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.

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