Charles Hugh Smith at the Of Two Minds blog delivers an unpleasant message in End of an Era: What Isn’t Coming Back. He says the financial crisis is the just beginning of some tough times caused by overspending instead of saving, at all levels. We can ignore his message, evaluate the message, or believe the message. Charles makes some important points here, so I don’t recommend that we ignore the message or kill the messager. Instead, let’s see if we can learn anything that is worthwhile.
Below he identifies six conditions which underpinned the bogus prosperity of the past decade have changed for good.
1. Permanent decline of the assets which supported rampant consumerism. Having gleefully swallowed the fiction that real estate could rise indefinitely, and thus fund not only a plump retirement but a never-ending consumer binge, the American middle-class is now coming to grips with the reality that real estate valuations were a bubble which has burst. The bust is taking down the primary asset of the Baby Boom generation (housing) and the equity-extraction-machine of home equity lines of credit (HELOC).
… the entire superficial surface of jewelry, lavish cruises, huge suburban homes, etc. was based not on a foundation of savings and productive real wealth but on astonishing increases in debt. It was never sustainable, and the fantasy that it was sustainable, and perhaps even “deserved,” was always visibly absurd.
But it’s not just housing which has plummeted; it’s all assets classes. And that decline hasn’t just shattered consumer borrowing, it’s also wiped out much of the retirement wealth of the Baby Boomers. (Physical gold has risen in value, but other commodities have seen boom-bust cycles of appalling volatility.)
2. With their assets diminished, Boomers must now save rather than spend. The decimation of Boomer assets and retirement funding is documented in this report sent to me by longtime correspondent J.F.B., who has been presciently pointing out the risks to the Boomer retirement for some time:
The Wealth of the Baby Boom Cohorts After the Collapse (Center for Economic and Policy Research)
The median household with a person between the ages of 45 to 54 saw its net worth fall by more than 45 percent between 2004 and 2009, from $172,400 in 2004 to just $94,200 in 2009 (all amounts are in 2009 dollars). If the median late baby boomer household took all of the wealth they had accumulated during their lifetime, they would still owe approximately 45 percent of the price of a typical house1 and have no other assets whatsoever.
As a result of the plunge in house prices, many baby boomers now have little or no equity in their home. According to our calculations, of those who own their primary residence, nearly 30 percent of households headed by someone between the ages of 45 to 54 will need to bring money to their closing (to cover their mortgage and transactions costs) if they were to sell their home. More than 15 percent of the early baby boomers, people between the ages of 55 and 64, will need to bring money to a closing when they sell their home.
As if that isn’t bad enough, then other assets like stocks and bonds held in 401Ks and public pensions have also been trashed. Even those like myself who foresee a stock market rally don’t expect the market to shoot back to its 2007 highs anytime soon; stock valuations are correlated to profits, and in a global recession profits are unlikely to grow for most public companies.As companies lose revenue they look for ways to trim expenses, and unsurprisingly, employee retirement benefits (matching 401Ks, etc.) are already on the chopping block. here is another article on the topic submitted by J.F.B.: Retirement funds in danger for millions of Americans
For millions of Americans, the deepening recession has meant a dramatic drop in funds put aside for their retirement. While many have seen the value of these accounts slashed in half, the pensions of others have been rendered virtually worthless as their employers file for bankruptcy. For others, a layoff in the family spells disaster, and saving for retirement is out of the question.
Many older workers have been forced to cash out their 401(k)s to cover mortgages and pay credit card debt and other expenses, with the amount withdrawn sharply reduced from their original investment. For other, particularly young, workers, the prospect of putting aside anything out of their weekly paychecks is out of the question.
Take away easy credit and rising assets and replace them with falling asset valuations and tight credit. Now add in a pressing need to save rather than spend, and it’s easy to see why consumers cannot recover their free-spending ways.
3. Incomes for many in the middle class are in permanent decline due to the very structural changes the mainstream economists refuse to acknowledge. J.F.B. also sent me this sobering analysis of the erosion of jobs from the “middle” of the middle class: The middle-age, middle-income squeeze: Older workers taking lower-wage jobs due to broad-based market shifts, MIT study shows
Dramatic shifts in the U.S. labor market in the last 25 years are relegating older workers — even those with a college education — to lower-wage jobs, according to a research paper by MIT Economics Professor David Autor.This trend appears likely to steepen in the current recession, as employers accelerate the rate at which they shed nonessential positions.
In a paper co-authored with graduate student David Dorn, “This Job is ‘Getting Old’: Measuring Change in Job Opportunities using Occupational Age Structure,” which was presented last month at the American Economics Association conference, Autor analyzes a phenomenon that he refers to as the “hollowing out” of the U.S. job market from 1980 to 2005.
“One of the most remarkable developments in the U.S. labor market of the past two and a half decades has been the rapid, simultaneous growth of employment in both the highest- and lowest-skilled jobs,” Autor says. European labor markets echo this shift.
Automation, computerization and offshoring are reducing the number of middle-wage, skilled occupations — stock clerks, inspectors, telemarketers, payroll workers, sales agents and software programmers — Autor finds. These jobs are particularly vulnerable to automation because their core tasks follow well-understood routines that can increasingly be codified in software and executed by machinery.
Ironically, many jobs that require less formal education — such as construction workers, janitors, truck drivers, auto mechanics, home health workers and wait staff — are more difficult to automate than these white-collar positions because they demand physical flexibility and rapid adaptation to unpredictable circumstances (e.g., oncoming traffic, unhappy customers). Humans excel at this form of flexibility while current technology falls short. Demand also remains high for high-wage, high-skill jobs, such as attorneys, physicians, engineers and top managers — all of which perform analytic, interpersonal and problem-solving tasks requiring both expertise and intellectual flexibility.
Here are some recent entries on the structural demographic and employment challenges we face:
White Collar, Blue Collar, No Collar (February 9, 2009)
The European Model Is Also Doomed (February 7, 2009)
Endgame 3: The End of (Paying) Work (January 21, 2009)
End of Work, End of Affluence (December 5, 2008)4. Much of the “wealth” of the past decade resulted from the velocity of money bouncing between new credit, financial legerdemain and millions of real estate transactions. The so-called FIRE economy (finance, real estate and insurance) thrived on three conditions which have now closed out: cheap, abundant credit, unrestricted financial legerdemain (risky assets labeled AAA, etc.) and a bubble-fueled peak of transactions.
The “average” house-flipper bought and sold up to 6 or even more properties at a time, creating stupendous fees for mortgage brokers, lenders, realtors, etc. Much of that velocity is gone, and without a bubble in credit and real estate, then it will never return to its bubble heights.
5. Interest rates will rise for the foreseeable future. As noted here many times, you can’t borrow $3 trillion a year (or was it $9 trillion, or $13 trillion?) in a world of foundering profits and surplus capital and expect interest rates to stay low forever. This will further depress borrowing/debt and asset valuations like real estate which depend on low interest rates.
All of these forces are self-reinforcing; as interest rates rise, housing valuations will continue their decline, further lowering Boomers’ assets and ability to borrow more, etc.
6. Selling big-screen TVs made in Asia at Best Buy is not a formula for national wealth. It’s all well and good for every family to yearn for a big-screen TV made in Asia, but we as a nation have subscribed to the fantasy that charging the purchase of a big-screen TV is “wealth” when in fact it was only a simulacrum of wealth. Real wealth is making something others value enough to buy it from you at a profit, which then creates surplus capital which can be distributed and invested on a national scale.
If someone who created some of that wealth decides to use that surplus capital to buy a TV from Asia, fine; but charging the purchase on credit is not the same as deploying surplus/earned capital.
In other words, a consumerist economy based on ever-rising debt and trade deficits is completely unsustainable. The current “recession” might be called, “The Revenge of Reality.”
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