A Depression Trajectory

As a sort of follow-up to yesterday's post, we will muse a bit on how much world GDP decline to expect to this Depression.

One assumption that we are making is that over the next twenty years or so, fossil fuels will become too expensive to use very much as... well, fuel. The world is not going to run out of oil, gas, or high quality coal - but their fuel use will mostly be limited to its highest ends (i.e., not for mass private cars, heat, or electricity). In the post-fuel hydrocarbon era, much of the remaining supply will be used for non-fuel uses such as fertiliser, plastics, and specialty chemicals.

Its a rather uncertain thing modelling collapse, but it is not unreasonable to say that hydrocarbon production may decline 90% or so in the next 20 years. That may seem outrageous, but many people like ourselves who make a study of this matter are arriving at similar conclusions. Consider this recent post at The Oil Drum. It's a bit technical, but Figure 3 is worth a thousand words.

As every schoolchild knows, or at least ought to know, the industrial economy grows or shrinks with the supply of fuel. If fuel production declines 90%, the economy will fall by a similar amount. There will be efficiency, nuclear power, solar power, hydropower, and many other ways to mitigate the loss of energy available to society - hopefully enough to keep things civilised. And once Civilisation has weaned itself off fossil fuel, economic growth just may well resume from a new, low base and at a slower rate.

We believe an energy-intensive economy such as the USA's will experience roughly a 90% decline over the next 20 years. At the end of the Depression, per-capita income is likely to be in the neighborhood of $5,000 a year in current dollars.

We suggest the Reader consider what life might be like for them on such an income, or a bit more or less - depending on their skill level. Also to consider what sort of means they would have to produce any income in a world where most people can afford very little beyond the basics of food and shelter.

It will be very difficult to hope that investment capital will produce much income. Which industries will even survive this depression? Virtually all bonds are sure to default, including government ones - either directly or through inflation. Successful investors will likely be the active, hands-on sort.

To earn income will require being involved with a surviving industry, such as agriculture. Otherwise you will need to become entrepreneurial, and hard-working. Though challenging, the changes ahead are manageable - as long as you keep a positive outlook.

Recovery and Mobility

In order for any kind of recovery to arise out of this Depression, workers must have the mobility to move to where the jobs are. The housing crash in the USA and policy response to it is impeding this necessary step.

In areas where jobs are vanishing, housing prices are falling as well. Many owners, whose houses are worth less than the mortgages, who can still afford their housing payments feel trapped in their houses because to sell would mean bringing cash to the close. They feel unable to move to areas where job prospects are better.

Government efforts to "keep people in their homes" are misguided for this reason as well. It is little benefit to a person to keep him in his house when his long term economic prospects are poor in that locale.

We propose as a better policy and an aid to stuck property owners a system of municipally-owned housing trusts to take title to physically sound, but financially impaired, properties. The former owners would formally lose their equity (the market has already taken the value away) but with out the negative credit event associated with default, and banks would accept conversion of their mortgages into municipal bonds secured by the properties. The former owners would then have the option to continue renting their homes at market rates, or move on to greener pastures.

Another Face of Predatory Finance

In a previous post, we wrote about synthetic CDOs, the multi-trillion-dollar ticking time-bomb of financial doom. Those SCDOs are still out there in the financial aether, waiting for the right set of companies to go bankrupt, so that they may transfer an unknown, but vast, amount of money to major American banks.

This is predatory finance at its finest: create an 'asset' which has no basis in realty, hoodwink investors into believing the monster is a bond, set up a holding company in the Cayman Islands with a used office chair for collateral... and then wait. Sooner or later, the companies which trigger the SCDOs (General Motors, American Insurance Group, Fannie Mae, el al) will implode, and gift to the sponsoring banks a huge bag of money.

There's another tool of predatory capitalism we've just found: negative-basis trade. Bloomberg has a good article about the subject, but we'll summarise. A bond-holder of a failing company -- say, Ford -- can purchase a credit default swap for their bonds, to insure against Ford going bankrupt. If Ford did indeed go bankrupt, the bond-holder would be reimbursed the full face value of their bonds, rather than what the market says the bond is worth.

With Ford dying of carbon monoxide poisoning as we type, it's looking more attractive to these negative-basis trading bond-holders to simply force Ford into bankruptcy. That way, the bonds will pay out their full face value, rather than the understandibly depressed value seen in the bond market.

Negative-basis trading is, above all, a tool of financial assassination: it allows holders of significant amounts of bonds to obstruct a company's reorganisation and force the company into bankruptcy. Investors who make their money in this manner have every interest in forcing as many companies -- no matter what the potential for recovery -- into bankruptcy. This is horrifically destructive to the economy: first and foremost, it is cannibalism; secondly, it is seriously damaging the economy's capacity to form investment capital for productive ventures.

On top of it all, this is the Golden Bullet for any and all banks waiting for their SCDOs to activate. With negative-basis trading, a bank can efficiently and legally 'kill' any and all companies which need to fail in order to trigger the $50+ trillion in SCDOs. It's akin to taking out jumbo life insurance policies on one's neighbours... and then killing them.

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.

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.