21st Century Economics

     The economy is in the can but our politicians keep telling us that we have bottomed out and are on the upward swing.  They point to rising prices in home sales and in a stock market that has been volatile but generally upward for several months.  All true.  But the mega-trend that is behind all that improvement is the $100 billion that the government is investing in the economy each quarter as a function of the ARRA.  Actually, it is more than $100 billion because there is still funds left over in the TARP funding that is being spent and there are other funds, like the $33 billion for the war effort, extension of unemployment funding, jobs creation programs, state subsidies, etc., that are being invested in the economy.  In the worst of times, the economy will show some improvement if you dump that much money into the markets.     

Unfortunately there are some huge problems with this plan.  Here’s why.     

The ARRA - American Recovery and Reinvestment Act - of 2009 is supposed to invest $767 billion into the economy within a 2 yr period.  That works out to be about $100 billion per quarter.  It’s working.  The economy is making a slow recovery.  Jobs are returning slowly.  Banks are lending again, a little.  Cars are selling again, sort of.  Inflation has not jump too much.  The dollar has not been devalued by much, yet.  The fact that we are spending $100 billion per quarter into the economy has a lot to do with this “recovery” but there is a huge problem with this tactic.      Virtually all of the ARRA money is deficit money - money over and above what we have collected in taxes.  In January 2010 alone, we added $680 billion in deficit spending.  The national debt is well over $12 trillion today and will climb to over $14 trillion within the period of time that the ARRA is active.  Even the CBO predicts we will conservatively add $9.1 trillion by the end of this decade (2010-2019).  That will put the national debt at over $21 trillion.       

This is a huge problem that is not getting the attention it deserves because it is something that has a slow development and a slow impact but like the lava in a volcano or the water in a flood, it moves slow but has devastating effects.  This debt is real and it has its consequences.  The debt represents borrowed money on which the government pays interest.  In 2009, we paid $383.7 billion of interest payments on the national debt - that is just over 3% on the total amount.  That is also 12.79% of the approx. total $3 trillion collected in taxes for 2009.  That payment on the debt rises to $671.5 billion by 2019 or about 16.65% of the total taxes expected to be collected in that year.       

Two problems with these estimates:  One is that the expected taxes to be collected in 2019 is based on a fixed rte improvement of about 3% per year between now and then.  Because of reasons you will see below, that is probably not a true estimation.  2009 taxes collected were 12.9% lower than 2008 - not 3% higher.  A more realistic estimate is that tax income will rise thru 2010 and then decline for several years before rising again.  The net gain between 2009 and 2019 might be closer to 1.5% - if it is positive at all.     

The second problem is that, as we will see below, interest payments on the debt paid out might be higher because of inflation.  It is very likely that all this deficit spending will devalue the dollar and increase inflation making the payments cost more.  Rather than an average of about 3% interest payments, it is much more likely to be about 5% or more.       

When you recalculate the total interest paid in 2019 using these projections, we will pay out 30.2% of the total taxes collected. 

But wait there’s more…..     

The national debt number that everyone works with is the debt owed by the General Fund.  That is the working capital of operations within the government.  Any deficit to that amount represents funds spent over and above taxes collected.  That is exactly the definition of the various Trust Funds within the government.  We have $800 billion in the Federal Pension Trust Fund (FPTF) for the retirement payments to the military and civil service.  This Trust Fund is money that was collected and set aside for the federal employee pensions but then the actual money was spent by the government - leaving essentially an IOU in the FPTF.  There is no bucket of money anywhere containing that $800 billion and set aside for the federal employee pensions.  It is simply a certificate that says that at one time the total excess collected and not paid out in pensions was $800 billion but Congress paid it out in other expenses.  So this is an amount that also must be paid back and because of COLA adjustments, has an ongoing increase to it. 

But Wait There’s More….     

There is, in fact no money in any of the “trust funds” that are “managed” by congress.  The $280 billion in the Medicare Trust is also gone.  The $3.1 Trillion in the highway trust fund is also gone.  The $1.7 trillion of the Social security trust fund is also empty as it every other trust fund in our government.     

The demand for payments OUT of these trust funds is growing at a rate much faster than inflation or in the growth of the economy.  For instance, the needed major infrastructure projects that would otherwise be paid for by the highway trust fund far exceeds the current trust fund balance.  In fact, the repair or replacement of just the bridges in the US that need immediate attention exceeds the amount in the trust fund now.       

The payout from the Federal Pension Trust Fund, the Medicare and Social security Trust fund all are expected to rise very rapidly over the next 10 years as the 74 million baby boomers retire.  For instance, the $1.7 trillion trust fund money plus all the money collected in SS taxes between now and just 5 years from now will be entirely gone by 2018 unless SS benefits are significantly cut.  The average 9% rise in medical costs plus the 280 billion Medicare trust fund money plus all the money collected in Medicare taxes between now and just 5 years from now will be entirely gone by 2016 unless there is a significant cut in Medicare benefits.     

A realistic view of the actual debt and an honest estimate of the rise in cost and the expected tax income would show that in less than a decade, we will likely accumulate in excess of $25 trillion in national debt and will be paying out more than $1.25 trillion in annual interest payments or better than 1/3 of the total annual taxes collected.  That means that rather than the usually 2% or 3% reduction in the annual increase in spending, our government would have to reduce actual spending by more than 30%.  That is something that they have never even considered and certainly have nave done.  In fact, basic economics says that our economy could not survive such a major decrease in funding for entitlement and military spending programs.     

But wait, there’s more. 

As bad as this is, it is unfortunately, not the worst of it.   First you have to appreciate the really really bad timing of the ARRA.  The following is a list of the confluence of events that will all take place over the next 15 years:     

1.Since 2005, it is not just the government but the US population has spent more than they made in income.  A net negative savings rate.  It has continued every year since at increasing amounts of negative savings.  The economists refer to it as wealth spending and it comes primarily from credit cards and home mortgages.  People borrowing to pay bills for items over and above their income.  The ones most affected are the baby boomers.  This latest economic crisis may change the attitudes back to a positive savings but it also may be too late.  Retiring boomers don’t have time to save enough to cover retirement so they will rely on the equity in their homes and investments ….precisely the two assets most impacted by the current economic crisis.     

2.    74 million baby boomers are retiring right now at a rate of 10,000 per day.  That will increase to over 20,000 per day by 2015.  All of them want social security; many will need it because they have no savings.   Applications for SS benefits are up 23% in 2009 over 2008 and the rate of increase is growing.  This increase is remarkable because the oldest boomers (those born in 1946) do not reach full retirement age until 2011.  What this reflects is the massive numbers that are taking their retirement money at age 62 because they either need the money or they have retired early.  If all or even a significant part of the boomers do this, then all of the timetables you see below will have to be moved back by several years.     

3.    As many as 70% of the boomers are expected to sell their MacMansions (homes over 2,000 sq ft) and second homes (1 in every 4 boomers owns a second home) over the 2012 thru 2025 period - putting more than 650,000 homes on the market per year over and above the amount that is historical normal roll-over.  This means that home prices will plunge and stay down until we burn off this excess which is estimated to take 10 to 15 years.  During that time, new home construction will be reduced, wood sales will drop, furniture, rugs, construction jobs, etc. everything related to that industry will also trend downward for a decade or more.  In the meantime, the demand for low cost housing ($600/mo including utilities and taxes) will skyrocket but are nearly non-existent today and currently there are no plans to provide them.  These homes have the lowest profit margins and there are very few investors that are willing to build “projects” like this.  Only the government would be motivated to invest in such massive low-income housing projects and they may not have the money to do so.     

4.    The social security fund will collect $10 billion LESS than it pays out in 2010 and $9 billion less in 2011.  This is the first time that such deficit spending has occurred and it is happening far sooner than anyone has ever projected.   According to the CBO, it will go positive from 2012 thru 2015 but that is based on the CBO projections that the economy will make a continuous recovery over all of that period.  And then it will go negative permanently - in fact, it may be as much as 75 years, if ever, before it will go positive again.  The reason for it going negative for so long is that there will be so many retired people receiving SS and Medicare than there are working people.  When the SS started, there were more than 25 workers for every person receiving benefits.  In 2018, that will fall to less than 2 people.  The taxes that two people pay will not cover the benefits for one person.  However, the average boomer will get $1100 per month in SS - not enough to live on for most.       

5.    The boomers put more that $7 trillion into the stock market over the past 25 years.  As much as 30% of that was lost as a result of the current economic crisis.  This loss means that boomers will be withdrawing money sooner, faster and will run out quicker than they had planned.  What was not lost will be used to fund their retirement.  This means that the stock market will stop receiving the huge inputs of funds and will begin paying out huge amounts in dividends and cashed out stocks.  To be able to fund these withdrawals, companies will have to completely alter their financial priorities - cutting R&D (always the first to be cut out), cutting any new growth or expansions, cutting back on all non-essential expenses, and reducing their work force.  Jobs lost during this crisis will not come back for a lot of industries.  Those jobs that do come back may not last long as they will be cut as soon as the effects of no more TARP, ARRA or other government investments and as lowered consumer spending is felt.      

6.    The national debt will cause two major problems that are economic inevitabilities: (1) the value of the dollar against foreign currencies will drop and (2) inflation will skyrocket to all time highs.  This will mean that all foreign goods will increase in cost with the most effect being felt in the price of fuel - gasoline, heating fuels, airline fuel, etc.  Rising transportation costs will cause almost everything else to rise.  A really serious consequence that could happen is that OPEC decides to change from using the dollar as their base currency to using the EURO.  Right now, all oil, worldwide is purchased and sold using the value of the dollar as the currency.  If OPEC decides that the dollar is too inflated or to over-extended, then they might very well switch over to the EURO.  This has been a threat for the past 10 years and has been stopped only because of the threat of Iraq, Iran and other Middle East unrest.  We have bought the allegiance of Saudi Arabia by giving them sweetheart deals on military aircraft and other weapons and protected them with our Navy and Air Force.  If they decide they are now strong enough, their enemies are weak enough or that we cannot provide any real benefits, then they will switch to the EURO or to gold.  Either way, the devaluation of the dollar against other currencies will make the price of oil climb to over $10/gal. or more.     

7.  All 74 million boomers will want Medicare and a drug program.  The current health care reform will add to that cost by adding those 15 million lower income people that did not contribute as much to their taxes as the middle and upper class.  This is expected to add at least $1 trillion to the total bill that is already projected to vastly exceed income to cover the costs.     

8.    Because of the economic crisis, negative savings, loss of equity, stock market drop and rising costs - many boomers will try to remain in the work force but they will mostly compete with younger workers for service industry jobs at the bottom of the salary range.  When many businesses will not be expanding, the job market will be saturated - forcing many to draw welfare, food stamps, fuel, training, housing, unemployment and other subsidies - adding to the costs of both state and federal government entitlement programs.  This is over and above the payouts to entitlement programs like social security, Medicare, seniors prescription drug programs and other national subsidies.  The sheer volume of old people (mostly baby boomers) will strain every social service program in every town, city, state and nationally to beyond their ability to respond.  Projections that you will never see from the government include an estimated 20 million people might be homeless by 2020 - up from 3.5 million in 2005.       

9.     Unemployment will hit over 10% in 2010 and is expected to lower in 2011 and beyond - according to the government.  But of course, that is what you’d expect them to say.  After the ARRA and TARP and other government investments stop, job creation will stop and job losses will begin again.  But what we hear about as unemployed is not at all accurate.  They only count those that are unemployed and actively seeking employment and are doing so with the help of the government.  Those that have taken jobs only to hold them over until they can get a better job, those that have stopped looking because they have exhausted all possibilities, those that are seeking jobs outside of the government programs and those that are doing handyman, maid or other private work because they cannot find other work are all no counted.  In the future, the massive number of old people that will have to work because their social security does not cover basic living costs - will not be counted in the unemployment figures.  Real unemployment in 2010 is probably closer to 14% or 15% of the working population and despite investments and other efforts; unemployment is likely to grow to over 20% by the peak of the boomer retirement era - in 2020.      

Now - why is all this not apparent right now?  Because we are pumping $100 billion into the economy every 4 months.  The ARRA money is hiding the fact that tax receipts in every state in the union are not covering expenses.  It is hiding the fact that the SS fund is running a deficit right now.  It is hiding the fact that the housing market is already saturated with “toxic assets” even before the boomers start selling in mass.  All that plus we are recoiling from a huge financial loss and we are still ONE year away from the first boomers (born in 1946) reaching full retirement at age 65.       

What will happen in 2012, when they have spent all the ARRA money?  How fast will the impact of all of the above inevitable events take to bring the economy into a 10+ year depression?  Ask Chris Dodd and Byron Dorgan - they can see that the Ship of State is being held afloat by band-aids and threads and is leaking badly.  They are abandoning the Ship of State before they are grouped among those that will be either blamed for causing this problem or held accountable for fixing it.   It going to be a helluva mess.     

At the beginning, I said that 2010 is your last chance.  During 2010, when ARRA and TARP and other government investments are still being paid out - while the inflation has not yet taken hold - while most of the boomers are still working and while we have not yet experienced a major devaluation of the dollar - the economy will grow.  The market will climb and you can make some money in the market.  It will be volatile and it almost certainly will not last for all of 2010 but this is your last chance to make an investment in which the objective is more than preservation of the principle.       

Probably in the early part of the 4th quarter, the speculators that will try to jump the gun on inflation and reduced government spending will begin bailing out of the market and into gold or other cash equivalents.  Gold in late 2010 and for the next several years will be rising massively.  As long as the basic economy does not completely collapse, gold will be the safe haven for several years to come.  I for one will be moving into gold in the third quarter or perhaps even sooner.  I will also be carefully picking stocks and commodities that I will be selling short and buying long on to take advantage of this inevitable set of events.  When I did this coming into the Y2K event in 1999, I made a fortune.  This will be the same kind of opportunity but much bigger and it won’t be over in a few weeks.  That means that there are dozens of opportunities to make tons of money if you simply are willing to open your eyes and see the mega-trends that are really driving what is happening.  

The demographics of the coming crash are undisputed and unavoidable.  They pertain to the market forces driven by the baby boomers – all 77 million of them.  21 million households in the US are boomers – 46% of the total homes in the US are boomers.   Their influence comes from the fact that there are so many of them.  Their impact comes from the fact that this large quantity rose and fell so quickly.

Following WWII, a lot of horny soldiers and sailors came home from the war.   They married, made babies and worked very hard and were a part of making a lot of new infrastructure and industry come into its own.  The world was making a rapid recovery, economically, from the war years and the economies of most industrialized nations of the word began to grow rapidly.  Despite a brief interruption from the Korean War, this growth trend continued.  This was a good thing because the huge quantities of babies cost a lot of money to care for and educate.  Fortunately, our industrial and economic success could absorb the burden of those costs.

In a relatively short period – from about 1950 to 1960, the baby population grew to record levels.  This was a huge influx of people into our society.  By 1960, most of the WWII generation parents had had two or more babies and were now ready to settle down to being parents.  Coincident with that, came “the pill”.  The first easy to use oral contraceptive that was safe and worked.  The birth rate plunged to very low levels and did not rise again until the echo-boomers (the children of the boomers) began having their children.

The baby boom officially was from 1946 to 1964 but if you look at the above chart, you will see that from 1950 to about 1960 is the greatest rise and from 1960 to 1974 is the largest decline in births.  Using the median age of these groups, you can see that the average boomer is 52 years old in 2007 and will be 65 in 2020.

The rapid rise of the boomers is what created the school shortage and overcrowding in the 50’s and 60’s. 

In the 60’s, we had the Love Generation, Hippies and counter-culture that were primarily driven by 77 million teenagers going through adolescents.

In the 70’s we had a massive boom in employment as these 77 million people entered the workforce.  Part of that boom was in massive increases in productivity as more people with money began buying the things that adults buy and the manufacturers had to increase production to keep up with demand.  Another part of the workforce extended the counter-culture and boom in personal computers into the workplace.  This created the beginnings of the tech boom, personal computer sales and the entire software industry.

In the 80’s, when the median age of the boomers was in the early 30’s, they reached their peak home buying years.  The housing boom of the 80’s drove home sales and new construction to all time highs.  Car sales also boomed as did furniture, TV’s, microwave ovens and the other entire household and family expenses that come from full employment.

In the 90’s, the boomers were approaching their peak earning years in their 40’s and 50’s.  With that earning, they began, for the first time, earning more than they were spending.  In this decade, the boomers put more than $7 trillion into the stock market – mostly into mutual funds.  This rapid influx of money into businesses allowed them to expand, do R&D, introduce new products and explore new markets.  This was massive influx of money was what drove the technology boom of the 90’s.  The search for new investments created Silicon Valley and put Apple and Dell and Microsoft on the map in a big way.

The large amount of money was, in fact, larger than the real value of the stocks that were being invested in.  Price-Earnings Rations (P/E) of the mid 20’s was considered to be reasonable and normal but toward the end of the 1990’s, we were encountering P/E rations of 180 or more.  This was a bubble in the truest sense of the word and existed only because of the competition between investors to find and invest in almost anything that would show a profit.

Surprising is the fact that beginning in the late 1980’s and continuing to the present, the boomers, as a group, have saved less money than any other generation.  In fact, the net total spending of the boomers exceeds the net total earnings for the past decade and a half.  That means that the boomers are buying things faster than they are earning money to pay for those things.  There is a net negative savings across the entire group of boomers.

The realization of the possible impact of the crash of society from the Y2K scare, the aging and maturing of the boomers and some nasty manipulations by the banks and Wall Street giants brought the boomers back to reality by 2001.  We experienced the Tech Bust of 2001.  Stocks crashed.  Thousands of tech companies with P/E’s above 80 simply ceased to exist.

For a brief time, people tried to recapture that moment of robust stock activity by “day trading”.  The single guy that thinks he can find that winning stock better than all the Wall Street gurus.  That quickly died when they realized that sales commissions and taxes ate up all but the luckiest buys.

In the early part of the new century, the boomers have mostly been earning lots of money, putting more of that into investments and buying more stuff.  Since they are earning as much as they ever will in their lives, the boomers are searching for places to put all that money.  What they found and are buying in massive quantities are second homes, vacation homes, big-ticket items like expensive cars, boats and airplanes.  Vermont is one example – there are more non-resident homeowners than there are resident homeowners.  Major sports and entertainment centers have grown significantly in this period.  Las Vegas, Orlando, Vale Colo., Vermont, the Gulf coast, etc..

As we come to the end of 2007, we have a few boomers that want to retire early.  These are the boomers that did well in the stock market, bought big homes and second homes or vacation homes.  They are empty nesters because the kids are not living at home and many of them are already out of college.  When looking at the value of their homes and their real needs, many are deciding to sell off their homes and retire early.  If one in ten boomers are doing this, that is more than 2 million homes put on the market in a relatively short time.  It might be more if the couple with a big main house (over 3,000 sq ft) and a vacation home or second home want to sell both of them to buy a ranch or condo.  That puts two houses on the market.

The early impact of this began in 2004 and has been increasing since.  As more homes come up for sale at the same time that the buying population is decreasing, the homes have to go down in price to sell.  This is often measured by the “time on the market” before a sale is closed.  In early 2004, the average time on market was 37 days.  By the end of 2004, it was 67 days and by the end of 2007, it was 137days.  That is the average.  In some markets, sales are almost at a standstill with time on market measured in years.

Of course, if you are among those that want to sell your home to retire early, you will lower the price to sell it in this kind of market.  Home sale prices have dropped more than 25% in some flooded markets.  New home construction is way down, especially for large homes.  The shows on TV about “flipping” a home are now telling stories of homes that have not sold in 6 to 9 months.

A by-product of all of the money and home sales is creating a secondary effect in the economy now.  In the 1990’s and up to about 2006, the banks have had so much extra money that they were having a hard time finding people to lend it to.  They are, after all, in the business of selling money in the form of debt, i.e. loans and the biggest loan is for real estate. 

Like any business, when they have too much inventory, (in this case the excess inventory is money) they have to lower the price.  That took the form of lowering the interest rates on mortgages but that was not enough, they also needed more buyers so they lowered the standards needed to qualify for loans.  This is the sub-prime market and the adjustable rate mortgage markets. 

As was fully predictable, these high risk loans do what high risks loans do, they defaulted.  Some defaulted because the adjustable rate mortgage adjusted upward to a point they could not pay.  Some defaulted when they realized that the housing bubble has popped and their home is not worth on the market what they still owe on it.  Still others were simply bad risks that never should have qualified for a loan of that size.  The result has been a huge drop in the value of real estate and related investments.  That has pulled down the worth of the banks that valued their property or mortgages as part of their net worth and market value.  The failure of several banks has shown that it can happen and is causing the stock market to react by an exodus out of real estate and financial markets – dropping the market further.

Unfortunately, this is all in advance of the highly predictable impact of the retiring baby boomers.   In the second decade of the new century, we will see the boomers begin to retire at a rate that will rise to over 1,000 per day. 

Once retired, they will want their social security and Medicare which is another can of worms that I’ll cover in another article but suffice it to say that the US Government is not at all ready for what is to come.  Since so many saved so little during their peak earning years and so many planned to finance their retirement with the sale of their homes plus social security and investments that any drop in any of those three sources of income will become significant.  Unfortunately, all three of those three sources of income will probably be way less than anyone had planned for.

These retired boomers will put their homes up for sale because that is the way that most planned to finance their retirement.  As with the housing boom of the 1980’s, the bulk of boomers will try to sell within a relatively short period of time and the result will be a flooded market with way more inventory than buyers.  Prices will drop thru the floor.  It is, indeed, unfortunate that the sub-prime and mortgage financial crisis has hit at this time.  This may well depress the market until the bulk of boomer homes floods the market – driving prices even lower and creating even more defaults and foreclosures.

As we have seen in 2008, the sub-prime and mortgage financial crisis has spread to the general stock market which is down to where it was 16 years ago and still going lower.  Gold is at al all time high and there is talk of a recession that will devolve into a major depression.  It is, indeed, unfortunate that this stock market financial crisis is hitting just as the boomers are retiring because it is now that they will begin to withdraw that $7 trillion that they put into the market over the past 20 years.  Cash out of stocks will put more available stock on the market – lowering the price.  Dividend payments will withdraw cash from corporate spending and cause them to cut back in other areas – most often it begins with R&D and plans to expand and then moves into cutbacks in production – cuts in staffing.  We have seen massive layoffs from all of the airlines and all of the automakers and many smaller industries and businesses.  The current crisis will bleed right into the period when the boomers will suck out their investments and lower the market even more.  If they panic and try to withdraw early or all at once, this could collapse the market.  Certainly the investments that the boomers are planning on will be much less than they think they will be by the time they begin to withdraw it.

The bottom line is that the baby boomer demographics has caused and will cause massive changes in the US economy in each age it has influenced.  A prudent investor will find ways to profit from such an economy.

Housing Dimple

  Written Jan 29, 2007

We use the term “bubble” to describe a brief expansion in a select market, as in the recent “housing bubble”. What is the opposite of a bubble?  A Dimple?  Whatever it is, I believe we are heading for a doozy in about 8 or 10 years.  Here’s why.

Insurance companies and investors have actuary studies that show that people do predictable things at certain ages.  The 77 million baby boomers bought houses in the 80’s and early 90’s as they moved into their peak earning years.  As early as 1982, they were calling the rising sales a housing market bubble but by 1992, they were talking about a housing slump.  This eight year period marks the peak house buying ages (from age 27 to 37) of the boomers.

Those same actuary studies indicate that it is inevitable that those same boomers will sell their homes in record numbers as the owners age, moving out of their large primary homes for a smaller home - usually seeking a ranch style (one floor) or a condo (no yard maintenance).   The so-called “empty nesters” will most often sell the larger homes (4 or more bedrooms), second homes and those with high-maintenance property.  In Vermont, these are also the homes with high heating, electricity and tax costs that are likely to be sold.

There is another reason that the boomers will sell.  In their lifetime, most boomers have never seen a prolonged period of time when there was a major housing market crash with protracted losses in real estate investments.  In fact, under the motto of, “No one has ever lost money in real estate”, many boomers invested in their homes with the idea that it will gain in equity and, when sold, will provide a substantial boost to retirement savings, adding to the motivation to sell.  Thinking of taking advantage of large real estate appreciation of the past, a home bought in the 80’s would, by that logic, be reasonably priced in the seven figure range by the time they retired in the early to mid 2010’s.  This might have been true if there weren’t so many that had the same idea. 

Certainly some will keep their homes but it is a statistical certainty that more than the average quantity will sell.  As with the buying boom of the 80’s and early 90’s, this sell-off will occur over a relatively short period of about 10 years probably something like 2009 and 2019.  The laws of supply and demand dictate that prices will drop as the supply increases but unfortunately, the demand will be dropping at the same time.

 Following the baby boom of the late 40’s and 1950’s, we experienced a precipitous drop in birth rate.  This was due to the rebound from the baby boom combined with the introduction of “the pill” in 1960.  The result was a fifteen year drop in birth rates. However, many boomers decided to put career ahead of family or to have children later in life, resulting in an echo boom that diffused over a longer period of time - more than 30 years.  The end result is that anything of enduring quantity created to accommodate the volume of baby boomers will be in excess supply for more than three decades before the population will again rise to the levels to create a similar demand.  

One possible scenario – The Housing Dimple – the economic reverse of the buying boom of the 80’s:            The boomers sell-off will increase normal annual large home sales by as much as 400%.  The expected buyer population will be much less than the volume needed to maintain a modest market demand.  As a result, there will be a glut of unsold large homes on the market.  Desperate sellers will lower prices and new construction of large homes will virtually stop.  The excess supply will drive the sale price of large homes down and home values will fall dramatically.  A home that could sell for $650,000 in 2005 might sell for $250,000 or less in 2015. 

There are, of course, lots of factors that might mitigate this kind of scenario.  There are also lots of factors that might exacerbate this scenario.  It gains credibility when you consider that this has already happened in some high value markets.  Actuary studies predict a high statistical probability that there will be implications and ramifications in real estate and in other markets and investments.  Large losses as well as gains are possible.  A prudent choice might be to plan ahead. 

References:

 http://www.realestatejournal.com/buysell/markettrends/20060619-fletcher.html?refresh=on

The 21^st Century Business Model  

Here in Vermont, we spend a lot of time and effort holding on to “the good old days”.  Its nice to walk into a local store where you know all the sales people and the owner by their first names and they all know you.  Mostly because of that, we don’t mind that the store’s inventory is not as large and prices are not quite as low as the mega-mart over in the big city mostly because of that good old fashion Vermont service.  This is a 20^th Century business model that is coming under increasing pressure to change.

Part of that change is that the growing use of computers and the internet is making it more and more possible for people to shop almost anywhere in the world for almost anything they need or want and at prices to which most store-front sellers can’t compete.  Even without the competition of a nearby mega-mart big-box store, the global economy will eventually affect most merchants and many service industries.

One way to address some of that competition is to go online.  Nowadays, even local stores are often expected to be listed in online directories with store hours, maps and phone numbers.  It is becoming increasing important to have an online presence just to remain competitive but with a little extra effort, you can also create added income streams and cash flow with a surprisingly modest investment

The most elaborate web sites cost about $250 per page but it is possible to begin with building a simple static web site using free template-based applications and online web hosting services with monthly hosting fees as low as $10.  Alternatively, you can use some easy online services or hire a programmer to create a dynamic web site in which you frequently change web-page content in as little as one hour per month.  Annual costs can be as low as $360.  Any business can break into this market with one of three basic options without the need for expensive computers or training.

The Menu Option:             You can setup a simple static web site that offers a menu or inventory listing of your sales offerings.  Similar to a restaurant menu, you list what you sell or just list types or groupings of merchandise or services, but without prices.  You also list store hours, maps and contact information.  The advantage is like having a large, detailed, online business card or permanent advertisement for about $120 per year.

The Take-Out Option:            If you already have a small or computer-based inventory, you can easily setup an online version of a take-out order by allowing web users to see all or some of your inventory listing and place orders online for later store pickup.  By adding a simple order save function, you can allow people to build their shopping list over some period of time (weeks or months) and then schedule the in-store pickup for a specific date or they can place special orders or orders that require preparation.  The order could show up on an in-store printer and be prepared for customer pickup and payment.  This avoids online money transactions but can still enhance sales and provide a value-added service for your customers.

The E-Commerce Store:  The most elaborate online sales option is to put up a full function store web site.  There are turnkey, off-the-shelf, e-commerce software packages and online services that can provide this capability starting around $50/month.  Such a web site does everything for you except delivery.  It takes the order, adds in shipping, handling and tax and then collects the payment.  All you have to do is collate and mail the order or prepare it for pickup.  Such sales can be for a very select portion of your inventory that might appeal to online buyers outside of your immediate store location. 

Don’t dismiss these options too quickly because experience shows they can enhance customer service and might lead to large volumes of sales at less labor and lower overhead expense than in-store sales.  These options are ideal for home-based or Vermont specialty stores and many small businesses.

This is the 21^st Century and your sales competition as well as your potential buying market is growing every day.  You need a 21^st Century business model if you are to survive.   It is possible that your regular customers of the future could be a rancher in Wyoming or a schoolteacher in Japan.  They, too, might get to know you by name and you know them and they are repeat buyers from you because of your good old fashion Vermont service.

What has happened in the financial markets

Banks are just money stores.  They sell DEBT!   Banks sell money by making loans and mortgages to people at an interest rate so that the people pay back more than they borrowed.   They sell debt!  Remeber that.  It is in their best interests to put you in debt to them by any means possible.  In that light, much of what they do makes much more sense.

Actually, you don’t exactly buy money but they do lease it.  By offering various services, safeguards and payments, the bank gets people to put money into the bank’s inventory.  The bank then makes payments to the depositors by giving them payments in the form of savings interest rates, free services and other benefits.  They can afford to make these lease payments because the interest rate they get from their loans is much higher than they pay out for the use of the money they are loaning. 

The pool of money that is deposited ends up being very large when compared to the amount that has been put out in loans.  In fact there are laws that mandate that the bank must hold in reserve a very small pool of money to cover the normal fluctuations of deposits and withdrawals.  It amounts to only 10% of the total amount of money they have lent out.  This is called fractional banking.

While this small pool of deposited money is held by the bank, they try to make it earn more money by making investments.  Some of this is in Treasury Bonds but mostly it is in things that people want to buy by borrowing money from the bank. 

In this regard, this money bank operates like any other store.  It has sales people (loan officers) that try to sell their inventory (debt) and inventory managers (asset managers) that try to attract more deposits from more people.  The profit of the bank is made from making that small pool of deposited money earn additional income while it is in the banks control. 

Now suppose that our economy is booming and lots of people are earning lots of money.  They will want to put it into a bank for safekeeping and that makes the small pool of deposited money grow much larger.  When the bank has millions of dollars just sitting in its vaults, not earning money on interest loans, then the bank is effectively losing money. 

The response is to tell the sales staff to make more loans - this is, get more people into debt to the bank.  The problem is that in a given community serviced by several banks and in a booming economy, there may actually be a shortage of people that want to borrow large sums of money.  To entice borrowers, the bank will lower their interest rates and loan application standards.  They don’t want to lose money, just get that initial sale, so, for mortgages, they offer a low rate for the first few years and then will raise the interest rate back up. 

But again, the community is serviced by several banks and there are just so many mortgage loans that can be given out so the bank looks for other kinds of investments that can earn money.  Most banks have a portfolio manager that handles the various Wall Street investments.  But this is not the kind of investments that normal people make.  A bank might have $300 billion in its pool of deposited money and it is not legal for them to put very large sums into one stock investment and it is not cost effective to make thousands of small (under $10 million) investments in stocks.  

So the banks have come up with their own kind of investments.  These are the kind of investments that you need billions of dollars before you are allowed to participate.  One kind is to bundle all of your mortgages and sell them to another bank or investor.  This had the effect of giving the bank an immediate return on its mortgage loans and the buyer gets its reward by gaining the long term high payoff that every mortgage pays.  There are also tons of other weird and very complex “instruments” that banks use – like derivatives. 

These high cost instruments cost billions of dollars and are valued based on their risk level.  As with most investments, if the bank is willing to take on a little more risk, then the reward is potentially larger. 

Ah but here is the problem.  As the pool of deposited money gets larger, the bank is under pressure to get more of that money out into investments and earning profits for the bank.  When they have tapped out the market for loans and investments at a safe and secure risk level, they are under pressure to change that acceptance level of risk and loan out at greater and greater risks.  In this case, the risks may be that the collateral of the loan is not worth the value of the loan or it might mean that the derivative has a high risk if the economy fluctuates any.

In the great Savings and Loan Crisis of the late 1980’s and early 1990’s, that was just such a situation.  A booming economy and the offer of high interest rate on deposits brought in billions of dollars.  When the real estate boom of the 1980’s hit, the S&L’s wanted to make all that deposited money work for them.  Deregulation had removed most of the normal safeguards allowing the S&L’s to invest in more than $160 billion of bad loans – mostly for real estate that was not worth the amount of the loan.  The US government paid $128 billion to bail out the S&Ls. 

Over the past 30 years, the baby boomers have put more than $7 trillion into various stock market, real estate and banking investments.  Companies like Bear Stern took those deposits and made a lot of investments – mostly in the high risk derivatives.   They were overextended and under-collateralized into high risk ventures that collapsed when the national economy took a dive. 

One of the impacts of the baby boomers retiring is that they will be selling off their homes.  Many have second homes or very large homes that they will not want to keep in retirement.  The sale of these homes will oversupply the market and drive prices down – which is exactly what is happening right now. 

That combined with the devaluation of the dollar on world markets and you can see why Bear Stern defaulted.  But stand by, this is just the beginning.   The sub-prime mortgage problem, the massive rise in bankruptcies and the devaluation of the dollar will combine with the real estate crash to make for one awful economy and any financial institution that took on a little more risk than was prudent will find themselves in big problems. 

Unfortunately, that includes the federal government.  The FED has a finite ability to manage these crisis situations.  One is to lower their prime interest rate but it is now below 1.25 – the lowest since WWII – and if it goes much lower, the primary tool that the FED can use is gone.  In addition, the FED has just paid out $160 billion to guarantee loans for the Bear Stern bailout.  Since this is a federal guarantee, the buyer has very little risk and if they begin to falter, you can bet they will call in that guarantee. 

There is no honest appraisal of the US economy that does not lead to the conclusion that we are headed for a major financial crisis in the next decade and it will be unlike anything we have ever seen before.  

It has begun!

It has begun!

The January Effect is a well known and fairly consistent trend in stock market swings. In the 4th quarter, each year, large institutional investors dump losing stocks to take losses that will offset their wins over the previous year. This puts a lot of supply of poor stocks on the market and puts a lot of cash into the hands of the investors. The fact that these are stocks that normally are not swept up by others and the holiday spending spree of the consumers, usually absorbs most of this sell-off so we normally do not see a large drop in the market nor a rush to sell off winners. However, after the New Year starts, these same investors, now flush with cash, want to invest and most do so in January.

With all this pressure to increase the market, in fact, quite the opposite is happening. It is taking a dive. This means that the market drop is actually much worse than it appears. It is diving despite all this upward pressure - or more precisely, investors have lots of reasons to buy but instead they are selling in large numbers.This is not a new trend. The NASDAQ and Dow hit highs in October and have mostly been going down since. This has a lot to do with the Bush administration’s policies of trade, tax and politics but it also has to do with the normal cycles of regression to the mean of normal and typical stock performance. We have been due for a recession for some time.

I may have been wrong about that date. It might have already started. This is not that unusual since it is common for investors to buy on rumor and sell on history (news) – making them always over reactive to even the hint of good or bad news. In this case, they are perhaps acting sooner than I had expected or maybe just reacting to a shorter term crisis that will coincidentally run into the large crisis looming just ahead.As one of the more informed generations of investors, they may well be aware of the coming problems created by the boomers and may well be also reacting to that crisis a few years in advance. This can happen if the institutional fund managers are of the mind to be cautious about what they know will happen eventually.

Bottom line is that a major financial downturn has started and will continue for the next two decades or it will take a short spurt upward for a year or two before taking the plunge for two more decades. Either way, prepare now or suffer later. 

Federal Marketplace

New Business Development
in the
Federal Marketplace

This is a $600+ Billion annual marketplace that sells buys goods and services from virtually every aspects of the economy from pencils to airplanes and from plumbers to computer programmers. The buyers in this market often pay top dollar and once you get a contract, it often leads to others at even larger profit margins.

It costs to get on the GSA schedule and it takes some time to qualify but it is worth it if you are a supplier of some product or service that is in demand in the federal market.  

Wealth , Power, Influence

Wealth , Power, Influence
They Got it, You Don’t
Consider this:

If you are smart, you will watch to see if this is true and if it is, do something to both protect yourself and to take advantage of it.  

Boomer Employment - An Historical View

Boomer Employment
…A Look Back

In order to understand the movement of the economy and business investments, you need to understand what motivates these activities. Employment is the critical element for productivity (the GPD) and for consumption (CPI). If the workers are not working there is no productivity and no income to spend on goods and services. There is also a loss of taxes and federal investment in the economy - less Dept. of Defense spending and reduced government subsidy programs. Just the opposite is true if we have full employment. Interestingly enough, these trends and cycles are VERY predictable and therefore you can position yourself to profit from them.

Another inevitable outcome of this period will that employers will be willing to hire and retain older workers longer. It will no longer be out of vogue to be a late 50’s or 60’s manager or blue collar worker. These workers will need to work because their retirement money will almost certainly be insufficient.