Wednesday, March 06, 2013 - Hollowed Out

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Hollowed Out

by Sinclair Noe

DOW + 42 = 14,296
SPX + 1 = 1541
NAS – 1 = 3222
10 YR YLD +.04 = 1.94%
OIL - .39 = 90.43
GOLD + 8.70 = 1585.10
SILV + .34 = 29.04

I have to admit to a hollow feeling in these celebrations. The High Frequency Traders are probably having fun. The Wall Street banksters are swimming in waves of liquidity, freakishly similar to 2007, when they leveraged everything and then leveraged the leverage, and then leveraged the risk on the leverage. And after they burned the place to the ground, they took a bailout to rebuild, and they left the grounds slathered in debt.

So, the Fed has cut interest rates to near zero, which is the optimal level when you are getting buried in debt. The low interest rate has the combined effect of lowering debt issuance and servicing costs, as well as increasing bank margins. The side effect is that currency debasement boosts competitiveness, investment and inflation. A few jobs result from increased competitiveness, but not enough to create a virtuous cycle. ADP said the private sector added 198,000 jobs last month; tomorrow we get the government's monthly jobs report; and the word we now associate with the jobs report is “modest”.

Here we are again; the Fed is juicing asset values and telling us they're doing it to prop up the economy, while all it really does is juicing the banksters and the corporate cronies. Not so much for the rest of America; still struggling to stand straight after taking a sack of bricks to the belly. And while the economy is showing signs of improvement, it is hollow, absent the middle class; workers pay has been shrinking as a part of the total GDP ever since the meltdown.

You've probably heard that household income is down 8% from 2007, but that's just part of the story. The gap between the richest one percent and the bottom 80 percent has grown exponentially over the past 30 years. With 53% of the population earning $30K or less per year, there is no question there is an asset bubble. The inequality is far worse than you think. The top 1% has 40% of the nation's wealth. While 80% of us have just 7%. And the top one percent own 50% of the stocks , bonds and mutual funds. So, this celebration of the market high is like throwing gasoline on the fire. There will be more and more attempts at redistribution until the whole thing pops. Enjoy the ride 

So, the record high for the Dow is more a reflection of how the corporations have squeezed workers, and how this is supposed to be the new normal. A new report by MIT on innovation and production seems to capture the desperation and how this has left the country at a competitive disadvantage. It says, in part:

One of the key danger points identified in these reports is the declining weight of the U.S. in the global economy. Even though the U.S. share of world manufactured output has held fairly steady over the past decade, economists have pointed out that this reflects good results in only a few industrial sectors. And even in those sectors, what appear to be productivity gains may be the result of underestimating the value of imported components. A close look at the composition of a worsening trade deficit shows that even in high-tech sectors the U.S. has a deteriorating picture. While the output of U.S. high tech manufacturing is still the largest in the world and accounted for $390 billion of global value added in high-tech manufacturing in 2010, U.S. share of this world market has been declining, from 34 percent in 1998 to 28 percent in 2010, as other countries made big strides ahead into this market segment.

Jobs are another huge concern. The great spike in unemployment over the past five years was disproportionately due to loss of manufacturing jobs. And as the economy revived, such jobs were very slow to return. In fact it is clear that many of them never will.

And the loss of jobs in manufacturing does not mean that the sector is now lean and mean. Nope, it has been gutted and it might not recover. What manufacturers we still have left in this country are having a hard time with innovation because they have lost the rest of the manufacturing community. Turns out that innovators need other innovators. They were not finding any complementary capabilities they could draw on in the industrial ecosystem as they tried to develop new components: no outside funding, no connections with community colleges, no trade associations, no research consortia.

It's called internal integration. A designer could go down the street in their hometown and talk to a manufacturer about the ease or difficulty of producing a new product. But now, the shop down the street is boarded up or torn down. To actually produce something requires a social ecosystem in which ideas can flourish and be tested with fairly low risk, at fairly frequent intervals, before they develop into actual products. Some might claim that the innovative process has gone high tech, and to some extent that is true, but it has also become fragmented across firms and geographies.

What we do not know, though, across different industries—and particularly for emerging new high-tech domains—is whether the separation of innovation from manufacturing will allow innovation to continue full-bore at its original home, or whether separation comes at the price of learning and creation of capabilities that might produce future innovation at the original home base. Separating innovation and manufacturing—in different companies, or in different locations—might make it unlikely that a firm would gain full advantage from implementing technological advances within manufacturing.

And of course, when jobs are lost, the experience of the worker is also lost. This at a time when many workers have finally mastered their trade and might have the ability to think beyond mere competency and look at innovations. And the longer the worker is unemployed the greater the probability the worker will become unemployable. Skills unused diminish over time.

Outsourcing and offshoring are not about improving flexibility and innovation, but about what managers usually say it is about: lowering labor costs. It’s actually a form of looting, just not the financial kind. The reduction in manufacturing floor costs is partially offset by an increase in managerial coordination, so it’s actually a transfer from blue to white collar workers, particularly the very top executives. And it increases risks of the enterprise. One glitch in the supply chain can wipe out profits claimed from lowering labor costs. And the longer-term effect is to hollow out the middle class which once formed the core of the customer base.

Not to worry, the Fed will continue to juice Wall Street and perpetuate the asset-based economic growth model, which in turn gives the Washington politicians a fig leaf to hide their dysfunction. Bernanke has stated he will use proper monetary policy until there is a recovery per employment; therefore, we will get a recovery. Perfectly logical. And I’ll keep flapping my arms until I begin to fly; therefore, I will make myself fly at some point.

The stock market is not a proxy for economic activity. Rather, it is a proxy for leveraged speculation using cheap borrowed money. The low volume and extreme volatility suggest a very dangerous top. Those now getting up the courage to plunge in will most likely be buying from those now hoping to get out before the next crash.

None of this means the crash will not be delayed for a year or two, or even longer. Nobody has any idea what will happen next. The real things we know about the economy is that taxpayers got stuck with Wall Street's gambling debt, and the employment shortfall, and the rents being extracted by the financial sector. And so far, we have done next to nothing to change the system.