Recession 2007: Part I
by Eric Janszen - October 27, 2006
Riding a bicycle is an act of continuous, unconscious balance, the habit of turning right as the bicycle falls slightly right, left as it falls slightly left, in a series of minute automatic corrections. Recently spent a few hours trying to teach my seven year old niece how to ride. A few hours of pushing, running, and catching, and after she fell down a few times, were a lesson for me that I'd forgotten: this balancing act is learned and not innate.
I've been riding bikes for nearly 40 years. Today I'm flying down the bike path in the chill autumn air. At least I feel like I''m flying, full throttle, without the obstacles that plague this course on a typical warm summer day: spaced out children whose parents have abandoned them to learn the US drive-on-the-right rule the hard way; a group of teenage boys re-enacting a segment of "Jackass" with a shopping cart; roller-bladers competing with each other for their own special category Darwin Award, flailing their legs–using the whole path–to the rhythm of the music streaming into their heads from little iPod ear buds, blocking the sound of equally oblivious car drivers at intersections; not to mention other cyclists ranging from the Lance Armstrongs on their 16.8 pound $3,600 carbon frame bikes who must imagine they're on an open stretch of road in Valkenburg, to the wide seat waddlers on their two wheeled Winnebagos.
It looks serene in the picture to the left, but if you can imagine a typical day's third world traffic jam of donkey carts, rusting Toyota pickups filled with garbage, over-flowing busses, and pedestrians carrying food on their heads thrown together with BMW M5's and Mercedes-Benz SLK's on the autobahn, you have the sense of it. You can count Near Misses Per Hour (NMPH) rising well into the mid double digits the closer you get to town on this path on a Saturday afternoon in July. Even practiced old riders meet their match and lose their balance at the hands of a small children here. But this cold morning, even though the sun shines bright and inviting, leaves me more or less alone, free to pump the peddles at a steady pace and contemplate.
I'm thinking about my own bicycle, one of several I own–variety is the spice of biking. Among my favorites, a vintage chromoly frame Fat Chance made by Chris Chance of Fat City Cycles in Somerville, Mass in the late 1980s, and the carbon frame bike I'm riding this day. If my Dad were alive, he'd marvel at this astonishing gadget that easily carries my own middle aged frame 35 miles into the city and back in less than two hours. If I could take it back to him in time, to 1992, he'd wonder what planet beamed it here. Same goes for the average car today. Send a Toyota Prius back to, say, 1980. What would they think? They wouldn't even understand the paint, never mind the hybrid engine. What would it cost to reproduce it then? $10,000,000 in 1980 dollars? More?
Dad was a physicist and the inventor of the Janszen Electrostatic Loudspeaker. My brother David got the engineering genes and is now carrying on the family legacy. If you have some disposable income to dispose of well and want the best sounding loudspeakers on earth, see the modern Janszen Electrostatic.
On iTulip we focus instead on the hard-earned wisdom our society seems to have lost on our path toward the best of all possible worlds, filled as it is with obstacles and lessons that we need to learn–and re-learn–such as that credit creation is not a zero sum game; you can have too much just as you can have too little. Credit can get out of balance, putting the economy and financial system at risk of falling over. An unexpected obstacle can trip it. But I am also keenly aware of how much better the world is today in so many ways than in the past. I appreciate technology, I grew up around it, and know that without so much credit we'd have less of it. We take for granted every day technology that lets even the poorest among us live better than kings 200 years ago. Fact is, most of these inventions are a product of our credit system. Credit is at the heart of the capitalist engine.
Credit funds the work of inventors, trendily called "innovators" today. It supplies our world with more of them when credit is in excess to fund R&D and businesses on one side and consumption on the other. It makes the technology I'm riding on this day possible. But the question of credit is the same as in most aspects of life, like the act of riding a bike itself, a matter of balance.
As I ride, I find myself wondering about my focus on the negative side of our credit system when others focus on the positive side, the fun stuff–the results credit enables–the businesses and technologies. Is my focus on the negative out of balance?
Out of Balance: Household Spending
Out of Balance: Household Borrowing
Out of Balance: Foreign Borrowing to Fund Fiscal Deficits
Dad was a physicist, Mom a psychologist. I grew up reading psychology books, a few very good and some not, but didn't read any Freud until college. He was out of vogue when I was a kid browsing Mom's books in the family room. "The wish is father to the fear," I'd later read from father Sigmund. Is my fear of a recession a kind of wish, or is it something I have come to see from years of research, the way a commodities trader knows to make a trade in gold or oil or currencies, living behind a computer screen, an arbitrage player, trying to defeat a thousand other guys doing the same thing using similar techniques on the other side of the trade, with access to more or less the same information at the same time, making their money off a combination of instinct that comes from years of obsessive attention to price moves, changes in market structure, judgments of market rumors, and decisive action in the face of ambiguity and contradictory data.
As I ride closer to town, I stop to take the shot above. A conversation I had with a reporter for the Wall Street Journal pops into my mind. It's 1998, not long after I started iTulip.com, while also working as Managing Director of Osborn Capital. She's jaded, as any reporter must be after a few years of dealing with the public. This is especially true for the financial press. She is trying to get my angle. As I go on about the tech stock bubble and where it's going, I can sense the wheels turning in her head: "How's he going to make any money at this iTulip thing? And if not money, what does he want?" The analysis and guidance of market conditions were part of my job, but sharing it via iTulip part wasn't. I'm telling her that tech stocks are a bubble that will pop in a year or two, followed by some kind of recession, followed by reflation and recovery, followed by a really bad recession. "Yeh, end of the world, right?" "No," I said, "Although there will be times when it may feel that way." After a few more minutes of conversation, she hangs up, satisfied that I'm a crackpot. No story. Not until 1999 did the iTulip message start to look more presentable.
I ride into town and recall a conversation in 2001 with a woman who at the time was running a massive bond fund for a major investment bank as she had for 14 years. We are flying first class to London, worthwhile not so much for the food and drinks but for meeting interesting people. She mentioned that the credit bubble was at that time taking a breather but was due to resurge with a vengeance. However, she warned, ultimately the market for bonds had to cope with the fact of too many of them, that when the US was no longer able to produce enough income to pay them off, a period restructuring was inevitable. A recession will correct the difference between supply and demand for all kinds of US bonds that was artificially maintained increasingly by the need of foreigners to buy them to keep the US afloat. A recession will bring them back into balance.
I sit by the river to take a short break and munch a Powerbar to get my blood sugar up for the return ride home. The carbon fibers embedded in the frame glisten in the sun through the transparent resin that holds the carbon fabric together as a light, rigid tubes.
Balance. Falling left and falling right. Corrections, but no spills, not for many years.
Incredible inventions on one side, too much credit on the other. Dodging obstacles. Re-learning hard-earned lessons about how to avoid falling over.
What a tragedy if a failure of our credit system leads to a decline in invention and puts a major dent in our living standards because we forgot the lessons of the past. We have seen this happen recently in the high tech industry where the capital structure remains dysfunctional after a stock market collapse and depression in the tech industry followed the extremes of the tech stock bubble. In the VC industry, five years after the collapse, capital input-output within the system suffers a worsening impeedence mismatch: lots of money to go into deals but less return for entrepreneurs and VCs, fewer entrepreneurs seeking venture capital, lower deal quality of early stage deals, and over-pricing of later stage deals on the input side of the circuit; on the output side, few IPOs or other major liquidity opportunities. A system once in balance, then in unbalanced bubble hyper-growth, malingers years later–wobbly, out of balance.
Once the credit markets roll over, many of the credit bubble driven mega-deals you read about in the paper for the past couple of years, now reaching a crescendo of greed, will go the way of the AOL-Time Warner merger that closed in January 10, 2000, near the top of the equity bubble. Instead of dysfunction in equity based financing as we experienced after the tech stock bubble, we will see dysfunction in credit based financing, the heart of capitalism. Distressed debt will be the order of the day. Every credit dependent industry, especially construction and real estate, will fall hard, but the advertising driven media industry will suffer, as well. Some industries and regions of the US are already in recession, such as the automotive industry, and others are entering recession. In a diversified modern economy, many regions and industries must be in decline together for the entire US economy to be called officially "in recession," but this definition is academic and of little use to most of us.
The weather forecast for the coming week is for more clear, cold weather. Next time I'll take the Fat Chance for a spin and contemplate the timing and character of the recession coming in 2007, material for Recession 2007: Part II.
For a layman's explanation of financial bubble concepts, see our book americasbubbleeconomy
For guidance on how to play the coming currency corrections, see "Crooks on Currencies"
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