Energy Independence the Hard Way, Part 2

Read Part 1 here.

Yesterday's post asserted that the United States will painfully achieve energy independence in the coming years, through economic collapse and demand destruction so pervasive and deep that it boggles our mind. Nevertheless, we see this eventuality as a certainty for the U.S. Today we give details.

The 2007 Depression, as we have said many times before, is lowering income; that is the nature of an economic depression. In the United States, one can expect to see income on par with the global average ($10,000 per person). This means an approximate loss of 78% of present United States average income ($45,800).

This destruction of income will come hand-in-hand with several other, global trends. The first is peak oil: the unstoppable decline in oil production, ever since production peaked in 2005. Oil exporters, like Saudi Arabia, are already beginning to divert more of their production for domestic use, and less for exports. Once the fall in global oil consumption, due to the Depression, is overtaken by the fall in oil supply, the price of oil will inexorably rise.

Additionally, the U.S. Dollar is rapidly facing its demise as the world's reserve currency. As the world savours one last economic violation at the hands of Bretton Woods, the call has gone out for Bretton Woods II, and a global central bank. This is the death knell for the privileged position the U.S. Dollar enjoys, and the end of inexpensive imports for the USA.

Putting these trends together, everyone will be poorer in the United States. Gasoline will be far more difficult for the average American to buy. Because of both these trends, personal vehicles as they are known today (i.e. gas-sucking commuter tanks) will no longer be affordable for all but a tiny minority. We posit mopeds will be the more attractive option, or motorcycles, if one feels affluent.

This change in income and transportation will necessarily bring a change in living space (see an earlier post). In 1950, the average American enjoyed 292 square feet; the McMansion binge makes today's number around 900 square feet per person. A 75% drop in today's average living space per person seems about right to us. This, taken together with improvements in energy efficiency, will greatly diminish the need for home heating, lighting and cooling. Commercial space, especially retail, can expect a equivalent slimming down.

In conclusion, we come back to President-elect Barack Obama's economic stimulus programme at change.gov. Billions of dollars, if not trillions, are going to be thrown at the "energy problem"... but we will bet good money it will have no lasting effects. The economic collapse we've outlined is an unstoppable force that has a programme of its own.

Smell that in the air? That's change.

Energy Independence the Hard Way, Part 1

The Year of Our Depression 2008 is quickly grinding towards a smouldering ruin of finality, and already we sense that there is great hope that 2009 will be the turn-around year. Great faith seems to be place in President-elect Barack Obama's multi-hundred-billion-dollar make-work programmes. It seems to us that Mr. Obama is considered the man who can lead this nation to a better future.

Mr. Obama's transition website paints a starry, starry picture of energy independence: 1 million plug-in hybrids purring about by 2015; 10% renewable energy by 2012; 5 million jobs and $150 bullion over ten years. How lovely, but we point out to the President-elect that $150 billion is chump change; the Federal Reserve has 'injected' over $1 trillion, and that hasn't done squat. What can a measly $150 billion do for energy?

We posit a different scenario for energy independence, although it won't be appearing on change.gov anytime soon. In a decade, the government will have spent more money than we have the vocabulary to describe - but all for naught; infrastructure programmes will have been started, and abandoned. In essence, the United States will be so poor, its domestically-produced oil (currently about 25% of supply) will be all that is needed.

Cliffhanger? You bet. Part 2 tomorrow.

We Scared Ourselves

Yesterday's post about dealing with hyperinflation got us scared. So we will tell you about two action steps we are beginning to implement immediately.

The first step is to lay in a one year supply of non-perishable food and basic consumable items. We will maintain this inventory and rotate the stock. Our inventory consists of things like 100 pounds of rice, 100 pounds of flour, 100 pounds of oats, and so forth.

We imagine several benefits from this programme. First, is that it is probably one of the best uses of cash. If stuff explodes in price, we will regret hanging on to our little dollars. Second, it provides an emergency ration we could use to keep being reasonably well fed if shortages should develop. Third, it will lay in a stock of useful 'trade' items such as food, soap, razor blades, etc. More than once a neighbor has knocked on the door asking for a roll of toilet paper. Next time we'll ask for a jar of herring, or whatever, in return.

The second step is to keep an eye out for things that are 'too cheap'. There is much liquidation going on as many businesses fold. This makes for a plethora of odds and ends that get sold below cost at places like Big Lots (and even Wal-Mart from time to time). Additionally, more good, cheap stuff is pouring out into our neighbour's lawns during rummage sales. It's an art to know when to pounce and 'buy it all', and when to avoid buying something one won't use and probably can't parlay into something one will.

We suspect the coming hyperinflation is going to turn a lot of people into peddlers. It's a tried and true survival strategy in hard times. It's also a way people can work together - swapping an extra candle for a chocolate in order to maintain a modicum of creature comfort in a dark hour.

The Trauma of Making Money in Hyperinflation

As we were working today, eking out our honest dollar, a thought occurred to us: how will we get that dollar when hyperinflation hits? Sure, we'll be making something, but as the people in Zimbabwe have discovered, that something might not be worth a whole lot by the time one gets to the store.

Let's look at a simplistic business model: buy inventory at price X, sell at price Y, lock in profit at a comfy 7%. What happens when the inflation rate in the time between the purchase and sale is 7%, or -- especially -- 14%? Not being able to replace the inventory for less than it sold for, one loses on every sale (but makes up for it in volume, we suppose).

A similar thing will occur in wages; one may indeed make $25 an hour, but by the time the paycheque is cut and the tasty eats (extra fries, hold the mayo) from McBurger Kong costs $25, the apparently higher pay is pointless.

We like our eats, and our apartment, 'n stuff, and we cheerfully work to keep all that going. Right now, with inflation relatively 'stable,' it's easy to budget our expenses as a percentage of our income. It'll be a different story, when inflation is burning through cash faster than Bernard Madoff. Contracts, rent, interest, profit margin... all these things will become very, very different in the coming year. And we are very, very worried about that.

You should be too, dear Reader.

Income Replacement

Because the 2007 Depression will entail income loss for just about everyone, we would like to discuss some ways of replacing your lost income.

Passive Investors are currently faced with income losses from (among other things): lower interest rates; cut dividends; and loss of capital. The solution to this lies in either taking greater risks, or rebuilding capital by reinvesting more income.

Self-Employed Persons are seeing business drying up right and left. The solution here, as ever, is to dynamically be on the look-out for income opportunities. At present, opportunities are fewer than before, but they are still there.

Many Employees are presently experiencing cuts in pay and hours, as well as the ever increasing layoffs. We believe that many, if not most, of the currently employed will become formerly employed. The approach of collecting unemployment until the economic situation improves may not work out as it has in the past. Furthermore, reemployment will likely come at vastly lower wages. One solution here will be to become entrepreneurial, which only promises hard work and uncertain income.

The Industrial system has historically been neo-feudal: in exchange for 'knowing one's place', employees would be both offered the security of steady income and relief from the burden of figuring out where the business was coming from. As globalism progresses, workers in OECD nations will find increasing downward pressure on their remuneration. We suspect that most workers will opt for the security of the paycheque, even at lower wages.

The relentless downward pressure on wages and its effects on the economy as living standards decline have been recently discussed elsewhere in Worse than the Great Depression. It is not a happy prognosis for the world's top quintile of income receivers. For most, income will decline and not be replaced.

You, Reader, can make an exception of this for yourself through creativity and Peasant Virtues.
Good luck!

What is Poor?

As one of the biggest shopping day of the year dawns, we look out the window and -- to quote the archetypal priest -- we think of those less fortunate. No, dear Reader, we don't mean those who couldn't buy their family a new plasma TV. We refer to those in the world are inconceivably poor: they cannot even afford proper nourishment.

For example, take Haiti. 80% of Haitians live on $2 or less a day -- making them part of the 2.4 billion or so who live on the same budget. Mind you, Reader, than isn't $2 for food a day, that's just $2 a day. They are so poor they are eating baked mud, potentially ingesting various toxins or parasites. This mud they eat is euphemistically referred to as a cookie.

Mmmm, cookies.

We have no ethical axe to grind, one way or the other. We merely feel greatly irked at people who worry when they cannot blow large amounts of money on the holidaze. For instance, a worker at a recently-reopened cookie manufacturer in Ohio said, after getting a $1,500 gift card, 'I can give my kids a Christmas.'

Really? No kidding. We can see a couple ounces of gold dancing in our eyes if someone handed us $1,500. A person in Haiti would have probably screamed for joy, since they could then have eaten on $5 a day for about a year... but this person instead saw Wal-Mart, or possibly Toys-R-Us.

No one in the West quite understands what it truly means to be poor. We certainly don't, and we don't want to, either. The poor of Haiti have little-to-no hope of improving their financial situation, because they cannot even afford to live hand-to-mouth. In the West, one still has the potential to improve one's finances, even in this Depression. If one gets a windfall, like the worker and her $1,500, one must think long and hard about spending it wisely. Use it for a lasting improvement in one's living conditions: pay down debt; shore up investments; buy some precious metals. To fritter away a windfall, time and time again, launches one on the road to perfect understanding of just how poor the average Haitian really is.

The Long, Dark Teatime of the Holidays

As we sit at the keyboard, the rest of the Western world kicks back and takes some time off. The news services grind slower than usual; reporters are having a little eggnog with their vodka. This makes us twitchy: some of the greatest political coups d'etat have occurred when the holiday spirit permeates the air...the long, dark teatime of the year. Take the Federal Reserve Act of 1913... it was passed under the cover of darkness, after the majority of Congress had left for their Yuletide cheer. Who knows? As we type, a financial Kristallnacht could be going on without the slightest publicity...

What news we do see, though, is rather grim: retail traffic is down 24% year-over-year; the commercial real estate industry is whining for its bailout; the National Retail Federation wants a three-day jubilee on sales taxes; local banks are getting some hog slop from TARP; GMAC met with the elves at the Federal Reserve and was magically made a bank.

We wonder about GMAC's new status as a bank holding company. This company is, quite simply, a failed arm of a failed company of a failed industry. Not our idea of a good investment of the people's tax-dollars, and surely even the government must realise this. The details, though, are interesting: General Motors has to reduce its holdings in GMAC from 49% to 10%; Cerberus Capital must reduce from 51% to 33%. The 57% difference goes to an unnamed, independent 'trustee.'

This has deep implications: GMAC is now eligible for its share of TARP-feed... but the Fed's terms effectively cut off GM from the benefits of the gravy train. Cerberus won't get much of the money either, since the lion's share is going... somewhere. Hmmm, we wonder where. Were we the betting sort, we might be feeling lucky and put money on a former investment bank with the initials G.S.

But yet, we're heard that things aren't so bad: Turkey's PM is telling us this whole thing is just in our head. This would be funny, if the situation weren't so tragic. To quote Queen Victoria, we are not amused.

The Sovietisation of America

A recent article in Bloomberg discusses galloping statism around the world. All theoretical concerns aside as to subpar growth, and suboptimal investment decisions - we see the core problem being this: Beyond the domain of rudimentary public services, central planning creates bogus livelihoods in bogus industries. Take airline luggage inspectors. In the USA, the TSA employs about 45,000 screeners, slightly more people than the number of people killed each and every year on USA highways. We wonder how many lives the screeners have saved. Is this truly a good use of scarce economic resources in a contracting economy?

How will real needs be met if jobs are only created within or by the hands of government bureaucracies, and lost elsewhere? If the proposed make-work programs were along the lines of say, public transportation, truly affordable housing, or even beautification for heavens sake, we would not grumble so much. There is, after all, much to be done to make a smooth transition to a less affluent society. But why the largess for roads, auto makers, and ethanol? Soon enough all the highways will be to nowhere, as private motorised transportation becomes impossibly expensive for all but the wealthy.

In the waning days of the Soviet Union "people pretended to work, and the government pretended to pay them." Meeting real needs was largely left to the informal economy. Why do the government of the USA and its imitators want to recreate this tragedy?

Painted into a Corner

Mr. Henry Paulson, Jr., has had $350 billion burning a hole in his pocket since October. It's a terrible thing: he had far more money than he knew what to do with. He's been passing out the bucks willy-nilly, handing off bags of cash to friends, former co-worker, and former employers. Even so, it took him awhile to burn up the taxpayer's hard earned dollars: the last of TARP's initial $350 billion are set to roll out from the Treasury's loading dock. Now Mr. Paulson has pockets filled with lint; it is within his powers to now request the second $350 billion immediately... but he's making no moves to break open that piggy bank. 'Tis strange, we think: it's the season of giving, and he looked like he was having a ball of a time.

His compadre, Mr. Ben Bernanke, is having an even better time: $1.388 trillion worth of goodness, to approximate from the Fed's inscrutable balance sheet. We've looked at the Fed's latest excuse for a report... good luck making headway into its decipherment. Bloomberg has apparently sued the Fed for more information about the central bank's various lending programs... but the Fed may fall back to its legal trump card: the Federal Reserve System is a private bank, and therefore doesn't fall under the Freedom of Information Act.

We put ourselves in the shoes of these two men, and we can't help but feel... nervous.

Let us explain: the Treasury wants to keep the bailouts rolling, and the incoming Obama Administration is planning on spending trillions. At present the Treasury's bailouts are funded by investors buying Treasury debt... but when the cost of make-work programs start rolling in, these investors will be swamped. They just don't have enough money.

Enter the Federal Reserve, which can create a theoretically infinite supply of money. The Fed wants to prevent deflation by any means necessary, and buying up Treasury debt on the open market is just the thing for stoking inflation. The Treasury gets its money, the Fed gets its inflation and liquidity.

The policies of the Treasury and the Fed seem to be forcing them into an inflationary corner. Surrounded by seas of financial red ink, they have nowhere to turn but to the presses. They are playing with fire: sooner or later, all that paper money is going to start burning - first, in the people's pockets; and second, in their furnaces.

Mania and Depression

Mania and depression refer at once both to psychological states and to economic conditions. The parallel has long been observed, and is somewhat apt. The primary divergence between economy and psychology lies in the depression phase. Economically, the depression itself is primarily the consequence of actions taken during the mania. Or put differently, economic mania and depression are related as cause and effect. Psychological mania and depression, also referred to as bipolar disorder, are merely two phases of mood, related by a common underlying cause.

What was the mania that caused the 2007 Depression? Obviously, the 'housing bubble' was part of it, with its attendant mortgage-backed securities - a classic case worthy of Extraordinary Popular Delusions and the Madness of Crowds. But could the whole of the collapse be pinned on housing?

We propose that several structural economic flaws introduced during the 1929 Depression created an unbalanced economy and several long-lasting manias, the consequences of which will now need to be dealt with. Failure to reform these flaws will result in further economic collapse. Successful reformation will set the stage for economic recovery. We will be discussing these flaws and their resultant manias in this and future posts.

As an example, one flaw we would call Make-Workism. Among developed nations, this is most acute in the USA, as it does not officially believe in socialism. Where socialism would create public-owned enterprises to provide essential services (railroads, sanitation, water, electric power, low-cost housing, and so on), in the USA, government tends to avoid competing with private business and instead provides services that provide little or no economic benefit, e.g. shoddy education, prisons galore, unimaginably bloated military-industrial complex, airline luggage inspectors. The make-work strategy really took off during the 1929 Depression, and now employs a substantial portion of the population.

Make-Workism created a mania in government-directed activity because, like all manias, it seemed to work for a time, and gathered great popular support, largely as a result of generous pay packages, and well-funded lobbyists. Hardly anything valuable has been created by this mania, and much that is destructive. With the prospect of collapsing tax revenues, and the imminent bankruptcy of several US states and many municipalities, this mania may well be at an end. Do not look to see the public sector shrink gracefully though.

Bailouts are the Ultimate Corruption

As we had suggested earlier in the month, a token bailout has been given to General Motors and Chrysler. $17.4 bullion may seem like a ton 'o cash, but its chump change for these sieve-like companies. The Big Three have hit the proverbial iceberg; it's only a matter of time until they go propellers-up. Unsurprisingly, six in ten Americans would prefer to see those propellers than have their tax-dollars go towards making more gas-sucking, barely-functional fashion excessories. And who could blame such sentiment?

Even more odious, in our opinion, is the use of TARP (i.e. taxpayer) money to fund bonuses on Wall Street. The complete hypocrisy of, say, AIG's Jay Wintrob getting $3 million in 'retention awards' is mind-numbing. We personally feel so disgusted that we look for the lynch mobs forming, hunting down Wall Street's finest and stringing them up in Central Park... but we instead see complacence. The American public seems content to whine vaguely about things, but do nothing to stop out-of-control lemon socialism.

These bailouts, besides unwise and reckless, are the signs of corruption so deep and pervasive it makes our head spin. For example, Mr. Henry Paulson, Jr. is a former Goldman Sachs CEO. As Secretary of Treasury and manager of TARP, Mr. Paulson has given his former employer $10 billion of unregulated cash. If this isn't a conflict of interest, we don't know what is. Mr. Paulson also helped remove Goldman Sachs from the old net-capital rule; last we checked, before its recent, cynical move to become a bank, this allowed Goldman to leverage their assets-to-capital to around 30:1 - a speculative foray which taxpayers are now expected to clean up the mess from.

Therein is the rotten core of the affair: public money has been usurped. Money which could have gone towards any number of productive things -- which would have given real, measurable benefits -- instead are going towards rewarding those who created the mess in the first place.

These people -- the bankers, the auto CEOs, Mr. Paulson, et al. -- are so obscenely greedy we feel ill sharing the same nationality. Even though the entire world is in the 2007 Depression, they will still try to milk the system for every last dollar they can get. The callous disregard for the misery and suffering they are helping to create is staggering, but yet it is apparently greeted with cheers and accolades.

Deep Frugality: A Crash Course

In October of this year, the world entered the 'crash' phase of the 2007 Depression: markets tanked; orders were canceled; shipping froze; factories began closing; mass layoffs accelerated. The crash is continuing world-wide, and shows no signs of letting up. What this means for pretty much everyone, among other things, is loss of income - usually a lot.

How best to deal with that loss of income? The thing that will give the most immediate results is to cut spending. Rather than cut expenses willy-nilly, it is best to have a plan. First of all, you need to think long-term. Create a program for how you are going to divvy up your income, and then live within that guideline.

If you really want to thrive, you should think about saving 50% of your income. This may sound outrageous, but there are people who can do this - sometimes whole countries. No matter how little you make, you must 'pay yourself first'. This is especially important if you want to improve your condition. The prognosis for wages and salaries in the future is not good. Your hope for financial betterment will depend most likely on self-employment and investment.

Another severe suggestion is to limit your housing expense to 25% of your income. If you are paying more than that, you are at risk. In many parts of the country, such a limit is quite a stretch, but there are ways to meet it - usually by sharing space.

As for cramming the rest of your spending into 25% of your income, you must rethink what your 'needs' are. You do not need the following: new clothes; prepared food; cable tv; and many other things. When your income is low, managing on this limit is quite austere. You need to accept that. Resist social pressures to spend. Ignore marketing. If your friends try to tease you into spending, educate them - or find new friends. The alternative to frugality is to remained mired in creeping poverty, and risk sinking into destitution.

There are infinite ways to cut expenses, and develop Peasant Virtues. Sometimes it is even fun. You will learn new skills, and perhaps make new friends.

Signs of Nonfunctional Markets

Free markets are supposed to be very efficient. The general law of supply and demand states that if people want something, the market will provide at the proper cost. This 'cost' includes, at the very least: the cost of the raw materials required; the cost of manufacturing; the cost of delivery to market. Profit usually sneaks in there somewhere, but profit itself is a type of cost. It should suffice to say that the cost of a desired item is typically reflective of the cost to make another, similar/identical item.

When the cost of an item goes below its replacement cost, any number of things may be happening: the market for the item may be saturated, and people don't want to buy anymore; the item might have been so utterly hideous that no one would pay money for it. Most pertinent to our article, though, is when people line up to buy the item, but there is none to be had at the market's price.

A good example of this is in the silver and gold markets. Presently, physical bullion commands a fairly respectable premium over the official market price. Those premiums represent a disconnect, and a rather serious one at that. Healthy demand exists for physical bullion -- perhaps even more than ever -- but that is a demand that cannot be filled based on the official market price. In essence, two markets have developed: the official and the real-world. This is a sign of a serious market break-down, one which will likely have some serious, lasting repercussions.

More than just the bullion markets have been effected, though. One can see a similar situation developing in the oil and natural gas market. The Federal Reserve's zero interest rate policy (ZIRP) is another good example of breakdown. No normal human being can borrow money even remotely close to the Fed's target rate of zero... but yet there it is. This is a disconnect of credit: the official market says no interest, the real-world market has other ideas. Further government intervention and manipulation in markets will result in similar breakdowns, especially as the 2007 Depression progresses.

Where's the Bottom?

It is now pretty much universally acknowledged that the world's economy is in decline. Even a leader of the stature of Canada's Prime Minister without a Parliament, Mr. Harper, concedes a depression might be possible (source).

Thus, collectively society begins to leave the denial phase and move towards anger. One can expect to see more riots as in Greece and China; more factory occupations as in the U.S. and China; vendettas against banksters such as Mr. Madoff; and who knows what else.

After anger comes bargaining, depression, and finally acceptance. Whether this takes months or years remains to be seen. Even when everyone accepts the fact of the 2007 Depression, it doesn't mean that the economy has hit bottom.

The bottom will be found when failed and failing enterprises and institutions cease to be a drag on society's resources. At that point resources can be applied to meeting people's needs, and the economy can begin resuming more or less healthy functioning.

Generalities aside, what will the bottom look like? Probably half or more of the population will not be working full time, but getting by with a combination of self-employment, odd-jobs, informal work (much of it for barter), and so on. Large numbers will be jobless, homeless, and otherwise restive. There will likely be many disruptions to important services such as utilities, government, retail and banking. There may be many grand gestures by governments to turn things around, but likely they will be mostly for show.

What will turn things around is when people draw on their inner resources to become entrepreneurial - to spot opportunities to meet people's needs, learn new skills, and make new connections. New and surviving institutions will of necessity be extremely frugal and resourceful.

This is a very long way from where society is now. All the way down, people will be clamoring for bailouts, job programs, loans, and whatever else they imagine will remove from them the burden of responsibility to create their own means of living. You, Reader, would be wise to become entrepreneurial or align yourselves with such persons, if you are not already. Affiliation with dying enterprises and institutions may be maintained, but only if you are building up self-reliance on the side.

The Reality of Peak Minerals

An idea which is gaining traction in the mainstream is Peak Oil, the inevitable maximum level of world oil production. The idea of limits to growth is not a happy one for most, so we will sidestep the argument of whether or not scarcity of energy can be overcome with technology. Instead, we merely point to the facts: all major oil producers have peaked, and indeed world oil production (excluding ethanol, tarsands, and other such silliness) peaked in 2005.

But what of other minerals, the stuff that oil rigs and cellphones are made of? Their futures are no different from that of oil. In fact, many minerals have already peaked: the fertilisers potash and phosphate rock both peaked in 1989; industrial metals lead and cadmium peaked in 1986 and 1989 respectively;... and we hear rumblings that peak copper has recently been reached.

If peak minerals were to have occurred absent peak oil, the increasing scarcity of minerals might not have been as bad. However, the world is facing both increasingly-difficult-to-mine minerals, and increasingly-difficult-to-drill oil. Quite simply, this means that the prices of anything that requires oil and minerals will be going up in price - if not nominally (i.e. increased purchase price), in any case in terms of affordability (i.e. lowered personal income).

It seems to us that this is just about everything. Although some may say that improved technology will help alleviate the pressures of scarcity on supply and cost, we respectfully disagree. The pressures of scarcity will be made even more painful with the 2007 Depression. Falling incomes will make one poorer, inflation will burn up the purchasing power of what money one gets, and one's stuff will be more costly to buy... one will be feeling triplely poorer.

Redistribution Worsens a Depression

A common theme of government attempts to 'turn this troubled economy around' is merely redistribution: taking money from taxpayers, and giving it to selected recipients; taking toxic assets, and replacing them with Treasury bills; taking private companies, and nationalising them (to some degree or other). In one way or the other, this process represents capital and income forcibly moved from one possessor to another.

For example: Ben Bernanke, Federal Reserve Chairman, recently announced that he is going to expand the Fed's balance sheet as much as necessary (scroll down to the speech's fifth paragraph from the bottom). He also said that the balance sheet would have to shrink in the future... but not to worry about such things now (same link, third paragraph from bottom).

This amounts to simply moving a problem hither and thither, rather than actually solving it. By definition, this is Lemon Socialism: taxpayer money reallocated by the government to support failed or failing enterprises. In essence, lemon socialism takes the bad decisions of a few, and forces the majority to pay for, and suffer the consequences of, those decisions.

As these enterprises have proven unsustainable, such 'zombie-ification' represents considerable misallocation of capital. This, in turn, means that incomes will be generally forced lower by the disruptive economic effects of the 'zombie' enterprises. Falling incomes are part and parcel of all depressions, and so such misguided government bailouts will only serve to worsen the 2007 Depression. Lemon socialism shenanigans are doomed to failure; however, Mr. Bernanke's Soviet-style speech makes clear he will try it anyway.

President-elect Barack Obama comes from a different bent. His economic recovery plan is redistributive from a populist perspective, meaning he will look to prop up the lifestyles of the broadest majority of people at the cost of a few. The simplest demonstration of this is by lowering taxes on 'the poor,' and simultaneously raising taxes on 'the rich;' one can throw in another tax rebate cheque or two for good measure. In a way, one can think of populist redistribution as the opposite of lemon socialism.

A more specific example, though, is the Hubbard-Mayer plan: if passed by Congress next year, this plan will make available to any house-buyer a 30-year mortgage of up to 95% of the house's value, all for a low, low 4.5% fixed interest rate. Estimates put the up front cost of this program at conservative $3 trillion.

Though the mortgage plan is certain to be broadly popular, it is a very, very bad idea: mortgage interest represents someone's income. It's not a fanciful thing, because the interest a bank charges does eventually become someone's means of living. By lowering the 30-year fixed rate mortgage from 6.1% (this year) to 4.5%, money is being pulled out of the economy, lowering income, and since falling income is the essence of a depression, this will exacerbate the 2007 Depression. The math: take 4.5% from 6.1%, and one gets a difference of 1.6%. Take 1.6% of $3 trillion, and one sees that this program alone will take away $48 billion of real income per year. Poof.

What is Deflation?

There is, at present, a raging debate in the blogosphere and elsewhere as to whether the economy has entered a period of inflation or deflation. The conflict is not helped by the fact that there are no generally accepted definitions of these two concepts. We will attempt to create a definition that will provide a framework for analysis of various viewpoints.

First of all, the most useful definition of inflation and deflation would explain them as two sides of the same proverbial coin. A naive definition would call inflation, rising prices; and deflation, falling prices. Unfortunately in the real world, the prices for all sorts of things rise and fall continuously for a wide variety of reasons. Many analysts attempt to reduce their definitions to narrow, easily observed phenomena, i.e. official defined money supplies, or indices of consumer prices. Much of the contention arises over what is being observed.

Inflation and deflation could be said to be something that is hard to define but, like pornography, we know it when we see it. In that spirit, we define deflation as pervasive, structural falling of costs as measured by the currency across a broad range of economic activity; and inflation as its inverse.

By pervasive, we mean costs therefore do not just refer to retail prices, but also asset prices, wholesale prices, producer prices, and most critically wages and rents (including profits and interest). By structural, we mean that economic activity is inherently complex. Making money has many costs embedded within it, and what one pays out axiomatically ends up as many multiple others' income. This aggregation of costs, wages, interest, and so forth we call the structure.

Is deflation happening in the 2007 Depression? What costs have fallen so far? Obviously, the cost of many securities, houses, and commodities. Not so obviously, the cost of interest on national debts (with some notable exceptions, such as Iceland), and corporate profits. What about costs that are rising? The U.S. minimum wage went up in 2008 by 12 percent, and in 2009 will be going up a further 11 per cent; U.S. Postal first class stamps; and, as a personal example, our water and sewer utility service.

The picture is once again, conflicting trends. Over time, one of these trends will emerge the 'winner'. In the mean time, falling prices of certain things might be called 'deflationary', but that is very conjectural. For example, if the price of a commodity falls so much that it is unprofitable to produce it, the fall will simply be what is known as a price spike down. The price will then have to rise again, if people want to continue using the item. This is hardly deflationary.

Likewise, incomes will likely soon be shown to be falling, and some may call that evidence of deflation, but it might just be people becoming poorer. If what people want to buy does not also become more affordable, then there is no deflation.

It is our opinion that the 2007 Depression will probably not be deflationary. Two significant factors are at work to ensure that outcome. First, it is the stated objective of monetary authorities everywhere to prevent deflation. Second, many costs (such as minimum wages or social security benefits) are fixed by law, and even more costs, contractually over long periods of time.

It is also our opinion that the 2007 Depression will probably be, overall, strongly inflationary, if not even hyperinflationary. We believe that the overhang of money, and money-like securities (bonds, CDs, money market funds, etc.) from the bubble years combined with central bank efforts to prevent deflation will create a surplus of currency chasing a quantity of goods and services which is declining due to contracting production. In other words, when more money chases fewer goods, the outcome is inflation, not deflation.

Avoiding Conceptual Traps

A depression is a confusing thing. Many things which were apparently normal one's whole life aren't happening any more. Economic growth and 'progress' seemed like orderly, lasting processes. Disorder and breakdown now abound. There is a tremendous temptation to renormalise observed events into patterns that just aren't there. Patterns create a sense of place and order; lack of them causes anxiety.

We would like to take a look at a few conceptual traps that will ensnare the unwary. These traps are created in one's mind in a desperate effort to carry on as usual in the face of circumstances that require a change of strategy. Change is difficult - the 'same old' is easy.

The Value Trap is claiming many victims even as we write. The Value Trap happens when the prices of an asset falls to a level which seems like a good deal. Buyers who may have sensibly avoided 'bubble' pricing, now buy what appear to be bargains. Unfortunately, prices keep falling. Buyers of houses with mortgages find themselves soon 'under water', with their downpayment wiped out. It is imperative to adjust one's frame of reference as to the value of a prospective investment, and if something seems like a good deal - beware.

Institutional Security is misplaced confidence in employers, pension funds, governments, and so forth. Many of these institutions are in really terrible shape financially, and will not be able to deliver on their promises (the State of California comes to mind). There, a lot of people have been banking on long-term employment, contracts, and pensions that will not last. Do not assume even that U. S. government, or any other national government, will fulfill its obligations. It is critical under the present circumstances to develop self-reliance. Could you support yourself if left to your own devices? If presently self-employed, do you have a broad base of customers and suppliers?

The Sound Dollar Trap results from putting one's faith in the U.S. Dollar (or any other currency). Dollars steadily lose purchasing power (for a discussion, see this article and pay special attention to Figure 1). Currencies are themselves institutions (in a broader sense) that are unquestioned, background 'realities'. Keeping some currency is a necessity for most transactions, but it is not a vehicle for any kind of long-term savings or investment. Just because it may have done less badly recently than other assets, does not make it in any way 'good'.

Bailout Rebound is our term for the notion that "happy days are here again" due to some new government program, or bailout. This manifests itself in investment markets as Bear Market Rallies - upward price movements on some 'good news' in spite of the pervasive trend downwards. One wants to believe that the 'bottom is in', that markets are recovering and it's time to invest, or buy that bigger house one has been wanting. One wants to latch on to any sign of an emerging trend towards recovery. In the 2007 Depression there will be many bailout rebounds, false dawns followed by greater darkness.

A variant of the 'rebound' is Dodging Bullets. This is a type of wishful thinking that results from surviving incremental adversity. Just because you survived the first round of layoffs doesn't mean you'll make it through the next. If a mortgage has been renegotiated, the borrower will still likely default (see this article). While maintaining a positive attitude is always beneficial, do not delude yourself with survival bias. Remember that we tend to hear stories of survival only because non-survivors are not able to tell their stories! Things look bad all around, and they are probably going to get worse. The 2007 Depression is going to mark a major shift in everyone's modus operandi. Vigilance and caution are the watchwords of the hour.

Finally, we would advise bewaring the possibility of a Crack-Up Boom. A crack-up boom happens when the people lose faith in their currency due to accelerating inflation. When severe inflation is universally acknowledged, people will buy things - anything - to get money out of their hands and into something that won't lose as much value as the money does. This repudiation of currency creates an enormous demand for goods, and the consequent increase in production looks like a return to prosperity. But don't be fooled if this event comes to pass. It would be but a phase of the 2007 Depression as it morphs into a hyperinflationary depression.

Clueless Leadership

Today we learned a 'Pension Relief' bill whizzed through the U.S. Congress, passing both houses unanimously. Among the many popular items, was one in particular that caught our eye: easing the requirement that Corporate Defined-Benefit Pensions be fully funded. This comes just two years after the Federal Government toughened enforcement to protect workers and the Government Pension Insurance Fund.

No one likes to lose money, but pretending one didn't lose it doesn't help the situation. If a pension fund had terrible losses in the stock market this year, the employer should put more money in to ensure there will be enough to pay the retirees. If it can't cough up the bucks, then the benefits need to be cut. One can't go on paying out as if nothing happened.

This sort of thinking is not the exception these days. For another example, banks are being allowed to shuffle more of their impaired investments into the 'marked to make-believe' category of valuation to avoid writing it down to actual market values. The most extreme examples are to be found in the 'horror stories' of people who loose their income and yet continue spending on their credit cards all the way to bankruptcy and homelessness.

If any economic unit - be it household, business, or nation - is to emerge from the 2007 Depression not ruined, it must begin by fully acknowledging the painful losses that have already happened, and accept the possibility of further losses ahead. Only then can there be a truly appropriate response - which typically involves austerity and hard work. The glaring lack of leadership from elected representatives and regulators on this point is certain to have destructive consequences, namely: more insolvency, more income loss, and (as long as governments can pretend they have resources) more bailouts.

"Say it ain't so, champ!"

A friend tells us this line comes from The Champ (1931), when the young Jackie Cooper finds that his hero isn't as heroic and upstanding as one would have hoped. So, too, are the best and brightest of Wall Street losing their stature. Today, for example, saw the discovery of what is probably the second biggest Ponzi scheme in financial history (bested only by the original, Charles Ponzi).

The mastermind? Bernard Madoff, former chairman of the NASDAQ. The grand total? Clocking in at around $50 billion or so. This tops the other Ponzi scheme recently ended, a measly $3.5 billion swindle orchestrated by Tom Petters, a Minnesota 'entrepreneur'-cum-felon. Both these men ran schemes which ripped off the gullible for fun and profit; both these men are criminals. Both these men were respected investors; the news of their unscrupulousness is "inconceivable" to their cohorts.

Hahahaha. As Bugs Bunny says, "aw, go on."

These two swindles are telling, however, for a trend of the 2007 Depression. A Ponzi scheme -- indeed, any confidence scam -- is inherently unstable, even in the best of times. The 2007 Depression is going to squeeze these sorts of swindles into non-functionality, and some may blow up spectacularly. There are, however, more swindles out there than just the average Ponzi scheme, and many of them come in forms one wouldn't necessarily expect.

Take banking: one puts one's money in an account, and then pretends it's still in the bank. Unfortunately, one's money does not simply sit in the bank's vault; it goes into, say... synthetic CDOs; or stock of Fannie Mae and Freddic Mac; or sub-prime loans. The point is, one's money is not in the bank anymore. In fact, we'd argue it probably isn't anywhere anymore. Yes, if one wanted to take out one's money, one can simply walk into a bank and withdraw it. But what if every depositor of the bank wanted their money? The bank never holds enough physical cash to cover its deposits; it can't afford to. The bank, like Mr. Madoff's and Mr. Petters' Ponzi schemes, would implode, and depositors would be left holding the bag, hoping that government insurance pays out.

But the biggest swindle, in our opinion, is money itself. We use it every day: these green pieces of paper get us our food, heat, and shiny, shiny gold. They're legal tender, all right -- every bill tells us so -- but who guarantees this? The Federal Reserve, we presume, since they're the ones who own them... but the Fed is just a bank. We ask: what happens when everyone metaphorically cashes in their dollar bills to hold something tangible? "Say it ain't so, champ!" will be the general cry.

An Alternate View of the Depression

Today we discovered a very interesting blog. It is called "Meltdown 2011," and presents what we would call a conspiracy interpretation of current events. The author, a Mr. Scott Gallup, believes the 2007 Depression, or "The Meltdown" as he calls it, is being created intentionally to further the ends of what he calls 'Shadow Powers'. Generally, we discount such a viewpoint, but nevertheless listen to it.

The 'doom and gloomers' have had a better predictive track record than the rest of the population lately, and one could chalk that up to the 'broken clock is right twice a day' effect. On the other hand, given the present economic crisis, the notion that they might be on to something deserves a bit more attention than usual.

If you can navigate Meltdown 2011's enigmatic layout, you will find a treasure trove of 'alternative ' information. We would categorise much of it as more than a little tired, but some of it is original and well-informed, such as it's coverage of issues in the precious metals markets (which was what drew us to the site in the first place).

It is a taxing task to attempt to wrap one's head around vast and complex issues. We ourselves attempt this with open-mindedness, and avoid reductionism. Our opinion is that even if some would-be overlord class is attempting to manage the world's institutions, economies, people and so forth, they are almost certainly not up to the task, and would fail to achieve their intended results. Ultimately, the only functional human systems are those where power and decision-making are widely distributed. Efforts to set up non-functional systems may bring misery and suffering (the Soviet Union again comes to mind), but in time they do collapse.

There are always attempts by politicians, seen and unseen, to grab power. That is what they live for, after all. Perhaps the 2007 Depression will be perceived by the political class as a capital opportunity to grab more power. Perhaps they will even succeed for a time. However, the more vigilant the citizenry is towards attempts to take power from it, and the more prepared they are for such an assualt, the less likely they are to be overpowered. Meltdown 2011 may be going overboard a bit in the vigilance department, but nevertheless it provides interesting food for thought.

Enabling Destructive Economic Behaviour

Although we ourselves are not of the socialist persuasion, we agree with socialists that there are cases where government can actually provide useful services, and at a reasonable cost. So reasonable in fact, that the case for privatisation is not particularly compelling.

Unfortunately, at the national level, the USA seems incapable of delivering that sort of socialism (with the possible exception of the Post Office). Instead it engages in malignant lemon-socialism, where destructive enterprises are rewarded with life-prolonging capital infusions, or outright government ownership.

Take, for example, a number of large banks, Fannie, Freddie, and Wall Street firms. These outfits swindled the world's investors. All issues of criminal fraud aside, their activities were and continue to be enormously destructive economically.

Investors lost confidence in them. Any sane governing authority would simply shut them down. In any sort of free market economy, they would be done already. There are thousands of better run competitors out there to take up the slack. But yet, the Federal Government saw fit to step in and keep them going. Not because no one else was providing some useful service they are. In fact, they aren't producing any useful service at all. Quite the contrary.

Another example is the bailout of the 'Big Three' automobile manufacturers. As stated in a previous post, there are many good, sound business reasons for these companies to go out of business. It's not like there aren't lots of other companies which can make cars. If the USA has a glut of car making capacity, then a fair chunk of it needs to go away.

The core economic problem of the failed Soviet Union was that its central planners took valuable natural resources and turned them into useless waste. Ignoring issues of quality and desirability, they measured output strictly in tonnage. This was socialism at its worst.

Unfortunately, the USA is following in the footsteps of the Soviet Union. Its central planners are diverting ever larger portions of the nation's income into operations that produce little or no benefit. The litany is extensive, but includes bloated 'Defense' and 'Homeland Security', subsidies for airlines, automakers, banks, construction, insurance, mortgage companies, prisons, and real estate brokers.

Spending by Governments at all levels in the USA is about 40% of total national income. Also, about 50% of the population is dependent primarily on government for its income. This is a country fairly deep into some kind of socialism. Is it getting a good value for its commitment? Does the USA have enviable public education? a low rate of incarceration? free health care for all? a first-rate passenger rail system? The answer to these questions is a resounding "No!"

On top of that, Government in the USA is quite involved with the private sector. Does the USA have a healthy industrial base? a healthy balance of payments with the rest of the world? energy security? well-paid, content workers? No, again.

We are profiling a country at the verge of leaving the club of wealthy, advanced nations, if not heading for outright collapse. The response of the political leadership to the 2007 Depression is very telling: bailouts, handouts, and more pork. This will do nothing to make the nation more productive and increase its citizens' income. On the contrary, it will make the nation less productive and exacerbate the decline in income.

Investing in a Depression

Income loss is the one fixture of every depression in recorded history, and so too will the 2007 Depression severely lower income. Whether through inflation or deflation, it is bound to occur. Income from investments is just as threatened by the 2007 Depression as income from employment. One only needs to look at: the drop in corporate earnings; the falling stock market; the minuscule yield on bonds, including government bonds; the increasing possibility of default of bonds, including government bonds; meaninglessly low interest rates on bank deposits.

In deflationary depressions, like the 1929 Depression, cash is king because its purchasing power increases. This can happen through several ways: its market value increases (as in a hard money system); the velocity of money drops (i.e. the speed at which people spend money for stuff); supply physically decreases (as theoretically possible in a paper money system, maybe); some combination of all the above.

Although it is possible that in the 2007 Depression "cash is king," we are of the opinion that cash will be trash in the very near future. Because the Federal Reserve is putting its considerable might into preventing deflation at all costs, we feel that inflation is the name of the game. This will happen through several ways: physical supply of money will expand at an accelerated rate; the velocity of money increases; or a combination of the two.

As all but one historical paper money experiments have ended with a hyperinflationary depression, investing will take on a new face. It will not necessarily be to increase wealth; rather, it will be to lose as little as possible, or hopefully preserve it. Gone are the days of making investments which will increase steadily in value. As one individual of our acquaintance put it, when the water goes out before a tsunami hits, don't go onto the sea bottom and fight over the fish. Head for higher ground instead.

We feel very strongly that the tsunami will come in after the synthetic CDOs we wrote about in yesterday's post start unwinding. Between then and now, however, 'higher ground' may be a difficult thing to find. Investment markets of all varieties are in disarray, and supposed safe havens (bonds, precious metals, and select foreign currencies) don't look so good. One could take cynical risks, and throw one's lot in with one of the biggest swindlers in human history: JP Morgan. When their synthetic CDOs start paying out, they might be the biggest winner... or they might not be. Time will tell.

Why JP Morgan wants Detroit to Die

The Big Three automakers (Ford, General Motors, Chrysler) are begging for a bailout. Although we haven't seen the CEOs of the companies on bended knee, we assume their pleas are strident and whiney. Nevertheless, we are certain that a token bailout is being rammed through Congress as we clatter away at the keyboard. $15 billion may sound like a lot of money, but it's a drop in the bucket for these behemoths. They are hemorrhaging capital, disbursing money like Ebeneezer Scrooge doesn't.

Despite this, there is no way in Mordor that the Big Three will live to see Christmas 2009. The obvious reasons: they're unprofitable; they're not competitive, either domestically or globally; their cars are crappy, ugly, out-of-date energy hogs that cost too much and are difficult to repair. Please, don't get us started, it will make us rant loudly.

Like we said, however, those were the obvious reasons. But there is something else - a Sword of Damocles - hanging invisibly over Detroit as we type: synthetic collateralised debt obligations (SCDO), which are soon to become massive windfalls to big banks, like JP Morgan. These SCDOs are very complicated, so please bear with us as we use the Business Spectator to explain:

"A synthetic CDO is a collateralised debt obligation that is based on credit default swaps [CDS] rather than physical debt securities... Here’s how it works: a bank will set up a shelf company in Cayman Islands or somewhere with $2 of capital and shareholders other than the bank itself... That allows the so-called special purpose vehicle (SPV) to have “deniability”, as in “it’s nothing to do with us” – an idea the banks would have picked up from the Godfather movies.

The bank then creates a CDS between itself and the SPV. Usually credit default swaps reference a single third party, but for the purpose of the synthetic CDOs, they reference at least 100 companies.

The CDS contracts between the SPV can be $US500 million to $US1 billion, or sometimes more. They have a variety of twists and turns, but it usually goes something like this: if seven of the 100 reference entities default, the SPV has to pay the bank a third of the money; if eight default, it’s two-thirds; and if nine default, the whole amount is repayable...

Finally the SPV is taken along to Moody’s, Standard and Poor’s and Fitch’s and the ratings agencies sprinkle AAA magic dust upon it, and transform it from a pumpkin into a splendid coach.

The bank’s sales people then hit the road to sell this SPV to investors. It’s presented as the bank’s product, and the sales staff pretend that the bank is fully behind it, but of course it’s actually a $2 Cayman Islands company with one or two unknowing charities as shareholders.

It offers a highly-rated, investment-grade, fixed-interest product paying a 1 or 2 per cent premium. Those investors who bother to read the fine print will see that they will lose some or all of their money if seven, eight or nine of a long list of apparently strong global corporations go broke. In 2004-2006 it seemed money for jam. The companies listed would never go broke – it was unthinkable.

Here are some of the companies that are on all of the synthetic CDO reference lists: the three Icelandic banks, Lehman Brothers, Bear Stearns, Freddie Mac, Fannie Mae, American Insurance Group, Ambac, MBIA, Countrywide Financial, Countrywide Home Loans, PMI, General Motors, Ford and a pretty full retinue of US home builders." [emphasis added]

Please, read this article from the Business Spectator. It is an excellent discussion of the swindle that are SCDOs. It is an epic financial bomb with an uncertain fuse, but will certainly go off with the Big Three dead and buried. And that, dear Reader, is why JP Morgan wants Detroit to die. While JP Morgan may or may not have invented SCDOs, they are certainly at the top of the guest list at this reportedly $50 trillion jamboree (yes, dear Reader, that's trillion).

Put simply, there is an unbelievably huge pie out there, somewhere, and JP Morgan is getting hungry. A little thing like the Big Three, or any of the other companies on SCDOs lists, will not stand in the way of their slice.

Peasant Virtues

As our income has fallen, we have been trying to rediscover the skills our ancestors used to manage their financial affairs. We break the skills into three sets: Industry, Frugality, and Thrift.

Industry is not here referring to factories and mines, but the idea of doing things for one's self. Hungry? Don't run to McBurger Kong, but make a meal for yourself. Cost of fresh food got you down? Grow some. The basic principle here is what economists call import substitution. Instead of importing goods and services into your household and exporting money, you substitute the fruits of your own labour (sometimes literally) for what you would buy from others.

Industry is also about figuring out what you can do to make extra money, on the side - if you still have a job, or as self-employment. Lots of things always need doing. If you can't figure out what to do to make money, keep busy around the home - chances are there are many worthwhile projects. Also, you may teach yourself some marketable skills.

Frugality is all about enjoying what you have as long as possible before you replace it. And when you do replace it, do that as inexpensively as possible. Let's suppose you have an article of clothing, say a sweat-shirt, and it's getting a little ratty on the collar and cuffs. Does it still keep you warm? Then keep it! You might say, "But it's shabby." Listen: a new one costs money (even if you make it yourself), and this one is free. Any money you spend is infinitely more money than not spending money. A new thing is not infinitely better than an old, shabby but serviceable thing. When you spend money to replace something which still works, you are being irrational. It's OK to be irrational now and then, but don't try to pretend that you are being rational by coming up with reasons that the new thing is better.

When it comes time to replace something, go first to rummage sales and thrift stores. Often you can find very good quality things at minuscule prices. Frugality is also about finding which stores get you the best prices, finding the best deals, conserving energy, and repairing things as cost effectively as possible.

Thrift has two components. The first is to look at money coming in as something to be saved, not spent. This is, for inhabitants of the developed world, counter-cultural. One hears countless messages to spend from family, friends, coworkers, employers, salespeople, and marketing. If your financial situation is not so good, the more you save the faster it will improve.

The second component of thrift, which answers the question of where the best place for most people to put their savings, is: Never, ever borrow money. People have gotten very lax on this in recent decades, and the results have been catastrophic. If you are fortunate enough not to have burned by your debts so far in the Depression, don't take any more chances. When all your debts are paid, you may then delve into the joys of learning to invest your savings. On this last point we must insist that you learn to manage your own affairs, and not leave the decisions to 'experts'. The experts have done very badly lately.

What is Productive Capacity?

Arising from yesterday's post is the question of what wealth really is. Well, this is frankly very difficult to answer. Perceptual wealth is the name of the game right now, it seems: houses in and of themselves are worth 'something;' credit cards are seen as money; various corporations and banks are 'too big to fail.' These are all things which are teetering on the brink of major market revaluations (downwards), all the while desperate attempts are made to prop up their present, unsustainable valuations.

In ye oldie days, economies were predominately run from a mercantilist perspective. Mercantilism generally held that wealth was embodied in money (i.e. gold and silver). Prosperity and productivity flowed from the active hoarding of money, which thereby enriched the nation.

Anyone who has ever owned physical gold or silver should know this is hogwash. We have placed a bar of silver upon a table, and stared at it for quite a while, but as it sat it generated no wealth. Sure it was pretty, but it was only a store of value, not a productive investment. It could never produce wealth by our passive holding of it. To this we add the ideas that stocks, bonds, or houses are wealth: they are mercantilist delusions of the 20th and 21st Centuries, for their hoarding will never create wealth.

Towards the end of the 18th Century, mercantilists were superceded the physiocrats. Physiocrats held that wealth did not come from hoarding money (i.e. bullion), but came from productive capacity. At the time, the physiocrats equated 'productive capacity' with 'farming,' but we will broaden the definition, thanks to UNCTAD:

"...the productive resources, entrepreneurial capabilities and production linkages which together determine the capacity of a country to produce goods and services."[source]

Note that nowhere is 'money,' 'the stock market,' 'real estate,' or any other such silliness mentioned. Productive capacity is what makes the stuff that people need or want, and the services that people need or want. It is what Marx called labour, although that is a bit oversimplified because productive capacity does include machinery and other such complex systems.

Creativity; optimisation; ingenuity; making do; these are all part of productive capacity. However, productive capacity cannot be reduced to any of these things: it is a complex system which must be regarded as a cohesive whole, and guided by human thought. As long as you, dear Reader, are a creative person and know how to do things, you have productive capacity. Nurture this ability; it will certainly come in handy in the Depression.

Perceptual Wealth

Much of financial news of recent note has typically been about how much money has been sucked into a black hole. People bemoan the falling value of their 'nest egg' real estate; stocks hopped onboard a time machine and revisited the Nineties; California real estate is already in the Nineties, and seems to have a hankering to see some disco. There's a distinct possibility that some financial sharkskin suits might be spotted in the near future, and we wouldn't rule out a resurgence of the Zoot suit.

But what, really, has been lost? In our examples, and indeed in general, money hasn't actually gone down a black hole: all that has changed is the hypothetical price tag on a given investment. Nothing changed physically about the houses in California (usually); the same can be said for stocks. One day they were value X, and the next they were value Y... the bad news: Y was less than X.

Such fluctuations are normal in a market's valuation of a given 'thing,' and are to be expected. Just because 'the market' says a certain Californian condo appraised at $450,000 doesn't necessarily mean someone will actually buy the place. The condo is worth what someone will pay, and not a cent more. Trouble sets in when people confuse a market valuation with 'money in the bank,' and spend $400,000 as if they had already sold the condo.

We suppose it's all well and good to do this when the market is forever going up... but surprise! No market is immune to the inevitable downturn, and now the average Californian real estate speculator is 'under water' (i.e. owe more than their properties are worth). They're saying they've lost money, but have they really? They didn't sell their property, but yet they spent like they had a big pile of cold, hard cash. They thought they were wealthy, but clearly weren't... so what did they have?

Perceptual wealth, dear Reader; the perception of wealth, without actually being wealthy. These real estate speculators (a.k.a 'homeowners') truly believed they were wealthy, and so they spent and lived as if they were wealthy, but in the end what made their 'wealth' wasn't real. It was an opinion, a valuation; it was what someone said the investment was worth. Writ large, the real estate bubble more resembles a confidence scheme, but it all began with someone feeling wealthy because they bought a condo in California.

Is The Media Crying Wolf?

Since the present epoch is 'The Information Era,' and the economy is the big story of the moment, there is now abundant commentary on the "Deepening Recession." The question of whether the world may be in for a depression has now hit the mainstream.

Given the mainstream media's poor track record of appropriate attention to what is truly relevant, legitimate questions arise: "Is this recession thing just media drum-beating - a 'media event'?" Is the economy even that bad? Or are things actually much worse? Could it just be that it was a bad downturn, but now that it is getting so much press, one can figure the worst is actually over?

Our opinion is that things are actually much worse, and that the bad news will be 'spoon fed,' and not so much as a result of some sinister conspiracy as from the cycle of denial, confusion and slow recognition of conditions as they are.

The essence of the 2007 Depression, like depressions before it, is falling income - whether through pay cuts, unemployment, or lower returns on investments. Falling income sets off a vicious cycle of economic contraction as households spend and save less, tax receipts fall, and organisations invest less - further reducing what will become others' income.

An economist whom we admire, a Mr. Williams, presents a strong case that the USA has been in recession since 2000, and that government statistics to the contrary are unreliable. You may read more about this at his website. If the USA has indeed been contracting economically for the past seven years, then the apparent prosperity was most definitely a bubble. Its crashing down now is only the reality that a shrinking economy cannot support exaggerated consumption.

There is a great deal of productive capacity in the human race and its artifacts. Income is flowing from this capacity, but one must learn to live within and not beyond one's means. When this story is the top of the news, then you will know the worst is over.

Rethinking Luxury

First off, we're pleased to announce the launch of another, sister blog: the Silver Money Report. This blog will deal exclusively with topics pertaining to silver, notably in its investment and monetary functions. We have other blogs in the works, which will be rolled out for public consumption in the future.

For today's post, we would like to look at the idea of 'luxury.' We're sure that, to most, 'luxury' is probably brings to mind the lifestyle of a movie star or pop singer, rather than the middle-class living standard of yesteryear. Luxuries typically embody a large amount of wealth, whether financial or otherwise. In the past, one could demonstrate one's wealth by, say, gold-trimmed plates and solid silver silverware. The American rich of the late 19th and early 20th Centuries bought automobiles to show off their wealth.

Westerners in general (and Americans in particular) have forgotten just how much of their lifestyle is actually a luxury. Eating meat is a luxury; indoor plumbing is a luxury; a private room is a luxury; more than twenty square feet of living space per person is a luxury. We're sure these things sound more like necessities to you, Reader, but rest assured they definitely are not. Rather, these are the 'victory' of the 20th and 21st Centuries: making the luxuries of the 19th Century the necessities to the masses.

We're not saying that these things will necessarily once again become luxuries, but we're willing to bet the 2007 Depression will push the average closer to historical norms than Americans (and Westerners) are willing to accept all at once. Average living space in the West may not become ten square feet per person again, but it will probably be closer to 200 than the 1,000 Americans enjoy presently. Indoor plumbing probably won't go away, but the average person almost certainly won't have their own, private bathroom.

Perhaps the biggest luxury that Americans especially are unaware of is being able to live anywhere. Many areas of the United States are not viable economically, either from lack of productive capacity, remoteness, or outright uninhabitability. As energy becomes scarcer, and the 2007 Depression squeezes the economy even more, the 'live where I want to' mentality of Americans will likely end.

We could go on, but we instead will suffice with saying that knowledge of the living standards of the 19th Century is something one might want to be more familiar with. Not to forget, there are 4 billion people in the world who do not have even the quality of living as the average in the 19th Century. They are perfectly willing to fight tooth and nail, and work as hard as humanly possible, to get their indoor plumbing. They will work harder for this than you ever will, or ever have.

Did We Say 2008? Hahahahaha...

It's now official, folks: according to the National Bureau of Economic Research, the United States is in a recession... which started in December 2007. Actually, the recession is really a depression, but that's a detail; the illusion that things are just 'slow' has been eradicated, a year into the problem. Whatever the case, we wish the Depression a happy first birthday!

It is customary to name a depression after the year in which it started, so officially the United States is in the 2007 Depression. We resist the temptation to retcon our previous posts to fit the present circumstances, but we will use 2007 Depression from now on. It is the way this depression will be remembered in the history books, and who are we to argue with history?

Now that the economic situation is 'official,' let's look at what this may mean. One thing we feel is certain: fear is going to be much stronger than before. As an example, news has broken that credit card companies are thinking of cutting $2 trillion in consumer credit. Although we aren't convinced the banks will actually do this, it's a sign of increased tension and fear.

Fear will also help drive President-elect Barack Obama's sweeping social programmes with neck-snapping speed. In the manner of President Franklin Roosevelt before him, we believe Mr. Obama will be coming out swinging... and one doesn't want to be in his way. We fear his new policies, like Roosevelt's inept and destructive New Deal, will only serve to worsen and prolong the 2007 Depression.