Pondering Orlov's Five Stages of Collapse

Dmitry Orlov blogged an interesting piece entitled The Five Stages of Collapse. It's well worth a read if you can tolerate doomer porn. The best part is the five-stage model itself. His notion is that social collapse follows five progressive steps, and that although collapse may be arrested at any one of the stages, each stage leads to the next one - a progressive breakdown, if you will.

Happily for us civilised folks, collapse usually is arrested before it progresses very far. In wealthy, developed countries even if this Depression turns out to be a doozey, and the first of many more to come, odds are it won't take us very far down the path of social disintegration. We would like to justify this optimistic opinion using Mr. Orlov's own model.

Orlov's first stage is Financial Collapse: "Financial institutions become insolvent; savings are wiped out, and access to capital is lost." This is what most of the world (China excepted, perhaps having a reprieve for the moment due to its many bubbles) is experiencing at present.

We agree with Orlov that governmental policy is not favourable to arresting this stage, and what will come next is what he terms Commercial Collapse: "Money is devalued and/or becomes scarce, commodities are hoarded, import and retail chains break down, and widespread shortages of survival necessities become the norm."

If hyperinflation takes hold because unsupportable debts are monetised, then this scenario may very well play itself out as Orlov describes it.

On the other hand, if the USA and other rich economies maintain non-hyperinflating currencies, the combined result of unsupportable debts and misguided government policies will be catastrophic loss of household income. Goods may not become scarce, but the means to purchase them will.

In either case, whatever government may decide to do or not do about the situation, the people themselves can arrest Commercial Collapse by any number of actions to ensure the continuing flow of goods and services. The so-called informal economy of legal goods and services delivered 'under-the-table' already provides one template for a popular, self-organising market. Many civic organisations such as churches, clubs, co-ops and farmer's markets can operate as clearinghouses. Barter banks and scrip systems of 'bona fide' money can spring up where they do not already exist. Thus the solution to arresting Commercial Collapse absent highly-unlikely, successful government intervention, is for people to set themselves up very much in community, and to become a lot more creative than they are used to.

We suspect that enough people can rise to the occasion. Only a tiny vanguard of creative types is needed to successfully establish functional patterns of mostly-local commerce.

It should be noted that under this scenario, Commercial Collapse would be arrested at a level of affluence that is only a fraction of what most inhabitants of the World's developed countries are used to. It won't be an easy adjustment by any means. Two classes of persons are most vulnerable: the poorest members of society who lack work and social skills; and affluent members who derive their livelihoods from access to those institutions which are not likely to survive the Commercial Collapse.

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.

Bank Losses Growing

This weekend the FDIC took three more U.S. Banks into receivership. The losses absorbed by the FDIC were rather striking. Out of total assets of the three banks of $4,444,500,000 there was a total $1,437,500,000 in expected cost to the FDIC. Added to the FDIC losses are the losses born by stockholders and uninsured creditors of the banks. The total losses are thus well over 1/3 of the value of the assets.

The loss level of FDIC losses to total assets from all 57 U.S. bank failures since the Depression started stands at 5.16%, up from 4.84% last week. Excluding the costless WaMu operation, the level stands at 23.56%, up from 23.08%.

It is impossible to know how much worse the failed banks and not-yet-failed banks are than the survivors. Or indeed, what percent of banks will fail. Nevertheless, we will make a few 'back of the envelope' calculations.

Suppose 10% of the banking industry is slated for liquidation. This would constitute about one and a half trillion dollars of assets. If the FDIC can contain losses to the 5% level that would be 75 billion dollars - a lot of money, but manageable given its substantial credit lines from the U.S. Treasury. If losses are closer to the 25% level, that would be 375 billion, or a good chunk of those credit lines. Substantially more than 25% losses, or more than 10% of the industry doomed means the FDIC will need larger credit lines.

The subject of FDIC credit lines raises an interesting question. How is that money to be paid back? Formally, that means raising the (already high) premiums the FDIC charges banks for deposit insurance. The consequences will include lower savings rates, more bank fees (ouch!), and higher interest costs for borrowing. These effects will aggravate the Depression due to less income from savings, and from the greater disincentive to borrow.

As the Depression grinds on, we will continue reporting the FDIC loss statistics and their possible significance.

Getting Off the Road to Ruin

The Metropolitan Life Insurance Company recently released a study of the effect of the current economy on American's finances. The study came up with some disturbing facts, such as that that about three-quarters of the population has three months or less of savings to draw on in the event of unemployment.

The most interesting thing we found in the study was the conclusion that Americans are shifting away from Consumerism toward a more balanced view of what will make them happy. We see this as a tremendously positive development. Among other benefits will be an increased savings rate and the potential to have both households and the economy as a whole on a more secure footing.

Over fifty years ago in The Affluent Society, J.K. Galbraith predicted that if the Great American Marketing Machine was unable to manufacture ever more consumer wants to keep household debt expanding, a depression would ensue. We suspect that his prediction may have finally come true.

Debtoholics

This article from Maclean's shows the sorry state of a typical middle-class family with poor money management skills whose ambitions for affluence exceeded their income-producing capacity. Stories such as this one are becoming ubiquitous as ever more households suffering from job loss and overindebtedness careen toward bankruptcy.

At least one organisation - Debtors Anonymous - looks at using debt for spending as a seductive but destructive process. We wonder how much of the current economic woes result from people having a serious borrowing problem.

It was, after all, the sub-prime mortgage fiasco that set this whole Depression thing rolling. People become bad credit risks (sub-prime) because they don't manage their money well. Often that results from compulsive borrowing and spending.

We suspect that the damage to the borrowing class as a result of the Depression will be so dreadful that everyone now living will be very cautious about borrowing any money ever again. This development would be horrifying to the financers of consumerism and their minions (a.k.a. the Government and the Media), so we expect a tremendous push to coax the populace into perpetuating their spendthrift ways. The recent hatchet piece by Newsweek is a good example.

We hope that the people will not be so unintelligent. Happily, savings rates are rising, and household debt is falling. Unfortunately, there is a good chance that a false spring of recovery will get the masses borrowing again. But that will be the last hurrah for the debtoholics.

Savings are Good

Newsweek had a blather-filled piece which got our attention the other day. The very idea that savers should not be saving, because the economy needs rescuing, is very confusing to us. If the economy is tanking, as we believe it is, is it not prudent to save as much as possible? Why should savers sacrifice their financial well-being on the altar of preserving appearances?

This is part of a disturbing trend which we've been watching develop: the propensity of the mainstream to blame savers for the economic woes of the world. 'Savers are ruining everything!' the press seems to whine, apparently forgetting that savers – as the backbone for the credit industry – have every right to stop investing, if their money isn't being well-treated.

It has been stated by others, but we will add our voice: one cannot become rich by overspending one's income. If one wishes to live comfortably in one's 'golden' years, for example, one must prudently prepare for such an eventuality. Savings, in their many forms (from certificates of deposits to gold bars), are the vehicle for this... or for starting a new business, or taking on an apartment building, et cetera, et cetera.

If memory serves, John D. Rockefeller once stated that, if one wished to be rich, one must save half of one's income. He, as the world's first billionaire – and those were silver dollars back then – is a high authority on such matters. He did not say to spend 150% of one's income; rather, he was living proof that the prudent savings of one's income was a road to financial success. So rich was he, that his descendants still live upon the vast wealth he accumulated.

So... who should one listen to: a writer for Newsweek, or the first billionaire? We know who we'd choose. Mr. Rockefeller may have been a bit... off... but he prospered in good times and bad.

Increase in Savings Rate Explained

Fortune Magazine just published an article bemoaning the lack of consumer spending and (what is to the author) a paradox of increasing savings rates. Mr. Colvin, the author, apparently does not get out much, because anyone with eyes to see can tell you why savings rates are increasing.

People are 'saving' only because they are paying off their debts. They are not paying off their debts because they want to, but because they can no longer refinance their debts with home equity loans, low-rate promotional cash advances, or even just plain juggling their balances between credit lines. Banks are relentlessly cutting lending. Credit lines are cut and new loans are harder to get. In order to pay off their debts, people must cut their spending on whatever they would have bought if they didn't have to pay off their debts. Consumption declines, 'savings' increases, end of story.

The dimness represented here by Mr. Colvin and other writers in the leading financial publications is disconcerting. If the investing class continues to be as misinformed in the Depression as it was during the Mania beforehand, recovery will be very far off indeed.

Deep Frugality: A Crash Course

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

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

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

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

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

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

Preventing Deflation Won't Stop the Depression

The world's monetary authorities are, at present, desperately trying to stop "deflation." Deflation is a complex and controversial topic, but suffice it to say deflation is the perception of falling prices. The theory behind central bank actions is that when prices are perceived to be falling, one becomes reluctant to invest or even spend on consumables, when just waiting will get one a better deal.

Obviously, stock and commodity prices have fallen dramatically in the last few months. Most real estate has been falling for a couple years now. Consumer prices are beginning to fall as well. Can this process be stopped? Actually, yes. Central banks can ensure that the money supply rises fast enough to devalue the money in one's pocket, making assets, goods and services again an attractive use of that money.

Can arresting deflation stop the 2008 Depression? No, it cannot. Depressions are a self-reinforcing process of declining income. Wages have been falling in purchasing power for decades. Households responded at first by sending more of the population into the workforce to support the household. Families with a single 'breadwinner' are now quite rare. Lately, workers have taken to eliminating savings, borrowing against the value of their homes, as well as taking on increasing amounts of consumer credit in an attempt to fund their spending. This is, of course, not sustainable. In fact, defaulting consumer debt will be a serious drag on the world economy for quite some time. A further drag is rising unemployment, and over all personal income in decline.

At this point, the economy will not recover until several things happen: the losses from bad investments are recognised; failing undertakings have been liquidated; savings rates return to healthy levels; employment and the purchasing power of wages begins to rise. Current government policies are not promoting any of these conditions. If anything, the policies are working against the first two conditions.

It is possible that we are witnessing an effort to 're-inflate the bubble.' Perhaps if the public sees that their houses and investments have stopped falling in value, they will pull out their metaphorical charge cards and dig themselves even deeper into debt. Leaving that central banker fantasy aside, we believe that conventional economic theory is incorrect. The current decline in prices is a symptom of economic contraction, a destruction of purchasing power. Alleviating the symptom will not cure the disease. Denominating prices in a debased currency will do nothing to help the current situation, and even risks igniting an economy-destroying hyperinflation.