Culture, Positive Feedback, and Collapse

University of Toronto professor Richard Florida has made quite a reputation for himself introducing the concept of the 'creative class' and its effects on prosperity within a city. As we are sympathetic to the Florida's perspective, we are concerned that since the Depression is so hard on 'creatives', it is consequently hard on society and the economy as a whole .

The bohemian side of the population tends to live a bit on the edge economically and as a recent article in the New York Times points out, the Depression has been very hard on the creative entrepreneur.

Artists are not merely entertainers, but educators as well. The arts they practice help put others into more thoughtful frames of mind. The inspiration found through the arts can help solve problems in any field.

A society in which the arts are decaying is a society in which the mental atmosphere is stagnant. As most productive work is mental and not physical, the result will be somewhat shoddy and degenerate work.

Unfortunately, the Arts are first on the chopping block whether in the household budget or the Provincial budget. Society needs the Arts to thrive, but when times get tough, the Arts get the short shrift. It is almost as if Society were consuming its seed corn by choking off the arts.

The Herbert Hoover Award

Unlike the popular phrase would have it, History never repeats itself; rather, History will be eerily parallelled. For example, the 2007 Depression does not repeat the 1929 Depression, but it is closely related. Instead of President Herbert Hoover talking about permanent prosperity, the present has President Barack Obama talking about the work needed to bring back permanent prosperity. Close, indeed, but not an exact repeat.

In honour of that parallelism, we present the Herbert Hoover Award. This Award will be given weekly to the individual (or group) which demonstrates ignorance of History by repeating the painfully obvious mistakes of the past. Without further ado, let us now turn to this week's winner of the Herbert Hoover Award! Presenting (drum-roll):

Illinois Governor Patrick Quinn

In a recent speech before the City Club of Chicago, Governor Quinn said that massive budget cuts were in store for the State, unless the legislature agrees to a 50% hike in the income tax.

"It’s no fun whatsoever to propose higher taxes on anyone, whether it’s families or business, but if we don’t do this, if we don’t repair our state and get it back in order we will regret it till kingdom come.” [source]

Apparently Governor Quinn is not aware that raising taxes during a depression, a credit crisis, rising unemployment, and social discord is a very bad idea. According to these excellent graphics from iTulip, the United States is suffering from a sharply rising unemployment rate. Illinois is not immune to the effects of the Depression. We have no doubt that, if this 50% income tax hike is passed, the citizenry of the State will suffer all the worse.

Congratulations, Governor Quinn. Your trophy is in the mail.

Too Many Obligations, Too Few Resources

Within the OECD nations, at all levels of society - from the household, to business, to government - obligations have been piling up for years: debts, pensions, social programmes - to name a few. Clearly, these obligations can only be met with continual economic growth. But what happens when anticipated growth fails to materialise?

This question is hardly academic. Virtually everyone and every institution is struggling with the fact of a less than expected actual income slamming into financial obligations. The general consensus is that this is a crisis, a mere interruption of the norm of perpetual growth. Once the crisis is passed, like a fever, economic health (a.k.a. growth) will return.

Our opinion departs from the general consensus. We expect growth to become the interruption in the general economic routine. It will become even more difficult for individuals or enterprises to amass wealth. The present uncertainty of employment and profit will continue and be normal.

In such an environment the notion of taking on any obligations is questionable. There will be an enormous cultural lag for the realisation of this however. Expect to see a lot of bad decisions to be made over the coming years: investments made with the expectation of a return to a prosperity that never comes.

Economic actors - everyone, that is - need to learn the new rules of economic life in a world turned upside down. We don't know them - no one does - but we could hazard a few guesses: you must live on half (or less) of your income; much of what comes in is not true income but a windfall and must be treated as such; never borrow money; investments must be recovered from cash flow in a very short time frame - perhaps three or four years for low-risk endeavours, perhaps one or two years for risky ones; all investments are riskier than they used to be.

At present, society is following a set of economic rules completely at variance with our guesses of the new rules. The transition to new rules will nevertheless be made, no matter how impossible it seems at the moment.

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.

The Worst is Yet to Come

What caused this Depression? Can anything be done to make things better? Can anything be done to make them worse?

A lot of things caused this Depression. It might be easier to to list what didn't cause it. At the top of the list would be 'a loss of consumer confidence'. In a nutshell, the origin of the Depression can be found in the prosperity which preceded it. Flaws in the economic system eventually crashed the system. There are many theories of what causes Depressions - many of them have much merit and they are not mutually exclusive.

One theory is that disparities of income and wealth create Depressions. These disparities were glaringly obvious in both the 1920s and the 1990s. So, to answer the second question, perhaps ameliorating these disparities would be helpful - some novel approaches could include creating a maximum wage, or introducing property taxes on financial assets. And, to answer the third question, if the opposite direction is being taken by public policy, it is probable that policy is actually making things worse.

In the present bailout-of-banks mode, financial assets are being protected even as millions of ordinary workers lose their jobs. The result of this is that the very wealthy are becoming less poor than they otherwise would in a freer system, while workers become comparatively much poorer. Thus disparities of wealth and income are not being allowed to narrow and lay the groundwork for a healthier economy. Public policy is actually making the situation worse.

Another theory of Depressions is that too much capital has been allocated towards uses where it is not really productive. This applies very neatly in the present circumstances to - say - automobile manufacturers or making McMansions in exurbia. What could be done to make things better is allow capital to slip away from these uses and towards what people want. Unfortunately, public policy is attempting to prop up both failing automakers and sagging house prices. Again, this will make the Depression worse.

We could go on. At almost every step, the reaction of policy makers is not only to not do helpful things, but to do exactly the worst possible thing. It's going to be a rough ride, folks.

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.

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.