Down and Down She Goes, Where She Stops, Nobody Knows

The numbers are pouring in daily: shipping is down, trucking is down, exports are down, imports are down. Typically these numbers show declines on the order of 10 to 20 percent year over year. Is it naive to suppose that the U.S. economy has declined 10% or so over the last year? Apparently, as the U.S. Government reports that the U.S. economy actually grew by 1.3% in 2008.

Frankly, we just don't believe that number. Mr. John Williams at www.shadowstats.com is reporting a 4% decline in U.S. GDP in 2008, which seems more realistic.

In any case, the decline is accelerating. The fourth quarter GDP numbers would have come in worse if there hadn't been an inventory buildup. As inventories are worked off in the face of collapsing demand, production will fall further.

The 2007 Depression is a new bird for everyone. Nothing quite like it has ever happened before. The last Depression (1929-1939) occurred with a vastly different set of social and economic parameters, and is not really a prototype for current events.

No one can present a formula for making it through the 2007 Depression. Survivors will be relying on improvisatory skills. It will be an era of living by your wits.

Watch the Vultures Choke

With the stock markets of the world looking like so many corpses across the financial desert, the vultures are beginning to circle. They fancy they smell a mighty feast, and in their minds they'll soon be dining on the choicest meats available. With beady eyes fixed upon 'investments,' they feel the markets are dead enough for them to safely swoop in.

For instance, we present this piece from the Financial Times:

"Vulture funds believe British companies will offer the best investment opportunity in Europe this year, as the country faces a sharper slowdown than its European neighbours. A poll of the funds, which invest in financially distressed companies, ranked the UK ahead of Germany, France and Russia."

Although we don't know the future, we can read the handwriting on the wall, and we suspect these vultures are falling into a value trap (see this previous post for more on such traps). Frankly, the markets haven't crashed nearly enough for our liking, and in the United Kingdom, they have a really long way to go. No 'asset' is anywhere near its bottom, especially in nations like the U.K. and the United States.

We posit that these vultures will move in swiftly and with great fanfare, patting each other on the back for scooping up 'bargains of a lifetime.' Soon thereafter, we expect the world markets will take yet another hard nosedive. The 'smart' money will be wiped out, and the carcasses of the vultures will join those of their supposed feast.

In this economic climate, we suggest it is better to be financial jackals. One shouldn't just wait until the prey stops moving: one should let it sit and rot for awhile. Jackals find that foetid meat aids the digestion... and so will it aid investing.

End of the Service Economy

We read today that the U.S. Postal Service wants to cut a delivery day. We see a dark trend behind this story. People just don't have the money to pay other people to do stuff for them.

When you're cutting your budget, one of the first things to go usually is eating out, that is, paying someone to cook for you. Then there is cutting entertainment - not paying someone to sing or dance or tell jokes for you. Cutting travel means not paying someone to fly you somewhere and give you an exotic place to sleep. Pretty soon a lot of people are out of a job.

In 1986, an article was entitled Taking in Each Other's Laundry - the Service Economy. A critical expression was thereafter circulated - "We can't get rich doing each other's laundry." In the following years as more and more people earned their living catering to other people's inclinations - it seemed that just maybe everyone could get rich doing each other's laundry, nails, or pet-washing.

Now that the economy is contracting and have less to spend, people are deciding to do their own laundry. This is setting up a feedback cycle of job loss and spending cuts that has a very deep bottom. We expect to see the US economy (among others) de-servicing, if you will, in the years ahead just as it de-manufactured in the 1980s. This process will be very painful and disruptive for many, and a good deal more than most could now imagine.

Racing to the Next National Blow-Out

As the financial hydrogen bomb cloud over Iceland begins to fade, her citizens are beginning to adjust to life in a long, cold nuclear winter. Surrounded by a glow-in-the-dark landscape, and a currency that burns to the touch, they've begun to pick over the ruins of their previous life. With a new coalition government in the works, and the age-old practice of whaling to provide jobs, Iceland will probably pull through... though she will be vastly changed. We hope they can find some whales.

Frankly, though -- and not to seem callous -- Iceland was a weak hand. One can call upon the Galbraith Financial Principle: the best and biggest will fail last. Iceland was neither biggest, nor the best; she was merely the first country squashed flat by the 2007 Depression. The question one should be asking is not how will Iceland pull through, but rather, who's next. This piece has a very good list: Great Britain, Latvia, Greece, Ukraine, Nicaragua. We would add Mexico to this list; however, these are probably the next countries to go.

Personally, we would put our money on Great Britain: she's in rough shape, and with the annihilation of the pound sterling in the works, the Brown Government could very well go to pieces a la Iceland. When governments say they aren't concerned about the value of its issued currency, bad things can happen. The Brown Government may feel it's on top of the situation, but it's no more in control than Zimbabwe's.

Then there is the terrible crime of hubris: Mr. Paul Marshall recently told a Treasury committee that a Madoff scandal in the U.K. is "very unlikely." Funny, but we remember Mr. Madoff himself saything that very same thing... Big investors are assuring the Brown Government that there is no "U.K. Madoff," but if the government believes that load of lies... they're unworthy of governing.

Hard Work Ahead

I have always been impressed at how easy my life has been compared to my ancestors. I am especially humbled to have seen a small town in Washington State carved out of the forest by my great-grandfather (among others) over 100 years ago.

Up until now, I couldn't imagine myself hewing down huge trees day after day, sawing them into logs, and so forth. But I am changing. The economic system that gave me and so many others the 'good life' for so long is failing. I don't think it will go all to pieces in one go, but there will never again be as much affluence and leisure as there was in North America from 1950-2000.

I am faced with the prospect of being a global economic citizen competing for a global income ($10,000 per year or so) with billions of other hard-working souls. We won't be working just a few hours per day for this either, but 10 or more hours every day of the week. It's a daunting prospect. At present, I don't really have the energy for it, but I am working on getting myself fit enough and accustomed enough to constant work that I can manage it.

I see many others around me very much not ready for this - whether from being out-of-shape, having various 'medical' conditions, or being just plain lazy. Many of them are on the dole, or involved in some sort of income-producing racket that makes minimal demands on their efforts. There is probably no helping most of them as times get harder and harder.

For the rest who are willing to change, the prognosis is not so bad. For those who are willing to make the effort, there will always be the rewards of hard work. In the future, being housed and fed will feel like enough.

Are Big Banks Committing Suicide?

We were chatting with a friend the other day, who holds a middling commercial loan from a major bank. He's a very good client of this major bank, and he has been with this bank for quite some time. He told us this bank was going to charge him a fee equal to about 5% of the value of his loan. Apparently, this 'fee' was do to an error on the bank's part, but they were going to charge him, anyway!

Another friend has held a line of credit from another major bank for over a decade. Just recently his interest rate on his card's balance was doubled to 20%. He, too, had been a good client, and always paid his bills on time.

Earlier we wrote about Citigroup backing mortgage cram-downs, and how we felt there was something fishy about the whole thing. Then we saw articles like this one from Bloomberg, or human-interest pieces like this from WiseBread.com... and we really started to wonder. Are these major banks actually queuing up on a roof, waiting for the opportune moment to jump to their death?

Lending is the bread and butter of these major banks. They are alienating their borrowers, but they can't make money without lending... so they must have something else up their sleeve. Personally, we think it's our beloved Synthetic CDOs. Bear with us for a moment, dear Reader.

With AIG, Fannie Mae, Freddie Mac and the Big Three on the government dole, their collapse has been pushed off into the future. That means the SCDOs won't be triggered by the deaths of those companies. However, SCDOs typically have money center banks as a default trigger on the trillions waiting offshore.

The management of these major banks know they can't kill the car companies... but they can destroy their own banks. Then, the SCDO dollars will flow bank into the United States. Where to, you wonder? Well, with the big banks presumably shut down, where else can the money go but into the pockets of the management? We would wager the managers have set up private investment vehicles which have taken the benefit of the SCDO payout off of the banks' books. Think of it as the ultimate golden parachute.

The Problem of Financing the US Federal Debt

There are countless misconceptions about where the money comes from to finance the US Federal Debt. One reads constantly in the financial press something like "the U.S. must have a sound fiscal policy, or the Chinese [or Japanese, or Arabs, etc.] will not fund the deficit." This is actually just silly.

Foreign trade partners have money to invest in US Government debt because they run trade surpluses with the USA. Debt is bought with funds left over after they have bought whatever they might want (if anything) that the USA has to sell them. The amount of debt they buy is incidental to their trading activities. Internal US policy (interest rates, inflation rates) has little impact on the process.

For a while it was a great deal for citizens of the USA. They got to buy stuff from abroad, and when the money was recycled back to the Federal Government, they got to spend it again! Things are changing, though. Foreign trade surpluses with the US are crashing. This is because foreign trade is crashing (see a previous post).

The U.S. Federal Government (and indeed any national government that has been running chronic trade deficits) will be losing a critical source of funding in the years ahead as international trade declines. It is highly unlikely that interest rates will be raised to attract funds as this would exacerbate the economic contraction. Instead, the loss of recycled trade deficits will be made up for by just that much more 'printing'.

As we have been hinting darkly, the USA is coming to the point where its economy simply cannot service the debt load it has placed upon itself. Given the way policy has been going lately, the outcome will be the quasi-default of runaway inflation.

Twilight of the United States?

We've been reading quite a bit recently about the U.S.S.R. Morbid curiosity? Perhaps, dear Reader, but not without an ulterior motive: Soviet Russia was the last major, industrialised nation to have a catastrophic meltdown. That's not to say we necessarily expect such a thing to happen here... but it's wishful thinking to say 'it can't happen' in the United States, or the United Kingdom, or the Eurozone, et cetera.

Such comparisons are not without their merit, especially as the government spending of the United States and United Kingdom are becoming ever-larger percentages of those nations' respective national economies. Large percentages of government spending in GDP are hallmarks of socialism... but if the government is the entirety of the economy, that's soviet socialism.

This potential transition is seen in moves like the U.K. nationalising the Royal Bank of Scotland, or the U.S. taking over Fannie Mae and Freddie Mac. Quantitative easing and monetisation of debt can bee seen as further steps towards sovietism. Perhaps the final nail in that coffin is the comment by Dmitry Orlov, that President Obama is America's Gorbachev. Mr. Orlov is a smart man, and he saw the post-Soviet collapse first-hand. We take him seriously.

The Scale of the Crash

Yesterday, Japan reported a 35 percent drop in exports from a year ago. This, coupled with the stock market crash, the housing market crash, millions around the world becoming newly unemployed each week, gives one a pretty clear sense that the world economy has fallen off a cliff.

The world has clearly not only entered a depression, but a great depression. Time will tell if it is worse than the 1929-1939 Depression. In any case, things are bad and getting worse.

In a previous post we said, "A halving of income for citizens of the 'Developed Countries' may well be baked into the cake by now." We ought not to have been so provisional. It is almost certain that incomes will be falling on this order. The question arises: will they fall further?

Unfortunately, the answer is probably Yes. It appears the whole credit-based model of economic activity is suffering a fatal, or near-fatal crisis. Remember, gentle readers, the financial architects of the global system gave us an economy that can only grow when people and organisations borrow and spend. When the borrowing stops, the growth stops.

Unfortunately for the model, at present borrowing can no longer grow. Incomes and revenues are falling, so debt burdens are becoming more onerous to households, businesses, and governments alike. Dropping interest rates to near zero is little help since the principal payments alone are the culprit.

Defaults do little to help the situation as they shock and injure the investors. It is looking more and more like gradual monetisation of debt and resultant inflation will be the only way out in the short term. That will be a frying-pan-to-fire operation, though. It will probably take a bit more time for leaders to employ that strategy effectively, as they hope against hope that the economy will fix itself (via consumer attitude adjustments perhaps?), or in response to feeble 'stimulus' programs.

In the meantime folks, prepare for the worst and hope the storm passes quickly.

Welcome to Futility, Mr. President

Now that President Obama has enjoyed the first day of the next four years of his life, we would like to take stock of the situation. In one fell swoop he has inherited a blown-out national economy, a global credit crisis of biblical proportions, two desultory wars of occupation, and the thankless task of fixing everything. No pressure, sir, no pressure.

Since it seems that a mass delusion has gripped many people across the globe, we feel it is our duty to break the bad news: President Obama will not make good on his bright, shining future. He is many things, this is true, but he is not a miracle worker. He is, first and foremost, a politician, and politicians can always be trusted to not be trustworthy.

All that said, he probably does realise the enormity of what is expected of him: 'fixing' the United States' economy, and indeed the world's economy. However, 'fixing' entails choosing some serious, mind-altering pain. He strike us as the sadomasochistic type of a different breed, to be honest, so we doubt he will do anything helpful. Instead, he will put the Citizenry of the U.S. -- not to mention other nations of the world -- through an entirely different, and worse sort of pain.

In the grand scale of things, we truly feel that the 2007 Depression is going to be far more painful than the 1929 Depression. At the same time, President Obama is not the Franklin Roosevelt of the 21st Century. He is, instead, the Herbert Hoover: the 2007 Depression has only just gotten started, and it's all downhill from here.

Good luck, President Obama.

Caution versus Confidence

Sometimes caution is a virtue. When things are going from bad to worse, one does not want to embark on boondoggles. Resources need to be conserved for redeployment in better times.

One of the functions of money historically is its use as a store of value. When prices are low enough that the desire for a good deal overcomes the fear of loss, money is pulled out of hoarding. In 1933, US President Roosevelt signed an Executive Order "forbidding the Hoarding of Gold Coin, Gold Bullion, and Gold Certificates." Evidently, Mr. Roosevelt decided that by forcing money out of hoarding, the same happy result would occur as if the money had come out of hoarding voluntarily.

We believe this was a critical error of judgment, and a factor which prevented the cure of some critical failings in the US (and indeed world) economic systems which caused the 1929-1939 Depression. We agree with the Austrian school of economics theory that excessive credit expansions are the primary cause of depressions. The excesses of these expansions are worked out primarily by a dissolving of the banking system and a subsequent reboot, so to speak. The policies of the Hoover, Roosevelt, Bush II, and now Obama administrations (and their international counterparts) did not allow the liquidation of the banking system. On the contrary, the popular solution to the depressionary stress is rescue of the failed banking system and further expansion of credit.

Classically, metallic money has acted as a brake upon credit expansion. In the Great Depression of 1929-1939 this brake became an inconvenience and was discarded. Since then, the world economy has been riding a runaway train of credit expansion. Sooner or later (and we vote for sooner), it will come off the tracks when spurious 'investments' do not produce intended yields.

Is the 2007 Depression then 'the big one'? It will be if world leaders decide to void the world's paper money supply of what little store-of-value-ness it has left. Zero percent interest rates and debt monetisation (both in progress) are a good start in that direction. Seeing their money become nothing other than something to spend, the world's citizens will dutifully spend away and the greatest crack-up boom ever will ensue, followed by the inevitable hyperinflationary catastrophe.

We would like to hope some other scenario is possible, but it seems less likely by the day.

Tragedy, or Farce?

With the latest joke rolling out of the Zimbabwe Central Bank, we wonder why such ridiculousness is able to thrive so long. In all honest, we feel that a $100 trillion note is probably Farce, but we really cannot be certain.

The history of Zimbabwe is most definitely one of Tragedy: a nation in continual economic collapse, aided and abetted by non-stop embargoes brought on by the United Kingdom and the United Nations, among others. The fine, upstanding governments of the world really know how to dole out "change," don't they?

It seems in history that every Tragedy has a correlating, and larger, Farce. In this case, the Farce is the embargoers -- the United States, the United Kingdom, the European Union -- following in the footsteps of the Tragedy they helped create. Many policies, such as price controls and rapid expansion of national money supply, have been well-tested by Zimbabwe's central bank.

In the flaming tailspin of the 2007 Depression, this collection of nations are flirting with the very same financial policies that Gideon Gono used to make Zimbabwe's hyperinflation-from-Hell. As the Wikipedia article notes, perhaps ironically, Mr. Gono is a "proved deflation-fighter." Mr. Bernanke, of the Federal Reserve, M. Trichet of the European Central Bank, and the Rt. Hon. Mr. Darling of the Bank of England are all working to fight deflation, as well.

They might not have noticed, but they're following in the footsteps of a failed nation.

Warren Buffett and the Fear

Oh come on! Can Warren Buffett be serious? Fear is what is causing the Depression?

Mr. Buffett was interviewed recently and according to the report:

Buffett said Americans are in a cycle of fear, "which leads to people not wanting to spend and not wanting to make investments, and that leads to more fear. We'll break out of it. It takes time."

Mr. Buffett is not stupid, and we certainly hope not senile. Is this then just the new Administration party line? (Just to clarify, Mr. Buffett is an adviser to the US president-elect. ) Is Mr. Obama going to serve us warmed over "We have nothing to fear but fear itself" pablum?

OK, people: the world economy is not falling apart because Mr. and Ms. Average suddenly got the heebie-jeebies. There was a massive CREDIT BUBBLE that exploded and sent trillions upon trillions of dollars, euros, pounds, and yen to money heaven. Mr. Buffett knows this, by the way, as he coined the term 'weapons of mass financial destruction' to describe banks' use of derivatives.

The world could use a little honesty here. Mr. Buffett is proving very disappointing in this department. We suspect more disappointment will follow.

Keynesianism Can't Save the Economy

As TIME magazine has noted, "we are all Keynesians"... again. Mr. Keynes has certainly made quite the comeback from the graveyard, and his reanimated fingers are slipping back into the modern economic pie. This is taken as a 'good thing,' a point which we won't belabour. However, if the shuffling zombie of Mr. Keynes were able to take stock of his economic surroundings, he might notice things are a little different now, than in the 1930's.

In 1930, according to usgovernmentspending.com, the United States government's direct spending was 13.22% of the national economy, up from 11.29% the year before. By 1939, at the bottom of the 1929 Depression, government spending was 20.66% of GDP. Not a whole lot by today's standards, as 2008 saw direct spending of 36.59% (guesstimated on the site), but about double the percentage of 1929. Doubling government spending was indeed a shock at the time.

As a vignette of Mr. Keynes makes clear, shock value was very important to him. He was all-around an economic shock jock, as his disciple Paul Krugman puts plainly. Shock is what makes Keynesianism work: the shock of a sudden expansion of government spending in the private economy.

We seem to remember a quote from President-elect Obama (although we cannot remember the source) stating that whatever Mr. Krugman wants, Mr. Krugman will get. He's the Nobel laureate, after all... and he's screaming, "spend!"

Right now, though, the so-called 'economy' of the United States is already about 40% government spending. The "jump-start" effect that Keynesianism looks for may require a doubling of government spending in an economy. At the same time, the United States economy is shrinking rapidly... so the end result of a proper Keynesian shock could leave the U.S. government as 100% of the economy, give or take.

Does this new Congress, or the President-elect, or both, have the political will to turn this country into a new Soviet Union? We truly do not know, but if the economy became the government's, the United States would be as Red as Red could be.

Peak Population

There is fair amount of writing available about humanity's date with 'die-off', and although this is a possibility for the world, we believe a much gentler scenario will bring about a gradual decline in human numbers. It is not a particularly happy scenario though.

We agree with Dr. Virginia Abernethy's theory that it is anticipation of prosperity that causes people to choose to have many children, and concerns of hardship that cause them to limit their reproducing.

In the coming years, as the 2007 Depression deepens, many will come to realise they simply cannot afford children. Most potential parents will see dimmer prospects for themselves, less generosity from relatives, less aid from governments and social service organisations. In poorer countries, their will be less charitable aid coming in, and starvation will become more common.

It will take some time for real population restraint to take hold. Many people will continue to have children expecting the economy to 'turn around'. Efforts to limit migration from poorer countries to richer ones will build only gradually. Recognition that the world's economic landscape has changed will come only long after the fact.

But nevertheless, we expect to see noticeable changes in birthrates in the next few years. Many nations are already at below-replacement birth rates and rely on immigration to maintain their populations (if possible). Most of these nations' governments view this situation as a bad thing and have generous welfare programs to encourage childbearing. We expect steadily more nations to join the club of 'sub-replacement fertility' in spite of ever more shrill complaints about 'demographic collapse'.

We are not of the opinion that declining population in itself is necessarily a bad thing. In any case, it is an appropriate response to a deteriorating economic outlook.

Don't Buy a New World Map Anytime Soon

Due to circumstances beyond our control (i.e. we screwed up), we regrettably did not post yesterday. Rest assured that those responsible for this travesty have had their dessert privileges revoked.

With the increasing potency of the 2007 Depression shaking the starch out of the world economy, a surprising amount of dirt is presenting itself. Take Bernard Madoff, whose nimble fingers seems to have found every pie. But in this game of musical chairs, it won't be just individuals and organisations which end up with no chair beneath their tush. With the global implications of this depression, we expect some nations will be among those looking stupid when the music stops.

Take the obvious, our favourite whipping-boy for all things hyperinflationary: Zimbabwe. With several name-changes behind it in the recent past, this much-embargoed country may be due for another. There are also the faux nations of Somalia and Yemen, where the 'official' government draws lines on a map of where they'd like their sphere of influence to be.

However, the bigger threats, at least according to the United States military, are Pakistan and Mexico. Neither nations are the paragons of stability, as both are wraked with violent resistance against the central government: Pakistan is fighting 'The Terrorist'; Mexico has lost chunks of Chiapas to the Zapatistas. Mexico is also facing the collapse of their Cantarell oil field (which suffered a 36% drop in 2008 production alone), upon which the government is heavily dependent for its budget.

A facet of world events we've been missing for a while is the novelty of a brand-new world map. Our only wall-sized map, for instance, still has the U.S.S.R. on it. And just when we were beginning to think about getting a new one, the whole world goes into a depression. Thank heavens, we say: now we have an excuse to not get a new map!

The Severity of the Situation

Recently an aid to the Saudi Arabian oil ministry stated oil demand may fall 23% to 45%. This is a startlingly candid figure coming from a rather conservative and secretive organisation. If oil demand is falling that much, economic activity as a whole is pretty much falling on par, and the 2007 Depression will become more like Great Depression II, if not the Greatest Depression Ever.

On the other hand, Saudi Arabia is known for its disinformation campaigns. All the while oil was rising from $30 a barrel to $140, Saudi Arabia said "we have plenty of oil at lower prices, it's just that no one wants to buy it." The present situation could be that the Saudis are now recognising the long-predicted collapse of their oil production is now imminent. What better way to cover up their declining production potential than to say "no one wants it."

This in itself would be bad news, of course. It would be more evidence of the certainty of peak oil, and the tremendous difficulty that would present to the world's economies.

A halving of income for citizens of the 'Developed Countries' may well be baked into the cake by now - whether the drop in oil production is cause or effect. It is not a pretty thought, but it would be best to plan for some pretty tough times ahead. Most predictions from mainstream media should be discounted, as they will be attempting not to sound alarmist. Pollyannish advice such as "it's never been a better time to buy real estate," or "the current recession is a bump in the road to greater prosperity" should be seen as a quick route to financial suicide.

The growth paradigm of the past few centuries is over. While up until recently, recession and depression were interruptions of chronic growth; for the foreseeable future, spurts of growth and recovery will be interruptions of chronic collapse. This is quite a change, and at first few will be able to wrap their heads around it. It will turn a lot of rules of thumb upside down.

We are not saying all is doom and gloom. As long as people have the liberty to innovate, the world will adjust to a new (and possibly better) way of doing things. It is possible to live quite well on a 'low throughput' diet. Thrift, conservation, invention and efficiency can deliver a good life on a low budget. On that you can bank.

Dark Clouds over the Eurozone

In a wee little article, Bloomberg released the news that the United Kingdom will not be allowed to join the euro. As a friend of ours noted, the shorter the article, the worse the news. In this case, it means that the European Union is going to let the pound sterling hang in the wind, as it were. This will not be good for the pound, of course. One of the big hopes for the pound was the possibility for exchanging them in for new, shiny euros.

British Parliament, figuring they have nothing to lose, is deliberating on whether or not to loose the dogs of war: quantitative easing. By allowing the Bank of England to delay its reporting of the amount of money it's pumping into the U.K. economy by a month or so. It's not like the Bank knows what it's doing anyway, but this move ensures the pound sterling will die a screaming, hyperinflationary death.

As if to rub salt in and rub sandpaper over the festering wound is this charming piece from the London Times. The action of taxing savings accounts will amount to nothing more but confiscation, a rape of savers in order to 'restore prosperity.' We suppose the mindset is, 'if you won't spend it, we will!'

Although this problem is presently only the United Kingdom's, it is not isolated from the rest of the Eurozone. If it appears that the Bank of England's efforts are working, the rest of the European Union will not be far behind in implementing similar policy. As central bankers are a reactive lot, and not anticipatory, the Eurozone will not see the doom of the pound sterling -- and indeed the euro itself -- until hyperinflation has already murdered the currencies.

The Impact of Government in a Shrinking Economy

Volumes have been written on the effect of government spending on economic growth. Observers of nearly all political persuasions (anarchists and totalitarian communists aside), believe there is an optimum point of government involvement in an economy. An economist by the name of Richard Rahn came up with his eponymous curve which attempts to use empirical data to plot growth rates in GDP versus government spending as a share of GDP. Unfortunately, Mr. Rahn's methodology's scientific efficacy is debatable, but it is intuitively obvious that there must be some point of optimum (if it isn't intuitively obvious consider this: in a state where there is virtually no government spending, economies collapse as crime and piracy run rampant - e.g. Somalia; and when government makes virtually all the economic decisions you end up with another kind of failed economy - e.g. the Soviet Union).

All other things being equal, the spending of governments would tend to fall along with the economy in the 2007 Depression. As income declines, so do tax receipts. States of the USA have to balance their budgets (more or less) and so must cut spending to match the decline of taxes. The US Federal Government (along with most other national governments) has no such restraints, and much is being made at present of how much deficit spending to make to 'help' the economy. Could too much government spending go past the point of 'help' and into 'hurt'? How much of the economy can be in the government's hands without collapse setting in?

The EU government spending as a percent of of GDP has tended around 50%, while by comparison, the USA has tended around 40%. If the OECD economies contract by 50% and government spending does not shrink along with it, the percentages will rise to 100% and 80% respectively. Obviously, this is well past the optimum.

At some point into the 2007 Depression, governments will likely be forced to shrink. This will not be a matter of libertarianism, but of practical economics. Painful choices will be made, some of them critical. Health care, education, national defense, police, fire departments, food stamps, pensions? Where will the axe fall?

We Smell Trouble...

In a previous post we wrote about the looming tidal wave of mind-numbing horror and destruction known as synthetic collateralised debt obligations (SCDO). In that post, we pointed our bony finger at JP Morgan and screeched, "it's them! THEM!"

We still stand by that statement, but this article from CNNMoney.com got us thinking. Citigroup has announced that it will back legislation allowing bankruptcy judges to unilaterally rewrite mortgage terms. This, in effect, means that judges can 'cram-down' the principle of the mortgage, or lower the interest rate on the loan... or both, presumably.

It makes sense, in a way: with house prices on a one-way trip to purgatory, banks' balance sheets will be obliterated as the value of their foreclosed properties approach zero. Citigroup, realising this, decided to cheerfully volunteer itself to be violated by bankruptcy judges, since it seems like the less painful option.

We wonder about that, though. There are trillions of SCDO's floating around in the aether, just waiting for the right company, or companies, to collapse. We're confident JP Morgan has a pretty big piece of the pie... but maybe Citigroup has its own trillion or so, waiting in the wings.

Honestly, dear Reader, we don't know. Perhaps Citigroup is simply making a last-ditch effort to bail itself out. We just have to wonder what the hell it's doing, as this move smells fishy.

Is Medical Care a Necessity or a Luxury?

We do not propose to answer this question on an ethical basis, but on an experimental one. We believe that the 2007 Depression will cut into incomes so severely that social observers may get an answer to the question based on patterns of spending cutbacks.

It is irrelevant whether medical costs are paid out-of-pocket, through insurance schemes, or by a government. In the coming years there are going to be severe budgetary constraints at all levels in society from the household to the United Nations. Whether the decisions are made individually or politically, the issue of whether to spend on medical care is going to loom ever larger.

This also raises the question: if medical spending is to continue, what spending will be sacrificed? Obviously, goods and services which are noncontroversially considered luxuries such as travel, dining out, and entertainment may be first in line to the scaffold. After that, electronic and durable good purchases may be deferred or forgone. Then we are getting into the 'meat and potatoes' - necessities.

The USA has, notoriously, the most expensive and least broadly available health care system in the world. If the same or more money is spent, will the USA become a nation of people metaphorically taking each others' blood pressure? In 2008, Medical spending was 17% of GDP. If GDP falls 50%, will medical spending become 34% of GDP? Or will priorities change?

If the axe falls on medical spending the implications are quite dramatic. Workers and investors in the industry have been used to steady (often lucrative) work, and reliable returns. What will the consequence on consumers be? Will even more Americans find themselves uninsured and without access to anything but the most primitive services?

Many questions...with many answers forthcoming in the years ahead.

In Search of Financial Viagra

We couldn't resist; really, we couldn't. Larry Flynt (founder of Hustler) and Joe Francis (CEO, Girls Gone Wild) have queued up, collective palms up for $5 billion of government bailout money. In an epic fiasco which has reportedly consumed more money than all major wars the United States has ever fought... we can't think of one reason why Messrs. Flynt and Francis shouldn't get their cash.

With adult DVD sales down 22%, one could assume that the adult entertainment industry is indeed experiencing har... difficult... times. But, we're more of the opinion that Messrs. Flynt and Francis are making a wee joke, and -- more importantly -- making a valid point. We quote Mr. Francis:

"...the US government should actively support the adult industry's survival and growth, just as it feels the need to support any other industry cherished by the American people..."

The award for maximum bitchiness, however, goes to Mr. Flynt:

"...everyone and their mother want to be bailed out... the porn industry has been hurt by the downturn like everyone else and they are going to ask for the $5 billion. Is it the most serious thing in the world? Is it going to make the lives of Americans better if it happens? It is not for them to determine."

Well, think of Mr. Flynt what you will, but we have to admit he's got a sense of humour.

Growth: Quantitative versus Qualitative

For the purposes of this discussion, Quantitative growth in business or society could be said to be just doing more of the same thing with more people and machines or whatever. Qualitative growth is doing a given task more efficiently, or developing more valuable products and services from less valuable ones.

When economies are expanding, quantitative growth will usually yield impressive growth of sales, and profits. For society as a whole, there is increased economic activity, increased tax revenue for governments, and increased income for investors and workers.

Qualitative growth tends to happen more slowly. It comes about through innovations. Sometimes it happens as continuous incremental improvement, or sometimes as flashes of inspiration.

There has been a lot of quantitative growth in the world over the last several hundred years, and especially over the last fifty. We believe this trend is transient, and largely the consequence of the exploitation of fossil fuels and mineral resources. As society glides down the slope past peak just-about-everything, quantitative growth and the economic theories which justified it will become a thing of the past.

On the other hand, qualitative growth seems to spring from the human spirit and will probably rise to the occasion of being more needed than ever as the product of the bowels of the earth are exhausted. On this count we are very optimistic. From what we have seen of ingenuity in ourselves and others, this is an inexhaustible resource.

To allow qualitative growth to become humanity's primary economic driver, several changes will have to happen to the way people look at their lives: First, they will not measure themselves by how much they consume, but rather by how well they do things. Second, they will have to let go of always wanting more and different, and instead learn to be satisfied with making the best of what they have, with only a small allowance for novelty. Third, they will have to learn to practice restraint.

It seems to be human instinct to "be fruitful and multiply." Unfortunately, the human race seems to be multiplying itself into overshoot and collapse. People need to realise that humans can either shrink their numbers gracefully, or have the natural limits of the Earth do it for them painfully. In not many years time, much of what was once termed progress will be seen to have been a swindle - an orgy of consumption and resource extermination that benefited only a tiny minority of plutocrats and left the rest with broken illusions.

Pay Now or Forever Hold Your Peace

In previous posts, we and our co-writer have argued that housing values will make a serious face-plant on the road ahead (see this article, and this one as well). Put concisely, just about any mortgaged house in the United States, and indeed the world, will end up 'under water' in the near term (i.e. the mortgage is for more than the house is 'worth').

We turn at this point to the Washington Post, which has an article about Ms. Elizabeth Small. Although the article does not make it clear, she's probably worth around $1.5 million or so... until recently, that is. Now, she has lost $1 million since 2000, including $200,000 since April 2008. She can no longer afford to pay her mortgage payments and living expenses off of her investment income, and Social Security -- surprise! -- doesn't provide all that much security, after all.

To defend her dwindling capital base, she reported she was looking into certificates of deposit, or bonds. Last we checked, both those 'investments' were paying 0%... Her course of action -- which quoted professional money managers didn't even think to recommend -- should be to either pay off her mortgage, or walk away from her house. Ms. Small, we think, is in a situation similar to other people: she's not taking the best step of all, which is to pay off debt, or default.

We suspect the monetary powers-that-be will attempt to rescue people like Ms. Small with hyperinflation. Hyperinflation will reduce the value of the mortgage payments (or perhaps even the mortgage itself) to meaninglessness; say, a caramel macchiato, with an extra shot of espresso. However, the benefits of the debauch of the currency will only accrue to those who can maintain their income, and have it go up roughly in lockstep with the rate of inflation. Needless to say, it would be a Pyrrhic victory to those few who pull it off. We regret to inform Ms. Small that she will not be one of them.

The Doom of Air Transport

One or both of two things is going to happen in the very near future: kerosene is going to become a lot more dear as light, sweet crude fades away to the specialty corner of refiners' crude oil menus; and most of the people now flying or sending cargo by air will become too poor to afford the luxury.

The implications of this are devastating for a huge chunk of the developed world's economy. Aside from the airline and airport industry, the pain will be felt most acutely in regions dependent on air tourism, and airplane building.

According to the Boeing company, air travel has been growing even faster than World GDP. When World GDP shrinks as we expect, air travel can be expected to shrink much, much faster as GDP shrinkage will likely be skewed towards OECD countries who are the primary users of air travel.

Losses can be expected to pervasive and vast. Airports themselves represent hundreds of billions (maybe trillions) of dollars of sunk capital. That capital supports a great quantity of municipal bonds, and the income of investors who depend on them. The collapse of air transport should prove quite a bit more economically disruptive than the failures the 2007 Depression to date, even including the likely end of the 'Big 3' auto makers.

Of course, it will all come as a 'surprise', and 'No one saw this coming,' will again be the refrain. We wish we could say, "You read it here first, folks," but people have been warning about the demise of air travel for decades. If these Cassandras had been listened to, the USA would still have a decent passenger rail system.

It's a good thing boats use the left-overs from refining oil...

Wal-Mart and Fixed Costs

We're pleased to announce we've started blogging on the Curmudgeon Report. As the name would suggest, we will use that blog to rant. Probably loudly. Comments are appreciated and invited, as they are on all our blogs.

The previous post of our co-writer got us thinking today, while we partook of services at the Church of the Consumer. Namely, we went shopping in the local Wal-Mart. Looking around, at the ruts developing in the floor, the tears in the linoleum, the spotty supply of cooking oil... we asked ourselves: how will Wal-Mart last?

Yes, we are fully aware that many have been calling for the death of Wal-Mart. In our reading experience, these run along energy-availability arguments, such as the arguments of James Kunstler. We don't dispute what Mr. Kunstler says, but we don't believe that Wal-Mart necessarily has to go under. In our estimation, it's an excellent company with a brilliant business scheme.

But, at the same time, we are certain that any one regular Wal-Mart store -- much less a Supercentre -- represents enormous fixed costs. Electricity, heating, maintaining, and cleaning the store; transportation of inventory and stocking; none of which are exactly cheap.

We fully believe that the economy in the United States is going down 50%-75%, followed (we hope) by a long, slow recovery. With this catastrophic drop in economic activity, we doubt Wal-Mart will be able to continue to serve the 25,000 or so population area. We suspect only places of 100,000 persons and up will be able to support a store. That, of course, means a lot of Wal-Marts are going to be closing... probably even the one in our town.

The Problem of Economising and Sunk Costs

Today's post may seem a bit technical, but it has everything to do with day-to-day decisions for ordinary people.

This subject came up for us when we were trying to think about ways to save on our phone bill. We pay a fixed charge for our phone service. It is the cheapest plan we can get. We never use all the minutes we are allotted, and if we talk evenings and weekends we can jabber on endlessly if we choose to.

Why is the economic system set up to provide an incentive to consume as much as possible? It is because the cost of much of what we consume is largely in the physical plant and not in the material processed or delivered. For telephone, most of the cost is in sending up all those satellites,laying all that cable, setting up the switching networks, and building those towers. Once the infrastructure is built, servicing and maintaining it all is not as costly. Utility companies recover their fixed, or sunk costs by charging customer fees to be hooked into the network, not so much for their usage of photons, water molecules or whatever. Another way this plays out is in property taxes for municipal services. People do not pay for fire, police, or streets on a per use basis.

A problem arises when one is trying to economise, and one hits the floor cost of a service. With telephone service, we can go to a pay-per-call plan. That option is not available for water, electricity, natural gas. If all you want is a little bit of light or heat, it may well be cheaper to burn kerosene for light and for heat, because it does not require an expensive, special distribution pipeline right to your door. What happens if a lot of people, on account of poverty, drop out of the utility system? That forces up the the connection fees to the remaining users and prompts more drop outs. An adverse positive feedback loop (vicious cycle) is engendered, threatening the very existence of the service.

We suspect such a dynamic will soon be at work in many areas. Highways in particular come to mind. The USA has 4 million miles (6.4 million kilometres) of roads and streets. Even at a conservative estimate of the average cost at $3,000,000 per mile, this assigns a value of $12 trillion to the country's public pavement - on par with the value of all publicly traded companies, or an entire year of GDP. As people begin to abandon their automobiles en masse, who will pay for the hefty annual maintenance of this vast piece of capital? Will mileage rates replace gasoline taxes as the State of Oregon is contemplating? Can property taxes on depreciating property cover street costs? Will general taxes be dubiously and destructively allocated to an obsolescing technology? (Answer: yes - see car maker bailout and Obama infrastructure plan).

Streets are arguably necessary, and will continue to be funded in some form or another as long as humans are civilised. Roads on the other hand, are almost certain to gradually fade away as people relearn to transport themselves and their stuff mostly on navigable waterways. Water transportation, though slow, is and always has been the cheapest, so we may as well plan for it.

Read the Handwriting on the Wall

One of the things we find amazing, at least in the area of economic depression, is how easily things can be explained away. The pieces are all there, but the dog ate the box and no one wants to put the pieces together. We can sympathise -- it looks pretty scary -- but we can't help but feel that seems like sticking one's head in the sand and hoping the volcano isn't, in fact, erupting.

For instance, in the Autumn of 2007 we were driving through a good chunk of the United States. At one point, we remarked to our partner that the number of cars in the road had fallen off a cliff. A few weeks later, the owner of a coffee shop we frequented said to us, that business was doing okay... even though the country was in a recession. We nodded sagely in agreement; we had seen evidence of the truth of his words. But guess what we didn't do, dear Reader? Even though we thought we saw the writing on the wall, we didn't start planning for recession.

Now, however, we're paying a bit more attention, especially to articles like this one from Reuters U.K., which paints a grim picture of a 55% drop in commercial loan issuance. Although good data seems to be impossible to find, we feel confident in saying that bank lending strongly supports the U.S. economy. How much, we can't say, but with a 55% drop-off in commercial loan issuance by banks... even the Wizard of Oz couldn't prevent the United States economy from contracting significantly this year.

How much, we don't know. Singapore has slid 12.5% year-over-year, but we have a suspicion it will be worse in the United States, and other economically weak nations. How are we responding to the signs now? We're preparing.

Getting from the R-Word to the D-Word

As the economic news gets worse and worse in the coming months, one can expect to see quite a bit of tip-toeing around the deterioration. In a world that rewards the positive thinker, it's just not hip to be gloomy. On the other hand, in order to be truly optimistic (making the best of any situation) and not just indulging in wishful-thinking, it is important to have a good grasp of reality. We maintain that it many respects this is not a very happy new year, and a view that acknowledges that is more reality-based.

So, here's our short list of New Year's Resolutions of general, good advice:

1. Do not take advantage of teaser-rate financing to buy a new car. If you absolutely must have a car, and need another one, for heaven's sake get a used one! There are plenty out there. Pay cash.

2. Be very cautious about buying housing. Buy the smallest house you can manage in. This is the opposite of real estate agents' advice. What makes sense in a rising market does not in a falling one. This market is still falling and will fall for a while yet. Pay cash. If you can't pay cash, and you think owning on a mortgage is cheaper than renting, rent a smaller place.

3. There is absolutely only one reason to borrow money: to pay back an existing loan, and lock in a lower rate. This will be a good year for mortgage refinancing.

4. Think about how you will get by if you lose your main source of income. Then think about how you will get by if you lose your second source of income too. Do not despair, just have a plan. It's not a happy thing, we know. It's a good year to plan and budget. Learn to prove wrong the adage: "budgets don't work."

5. Let 2009 be the year you learn to enjoy being frugal. And remember the best things in life are free!

Year of Our Depression 2009

As the calendar rolls over to 2009, we can smell the vodka on the collective breath of the nervous, the confused, and the despondent. The faux conviviality of eggnog additive long dispensed with, only straight shots will suffice for those who still have money. Only the deluded, the broke, and the swindlers can party with a clear consciousness: they have nothing to worry about. "What, me worry?" they seem to say, in a horrifying parody of Alfred E. Newman prose.

We worry, since we see nothing getting better, and a storm cloud of uncertain destructive qualities approaching in February. Deeper into the year, there are the looming predictions of, among other things, the demise of the U.S. Dollar. We take these things seriously, as the downward pressure on economic activity becomes ever more irresistible.

We are hesitant to make any specific predictions for 2009, other than the obvious: more bailouts. If you, dear Reader, think that you've seen the most disgusting, repugnant, out-of-control 'gimmie-gimmie'... think again. People will whine for bailouts; people will whine for 'tax rebates;' people will whine for free money of any sort for any excuse whatsoever. To put it simply, 2009 will be the Year of the Whiner.

On top of vast seas of whining, whining, whining will be the continued blow-out of swindles. Remember Bernard Madoff? In the world of the swindle, he was a loser and a screw-up. Why? He went down first. As John Kenneth Galbraith once sagely noted, "the biggest and best swindlers are not discovered until last."

Madoff was not the biggest, nor the best; he was just the weakest hand. We have pretty good ideas of who the 'biggest and best' are, but we don't expect them to fail... this year. But, there will be blow-outs spectacular of presently well-regarded 'enterprises,' which will be revealed as having been the walking dead.