The Real Deal

A recent letter to SurvivalBlog.com shows that at least one person out there has his or her head screwed on mostly right. The conclusions, unfortunately as is typical on that site, run toward the 'get your guns' mentality. However, the honest and intelligent observations are worth quoting at length.

The economy has taken a dramatic turn for the worse for many Americans. Hundreds of pages could be written to describe how it happened and who did it. While many individuals and households have had the financial resources and good fortune which will allow them to weather economic uncertainty, many will simply not be able to maintain their standard of living. Many two income households are now one income households and that income may have decreased due to companies cutting back on work hours. This situation has been occurring for many Americans for many many months, forcing people to assess what is important and downgrade their lifestyle. The time to make hard decisions has arrived, and will dramatically alter the lives of many for years.

People who relied on spouses to pay the bills are now paying the bills. Those who have relied on savings and unemployment benefits to maintain their standard of living are now faced with the reality that those resources are exhausted. Bills are not being paid. Healthcare premiums are not being paid. Automobile and household maintenance is being neglected which will create costlier repairs down the road. Simply put:

• You might have to stop making your car payment and save those payments up to buy a used car. The car you currently have financed will be repossessed.
• You might have to stop paying your mortgage and save those payments up to move into an apartment.
• You might have to give up your healthcare, your magazine subscription, your club membership, your vacation plans, your charitable donations, your cell phone, your internet access or home phone service, your lawn care service, your financial support that you provide to friends and family who are having financial problems themselves, and many more expenditures not listed here.
• You might have to contact an attorney to discuss bankruptcy.
• You might have to sell off your possessions and assets.
• You might have to move in with other families, friends, relatives, or shelters provided by the government or charitable organizations.
• You may come to realize that what you thought was valuable and important to you has no value or significance at all.

Basic human needs will become the biggest priority in your life after you shed the things that have merely brought comfort and convenience to you. You may be forced to downscale your lifestyle so dramatically that it will cause you to question your own intelligence and hindsight for not planning for such a life changing event.

We have a few comments to make on these observations. First, in light of how little access to emergency funds American (among other) households have as mentioned in yesterday's post, deferring maintenance on houses and cars is a species of financial brinkmanship that will not only require "costlier repairs down the road," but quite possibly become the 'straw that breaks the camel's back' of the impaired household finances.

As for having a car, our addition would be that you may find yourself needing to set up a living situation that doesn't require you to own a car - either sharing a car with a relative or friend, or walking and/or using public transit.

As these strategies for downward mobility become increasingly utilised, they will cause GDP to decline. Not only will demand for goods and services shrink, but the informal market (yard sales, thrift stores, eBay, etc.) will become flooded with cheap, liquidated stuff. We expect this strategy to be employed eventually by a majority of the population as the Depression runs its course and cascading failure undermines the economic system.

We find it a sad commentary on the state of 'the Press' that such an honest report can only be found in a 'fringe blog' and beyond that, as a letter. The Ministry of Truth does seem to have a lockdown on the situation. Telling information can be found, however, if you look for it. According to a recent Gallup poll, November year-over-year consumer spending is down 20%. This is a knock-your-socks-off, the-economy-is-in-a-Depression-folks number if there ever was one. The report qualifies its information as "self-reported" but even so, it seems a heck of lot more reliable to us than the bogus recovery spiel coming out of the Ministry of Truth.

Pathetically, the Gallup commentary states: "On a national level, the spending new normal suggests slower economic growth than otherwise might be expected in the years ahead." Let's take a look at 'economic growth' in the USA at present.

According to the Bureau of Economic Analysis, the growth rate is 2.8% in the third quarter of 2009. Consumer spending allegedly increased 2.9%. In order for the approximately -25% gleaned from Gallup data and the official +2.9% to reconcile, households would have to wildly increase their spending for housing (hard to do in the face of lower rents, skipped mortgage payments, and household formation gone into reverse), professional services (bankruptcy lawyers, anyone?), and so forth. Frankly, we don't think such a reconciliation is possible, and we smell a R-A-T.

October Credit Card Collapse Report

It has been a while since we provided an update to the story of the great credit-card pay-down. According to Federal Reserve data on US household revolving debt, consumer revolving loan (mostly credit cards) balances have declined 9.17% from year-end 2008 through August. This represents an annual rate of - 14%.

Given the high credit card delinquency rates lenders are suffering (5% at last report), much of this balance decline can probably be chalked up to charge-offs. This implies households are not (contrary to popular opinion) actually paying down their debts to any great degree. In the aggregate, non-defaulting households are actually only gradually reducing their debt level. Since we have direct knowledge that at least some people really are paying down their debts furiously, this means others are getting in deeper.

The tenacity of the credit card balances could offer alternate interpretations. It is possible that household finances are in OK shape, and that people are confident about their prospects for the future. On the other hand, it could be that many, many people are desperate for funds to pay the bills, and thus borrowing (instead of cutting spending) in the face of declining income.

Since we opine that we are in a Depression - one of the defining characteristics of which is declining income, we favour the second interpretation. If true, this bodes very ill for the profligate households, and not so good for the rest of us in the months ahead.

Why Aren't Savings Rates Moving Even Higher?

From the last quarter of 2008 to the first quarter of 2009, the USA personal savings rate went up from just over 3% annualised to just over 4%. This movement is expected during economic decline, but we are asking the question: given how severe the decline is, why aren't people saving even more?

The USA has barely budged from a culture of consumerism to a culture of thrift. Given the depth of the crisis, we would expect the response on the part of the citizenry to be more urgent. There are several possible explanations as to why the increase in savings is muted.

One is that the citizenry is 'buying' the official story that the 'recession' will be ending this year and recovery will follow. Thus, with the difficulties apparently only of a short-term nature, people can continue their spending habits mostly as usual with some minor adjustments (e.g. shopping more at Wal-Mart).

Another explanation is that somehow the citizenry 'knows' that the 'recession' is short-term and is acting appropriately. Things really are aren't all that bad. In this scenario, our estimations are way-off, and our use of the term depression, over-reactive.

Perhaps there is just a lot of cultural lag. We have read quite a few horror-stories about people who lost their livelihoods, but just kept on spending as if nothing was going on - and, in the process, depleted their savings and ran up credit-card debts. Perhaps a large portion of the population is engaging in massive denial and unconscious, inappropriate spending.

Finally, at the depth of the Great Depression in 1932 and 1933, much to their chagrin, Americans dis-saved and personal savings rates went negative. It's possible that history repeats and although people may want to be saving more, circumstances are too harsh and spending patterns are adjusted too late.

Punishment by Debt-Based Money

Debt-backed money evolved to facilitate economic growth in response to the braking effect of precious metal money and its inherently inelastic supply. Unfortunately during a depression, debt-backed money is destroyed as old loans are paid off or defaulted upon and new ones do not take their place, and thus can be even more restrictive to economic activity than precious metal money which is not destroyed. National Governments' and Central Banks' current furious pace of borrowing is an effort to replace private debts with public ones and keep the money supply from shrinking.

Will this public debt binge work? Only if the expanding public sector can engender sustainable growth. As we suggested in previous posts, there is a range of optimum government spending above which is too much, and below which is too little. Another factor is the quality of that spending. Government spending can be considered to be quality when it provides services that are actually useful (for example electric power) in contradistinction to wastes of resources (such as luggage inspection).

Yet another factor is whether any further consistent economic growth is possible at all. If it is not, and there are many reasons it may not be, then having debt-based money will be especially ruinous. Debt is a magnifier of both profits and losses. Now that humanity finds itself on the right-hand side of Peak Just-About-Everything, private debts are increasingly being realised to be more untenable than previously imagined, and servicing public debt will exact an increasingly heavy toll on an chronically shrinking economy. This toll will likely exceed the imagined benefit of maintaining the debt-based money supply.

Government and the Concentration of Decision Making

There is a trend we have noticed in the past: in the course of Depressions, a Federal or Republican Government will attempt to usurp various regulatory and legislative powers from its constituent nations (be they States, Provinces, Territories, et cetera). This can be seen in the efforts of the Hoover and Roosevelt Administrations during the 1929 Depression; many of Roosevelt's social programmes were so heavy-handed in their scope, they were struck down as unconstitutional.

The justification for this centralisation (in the U.S., as well as elsewhere) is simple: a single, cohesive approach to 'solving' a Depression has a higher chance for success than numerous, uncoordinated approaches. Logically this can make sense, as it would seem that, if a recovery programme (or programmes) are based on a Federal/Republic level, it would be less mired in regional politics.

In practise, we feel such a top-down approach simply does not work. One only needs to look at the American super-huge banks to see how a top-heavy administrative technique will inevitably pan out. Simply put, it concentrates the decision-making powers into too few hands... and those hands will make many mistakes. One person given the decision-making powers of ten thousand will eventually make one bad choice with the power of ten thousand bad choices.

It is a serious fallacy to assume that Government, somehow, is bereft of this concern, when it is just as mired by the problems of the concentration of decision-making. As a Federal/Republican Government works to gather-up the power of decision-making in various sectors - ostensibly to alleviate an economic problem - it increases the destructiveness of its bad decisions. Such concentration seems more efficient, but in actuality it is a very large problem.

That is why it is important for members (States and Provinces, cities and municipalities, et cetera) of a Federal or Republican Government to defend their decision-making powers. At the very least, this is to avoid the concentration of decision-making and the damaging actions which come from this concentration. Beyond that, though, the only feasible way to craft a regional recovery programme at the regional level; the best place of the Federal/Republican Government is to coordinate these various lower-level programmes, rather than usurp them.

If the sub-Federal/Republic level is gutted to such a degree that they are effectively rendered non-functional, this creates an even bigger problem: lack of resiliency. That is a serious concern in the 2007 Depression, as it is placing an unbelievable amount of stress upon the Federal/Republican Governments of the world. If such a Government were to collapse (or suffer 'interruptions'), having gutted the powers of its constituent entities, there would be no effective system of law-enforcement beneath it to ensure some degree of social order. Without State or municipal governments, it is not outside of the realm of possibility to see the rise of another Somalia, and the many problems which that non-nation experiences.

The Obama Bounce is Yet to Come

The classic form of an economic depression sees the occurrence of major rallies. These "bear market rallies" tend to be huge, setting records for size-of-rally, and luring in those who are foolish enough to believe 'the worst is over.' Such rallies are easily observable in any graph of the Dow Jones (see this one as an example; source), and are impressive for their ability to both capture the painfully credulous, and extract from them their money.

In this depression there have not yet been any similar, massive rebounds in the stock market. A quick perusal of this chart will show this to be the case. The recent rally-ette is nothing like the scale of the first rebound of the 1929 Depression, so it is likely that the big first false-flag rebound of the 2007 Depression has yet to appear.

It is, of course, possible that the shape of this Depression will be different from historical ones. Past performance is no guarantee of future performance, in bad times as well as good. That said, we're fairly confident that such a big rally will occur at some point in the future. The reasoning behind our statement is fairly simple:

We're pretty certain that times are bad, and they will be getting a whole lot worse. Still, too many people are getting gloomy; far more than we would have expected. As a contrarian investor and cynic, we feel that, when people are being this gloomy, it is with their tongue firmly in their cheek. People say they expect horror and doom, doom, doom... but they're just waiting for the next big rally, so they can buy in just as "the bottom is in."

Simply put, we see a value trap. The average person now living does not know a person who was working for a living (i.e. to pay the rent, buy the food, support the family) in the 1929 Depression. Absolutely no one now living has any idea of just how bad a depression can actually get. People have, generally speaking, convinced themselves that the stock markets only go up; when 'up' is not happening, it is a road-bump. Eternal prosperity is a huge part of the American ethos, and everyone wants their share of that prosperity.

So, we feel confident in saying that things are going to go up, and in a big way. At some point in the future, for no particular reason, all the people sitting on the sidelines, wringing their hands and fretting profusely, will suddenly lose their inhibitions. They will feel rich again; their pockets will spring forth with great gobs of money to buy... anything! The stock markets will soar wildly, houses will be bought and sold, cars will zoom off the lots (perhaps on going-out-of-business clearance from the Big Three?), and life will seem to return to a generally-accepted normal. President Obama's approval rating will zip up to record levels, and he will be hailed as the hero who saved the consumer economy; it was the "Obama Bounce" that turned America around. So too will the rally be touted as the triumph of the consumer economy. Happy days are here again!

This will be the greatest disillusion of the 2007 Depression, when the rally inevitably fails. The reason the rally will crash is the same reason why the markets first crashed in October 2008: a crash happened. For whatever reason, people then, as they will in the future, simply got spooked and started selling to spooked buyers. It doesn't matter how, or why, these crashes occur. Rest assured, though, crashes will indeed happen, and no amount of wishful-thinking and lucky-rabbit-foot-stroking will stop them.

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.