, stereos, clubs, etc.

This was not all fantasy. A friend of mine reports that he supported an entire house of hippies in late-60s Pittsburgh on his union steelworker job, and had plenty of money left to save for his trip to San Francisco. (As I recall, the rent for the big old house was less than $200 per month.) Hippies were the first ardent dumpster-divers/scavengers driven not by poverty but by the idea that since that our society generated so much surplus, why bother working?
Thus hippies sought out trees whose fruit was ignored and dropping, perfectly good food dumped behind grocery stores and restaurants, etc.

As noted here many times before, the purchasing power of American wage-earners reached a plateau around 1967 - 1975 and has been declining ever since.

The last great Bear market/recession changed that outlook drastically. The oil-driven crises of 1973 and 1979-80 revealed that the era of endless cheap petroleum was either threatened or already over, and the growth of cheap imports from manufacturers in Asia was just beginning.
As unemployment rose toward 10%, the January 1975 cover of Ramparts magazine blared: The End of Affluence: The Last Christmas in America. (TLCIA)

The government responded quickly to unemployment, high inflation and rising budget deficits: it started manipulating data to mask the politically inconvenient realities of rising inflation, unemployment and deficits by playing switcheroo with Social Security Trust Funds, inflation data, etc.--games it continues to play to cloak reality from the media-numbed public.
(Ramparts itself fell victim to the recession a year or so after the article ran.)

The Bear market, and thus the "real" recession, lasted 16 years: from 1966 to 1982. Now statistics are echoing that last great recession: Employers cut 533K jobs in Nov., most in 34 years:
The job reductions were the most since a whopping 602,000 positions were slashed in December 1974, when the country was in a severe recession."

In other words, since the Last Christmas in America.

We all know the 16-year recession/malaise had a "happy ending": huge new oil fields were discovered in Alaska, the North Sea, West Africa and elsewhere, ushering in a renewed era of cheap, abundant petroleum. President Reagan "saved" Social Security for a generation by raising contributions paid by employer and employees, and he heralded a "lower taxes, higher permanent deficits" ideology that is now accepted as the norm: deficits don't matter, even when they reach the trillions, because our good friends the Gulf Oil Exporters and Asian exporters will buy all our debt forever and ever, keeping interest low forever and ever.

Uh, get back to me on how that's working out in 2010.

Then the U.S. created and launched two revolutionary technologies which both created new wealth around the globe: the personal computer (microprocessor and cheap RAM) and the Internet (TCP/IP, Ethernet, and the commercialization of Tim Berners-Lee's World Wide Web with free browsers) spawning the generation-long boom of the 1980s and 90s.

But when the wheels fell off that boom in 2000, the U.S. did not create a new engine of wealth: it opted instead for a devilishly insidious simulacrum of wealth: debt which rose at an exponential rate throughout the economy.

Borrowed money and phony financial legerdemain (mortgage-backed securities, derivatives based on the MBS, etc. etc.) from 2000-2007 created what I have termed a "bogus prosperity": no actual new wealth was created, only a brief and doomed bubble of debt-based housing valuations was inflated which followed the classic model set down by the Tulip Craze in Holland hundreds of years ago: insane boom, crushing bust.

One key point which is usually overlooked when comparing "The Last Christmas in America" circa 1974 and TLCIA circa 2008: the wealth distribution in the U.S. was much flatter then. CEOs of financial institutions did not earn $10 million each; there were no hedge funds with chiefs pulling down $600 million each (yes, that was the average "compensation" for the top ten fund managers at the hedgies' glorious peak), and even minimum wage ($1.60/hour in the late 60s, I know because my wage stub recorded it) bought far more goods (purchasing power) then than minimum wage does now.

Not only was gasoline cheap, but housing was far and away cheaper than it is today. Just about any G.I./Vet could buy a house with his/her V.A. benefits (3% down), and anyone else could scrimp and save for a few years and then buy a house for 2 or 3 times their annual wage at an interest rate around 6%.

Even in the the most expensive city in the U.S. in terms of cost-of-living, Honolulu, I was able to rent an old studio apartment for $120/month--$525 in today's dollars. My tuition and student fees at the University of Hawaii per semester was $117--$514 in today's dollars. Can you find an apartment in a high-cost city for $500 and go to a four-year state university for $500/semester (not including books of course)? No. Was the state or Federal government running stupendous deficits to provide this education? No.

Meanwhile, in TLCIA circa 2008, obscene "compensation packages" are defended as "free enterprise." Well, what did we have in 1969? Unfree enterprise? Amidst all the ideologically convenient defenses of heavily skewed "compensation," we have to admit that the dream of affluence combined with leisure was based on the presumption of society's wealth being distributed somewhat evenly, not by a Communist central state but by the "free enterprise" system and modest common-sense government regulation (limited work hours, overtime, minimum wage, etc.) which protected employees from the excessive exploitation of the late 19th century and early 20th century Monopoly Capitalists.

That dream seemed at hand in 1969. Now, after "the limits to growth" were mocked by those expecting ever larger oil fields to provide endless abundant cheap oil, we find that Peak Oil was merely put off a generation; there have been no new discoveries of super-massive oil fields since the early 1970s, and the supposedly abundant alternative petroleum sources like shale oil are horrendously costly to exploit, for they require vast quantities of energy (mostly natural gas at the moment) to be consumed to extract the oil.

As oil has plummeted back to $42/barrel, surprise: new shale oil projects and other costly extraction projects are being cancelled left and right, as the projects make no sense below $75-80/barrel. So we are setting ourselves up for massive shortages in the near future when demand recovers (which it already is as gas prices have dropped from $4.50 to $1.69/gallon.)

Now we face a future which might well be called the End of Work for up to a third of the current workforce. Since agriculture employs about 2% of the workforce, industrial/factory production about 11%, essential transportation and essential government each a bit more, we have to ask: in an economy in which 70% of GDP is consumer spending, how many jobs are actually essential? How much actual wealth is being created/produced in the U.S. and sold overseas? Is giving people with Medicare coverage 13 costly and often ineffective medications and endless MRI tests actually creating wealth, or it mostly squandering it?

We might also ask: how much of the consumer economy is superfluous if wage-earners shift values and decide saving is more important than consuming? How many malls, storefronts, internet retailers, restaurants, fast-food joints, etc. can a newly-frugal economy support? How many dog-walkers, derivative salespeople, nail shops, carpenters, financial planners, realtors, etc. does an economy need if the FIRE economy (finance, insurance and real estate) is shrinking?
Based on the tremendous size of the service economy, construction, finance and government, I have estimated that 30 million jobs out of the current 134 million-strong workforce are superfluous. Many government posiitons are essential: police, meat inspectors, rangers, tax collectors, meter maids, etc., but as Mish so thoroughly illustrated in his detailed analysis of the California state budget ($130 billion or so), dozens of agencies could be eliminated without any visible effect on the economy except to the wage-earners who lost their jobs.

If 20-30 million jobs disappear, so do all the taxes those wage-earners paid; if 10 million homes go through foreclosure, the inflated property taxes the owners once paid will disappear, too. Once businesses close, it's not just wages which disappear: all the junk-fees governments levy disappear, too: the business taxes, the licensing fees, the permits, transaction fees, etc.

Does anyone think all these taxes and levies can fall and government employment will be funded by some other source? Yes, the Federal government can borrow money for a few more months or years at low interest rates; but soon, the surplus money which has piled up in exporters' accounts will be gone, and the endless borrowed trillions will actually start costing real money--money that will be diverted from government employment to pay the interest on all that wonderful debt everyone loved when they got a piece of it.

So how does a society deal with The End of Work when it also means The End of Affluence, even for many of those with jobs? How does government deal with declining tax revenues and rising interest rates? I will continue to explore these pressing issues next week.


Essay by Chris Sullins: (Part 2 will be posted this weekend)

Operation SERF, Part I(Chris Sullins, December 1, 2008)
Eduard Morgan sat in his wheelchair looking at a laptop on the kitchen table. A household wireless unit connected to a two-way home satellite system fed his browser with the latest news. He and a handful of other residents in his gated community were among the small minority of people in their city who still had regular access to the internet. Given the city’s frequent power outages and cable thefts outside his secure subdivision, household usage of the internet had dropped from its national peak only a few years ago.

Readers' commentaries 12/2/08 updated--check it out!


Holiday gift announcement: maximum two signed books per customer: Signed copies of Claire's Great Adventure (perfect for that impossible teen on your "gotta get them something, arggh" list) are limited to two per customer: $12 for one (includes $2.58 postage), $22 for two.
The regular price on amazon.com is $16.99; the $12 (incl. shipping/postage) is a special offer I am making to readers. Please send $12 via check (email me for an address) or via my Paypal account with instructions on how to inscribe the book, and I will mail the book(s) directly to you. If you'd like to read other readers' reviews before buying a copy, the cover image below links to the amazon.com page and two readers' reviews.
Read the first chapter.

Book Notes: My "little book of big ideas," Weblogs & New Media: Marketing in Crisis is now available on amazon.com for $10.99.
"Charles Hugh Smith's Weblogs & New Media: Marketing in Crisis is one of the most important business analyses I have ever read. It is the first to squarely face converging global crises from a business perspective: peak oil, climate change, resource depletion, and the junction of key social cycles will radically alter the business landscape in coming decades...."

Thank you, Don E. ($13) for your continuing contributions both financial and intellectual to this site. I am greatly honored by your support and readership.

Read more...

An Adversarial Culture: Auto Industry Bailouts

New Readers' comments 12/2/08--excellent as always.

I received a thoughtful commentary on the auto industry crisis from knowledgeable reader Joe H., who works in the industry.
Since I have no deep knowledge of the auto industry to share, I'll try to add some perspective. Before we get to Joe's astute comments, I would note:

1. It's easy to be cavalier about the situation--no bailout, etc.--but since hundreds of thousands of jobs are at stake I think it behooves us to consider matters carefully before announcing "what's best for the country."
As someone who suffered from the huge swings in construction spending/employment 1973-1993, I have experienced the sinking feeling one gets when one's livelihood vanishes. There will be a lot of suffering regardless of bailout or not, and we need to be aware that this is not just dollars and cents but people's lives.

2. It seems abundantly clear that there is massive over-capacity in the global auto industry; the industry can make millions more autos than there is demand for. All the major manufacturers are global companies, and there is some truth in the observation that Ford and GM could shutter their entire North American operations and go on as non-U.S. global manufacturers.
My longtime friend G.F.B. sent me this link about the new high-tech Ford plant in Brazil--a market Ford clearly sees as growing: Ford's most advanced assembly plant operates in rural Brazil (video). A related story reads, "Special report: South of the equator, Ford and GM prosper." (from 2007)

From a global perspective the manufacturers have little choice but to cut capacity in the weakest markets for their products. If that happens to be North America, then it is simply prudent management to cut capacity to match demand. Borrowing billions from the government, or receiving a "gift" of billions will not change this business reality.

While it's easy to demonize globalization, it is undeniable that all auto manufacturers build factories near their markets for a variety of reasons both financial and political. So to blame "globalization" is somewhat specious when the entire industry is globalized. If you cannot make a car for X cost and sell it profitably in another country for a profit, then it makes no sense to make cars for that market.

In other words, we want all the benefits of globalization--low cost goods, cheap international airfares, and so on--but we want all the jobs to stay in the U.S. It doesn't work like that. If you want to maintain domestic industries with trade barriers, you cannot expect to get the low prices of globalization.

3. The American consumer is highly indebted and therefore a poor credit risk. To the degree that autos are sold with little money down, high-interest loans, then we can foresee a large and long-lasting decline in auto sales regardless of the quality of the vehicles or the wishes of consumers for new vehicles. This is reflected by Nissan sales dropping as much or more as GM's sales. Honda and Toyota sales also declined by over 30%.

4. As the Wall Street Journal noted, not all domestic manufacturers are on the edge of insolvency: America's Other Auto Industry : There is such a thing as a profitable car maker in this country.
The comments from readers are also of interest: Readers Forum: America's Other Auto Industry.

5. The American public rallied against the first $700 billion TARP bailout of the banking industry 100-to-1; supposedly the sharp decline in the stock market changed many minds. In any event, Congress passed a $700 billion giveaway with few if any actual dividends to the U.S. taxpaying public. Now a bailout of about 5% of the TARP bailout (number one of what, five? Six? Twelve? I've lost count of the banking/mortgage bailouts) is proposed for the Big 3 and the uproar exceeds the one surrounding the TARP bailout which blew away 20 times more taxpayer funds. This is not to say I agree with the auto bailout, but it's a good idea to place it in proper context.

6. The Japanese, Korean and German auto manufacturers with plants in the U.S. buy most of their parts from U.S. suppliers, and their factories are staffed by U.S. workers. This begs the question of why Big 3 autos are losing favor with consumers.

OK, here are Joe's comments:
I am torn regarding the US auto industry bailout. Full disclosure is in order. I work for General Motors.

I want to highlight a few perspectives that have been lost in the clamor.

Point one: Max Bazerman writes a great deal about negotiations and their limitations. One of those limitations is that key stakeholders refuse to accept any solution that is arrived at quickly and easily. Stakeholders believe that negotiators must crawl over a mile of broken glass and shed a gallon of blood before the maximum/optimal solution can be negotiated.

The US auto industry, both management and labor, are well versed in the literature and the practical application of negotiating. US Congress is no slouch at the practice either.

---I have no inside information, so what follows is pure speculation---

One possible sequence of events would be for Congress to stiff the US auto industry once again. Then, the US auto makers would be compelled to conserve cash by ceasing operations until Congress resumes session in 2009. That is, it is conceivable that GM, Ford and Chrysler could lay off every employee on their rolls for the last three weeks of the year.

Between 50% and 75% of an automakers' cost of producing a car or truck is in the purchased parts. Ceasing production is dumb because you get slaughtered by your fixed costs. "Fixed" costs are often accounting charges to properly meter out cash out-flows that were made in the past. Day-to-day cash conservations is mainly a creature of variable cost management.

Would it hurt the car companies? GM has $25B or $30B of inventory on dealer lots. Ford and Chrysler also have huge supplies of cars and trucks. We could hold our breath for a long, long time.
Merry Christmas!
Retail would puke. A three week "trial bankruptcy" would provide the mile of broken glass and the retail crash-and-burn would provide the gallon of red ink, ah, blood.

Point two: Sloan Management Review published an article in the late 1980s (sorry, cannot remember the authors) that discussed The Cost Spiral.

Traditional economics very conveniently divides costs into two categories. Variable costs scale up proportionately with volume and down with volume. Fixed costs are fixed; that is, they do not change with volume.

The classic example is the pizza parlor. Your rent for the building is fixed. You pay $1500 a month whether you make zero pizzas, one pizza or 1500 pizzas that month. Your cost for materials (dough, sauce, etc.) is a variable cost. The material cost for making 1500 pizzas is 1500 times greater than the material cost for making one pizza.

The Cost Spiral article exposed the classic division of costs as a lie.

At some point in the production, your rented space is not large enough to accommodate the volume of business. You may need to rent a larger space and rent another pizza oven when demand is 1600 pizzas a month. That is, fixed costs act as fixed on the down-side but function as variable costs on the up-side.

A similar phenomena occurs with variable costs. Every variable cost strives to mutate into a fixed cost. It is as almost a law of nature...much like salmon swimming upstream to spawn. Labor craves stable cash flow so they demand Unemployment insurance. Suppliers seek to lock you into long term contracts. Girl-friends want to become wives. Additionally, the laws of supply-and-demand jack up prices when demand is high. So variable costs are super variable on the up-side and "sticky" or act as if fixed on the downside.

The UAW had a great deal of time to make labor, a cost traditionally identified as "variable", a sticky cost. They negotiated Supplementary Unemployment Benefits (take-home pay of about 80% of 40 hours take-home, for 48 weeks) and JOBS bank protections. Some of their internal logic was that if labor was a fixed cost, then management would be highly motivated to find real work for them. Plainly stated, management's ability to manage costs that *should* be variable costs has been nullified by UAW contractual language.

Each trip through the business cycle causes another accretion of fixed costs that ratchet up and variable costs that sticky down. Cycle-after-cycle, the arteries narrow and the organization becomes less robust, less able to rebound from external stresses.

Point three: Congress realizes that many Americans are envious of UAW represented auto workers. Many Americans are envious of line workers making 2 times the going freight for similar work. They are envious of the worker protections. They are envious of SUB pay and JOBS bank.

UAW workers have been their own worst enemy. A few, maybe fifteen in a thousand, have been know to go into BBQs, bars, and Bar Mitzvahs and BRAG how they have screwed the company. Those same few BRAG about how little work they do. They BRAG about what a crappy job they do. It is a mystery to me that the other 985 don't collar them in the parking lot and "paint a couple of dots" on their faces.

Congress realizes that it is against Anti-Trust laws for businesses to share business plans with their competitors. Sharing business plans is called collusion. But that is what Congress chided the US auto industry leadership for failing to do when they testified before Congress in November. That is patently disingenuous.

Still, it comes down to the Max Bazerman observation that key stakeholders believe that optimum solutions are forged in the smithy of hell. My guess is that I will have a front row seat."

Thank you, Joe, for a thought-provoking essay on the situation.

Reading Joe's comments made me wonder just how much a role our adversarial culture plays in this crisis. After all, unions and management fighting it out in bloody screaming combat is considered "normal" or as Joe suggests, even required.

Our entire legal structure is based not so much on justice (though it's a good principle to establish) but on adversaries duking it out in court. The truth is never the goal--winning the case by convincing the jury or the judge that your position is stronger than your adversaries' position is the goal.

Just how culturally bound this adversarial perspective truly is can be revealed by comparing the Japanese auto industry with the U.S. industry. I think executives and workers alike at Toyota in Japan would be quite confused by the management and union behavior in the U.S. It would literally make no sense to either group in Japan to strangle the company's competitive advantages. I suspect the Japanese might view this adversarial approach as a form of slow seppuku--ritual suicide.

The results of this adversarial approach are now painfully visible. I've engaged in a spirited debate over various auto-industry issues with my friend G.F.B., and I will mention one point on which we disagree--a point which I think illustrates just the sort of cultural divide I am exploring.

I proposed to G.F.B. that the UAW might have done better to focus on improving the quality of the vehicles they make rather than squeeze more benefits from management via negotiations. G.F.B. disagreed:

"The union is not in charge of quality control, design, marketing nor direction of the company. The union does not control the design of the cars, and the build quality tolerances that are set by the manufacturers. The guy on the assembly lines job is do his job well. The UAW's job is to protect and try to improve the life of the guy working on the assembly line. The company management's job is to focus their energy on making cars which will last 20 years. Clearly, they don't think that it important as you do."

(I had suggested that Detroit would be in a better position if they made cars which lasted as long as the Japanese nameplates made in the U.S.)

G.F.B.'s position is perfectly reasonable in the context of standard U.S. labor/management relations, and indeed many analysts see virtually all the problems as managerial; but for context, read this excerpt from: How Detroit Drove Into a Ditch: The financial crisis has brought the U.S. auto industry to a breaking point, but the trouble began long ago. Paul Ingrassia on disastrous decisions, flawed leadership and what the Motor City needs to do to survive.

"On Aug. 20, 1979, 18-year-old Brad Alty, fresh out of high school in Mechanicsburg, Ohio, was driving his Gremlin to work when the car broke down. He was two-and-a-half hours late to his first day on the job at a new motorcycle factory that Honda Motor was opening in central Ohio.
For the next few weeks, Mr. Alty and his 63 co-workers did little but sweep floors and paint them with yellow lines. Then they started building three to five motorcycles a day. And at the end of each day they would disassemble each bike, piece by piece, to evaluate the workmanship. Mr. Alty hated it, and he kept getting grief from his older brother for working for a Japanese company. "I thought I had made a mistake by going to work there," he recalled recently. "It was like, 'What the heck am I doing here?' "

But Mr. Alty stuck with it, and Honda stuck with him. Honda's real goal was to build cars in America, but the motorcycle plant allowed it to test the mettle of American workers for a modest investment. The workers passed the test. Honda started building Accords in Ohio in November 1982. Ironically, some U.S. Honda dealers actually protested that they wanted to sell only Accords made in Japan. But the quality of the Ohio-made cars was soon confirmed."

Perhaps the UAW leadership tried to influence management to pursue smarter planning and to focus on higher quality as a long-term strategy to retain UAW jobs; it would probably take an insider's information to know all that transpired over the past 20 years in the industry.

But I still wonder if some measure of Detroit's structural woes--and perhaps of the U.S. economy's structural woes--are not linked to the adversarial model of our society.

Holiday gift announcement: maximum two signed books per customer: Signed copies of Claire's Great Adventure (perfect for that impossible teen on your "gotta get them something, arggh" list) are limited to two per customer: $12 for one (includes $2.58 postage), $22 for two.
The regular price on amazon.com is $16.99; the $12 (incl. shipping/postage) is a special offer I am making to readers. Please send $12 via check (email me for an address) or via my Paypal account with instructions on how to inscribe the book, and I will mail the book(s) directly to you. If you'd like to read other readers' reviews before buying a copy, the cover image below links to the amazon.com page and two readers' reviews.
Read the first chapter.


Book Notes: My "little book of big ideas," Weblogs & New Media: Marketing in Crisis is now available on amazon.com for $10.99.
"Charles Hugh Smith's Weblogs & New Media: Marketing in Crisis is one of the most important business analyses I have ever read. It is the first to squarely face converging global crises from a business perspective: peak oil, climate change, resource depletion, and the junction of key social cycles will radically alter the business landscape in coming decades...."

Thank you, Paul B. ($50) for your astonishingly generous donation to this site. I am greatly honored by your support and readership.

Read more...

Starvation and a Quiet Revolution

Famine does not normally evoke images of peaceful revolution, but I refer to a financial starvation with great and positive political consequences. I refer to the starvation of banks.
All too many scenarios about the Coming Depression cast the citizenry/ debt-serfs in the role of passive victims, watching from the sidelines, as it were, as irresistable forces tighten their grip and hardships increase.

How about we re-write the playbook and make the debt-serfs players instead of passive observers. How about we have the debt-serfs slowly strangling the political power of bankers by refusing to play debt-serf any longer.

How do you refuse to be a debt-serf? By refusing to borrow money. It's really that simple.
What happens when people stop increasing their credit card debt, stop getting auto loans and stop signing mortgages? The income of banks plummets, and thus so does their ability to purchase political power.

But how can we live without ever-expanding credit? Won't the world end? No, it won't. Unbelievable as it may sound, life will actually go on if we all cut up our credit cards and only use cash or debit cards.

Rather than buy a new car with $1,000 down and a $25,000 loan, it is entirely feasible to save up money from earnings and buy a car with cash. It may be a used vehicle, but nonetheless no loan is needed. This is, after all, the way cars are bought elsewhere in the world--with cash.
Since housing is still dropping in value, and will probably lose value once inflation is factored in for years if not decades, why borrow money to buy a house? Why not save up and buy one cash, if you really want one? People in other countries routinely save up large sums as families and then buy real estate with cash. Once houses fall to the $50,000 range--a process well under way in many places--then saving up to pay most or all of the purchase prices becomes possible.

If a loan is absolutely necessary, then make it a 5-year loan. Put 50% down on the house and pay the rest off in 5 years. The interest collected by the bankers will be far less than the astronomical sum they collect on a 30-year mortgage.

Many debt-serfs will involuntarily renounce the debt-dependent lifestyle via foreclosure and bankruptcy. The seven-year holiday from debt ("cold turkey") imposed by bankruptcy is a positive behavioral modifier, as households will learn that life without debt is not just possible but actually better. Being free of debt is a great feeling--even if the "lifestyle" one can afford is frugal.

Voluntary renunciation of debt-serf servitude is a peaceful and legal revolution. The banks made their hundreds of billions of dollars in profit-- only a thin slice was needed to buy the silence and collusion of elected officials-- on the backs of debt-serfs. All those mortgage-backed securities, and the derivatives piled on the MBS? They were all based on real mortgages signed by debt-serfs.

Without the debt-serfs' mortgages, the banks have nothing to sell and nothing to spin into the gold of political power.

Yes, banks will still be able to earn outrageous profits on huge late fees and overdrafts... oh, but wait--if you don't use a credit card, in fact don't even own one, then you can't get nailed with outrageous late fees and overdraft fees, can you?

How about those greedy checking account fees? Close your account at the bank and open one at a credit union. If you don't "qualify," then join Costco or any number of other organizations out there in which membership "qualifies" you to join a credit union.

Outrageous bank fees? Just say no. Outrageous bank profits and political power? Just say no. Cut up your credit card, pay off your auto loan, sell your house and pay off the mortgage, or walk away from being a debt serf if repayment is no longer an option.

Yes, banks will still collect a sliver of profit from transaction fees on debit cards--but those modest fees cannot be spun into derivatives or political power gold. Yes, banks will make money on construction and commercial loans, but without debt-serfs, their vast profit centers will have dried up. Their ability to reap profits in the hundreds of millions will be eviscerated.

But how will the economy function with a much smaller banking sector? Just fine. All the essential services short-term debt plays in commerce--letters of credit for overseas trade, other commercial loans, etc.--will continue to be provided by someone somewhere. But the amounts of money to be reaped on these small spreads is modest compared to the huge spreads banks make on credit cards and debt-serf loans.

A much smaller banking sector will be a more highly regulated one, because it will no longer have the vast pool of money needed to buy silence and collusion in the halls of Congress. A tightly regulated industry will also have fewer loopholes to exploit in terms of tax evasion and funny-money legerdemain like credit-default swaps.

And so a new virtuous cycle will begin: less profitable banks will be far more tightly regulated which further reduces their income and thus their political influence.

Mao famously said that "Political power grows out of the barrel of a gun," and in certain circumstances that is obviously true. But it is equally true that political power comes from cutting up credit cards and refusing auto loans and mortgages, too. Reduce the monster's food supply and the monster starves. That's political power, too--a quiet revolution on many levels.

New essay by Chris Sullins:
Operation SERF, Part I(Chris Sullins, December 1, 2008)
Eduard Morgan sat in his wheelchair looking at a laptop on the kitchen table. A household wireless unit connected to a two-way home satellite system fed his browser with the latest news. He and a handful of other residents in his gated community were among the small minority of people in their city who still had regular access to the internet. Given the city’s frequent power outages and cable thefts outside his secure subdivision, household usage of the internet had dropped from its national peak only a few years ago.
The internet was well on its way to reverting back to its original users within the walls of government, education, and large corporations. Even without the loss of physical infrastructure supporting the hard-wired, few could afford it given the economic situation. The two-way home satellite system was a luxury even in Eduard’s neighborhood, but he still had some personal connections from his past professional career that cut him a good deal.

Readers' commentaries 12/2/08 updated--check it out!


Holiday gift announcement: maximum two signed books per customer: Signed copies of Claire's Great Adventure (perfect for that impossible teen on your "gotta get them something, arggh" list) are limited to two per customer: $12 for one (includes $2.58 postage), $22 for two.
The regular price on amazon.com is $16.99; the $12 (incl. shipping/postage) is a special offer I am making to readers. Please send $12 via check (email me for an address) or via my Paypal account with instructions on how to inscribe the book, and I will mail the book(s) directly to you. If you'd like to read other readers' reviews before buying a copy, the cover image below links to the amazon.com page and two readers' reviews.
Read the first chapter.

Book Notes: My "little book of big ideas," Weblogs & New Media: Marketing in Crisis is now available on amazon.com for $10.99.
"Charles Hugh Smith's Weblogs & New Media: Marketing in Crisis is one of the most important business analyses I have ever read. It is the first to squarely face converging global crises from a business perspective: peak oil, climate change, resource depletion, and the junction of key social cycles will radically alter the business landscape in coming decades...."

Thank you, David Z. ($50) for your stunningly generous donation to this site. I am greatly honored by your support and readership.

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Real Estate: Back to 1981?

There may be a few more spectacular real estate markets than Honolulu, Hawaii, but not many. With a median single-family home price around $615,000 (Honolulu home prices 3rd highest in nation), Honolulu trails only Silicon Valley and San Francisco in nosebleed-valuation territory.

But have Honolulu homeowners really reaped fantastic returns during the 2002-2007 real estate bubble? We have to look beneath the surface statistics to find out. While this exercise is specific to Honolulu, I believe it may be equally valid in many other markets in the U.S.
Here is my conclusion: the real (inflation-adjusted) gains in Honolulu were reaped in the 1970-1981 period; all buyers since 1981 have essentially made nothing. Yes, the nominal value of their house has risen, but when we factor in inflation, we find no real gains from the top of the last real estate bubble in 1980-81.

The house I am analyzing is located in the highly desirable neighborhood of Manoa Valley; I am familiar with this house because I used to live there.

My parents bought the modestly sized house (one-car garage) in 1971 for $45,000-- slightly less than the cost of a brand-new, much larger subdivision home in Hawaii Kai. A job transfer to the Mainland caused them to sell it two years later (1973) for $75,000. (I stayed to finish college, paying $120/month for a tiny studio in a rooming house, not far from President-Elect Obama's apartment.)

When my stepfather visited the property eight years later in early 1981, it was being sold for about $275,000.

The house has just sold for $550,000--even though the tax appraisal is listed at $805,000. I have no idea why the house was sold for $250,000 under its recent county valuation, but the MLS records show that it languished on the market for months in the $779,000 range earlier this year.

The sales price certainly suggests that appraised values as reflected by zillow.com and tax rolls may well be far above actual market prices as reflected by what people are willing to pay in November, 2008.

According to the Bureau of Labor Statistics inflation calculator, $275,000 in 1981 equals $655,000 in 2008 dollars. Thus an owner who bought this home in 1981 for $275,000 and sold it for $550,000 in 2008 actually lost money--$100,000 in 2008 dollars (more if we consider sales commission and transaction costs).

(I have no idea how many times the property was sold in the intervening years--the county records don't reflect that data.)

If the house had appreciated only at the rate of inflation in the years 1971-1981, the $45,000 value would have grown to $100,000. But at the top of the last housing bubble in 1980-81, the house was valued at around $275,000.

So the property more than doubled in real value (inflation-adjusted) in the years 1971-1981, but has since gained no real value, or even lost value. Even if this house had sold for $650,000, it would have gained no value at all since 1981 ($275,000 in 1981 = $655,000 today.)

Let's be generous and say the house "should have sold for $750,000." The owner would have gained $95,000 above the inflation-adjusted value of $655,000. Deduct the usual 7% transaction costs (about $50,000), and that leaves a rather modest $45,000 gain (in 2008 dollars) for 27 years of ownership--less than 1% per year.

Real estate is of course leveraged, so let's look only at the cash down payment. If we assume the buyer in 1981 put down 20% cash ("exotic" mortgages were unknown), then they invested $55,000 in cash. Adjusted for inflation, that $55,000 is worth $131,000 today--so a $45,000 gain works out to about a return of 34% on cash invested-- just slightly above 1% per year on 27 years of ownership.

Meanwhile the Dow Jones Industrial Average rose from around 800 in 1981 to 8,000 today, even after falling about 35% from its October 2007 peak: a ten-fold return. $55,000 invested in 1981 would still be worth over $600,000, if dividends had been reinvested.

Yes, I know about the tax benefits of home ownership, but let's not forget all the maintenance costs, too. Owning a house is not "free" even if you paid the entire purchase price in cash; there are property taxes and substantial upkeep costs. So as an investment, the calculations are not simple.

What is simple is that someone buying this house in 1980-81 for $275,000 actually lost $100,000 in selling it for $550,000 in 2008 when inflation is factored in. The evidence strongly suggests that Honolulu real estate has basically treaded water for 27 years, and all the nominal gain is just that: the real gains are either extremely modest (less than 1% per year) or actually negative.

Is this situation unique to Honolulu? Perhaps; but it does raise the question: how much of the supposedly gigantic gains of the 2002-2007 bubble were actually gains from the 1970-1981 period carried forward to the 2000s via inflation?

If this analysis holds true for other areas of the nation, we may find that the housing gains of the past 27 years have been essentially illusory.

New essay by Chris Sullins:
Operation SERF, Part I(Chris Sullins, December 1, 2008)
Eduard Morgan sat in his wheelchair looking at a laptop on the kitchen table. A household wireless unit connected to a two-way home satellite system fed his browser with the latest news. He and a handful of other residents in his gated community were among the small minority of people in their city who still had regular access to the internet. Given the city’s frequent power outages and cable thefts outside his secure subdivision, household usage of the internet had dropped from its national peak only a few years ago.
The internet was well on its way to reverting back to its original users within the walls of government, education, and large corporations. Even without the loss of physical infrastructure supporting the hard-wired, few could afford it given the economic situation. The two-way home satellite system was a luxury even in Eduard’s neighborhood, but he still had some personal connections from his past professional career that cut him a good deal.

Readers' Journal and readers' commentaries have been updated: Readers' commentaries 11/27/08.

Holiday gift announcement: maximum two signed books per customer: Signed copies of Claire's Great Adventure (perfect for that impossible teen on your "gotta get them something, arggh" list) are limited to two per customer: $12 for one (includes $2.58 postage), $22 for two.
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Book Notes: My "little book of big ideas," Weblogs & New Media: Marketing in Crisis is now available on amazon.com for $10.99.
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Coming Soon to a Market Near You: A Huge "Obama Spring" Rally

My friends have already heard about the "Obama Spring" I see coming to a market near you: a huge rally of epic proportions, powered by the euphoria of a new can-do insider-staffed Administration coupled with a sense that the "worst is over" in the financial markets/credit collapse debacle.

But wait--does this mean all the structural problems I've been highlighting for three years have vanished? Of course not; the Coming Depression is still on its inexorable way. But just as the stock market rallied huge in 1930 and 1973, we're due for a monster rally that blows the doors off the Bears' dour certainty.

But isn't the stock market based on the fundamentals of the economy? Hahahaha, please don't make me laugh this hard--I might hurt myself. As noted here many times: the markets have only the thinnest connections to reality--and that's even without massive intervention/manipulation. Markets reflect the emotions of the participants--and nothing else.
Any other connection--price-earnings ratios and all the rest--is illusory.

That's why you can be screaming that your favorite stock has a low PE while it continues plummeting to new lows. And it's also why a "momo favorite" like Google can climb from $250 to $750/share regardless of its high PE--and why it can fall from grace ($750) back to $250/share.

So with Mr. Obama about to take controls of the Presidency with a team of experienced insiders and an agenda of "getting America working again"--what mood do you reckon will seize the country? Dour gloom? Heck no--regardless of ideology and who they voted for, Americans will be increasingly euphoric. Want proof? Even Karl Rove had something positive to say about Obama's team.

That's so bullish, it's actually frightening.

But before going on, please read (or re-read) the HUGE GIANT BIG FAT DISCLAIMER below, which reminds you that 1) nothing here is investment advice 2) this is free, so you get what you pay for and 3) this is an amateur's opinion and nothing else.

It has been my observation that bearish gloom can only last so long before the human spirit demands an injection of hope. We are now overdue for such an injection. But more importantly, we're not just getting a run-of-the-mill injection of the good stuff--it's way beyond mere alkaloid. We're going to get the pure Americana high of "yes, we can."

This is the real deal, stuff so powerful it puts Twinkies and cocaine to shame. Americans are optimistic by nature, and they like to think it's a new day every day; yes, our financial sector blew up, OK, so did housing, but dang it, "yes, we can."

I called for the rally about 5 weeks ago and was (as usual) early: A Contrarian's Call for a Major Rally (October 25, 2008). But if you bought oil stocks as I did at that time, you may well be poised to enjoy some mighty-fine returns on your willingness to ignore the gloomy "certainty."

I no longer get married to any market view. "Should" the market go down because our economy has structural flaws that will bring it to its knees? I have no idea. The market was "surprised" by the collapse of the risk-riddled financial sector we all have anticipated for three long years of phony prosperity, so we can easily anticipate the market being "surprised" next year when long-term interest rates suddenly zoom up, ending the supposedly "permanent era of low interest rates."

And the market will also be "surprised" when the wheels fall off the Obama Spring rally in April or May.

But let's not get ahead of the rally we're about to enjoy for a few months; we can always put on our Bear suits again in April (they will have aired out a bit by then--and a good thing.)
Let's first look at how the market can gyrate wildly in a protracted Bear market--say, the 1970s:

Please go to www.oftwominds.com/blog.html to view the charts:

We can quibble about exactly how many sharp moves up and down are depicted here, but I count 12 huge legs up or down in the course of 12 years, each of which offered traders vast opportunities for immense profits either long and short. And with the markets much more volatile now (recall that 80% of the trades on the NYSE are "black box" trades made by computers programmed to squeeze a dime profit out of huge volumes) then we can safely guess that we may have 20+ large swings in the next 12 years of Bear Market.

As always, I base my views on the charts--like this 10-year view of the Dow Jones Industrial Average:

In a bloodless analysis, the extremes in ADX (trend) and MACD really pop out. As the cliche has it, "nothing goes up or down in a straight line."

Technicians will be referring to a variety of targets--Elliot Wave, fibonaccis, previous levels of resistance/support, and so on. The ones indicated on the chart seem like the most obvious ones:

1. the 50% retrace of the entire 2002-2007 Bull market (10,725 or so)
2. the previous 2000 high of 11,723
3. the shoulder of the "head and shoulders top" around 12,800
4. the high around 14,000

None of these targets is a "sure bet" of course but the breaching of each one sets the stage for the next one to fall--until such time as a key level proves to be unbreakable resistance. Then as technicians we plan our sells and our move to the short side. Readers' Journal readers commentaries updated: Readers' commentaries 11/27/08.

Holiday gift announcement: maximum two signed books per customer: Signed copies of Claire's Great Adventure (perfect for that impossible teen on your "gotta get them something, arggh" list) are limited to two per customer: $12 for one (includes $2.58 postage), $22 for two.

Thank you, Michael E. ($20) for your much-appreciated generous donation to this site. I am greatly honored by your support and readership.

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