JOHN VACHON, 1939 / LIBRARY OF CONGRESS
The great depression of 2020 is here. With millions out of work, driven in large part by COVID-19, the US is in dire trouble, in many ways, worse off than the Great Depression of the 30s because back then, the environment was viable, manufacturing capability was intact and the populace was unified and eager to get back to work. Today, financialization, ruinous debt and environmental degradation are just some of the problems America is facing and we haven't even discussed climate change. With this optimistic view in hand, an insightful essay by Charles Hugh Smith gives one pause regarding fixed costs and how it applies to possible economic collapse of a most pernicious kind.
A collapse of major chunks of the economy is widely viewed as "impossible" because the federal government can borrow and spend unlimited amounts of money because the Federal Reserve can create unlimited amounts of money: the government borrows $1 trillion by selling $1 trillion in Treasury bonds, the Fed prints $1 trillion dollars to buy the bonds. Rinse and repeat to near-infinity.
With this cheery wind at their backs, conventional pundits are predicting super-rebounds in auto sales and other consumption as consumers weary of Covid-19 and anxious to blow their recent savings borrow and spend like no tomorrow.
But ...
We're already in a post-normal world because the expansion of globalization and financialization needed to fuel the Old Normal has reversed into contraction. This reversal is an extinction event for all sectors and institutions with high fixed costs: air travel, resort tourism, healthcare, higher education, local government services, etc. because their fixed cost structures are so high they are no longer financially viable if they're operating at less than full capacity.
Only getting back to 70% of previous capacity, revenues, tax receipts, etc. dooms them to collapse.
And there's no way to cut their fixed costs without fatally disrupting all the sectors that are dependent on them.
Most operational costs are mandated and cannot be reduced: union contracts, property taxes, regulatory burdens, tax accounting, debt service, employee healthcare costs, minimum wages, etc. Other essential expenses such as commercial rent are difficult to renegotiate lower, as the landlord also has the same high fixed costs and any reduction comes directly out of his pocket.
To whit ...
A good example of this collapse dynamic is a restaurant with high fixed costs. It can't survive financially at 50% of capacity because it can't reduce its expenses by 50%. The owners can reduce staff but there are operational limits on this: even if there are only 10 customers rather than 100, you still need a kitchen and wait staff. Stripped to the bone, the owners might be able to reduce costs by 15% to 20%. In other words, if business rebounds to 80% of pre-pandemic levels, the restaurant can survive but not generate any profit.
It might survive at 70% if the owners do double shifts, but that isn't sustainable. Eventually, the overworked owners burn out and collapse.
Reducing costs is even more difficult for institutions such as hospitals, colleges and government agencies. Most of these institutions are unable to cut more than a few percent of expenses; a 10% reduction in expenses would require the closure of entire departments and eliminating core services.
In essence, it means reconstructing America on a more modest level as the complexification of almost everything thanks to financialization has reached its limits thus making the painful reset inevitable.
Any questions?
