Friday, October 29, 2010

A world of limits

As detailed recently, we are running up against hard limits in oil production and this has a huge potential impact on business. Declining incomes for the majority of American families have a cascading effect on consumption. With the uncertainty of the economy, many people are saving more. For most, saving is accomplished by paying down debt, not by storing up wealth for hard times. For many, it is too late; those hard times are here now.

By paying down their debt, people are destroying money. That may seem a strange idea to many, but money is created and destroyed by the stroke of a pen. When you buy something on credit, the money that pays for that item comes into existence at that time. It did not exist before. It is secured against your word that you will pay it back with interest. That promise to pay is treated as an asset, a lien against your future productivity. Like any asset, it can be and is traded. So when you pay down you debts that money you paid back no longer exists. Your cash cancels out your promise to pay.

With less money available, demand for goods drops. To attract what money is flowing through the economy, prices come down. We call this deflation. Many people think we are in a deflationary spiral. As jobs disappear, the money available to be spent decreases. People declare bankruptcy, which discharges all the debt they hold. This is good for the individual, but the income stream from those debts is lost to the banks. With the money gone, there is less money left to chase goods and services, the effect being that prices decline. Those still in business have to cut costs and this can impact all forms of advertising, even Yellow Pages.

Since contracts for Yellow Pages advertising are a long-term investment, paying off over the year that the book is next to people’s phones, the industry tends to be slower losing revenue in a recession but also slower coming back out. A business wanting to advertise in newspaper, direct mail, radio, television or even the internet can start and stop their programs at any time. Yellow pages run on an annual cycle, which makes it a good medium-term indication of business confidence. Want to know how well your local business community is doing? Look at the relative size between the books this year and the next ones that land on your door. Some will tell you that it’s because Yellow Pages is dead. Market research tells us otherwise, with 64% of respondents who were surveyed by telephone (rather than self-selecting on an internet poll) saying they used printed Yellow Pages only, and a further 19% turned to print when they gave up searching online for what they wanted to buy locally.

Money on a larger scale is produced at the stroke of a pen. Through the Federal Reserve (a private bank) and the U.S. Treasury, money is borrowed into existence. The details are beyond the scope of this post but suffice to say that billions of dollars are borrowed on behalf of the taxpayer. Currently the amount owed is in the trillions. Since 2007 we’ve been adding to it at a rate never before seen. Before 2007, the word trillion was most often heard during cheesy science fiction films. In the 1997 film “Austin Powers” the sum of “one hundred billion dollars” was the ludicrous sum Dr. Evil wanted from the world – or else he would destroy it. In 2007, Paulson went on his knees before Congress to beg them to give the banks seven times that or their actions would destroy the US.

The problem is not limited to the American consumer and the businesses that the American consumer keeps afloat via his or her spending. Both the UK and many of its European neighbors have run deficits for a long time. So what happens when the bubble pops for everyone? We are in the middle of finding out the answer to that right now. Since 2008, the central banks of various economies have been working together to try and manage the crisis. That accord is beginning to break down.

The problem changed this summer, when most countries chose to face the issue of their debt now and begin implementing austerity measures. Some countries (Portugal, Italy, Ireland, Greece, Spain – the PIIGS) have little choice. They are bound by the rules of their membership in the Euro zone. These moves by sovereign governments are not popular, as evidenced by the internal conflict with their citizens who are faced with paying the bill for what they see as the actions of a few bankers.

The UK implemented frugal measures voluntarily, using the mandate of the recent election to introduce cuts that will cause social problems for decades to come. In both cases, the cure is seen as better than the long-term consequence of a collapse of their currency.

The USA, however, chose audacity over austerity. For us, it is business as usual - until the rest of the world intervenes to cut our government's reckless addiction to credit. The American people are saving more and spending less, adopting personal measures of frugality. Many do so with no choice, unemployment bringing an end to their middle class lifestyle. Others still have jobs but find the difference between earning and spending can no longer be hidden with easy credit. For individuals, the bills are already coming due in the form of reduced credit lines and the end of the ATM-house.

The government, however, has no such problem at present. They have the keys to the vault, or rather, the printing press.

It will not be easy for the rest of the world to rein in the American government. For many years the American consumer was the beating heart of global trade. For many economies, the health of the USA was their health too. American imports have fueled the growth in many markets. A lot of the jobs people now do in poorer nations were once done in the US. We exported those jobs over the last few decades so that prices could fall slightly and profits could soar. In the theoretical world of economists, where growth hath no bounds, this is an effective model, with the profits from off-shoring jobs creating value for pension funds. Those pension funds keep the increasingly aging population of America spending long into retirement. Unfortunately, growth has limits and the models failed. Businesses collapsed and confidence in the economy plummeted.

The American consumer is no longer buying as much as a few years ago. When the jobs went abroad, so did their income. The money we send abroad to buy things we think we need continues to come back in one prevalent form: the purchase of US treasuries. In other words, we export one major product: debt.

We can do this because of the Dollar’s status as the reserve currency of the world. This will be challenged in the coming years; the BRIC nations (Brazil, Russia, India and China) are among those pushing for Special Drawing Rights – based on a basket of currencies, to be the new reserve currency.

When the Dollar loses the reserve currency status, then the voluntary adoption of austerity measures will no longer be necessary. America will compete equally with other countries around the world. Our other major export, hi-tech arms, will continue. Life in the US, however, will get more interesting.

It looked, for a while at least, like central banks around the world would try and inflate their currencies out of the debt trap. That option closed in June 2010 when the US resisted the idea of austerity at a G20 summit.

With the writing on the wall for the Dollar’s status, America has to become an exporting nation. The problem is our goods are too expensive compared to far eastern markets. To be competitive, the Dollar has to lose value against other currencies, although no government can afford to admit to doing so openly. So far efforts to do so are working to a small extent. Over the last few weeks the Dollar has lost ground to the commonly tracked Dollar index. It has also lost a lot of ground when compared to the value of Gold and Silver, which are pushing new highs.

Other countries are opposed to this. America is still a major importer of certain types of goods, some raw resources (oil being the best known) and luxury goods. To avoid becoming the dumping ground for goods coming out of the exporting countries, each nation is seeking to devalue their own currency. The ‘race to the bottom’ for wages has evolved into the ‘race to the bottom’ for currency value. It’s the public basis for the stance against China’s currency being pegged too low against the Dollar and the demand from Congress that it be revalued by around 20%.

The goals are not just to prop up exports and keep the level of imports down. Governments want to do this to maintain a positive trade balance, but they are not the only influences. There are large financial sharks in the pool, and they are hungry for profits. In order to encourage borrowing, the government is holding interest rates at close to zero. The big banks are more than happy to borrow money on these terms. All they need to do is ensure that they get a decent rate of return on that money. Those returns need to offset the declining value of the Dollar. In light of this, how does the tension between American and Chinese currency come in? Borrowing billions from the Fed and buying China’s currency is potentially lucrative. Put simply, if the Yuan is worth $ 1.00 today and next week, thanks to currency movements, it is worth $ 1.20, the banks make a huge windfall. When I was in Europe last June, one Euro would buy $ 1.19. Today it will buy $ 1.39. If I’d borrowed money at 0.25% four months ago and put it into Euros, I’d be laughing all the way to the bank. Oh wait, I would be a bank.

Why lend money to Americans who are saving instead of borrowing, when you can park the money in a different currency and see it grow in relative value to the Dollar?

Just like other countries oppose being the dumping ground for export goods, other nations do not want to be the dumping ground for dollars. Speculators, who cannot get a good return on investments when the interest rates are close to zero in the US, want to invest those dollars elsewhere. As they flood the marketplaces in other countries, they create inflation. This is good for the investors, who reap the benefits of the economy that overheats and inflates. Speculation is like a parasite that attaches to the host and pumps in an agent that causes inflammation, then draws out vital fluids. The end result can be seen in the US today.

This process makes Americans poorer in comparison to the citizens of other developed nations – at least compared to a year ago. Americans are still better off by far in respect to their access to resources, food, clean water and many other essentials. But they can afford far fewer luxury items. In terms of paper wealth, a foreign millionaire has seen his riches rise in comparison to US millionaires. A dollar buys less pounds, yen or yuan than a year ago. For American millionaires to keep up with the foreign Joneses, their net worth -- measured in dollars -- needs to rise.

Income is a zero-sum gain in the face of the production limits of oil. For one to become significantly better off, others have to reduce their standard of living. This is well underway in the US with continuing unemployment, cuts in welfare spending and inflation of necessities while non-essentials are undergoing a deflationary spiral.

High unemployment drives down wage levels, which translate to higher profits for businesses and higher dividends to shareholders. However, it is not a long-term solution since employers are also consumers in the marketplace and overall sales of everything but the most essential supplies will be impacted. With the American consumer impoverished then those goods that were exported to the US must find a new home.

So how will this impact Yellow Pages? An increasingly polarized population and a disappearing middle class will mean two disparate audiences, each with different priorities and spending patterns. For those who get the end of the stick with the sponge on it, the internet will again become a luxury. People who do not need a computer at home will cut costs. Internet cafés, common in Europe, may become a feature of communities. A lot more manufacturing will need to be done in the US if Americans are to afford goods. Many products will no longer be cheaper to import. The printed Yellow Pages will still be delivered for free to everyone who chooses not to opt out.

On the other end of the spectrum, those who do well in the coming collapse will see their personal fortunes soar in everything except comparative value to the rich in other countries. The import market will increasingly target the very rich, who will expect a level of personal service. With energy being less of an issue for those with plenty of money, online advertising may target this market, with elements of personalization and security becoming key factors in the decision on which internet search product to use.

Tuesday, October 12, 2010

Seattle introduces opt-out for Yellow Pages

Seattle city seems to have missed the memo.   Independent Yellow Pages are putting together a national registry for opt out.  Every book that gets thrown into a dumpster is wasted printing cost for them.  In an era of decline resources and an economy in recession, they will take every cost-saving measure they can.

So with an industry solution, paid for by the Yellow Pages industry, why would Seattle go to the expense of setting up a competing registry?  Don’t get me wrong, I’m all for competition where it benefits society.  Where’s the benefit here?

It’s certainly not about saving the environment.  Yellow Pages are made almost exclusively from recycled paper and wood chips.  The glue and ink is biodegradable.  Compared with the amount of junk mail and unsolicited catalogues we get every year, potential wastage is quite small.

When I first heard that the Yellow Pages business model was being labeled unsustainable, despite industry efforts, I was curious.  I felt sure I received more junk mail than Yellow Pages books - we get three Yellow Pages delivered to our door, AT&T’s book, Yellow Book, and the Valley Yellow Pages.

For one year I saved every piece of junk mail and unsolicited catalogue I could, throwing them into a box.  After one year, I weighed all this junk mail.  It weighed in at 75 lbs – compared to 5 lbs for the phone book.   Don’t believe me?  Here’s a photo:

One year's worth of junk mail!

So if environment was the issue, the city would be tackling junk mail as well.  It’s unsolicited and often even more unwanted than a telephone directory.  The offers are only good for a day or two and there’s another coming next week on “junk mail day.”    So if wastefulness is not the issue, what could be Seattle City’s motive?  Maybe money?

$ 0.14 for every book delivered
$ 148 per ton of books to be recycled
$ 100 (for now) license fee to operate a Yellow Pages in the city
(Taken from on-line research, not the bill itself.  E.A.O.E.)
Based on the figures from Seattle Public Utilities, detailed on this blog, the delivery fee will raise $ 280,000 and the recycling fee $ 350,000.  For now - as city revenues decline I expect these taxes, like many others, to rise.

A tax by any other name is still a tax.  This is a hidden tax on every small business in the city that is listed in the Yellow Pages.  Since Yellow Pages list every business for free, both in the classified yellow section and the alphabetical white business section, even that service to the community is now taxed.

A foolish move on the part of the city.  Locally delivered Yellow Pages helps keep money in the local community.  By giving a competitive advantage to online over local print, the city is driving shopping patterns online, where consumers often buy from out of state in the hope of avoiding sales tax.    

This is all about revenue raising.  Hopefully, the Association of Directory Publishers will challenge this in the courts before more cities jump on this tax-raising bandwagon.  

Sunday, October 10, 2010

The Wider Impact of Peak Oil

Yellow Pages Publishers, like all industries, rely on both a vibrant business community and a confident consumer base. Over the last few years, confidence in both sectors has taken a dramatic hit. For a while there was discussion of the decline being a “second great depression.”  Luckily, we only suffered a “great recession” rather than a depression. Cynics point out that it is a recession when someone else loses a job and a depression when you lose your own.

As Jeff Rubin, formerly chief economist of the CIBC pointed out, four of the last five recessions were preceded by a shock to the price of oil.  The most recent recession was not unexpected. A number of experts, including the renowned Nouriel Roubini, were warning anyone who would listen, back as early as 2006, that a spike in oil prices would have serious negative effects on both the US and global economies. James Hamilton of UC San Diego has detailed the causes and consequences of the Oil shock of 2007.  As he says in his abstract:

"Whereas historical oil price shocks were primarily caused by physical disruptions of supply, the price run-up of 2007-08 was caused by strong demand confronting stagnating world production."

Hamilton goes on to show that while the previous oil shocks of the last century were primarily caused by geopolitical events, from the Yom Kippur war to the invasion of Kuwait.  He explains how the shock of 2007 was different.  The inability of oil producers to keep up with demand caused the prices to rise, potential profits from buying long term contracts and selling again before delivery, drew speculators who pushed the cost to $ 145 a barrel in July 2008. 

None of the above is news to those who follow Peak Oil news on a regular basis.  However, Hamilton’s analysis of what was happening with physical production and delivery during the most recent shock was a source of new information for me.  I was not surprised that stocks of oil declined.  It makes good business sense to draw down reserves, purchased at previously lower prices and take advantage of the developing bubble only to replenish later when prices fall. The paper clearly demonstrates that speculation alone would not have accounted for the spike in prices.  A shift in the fundamentals created the opportunity for speculation, rather than money looking for a good return.  Peak Oil, specifically the inability or unwillingness to increase production, was at the heart of the problem. 

The impact on behavior of consumers was on a scale higher than expected. Oil at $ 135 a barrel represents 15% of all US take home pay – around $ 1 Trillion.   Hamilton states that although the increase in gas prices should only have caused a 1.7% decrease in non-energy expenditure, the reduction was 2.2%, the bulk of that decline took six months or more. 

Car purchases took an immediate and unsurprising hit.  While energy prices increased around 20%, it still only accounted for 5% of household expenditure.  However sales of vehicles dropped 10%, a big enough shock to the automotive industry to warrant government intervention. 

A bigger factor, one identified by Edelstein and Killian is the impact on consumer sentiment.  Rising gas prices in early 2008 hit the confidence of consumers and sales of truck and SUV sales by as much as 25% and car sales by 7%, as consumers shifted to more fuel efficient vehicles.  They recovered in the summer only to take a second hit in the fall. That second hit impacted all vehicle markets, cars more than SUV’s, which indicates the drop was not so much from the gas prices, but rather from a drop in income. 

Fear is an important metric in the marketplace.  It can drive consumption as well as hinder it.  Safety features of vehicles leverage the fear of an accident.  Fear of terrorism allows governments to channel billions of dollars to favored security industries and curtail civil liberties.  Fear of losing one’s job or of not being able to afford necessities can impact spending patterns.

One point, which I do not believe has received as much attention as it should, was the key determinant of demand in Hamilton’s paper:

"The most important principle for understanding short-run changes in the price of oil is the fact that income rather than price is the key determinant of the quantity demanded."

If income and not price determines demand, and there is a requirement to reduce demand (or the wheels come off the economy) then an increase in unemployment is what we would expect.

What does that mean for jobs?  Tackling unemployment in any efficient manner would create increasing demand as the working people can now drive happily around and consume.  Extra energy to deliver the goods they are now able to buy.  We bounce our collective heads off the ceiling of stagnant production again.

It should come as no surprise, then, that all efforts to reduce unemployment have not worked as well as the politicians told us they expected.  It may be pure coincidence that the stimulus package led to a level of unemployment the economists predicted, despite the assurances it would create or save jobs.  Is it now possible that unemployment is now a factor of energy availability and the plans and machinations of politicians are impotent in the face of that reality?  

The spike in oil prices caused ripples throughout society. Gas companies were very quick to raise gas prices with every upward move of oil but people felt they took their time lowering the prices as oil fell. Gas prices have direct and indirect effects on the behavior of consumers. It hit the pockets of families directly as they saw the cost to fill up the family SUV rise week after week. As a result they drove less, shopping less. At the same time, the cost of delivery also went up; the further materials or goods had to travel, the greater the impact. As prices rose, demand fell until equilibrium was reached. In many areas, the rise in costs was hidden by keep prices constant but reducing quantity.

Oil prices dropped significantly as the speculative bubble popped, but the damage was already done. Confidence and credit has yet to recover. We hear every day that there is money sitting on the sidelines waiting for investment. Pundits and commentators tell us that the problem is the banks are not lending, that credit is too tight but not to worry.  The economy us recovering well and green shoots can be seen everywhere and soon credit and money will flow and we will be back on track.

The state of retail tells us otherwise.  Many malls have empty shops. Closed and shuttered businesses abound. Even those shops that are still open have less products. The aisles in the big box stores are noticeably wider and there are less display stands at the end of those aisles. Talking to a relative who works for a distributor delivering to both Wal-Mart and Target, I learned that the better performing stores are moving 10% less product than a year ago, while the worst are down more than 25%.

If the money that is ‘sitting on the sidelines’ were to start moving though the economy, what would it be spent on? With less goods on the shelves, less stores open, that increase in credit moving though main street would have an inflationary effect on prices, which still remains the biggest threat to fiscal stability.

How serious of an issue is the threat of inflation?  Enough to cause politicians to do an end run around themselves to avoid increasing the money supply on main street.   

We narrowly averted such a disaster earlier this year when the financial reform bill passed through Congress. I’m referring to the Lincoln Rule being stripped out of the Dodd-Frank Wall Street Reform and Consumer Protection Act. The press gave a lot of coverage to the stripping of the Volckner Rule but far less about the Lincoln Rule. That is, until Matt Taibbi of Rolling Stone Magazine published a very detailed description of the political machinations surrounding the so-called reform.

In his usual style, Taibbi attributes the defeat of the major reforms to corruption of the political system. What he seems to fail to take into account is the impact the Lincoln Rule would have had on the wider economy. In essence, the Lincoln Rule, had it been implemented, would have forced banks to consider carefully if they wanted to play in the derivatives market. As Matt pointed out,

“Thanks to Clinton-era deregulation, the market for derivatives is now 100 times larger than the federal budget, and five of the country's biggest banks control more than 90 percent of the business.”

Put simply, this rule would have required the big banks to give up cheap loans from the Fed if they wanted to continue to play in the derivates market. So where would that money have gone if the derivatives market had been declared off limits? What would have been the impact on inflation if just one percent of that money had been redirected into the physical economy? That would have been the equivalent of the entire Federal Budget trying to find something to buy, creating its own shock in the marketplace. That could have created an earthquake in the economy that I, for one, feel thankful we have not yet had to face.

We are between a rock and a hard place. Businesses need easier credit if they are to get the economy moving, but too much credit in the system may precipitate a huge adjustment that many businesses are not ready to survive.  As we struggle to navigate this bumpy plateau, our models need to assume less energy and less wealth.

Friday, October 8, 2010

It's the data, not the brand, that counts. are no longer hording their data. They are now allowing the advertising they carry in their database to be displayed in other applications.
They have recognized an important point in digital delivery of advertising: you don't need to rely on a particular Yellow Pages brand. With the analytics that digital media affords, you can show how many eyeballs parsed the customers’ advert. It does not have to be on a web site or in a mobile application that is branded as Yellow Pages. Eyes on ads are what the advertiser really cares about. It's what Yellow Pages have been doing for decades. In the past, brand recognition was the way of showing usage of a telephone directory. Now customers demand metrics. Impressions are the digital equivalent of distribution and much more accurate.
A move in this direction also affords opportunities for mobile developers. Looking at the iPad, iPhone and Android Mobile Yellow Pages offerings, there seems little to differentiate them based on the icon and description in the store. In the same way as most users are blind to whose telephone book they pick up and use, most people with a smart phone really do not care who is providing the data to their phone - so long as it is accurate and useful.
If brand loyalty to a Yellow Pages company does not inspire downloading of an application, what will?
People often make decisions based on emotion. The stronger the feeling, the more likely they are to act. So mobile developers have an opportunity to partner with Yellow Pages and give people a good reason to download their application. At the same time, they can do what Yellow Pages has always done, serve their local communities.
How? By partnering with good causes that need fundraising and let them market the end product as a way of raising those funds.
For example, a cancer charity may raise funds by having a downloadable local search application in the iTunes store that costs the end user a donation of $ 4.99, a portion of which goes to the charity. With a sliding scale of contribution based on volume, the more the charity promotes the mobile application (maybe a flyer in the next mailing or an email blast) the greater the charitable part can increase - once development costs are offset. It’s an easy way for people to contribute to a good cause if they have a smart phone, making this an especially attractive impulse purchase.
The mobile developer shares part of the revenue with the good cause promoting it. The only real difference between a children’s charity application and a cancer charity or even a “vote Joe Blog for Mayor” application is cosmetic. The required development time and effort, beyond the initial development, is minimal. Effectively, they “skin” the mobile application for each “good cause” that signs up.
From a Yellow Pages perspective, it's a win-win situation. If they develop in-house, they get part of the revenue sharing for the download of the application - with all revenue collection handled by the download service like ITunes. If someone else does the development, they still get eyeballs on their data and the analytics to show their customers.
They also have the opportunity to sell premium (top of results) opportunities. In this case, using the Yellow Pages model, the charity acts like a Certified Marketing Representative (CMR) and sells enhanced placement when the data is delivered to that particular application. All the mobile application has to do is tell the API which application it is, and the order of data returned will reflect corporate sponsorship of that “good cause.” The charity gets commission on the sale, and the Yellow Pages processes the order in a manner similar to any other order from a CMR-type reseller.
'Pay for performance' is also a possibility, since gathering the metrics is key to demonstrating the value of having your advertising included in that Yellow Pages data. Premium positions are sold on a performance basis with the advertiser paying per impression or click through to additional profile data. The revenue generated pays “commission” to the “good cause.”
Of course, the long-term success of a concept like this requires that the energy needed for a mobile infrastructure remains available for the foreseeable future. Given the decade-long timescale I expect the impact of Peak Oil to take, the opportunities for mobile will be there for awhile, certainly long enough for the market to mature.
Here’s an interview with Stéphane Marceau of which prompted me to get around to posting this now rather than at some future time.