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The past week had the unmistakable feeling of an inflection point. Such moments of transition are the coming into awareness of potential realities and possible futures that had been slowly percolating in the collective unconscious. Per Clausewitz, “ it is always out of a mere inkling and foreboding of the truth that a man acts”… if anything, this has been a week of inklings and forebodings. There has been a general sense of expectations coming unglued, coupled with the anxiety that we’re not looking at a V shaped recovery, nor a U shaped recovery, but a long dreary slog through a slough of despond.
Not that we’re exactly shocked. The political class in the United States appears to have succumbed to the corrosive temptations of empires, rather like a primordial tarpit that slowly suffocates anything so unfortunate as to walk into said tarpit.
We also believe that Obama made a cardinal miscalculation by attempting to shift the agenda to health care reform dreadfully prematurely, long before the endemic problems in the financial and manufacturing sectors (and the attendant severe issues of unemployment) were adequately repaired. To have thrown the weight of his political capital into the infinite labyrinth of the health care industry so soon after the market collapse was pure folly.
This brief analysis based on the Fed’s data gives us a rather amazing insight into how extensive, consistent, and programmatic the collapse of the industrial sector in the United States has truly been. More incredible is that this chart showing the true nature of the decline, and the length of the decline, hasn’t made it into the financial media as far as we know. Quelle Surprise.
The first chart is the raw number, dating from 1939, when the average house cost $3,800, the last man was guillotined in France, Hitler invaded Poland, and Tina Turner was born, of people employed in the manufacture of durable goods.
This next chart shows the percentage of the entire US workforce employed in durable goods manufacture. As late as 1969 it consisted of 15% of the workforce, by 1990 it was 10% of the workforce, by December 2009 it was about 5% of the workforce. If it continues in this pattern, by 2030 it will cease to exist altogether.
Manufacturing employment
We predict this has put many Americans in such an economically untenable position that we will see the inevitable return to protectionism, nativism, and paranoia that is part and parcel of American history when fear and loathing of displacement enters the national discussion. These phases are rarely a pretty sight.
State budgets are in absolutely horrible shape. Unlike their federal counterpart, states can’t print money and they are required to run balanced budgets, which has become a technical and practical impossibility. When Montana and North Dakota are the fiscally healthiest states in the nation, you really have to wonder.
The difficulties are hardly limited to the United States. We’ve been wondering mightily about the real significance of the price of gold. Our attention has been drawn to the idea that China is a major purchaser of gold, which we interpret as being motivated by one of two reasons, neither are comforting. One is that there is no currency alternative to dollar based holdings, and at a ministerial level their confidence in the dollar, and perhaps the country that prints dollars, is coming undone.
Interestingly, Robert Prechter at Elliott Wave International has suggested that precious metals may be at a major top, based on a Fibonacci ratio analysis of other historical highs.
Is this time different, and if so, what might be different this time?
We tend to believe that a second scenario might be worth considering, that gold is not only being accumulated at the state treasury level, but also as a hedge by wealthy Chinese in case the Great Expansion doesn’t work out exactly as planned.
When we looked at the Global Integrity Index for 2008 for “practical implementation” of their legal framework, they were graded in the lowest quartile, below say, Serbia, Azerbaijan, and Ecuador. This suggests that, despite enormous strides, there is weak confidence that everything is as stable as it may seem.
In addition, we did a small study of the Consumer Price Index dating from 1914, taking through economics in its Classical, Keynsian, Neo-Classical, and Wherever We Are Now phases. This is very instructive, as it allows us to see American history unfolding in terms of price stability.
This becomes clearer when we convert this data into year-over-year changes and see that we never have dipped into negative territory since the economy stabilized and got moving around 1955. Until last year that is. Clearly deflation is perceived as a danger to be avoided at all costs. Whether it CAN be avoided is another question.
The world is in a most precarious condition when China must figure out a way to contain a potential runaway inflation and we must contrive to do the opposite. Should either zone lose control of the process, the opposing zone may also be thrown into a chaotic condition.
Which is all quite speculative. However, our friends at Petroleum Intelligence Weekly have somewhat ominously noted, American refineries are running at only 80% of capacity, and Japanese refineries are running at about 70% capacity, suggesting very weak demand for energy. China on the other hand is trying to get hands on all available energy sources, with very large refinery runs.
We took the CPI yoy data from 1914 and ran a Fourier transform to see if it might give us some hints about the future. Obviously this is only one possible model based on past economic cycles, so consider it one scenario out of many possibilities.
If there are long term cycles that became ironed out to a degree with the emerging US-China relationship, they may be reasserting themselves in this era.
It may also be worthy of note that a recent Supreme Court ruling on campaign finance reform was poorly received, to put it mildly. President Obama lashed out in language rarely heard directed by a President toward the court.
The intensely populist language points to a growing culture of populist resentment and radicalism in the American electorate, which makes for interesting times and impulsive legislation, typically leading to a reduced appetite for risk, at exactly the time that risk aversion may be leading us into a liquidity trap.
Public debate lurches from the timid to mediocre to the bizarre to the incoherent, a symptom of the intellectual incoherence of our age.
Which leaves us where? The political process appears to be slowly coming unglued, the media incapable of communicating anything like a clear understanding of the realities and perils we face, and the financial system uncertain as to whether there is another boot left to drop.
Although we are in no wise where we were in 1932, history, as Mark Twain said, doesn’t repeat but it rhymes. The core problem of the 1930s was incoherence. Established models such as the gold standard had broken down, the finance ministers and governors were products of an earlier era with no maps to guide them, and the world had entered a procedural vacuum.
Once again a generation of free market philosophers is having to improvise an interventionist strategy with inadequate models from a vastly different set of circumstances.
Mr.Market
“A man may be sharper than another, but not all others”
-La Rouchefoucauld
“Nothing on earth consumes a man more completely than the passion of resentment”
-Nietzsche
“People who bite the hand that feeds them, usually lick the boot that kicks them”
-Eric Hoffer
We are well to hold in mind that every political moment is an economic moment is a social moment. Long periods of prosperity create formulaic thinking, banal entertainment culture, speculative energy distracting from a general ennui, a certain nostalgie de la boue, an indifference to corruption, a fondness for idiocy, a displacement of common sense and common courtesy by trivial rules and regulations, by tinpot “outrage” in place of penetrating insight. This won’t be the first time we’ve been in these parts.
So far the Venture Capital Association reports that ventures are still getting funded. That’s a good sign, because it means that there is still great confidence in the long term for America to creatively respond and sophisticated investors do see the long term payoff as deserving of the risk. If venture money had dried up altogether, that would have been a far more ominous long term sign. Assuming that the VCs are better informed and more intelligent than the average investor, and have longer time lines with fewer constituencies to placate, we will take this as a positive sign of confidence in the deeper future.
However, for the moment, VCs don’t seem to be doing IPOs, we assume that their view of the current market is that now is not the time. We take that as a medium term negative. Perhaps a strong negative.
Or a large change in direction.
According to Ari Levy and Dakin Campbell in their January 19 blurb on Bloomberg:
Veteran venture capitalist Dixon Doll predicts that more U.S. technology companies will start holding initial public offerings in other countries as economic growth in Asia outpaces domestic expansion.
“In the next 10 years, I expect more portfolio companies to list on foreign exchanges,” said Doll, founder of Menlo Park, California-based firm DCM, in an interview last week. China “will become a big deal.”
The U.S. venture-capital industry is coming off its slowest two-year stretch for IPOs since the mid-1970s, with only 19 in 2008 and 2009, according to the National Venture Capital Association. Doll said that while U.S. companies may not flock to China in the next year or two, the world’s third-largest economy will be increasingly attractive for technology start-ups as its capital markets mature.
China’s gross domestic product will expand 8.5 percent this year and 9.3 percent next year, according to Bloomberg surveys of economists. That compares with average predictions for U.S. growth of 2.7 percent in 2010 and 3 percent in 2011, according to Bloomberg.
Doll, 67, said he expects 40 to 50 venture-backed companies in the U.S. to go public this year, because the “system is so constipated” from two years of inactivity. The financial crisis wiped out investment banks such as Lehman Brothers Holdings Inc. and Bear Stearns Cos., and forced more than 850 hedge funds to shutter in the first nine months of 2009. That left fewer banks to lead IPOs and fewer investors to buy shares in them.
In the words of Jim Morrison, “the future’s uncertain and the end is always near.” We simply may have to go through a painful schooling in the next few years as we unlearn many of the lessons we took to heart as we moved from what appeared to be a Keynesian orthodoxy undone by a great inflation to a Chicago school era that began brilliantly and ended in chaos. Until the new synthesis of economic theory, social expectations, political frames, and a stable contract between economic stakeholders in in place, we should brace ourselves for a witches ride.
China may successfully break with a historical pattern and successfully manage its’ way through a period of hyper-expansion. It is our belief, however, that stable institutions require a long time to develop, and a longer time to become uniformly internalized beliefs about the nature of social and economic reality.
The great downturn beginning in 2007 forced China to re-imagine itself as a nation of internal markets. Wise policy level figures have long understood the need to gorge expanding social classes on tempting distractions lest they become overly curious about the mechanism of the state itself. Which requires a rapid expansion of credit so that this new class CAN indulge itself in new toys.
We made this error between the Clinton and Bush administrations when we made the political choice to buy off the electorate with a fantasy world of palatial homes and (imported) consumer goods, founded on the substrate of a corrupt and unstable credit allocation mechanism. Will China be capable of discovering another, less Minsky flavored path ?
