Letter Re: Wealth Destruction–Real Wealth or Just On-Paper Wealth?

I followed the link in Thursday’s blog to this I followed this news story: 45 percent of world’s wealth destroyed: Blackstone CEO. It stated: “Between 40 and 45 percent of the world’s wealth has been destroyed in little less than a year and a half.” I don’t see how Schwarzman can be right about that. The factories are still there. the farms are still there. The houses are still there. And there are still warehouses full of everything from Machinery and bar stock to Sponge Bob Squarepants toys.So what has been destroyed are just “on paper” profits, not any real wealth. Please correct me if I’m wrong, but what is to stop us from just revaluating things, and getting along with life? Thanks, – F.T.G

JWR Replies: You are mostly right, but partly wrong. You are correct that there has been very little real tangible wealth that has been destroyed, other than inventory that might be discarded for lack of a market, some half-finished commercial and residential building projects that will eventually get bulldozed, and some perishables that have been delayed in transit and that went to waste. You are also correct that most of what still exists tangibly has genuine value. But consider that an under-utilized factory produces fewer goods than a fully-utilized factory. (OBTW, on that note, we can thank President Obama for at least keeping America’s gun, ammunition, and magazine factories working at a fever pitch.)

So let’s step back and look at the big picture…

What has been destroyed:

1.) Asset Values:
This goes without saying. Reader FTG is correct that facilities and capital equipment are physically intact, but their values have been greatly reduced. I expect to see this process continue for several more years.

2.) Wages and Buying Power:
By cutting out overtime, reducing shifts, idling assembly lines, canceling re-stocking orders, reducing pensions, scaling-back benefits, and laying off employees, there has been a great contraction in wage-earning income and hence buying power–even to the point where people are having trouble making their mortgage payments. This leads to a chain collision of missed house payments, foreclosures, and evictions. Worse yet, it means even more houses will be dumped onto a market that is already flooded with “excess inventory.”

3.) Credit, and the Perception of Credit-Worthiness:
As I’ve described before, the economy is presently in a phase characterized by revaluation–as the various market sectors probe for new market prices.(Economists call this “Price Discovery.”) Simultaneously, lenders are are positively petrified to lend to their heretofore “credit worthy” clients. There has been so much debt re-packaging that has gone on, that it is now very difficult to reliably assess any accurate values of assets and to evaluate loan risk

4.) Consumer Confidence
Much of the consumerism that built up in the US for the past 30 years was a Spendthrift mentality, created by the bygone oceans of “Easy Credit”. Both that credit and the resultant spending are now gone. And I do mean gone. In previous recessions, there had been brief declines in consumerism, but I can foresee that this one one will be different. This will be more like the 1930s, where the nation developed an entire generation of penny-pinchers. Don’t get me wrong–I consider this a good thing! Saving is admirable. Overspending is foolish. But from the standpoint of economic recovery, this could delay recovery by several year, since a large portion of the economy had built up around the concept of women with 25 pairs of shoes, and men with three sets of golf clubs

5.) For Many, the Hope of Retirement at Age 65:
Millions of American that were nearing retirement have lost any hope of retiring. Aside for the holdings of a few crazy “gold bugs” (like SurvivalBlog readers), their IRAs and 401(k)s have been devastated. There are also some company pension plans that have gone “poof” or that will surely be scaled back considerably. I don’t want to gloat, but those of you that took my advice three years ago and sold their dollar-denominated investments and invested in tangibles have come through the credit market collapse virtually unscathed. Some of you even came out ahead. Meanwhile, those that left their money in stock-heavy 401(k) accounts have been devastated. Losses of 30% to 50% have been the norm. Ouch!

6.) Carefree Mobility:
Before the housing bubble burst, people could easily change jobs, sell their houses (at a profit!) and move from coast to coast without much inconvenience. But to do so now constitutes major trial and tribulation. Up to 40% of people with mortgaged homes now have negative equity–meaning that the remaining principal of their mortgage now exceeds the market value of their house. (This is commonly called being “upside down” in a mortgage.) So now, even for someone that can make their mortgage payments, changing jobs to a new locale beyond commute distance means losing their house and starting over. And if they go with the “jingle mail” method, it means starting over with a ruined credit rating.

7.) The Last Shreds of Job Security:
Following the trend set by Silicon Valley, when the “Dot.Com” bubble burst in 2000, many industries are now getting positively ruthless about cost-cutting. There is now a constant barrage of news of layoffs, reduced benefits, and cutting our perks. Don’t expect “normality” to resume to the corporate workplace in our generation. Any vestiges of “job security” have become a thing of the past.

What Will Likely Continue to Be Destroyed:

1.) Further erosion of asset values.
The price of real estate (both residential and commercial) will likely continue to decline until either A.) The economy starts to recover, or B.) Inflation kicks in. If it is the latter, (which is what I suspect, sooner or later), property prices will start to rise only because general price inflation has grown. But this will be a false recovery in real estate. Real property values will continue to decline, while the currency unit itself is being destroyed. Yes, your house may be worth a several million dollars, but what will a million dollars buy you in such times? The same may happen with stocks. In the presence of inflation, news of a “stock market rally” will be nothing but fiction if the currency. Amidst the “Happy Days are here again” hoopla, real values will still be in the dumpster.

2.) More job losses and further-reduced wage-earning hours

3.) More failed pension programs

4.) The dollar itself as a currency unit. This recent news article was a subtle warning: The Swiss central bank has already fired the first shot in the global currency war. I expect large devaluations–both formal and informal–by many nations in the near future. The bottom line is that the US Dollar is doomed.

What will Remain and Gain:

Tangibles, Tangibles, Tangibles! I’ve been harping on that theme in SurvivalBlog for three years. Again, those of you that took my advice are mostly sitting pretty. Silver and gold have doubled, as have ammunition and many full capacity magazines. Productive farm and ranch land has held most of its value, while at the same time suburban real estate has plummeted. If you have not yet transitioned out of dollar-denominated investments, then do so immediately. (The current stock rally is nothing but a sucker rally in the larger context of secular bear stock market So this is a good opportunity to bail out.)

The present-day wave of deflation will likely be followed by a period of sharp inflation. At some point, all those trillions of “magically created out of thin air” dollars that will needed for the Mother of All Bailouts (MOAB) will inevitably catch up with the Dollar. My closing warning: Be ready for some serious consumer price inflation, most likely starting in 2010.