Wednesday, February 4, 2009

Pseudo-Wealth and Ghost Towns

Yes, it is going to be a very long and difficult year, according to James Quinn on the Prudent Bear website. This was the kind of thoughtful writing I was reading for the last four years, and why I believed the current crisis would occur:

The illustration of Old West ghost towns is something that every American can relate to. During the great gold rush of the mid 1800ss in California, Nevada and Wyoming, towns sprung up out of nowhere to support the gold mining efforts of those looking to strike it rich. General stores, bars, hotels, brothels and jails appeared out of nowhere based on demand from delusional prospectors hoping to hit the jackpot. Thousands of malls emerged throughout suburban America in the last 20 years as delusional shoppers thought they could spend their way to prosperity and achievement. Both delusions will end in the same manner.

When the gold rush ended as quickly as it started, the artificial demand collapsed and the towns were abandoned. These ghost towns sat vacant for decades, slowly decaying and rotting away. As you drive around today, you notice more and more “For Lease’’ signs on vacant retail buildings. Strip malls, inhabited by mom and pop stores, karate studios, pizza joints and video stores, have felt the initial onslaught of consumer deleveraging. As the pace of retailer collapse accelerates in 2009, larger malls will begin to go dark. Once bustling centers of conspicuous consumption and material decadence that were built upon a foundation of consumer debt, they will become ghost malls. Decaying, rotting malls inhabited by rats, wild dogs and homeless former retail employees will be a blight on the suburban landscape for decades.


For the last 20 years, the American consumers have carried the burden of the world on their broad shoulders. This has been a heavy yoke, but when you take steroids, it doesn’t seem so heavy. The steroid of choice for American consumers was debt. They have utilized home equity loans, cash-out refinancing, credit card debt and auto loans to live far above their means. It has been a wild ride, but the journey is over. They can’t score steroids from their dealer (banks) anymore. The pseudo-wealth created in the last 20 years has begun to unwind, and will increase in speed in 2009.

A permanent psychological change has occurred in American consumers. They have lost $30 trillion in value from their homes and investments in the last few years. No amount of fiscal stimulation will reverse this psychological trauma. The savings rate will increase from 0% to at least 8%. Economics and financial writer/adviser Mike Shedlock recently described the state of affairs. “Peak credit has been reached. That final wave of consumer recklessness created the exact conditions required for its own destruction. The housing bubble orgy was the last hurrah. It is not coming back and there will be no bigger bubble to replace it. Consumers and banks have both been burnt, and attitudes have changed.” Now the impact of a retrenching consumer will be felt far and wide, from Des Moines to Shanghai. Consumer spending has accounted for 72% of GDP. It will revert to at least the long term mean of 65%.

David Rosenberg, the brilliant economist from Merrill Lynch, describes what will happen: "This is an epic event; we're talking about the end of a 20-year secular credit expansion that went absolutely parabolic from 2001-2007.Before the US economy can truly begin to expand again, the savings rate must rise to pre-bubble levels of 8%, the US housing stock must fall to below eight-months' supply, and the household interest coverage ratio must fall from 14% to 10.5%. It's important to note what sort of surgery that is going to require. We will probably have to eliminate $2 trillion of household debt to get there, this will happen either through debt being written off, as major financial institutions continue to do, or for consumers themselves to shrink their own balance sheets.”

Every major retailer in the United States has built their expansion plans on an assumption that American consumers would continue to spend at an unsustainable rate. One basic truth that never changes is that an unsustainable trend will not be sustained. That crucial assumption error will lead to the bankruptcy of any retailer that financed their expansion with excessive debt. Warren Buffet’s wisdom will be borne out, “Only when the tide goes out do you discover who’s been swimming naked.”

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