Straight Talk with Charles Hugh Smith: Why The Status Quo Is Unsustainable

"Straight Talk" features thinking from notable minds that the PeakProsperity.com audience has indicated it wants to learn more about. Readers submit the questions they want addressed and our guests take their best crack at answering. The comments and opinions expressed by our guests are their own.

This week's Straight Talk contributor is Charles Hugh Smith, who has been an independent journalist for 22 years. His weblog, www.oftwominds.com, is a daily compendium of observations and analysis on the global economy and financial markets, as well as notable political, social, and cultural trends. Charles has authored a number of books across several genres, including the recent Survival+: Structuring Prosperity for Yourself and the Nation.

1. Of the many forces at play that you write about within the economy, society, and politics, which ones do you see as the most defining for the future? How do you expect things to unfold?

CHS: Clearly, demographics and Peak Oil are forces which cannot be massaged away by policy tweaks or financial engineering. I think the exhaustion of Global Neoliberal Capitalism and State Capitalism is apparent, as is the bankruptcy of the two ideologies that more or less define our politics. The reliance on expansion of credit and State power is a dynamic with only unhappy endings.

There are also structural end-games such as Baumol's Disease at work: The inefficient sectors of the economy end up dominating the national income. Services such as health care, education, and the Armed Forces become more productive at much slower rates than the overall economy. Looking ahead, the Empire (the hundreds of overseas military installations, the diplomatic and financial reach into every nook and cranny of the planet, etc.), health care, and other entitlements will require most of the national income. That is an unsustainable trajectory, especially as Peak Oil/peak everything kicks in.

As readers know, I am intensely interested in dynamics that are subtle and not quantifiable. Since they can't be quantified, they are generally ignored. Yet they are very real, even though we may not even be conscious of them.

The reliance on propaganda, for instance, has become so pervasive that the notions of truth and honesty have been hollowed out. Nobody expects the President or Ben Bernanke to speak honestly, as the truth would shatter an increasingly fragile status quo. But this reliance on artifice, half-truths, and propaganda has a cost: People are losing faith in government, in all levels of authority, and in the Mainstream Media—and for good reason.

The marketing obsession with instant gratification and self-glorification has led to a culture of what I call "permanent adolescence." Politicians who promise a pain-free continuation of the status quo are rewarded by re-election, and those who speak of sacrifice are punished. An unhealthy dependence on the State to organize and fund everything manifests in a peculiar split-personality disorder: People want their entitlement check and their corporate welfare, yet they rail against the State's increasing power. You can't have it both ways, but the adolescent response is to whine and cajole Mom and Dad (or the State) for more allowance and more “freedom.” But freedom without responsibility and accountability is not really freedom; it's simply an extended childhood.

2. You’ve written recently that you expect us to enter deflation because the amount of QE dollars pale in comparison to the amount of bad debt still to be destroyed. How can you be so sure? Why should anyone trust the dollar as a viable long term unit of wealth preservation in an environment where the natural checks & balances of the interest rate mechanism is being subverted?

CHS: Can I please have a softball question instead?

The words “deflation” and “inflation” are so loaded nowadays that I try to substitute “purchasing power” whenever possible. Conceptually, we tend to lump all sorts of things into words which may or may not actually be related. So we have to separate asset deflation/inflation from resource/currency prices.

One way to understand this is to measure everything in terms of what an hour of work can buy and how much real goods an asset can buy. If you sold your house in 1995, how many barrels of oil could you have bought? How about now?

How many hours of labor did it take in 1975 to buy health insurance? How about now?

This sort of analysis helps us understand that the average household has seen purchasing power stagnate or decline for 35 years, and that capital has seen its purchasing power rise. The Great Housing/Credit Bubble seemed to offer households a chance to “catch up,” and perhaps the lucky few who sold at the top and have been renting since did restore their lost purchasing power. But most households have seen their wealth decline.

There are so many moving parts to value and price that it's very difficult to make sense of deflation and inflation. I start with simple numbers: Americans have collectively seen their assets decline by about $12 trillion since 2007, $6 trillion of which is lost residential home equity. That has effectively destroyed the balance sheet of most homeowners with recent-vintage mortgages.

As interest rates rise and the stock market rolls over along with corporate profits, then another $10 trillion or so of bond and stock equity will evaporate. Given a decline of $20 trillion, then the Fed's expansion of its balance sheet by $2 trillion doesn't seem so mighty or irresistible.

As for the dollar's long-term viability as a store of wealth, there is precious little evidence right now for its long-term future, but the value of a currency is a political process more than a financial one. A currency is a claim on a nation-state's income stream and viability, so if those are devolving, then so, too, will the currency.

Sentiment is so negative on the dollar that I expect the opposite to occur. How could this happen? A political change in 2012 might shift priorities and instill some confidence that the U.S. is actually ready to deal with reality.

That said, assets such as income property, productive land, and energy will retain value whether the dollar is destroyed or confounds us all by stabilizing. Wealth held in any currency carries intrinsic risk, but over the next few years, the dollar may surprise us by strengthening considerably. That would give those holding dollars a golden opportunity to transform paper into real assets, which have been depreciated by the global depression.

You make a key point about interest rates being subverted. I suspect that State manipulation can only run so far, and then market forces and asset deflation will kick in. Again, the high-probability catalyst in my view will be the public and political class' loss of faith in the Federal Reserve's manipulations of the economy. I expect 2012 to be a pivotal year.

3. Do you think we as a society/world are going to pull back from the brink of collapse that we appear to be teetering on? Or do you think it's more practical to plan for how best to pick up the pieces afterwards?

CHS: There are numerous feedback loops at work and so things rarely proceed in a straight line. Governments will continue creating credit and money in hopes of overcoming the destruction of assets, and nobody knows how long that charade can continue. It may run longer than seems possible, just as the housing bubble ran for three years past what was already an unprecedented top.

I lean towards a “defense in depth” approach where we have an A, B, and C response. What can we do in present circumstances to increase our resilience and sustainability? That would be A (the simple things like conservation and cutting expenses) and B (harder things, like creating a new income stream or moving closer to your job/source of income). Option C would be a plan of action if things fall apart. Even then, most of us might be better off staying where we are if we have a social network of support and sharing.

4. There is no shortage of criticism for the mess we find ourselves in. Far more scarce but much more important are solutions. How does the world restore fiscal “soundness,” and what needs to be done to set the stage for a rebirth?

CHS: The reliance on credit rather than on capital will have to end, and that means the demise of the credit-based consumer economy run by the Central State and global cartels.

The State fiefdoms and corporate cartels have every incentive to maintain the status quo, so change will probably come from unconventional innovations. I'd like to see a private, asset-based global currency arise, for instance. Since it would not be a nation-state's currency, it would be relatively free from political intervention.

I tend to see parallel private-sector structures (opt-in, open-source) as solutions rather than counting on the bold revamping of status quo, Financial Power Elite-dominated structures. The incentives in these dominant structures are all to retain the status quo at all costs. So solutions that don't rely on their approval are more likely to occur.

5. How does the general citizenry take power back from the plutocracy you write about that has amassed a supermajority of wealth and power in the world?

CHS: I think voting against conventional politicos who are indebted to the status quo Power Elites and voting for any politico who dares to speak honestly about power structures and sacrifice is worth a try, as it is essentially cost-free.

Voting for third-party candidates seems quixotic, but as the public loses faith in the traditional sources of authority, then viable third-parties might arise, at least locally.

“Starving the beast” by eliminating debt and financial churn is also a two-fer: It reduces the income streams of the Plutocracy and accumulates capital for households. A society without mortgages or credit cards would also be a society without “too big to fail” banks. Commercial credit of the sort needed for business does not require global investment banks or shadow banking empires.

6. In your book Survival+, you outline strategies concerned individuals can pursue to prepare for a tumultuous future. Can you summarize the key elements of your guidance for those yet to read the book?

CHS: The basic ideas are simple: The political, financial and resource structures of the status quo are unsustainable, and so dependence on the Savior State is not a viable survival strategy. The “new” model is actually an “old” model that has atrophied and been lost: self-reliance, resilience, reciprocity and transparent, opt-in organizations with clear lines of accountability.

I spend 2/3 of the book on the critique because I thought it was essential to explain the powerful yet subtle layers of our social conditioning that resist this sort of fundamental transformation: permanent adolescence, the growth of the Global Empire as part of the national identity, the substitution of consumption for productive work, the surrender of autonomy in favor of over-reliance on the Savior State, and the conquest of our politics of experience by marketing and propaganda.

This sort of “soft” conceptual analysis is alien in a culture that is so reliant on quantifying everything, and that is part of the crisis we face.

To give a real-world example: About one-third of the U.S. citizenry is obese and unfit. Extrapolate these trends even a few years, and we're told fully half the populace will be at risk of diabetes. The consequences of this are horrific for individuals and society alike.

We know these trends are not good for us, but the majority of people find maintaining their weight and fitness to be essentially impossible tasks. While we are culturally conditioned to blame our own weaknesses for any deficiency in our response, I think social conditioning is the key factor. An economy/society dominated by marketing, instant gratification, and a desperate (and highly manufactured) yearning for self-glorification is not a healthy society, and the illness of that society manifests itself in poor mental and physical health.

In effect, our society makes us ill if we “buy into” the marketing and political/financial fantasies.

We can't really fashion self-reliance and a new parallel way of productive living if we're trapped in an interlocking mess of destructive social conditioning.

The “Survival+” approach is an intrinsically hopeful one, because I know it is possible to free ourselves of the social conditioning that leads to ill health and to live on a small percentage of the energy we currently consume.

For skeptics who say this is “impossible,” then I turn to the developing world for examples. People in productive, stable societies live quite nicely on a fraction of the energy we consume. The American lifestyle is not inevitable.

7. Every period of history feels unique and special to its inhabitants. Looking back through time, the sorry excesses of empire, maintenance of the status quo by the elites, and financial folly are quite commonplace. What, if anything, actually makes this period of time, troubling as it is, unique or different in the human experience?

CHS: Clearly, Peak Everything and a very fragile system of global supply chains upon which industrial societies are totally dependent are two unique characteristics. All of the efficiencies of these global supply chains are based on cheap, abundant oil and political stability. These two requirements are interconnected, of course; when the U.S. finally stopped shipping oil to Japan in 1940, then the Japanese Empire had no choice but to launch a war of conquest aimed at resources such as Indonesian oil.

As political stability and these long supply chains devolve, then nation-states will increasingly have no choice but to expropriate resources nominally owned by corporations located 6,000 miles away. Once the supply chains are broken, then the dependent structures will have to adapt. Those that can't or won't will collapse.

Information itself is a supply chain which is exquisitely vulnerable to disruption.

The other unique factor is the proliferation of disruptive weapons, not just nuclear but biological and cyber weapons. China has every intention of “winning” any potential conflict with the U.S. by disrupting the U.S. military, society, and economy via cyber-attacks on our infrastructure and communications. That ability to disrupt an entire nation via fiber-optic cables is new.

On the positive side, we as a species have never had such ubiquitous access to information and to a global ability to fashion our own networks of sharing and cooperation. It is easier now than ever before to share what works and how it works in specific situations.

The potential for open-source, transparent, scalable structures that operate in parallel with nation-states and global cartels is new. In the past, only nation-states and global corporations had the resources to establish these sorts of networks, and they were operated for the express benefit of the Elites at the top of the State and corporations.

What's also new is the widespread access to very powerful technologies. Computers and networks were once only accessible to small circles of specialists. Setting up supply chains or manufacturing were so capital-intensive that only a few organizations could afford to do so. This is still true for certain things such as computer processors, but a wide range of other productive work is now available to a much larger pool of humanity.

Innovative, appropriately scaled, and sustainable technologies are not new, but global access to them is new.

8. What formative experiences in your life led you to create a blog like OfTwoMinds.com? What are your goals for the site?

CHS: Since I'd been writing about housing and real estate as a freelance journalist for 15 years, it was a natural progression to push the sort of analysis I could never get published in the Mainstream Media onto the Web.

Writing for the public is something that I started in high school and it has manifested in various ways over the years.

In 1969-70, my good friend Colbert and I started an underground newspaper in Lanai High School. The administration assumed it was published by teachers, which was quite a compliment to a couple of 16-year olds. We printed it on the ILWU's mimeograph machine.

As an activist in the American Friends Service Committee (AFSC) and in our political party (a legal third party) in the 1970s, we had to constantly produce newsletters, leaflets, and campaign material, so the process of communicating ideas and defining positions in writing became familiar.

A close friend and I started a print magazine in Berkeley in 1984 called VoltAge, with a focus on technology and culture. It was horrendously expensive to publish a magazine, and I could only fund one issue. But that experience gave me a taste for eclectic media that combines a variety of topics and perspectives under one roof.

Though I wasn't consciously aware of it, I guess those previous experiences gave me the confidence to see oftwominds.com as a platform for a range of ideas and analysis.

Lofty goals can sound awfully pretentious, but alongside that risk is the notion that big goals can inspire us to great things. I have four goals for oftwominds.com:

Promote serious journalism on the web by presenting issues which the Mainstream Media sidesteps, dismisses, or whitewashes
Encourage an online role for what was once called “public intellectuals,” a category which has atrophied into MSM-approved academic pundits such as Paul Krugman and “entertainer”-type ideologues like Glenn Beck, both of whom parrot simplistic ideologies that are increasingly meaningless.
Contribute to the ongoing discussion of practical solutions for the interlocking crises we face,
Construct an integrated understanding of the ideas and issues which interest me and my readers.

And when I can't do any of the above, I try to write something mildly interesting.

9. Many leading econobloggers came to the profession via unorthodox paths, but perhaps none so much as you: philosopher, social activist, freelance writer, musician. What about your idiosyncratic background do your attribute your success?

CHS: How the site has gathered such a smart, world-wise readership has been a mystery, and I think the key ingredients that attract people are the two complementary threads which run though my apparently random interests and careers: an interest in the structure of problems and a desire for a hands-on, practical grasp of how these structures work in the real world.

In our increasingly specialized world, few people seem to bridge the divide between a conceptual understanding and a practical understanding. All of the things which have deeply interested me—building, urban planning, music, politics, gardening, health, fiction, journalism, and financial analysis— have a conceptual framework that you can learn, but that doesn't mean you can actually build a house, play a chord progression, start a business, write coherently, or make a profitable investment.

As we all know, the real world is messy, contingent, and unpredictable. So actually starting and running a small business that does millions of dollars of business is completely different from a pundit's simplistic view from 30,000 feet. That's one reason why the political class of the U.S. is so divorced from reality; they speak glowingly about “small business” with no appreciation for how difficult it has become to start a real-world enterprise.

Since I know about small business from experience, then it's obvious to me that small business is being strangled and will not be hiring millions of new workers.

We all want a coherent explanation of what's unfolding, and we also want practical suggestions on how to adapt. It's difficult to provide both, and the great thing about having a smart readership is that readers educate me about things I don't have any real-world experience in, such as health care.

So philosophy and hands-on working knowledge act as a sort of yin-yang unity: Both are necessary to understand and navigate the real world.

The basic idea behind philosophy is to think clearly about issues and work from first principles. Even non-linear philosophies such as Taoism have first principles which illuminate and explain the whole.

So my goal in any subject is to establish the first principles or assumptions, and then try to explain how each link in the thesis leads to various conclusions. Rather than accept ideas that are repeated as if they are true, we ask two questions: Exactly how does this argument work, and cui bono—who benefits if we accept this as true?

That is also the core of good journalism.

But in addition to journalism—explaining, critiquing, asking questions—we all want and need practical solutions or pathways. I guess I have always been drawn to a hands-on understanding of how things work, and that is the thread which informs oftwominds.com. I think my readership appreciates that practical working knowledge only comes from long practice and a lot of mistakes and setbacks.

Another way of defining these two complementary threads is to look at both as toolboxes. Ideas such as system analysis and evolution are tools which help illuminate the structure beneath the surface, and practical skills—breaking down tasks and gaining mastery one step at a time—give us tools for taking those insights into the real world.

Since I'm very average, and have no connections to wealth or power, I've relied on perseverance and enthusiasm. Maybe that carries over somehow to the blog.

10. What question didn’t we ask, but should have? What’s your answer?

CHS: One such question might be: What are the foundations of my general optimism about the Great Transformation ahead?

One is the process of evolution has expanded from the genome to culture and technology. All species must adapt or perish, and individuals have to adapt to changing circumstances. At a system level, there are feedback loops, positive and negative, which mean that extrapolating the present into the future is not very accurate. New feedback loops can be added, and the value systems of cultures can also adapt.

Self-criticism and honesty are essential to growth and learning. The American political and financial Elites are committed to maintaining the Status Quo at all costs, even to the point we have now reached that reality is replaced by simulacra.

But other elements of the society are actively questioning the Elites and our social conditioning. They are asking what part their own actions play in supporting and enabling the status quo.

Honesty includes expressing anger, frustration, whining, and all the rest of human emotions. The idea that maintaining a veil of secrecy and stiff-upper lip “everything's fine, shut up, and keep your head down” will yield positive results is wrong. That leads to discord, distrust, illness, and madness.

The greatest strength of America, or any society, organization, or individual, is open, honest self-criticism, and questioning. We only change when we have no other choice, and to expect the status quo to adapt without fierce resistance is impractical. So rather than waste energy trying to change those structures doomed to collapse or devolution, we're better off establishing our own networks of support, cooperation, and sustainability.

An honest appraisal will lead us to challenge all sorts of assumptions we have made about the nature of work, property, the economy, health care, the Central State and much else.

The choices will not always be clear-cut. I will end with a story about my friend.

Dexter Cate. Dexter was committed to saving dolphins from being slaughtered, and he'd found no official interest in protecting them.

So he swam out alone, at night, in a raging storm, and slashed the nets trapping hundreds of dolphins that were to be killed the next day. He was imprisoned in Japan for destroying “private property,” that is, the nets.

We all value property rights, but what was more important, the destruction of private property or the lives of the dolphins? The legal system was clear; the dolphins had no standing compared to the nets. Dexter chose otherwise.

What do we really value? Our answers will inform our choices in the transformation ahead.

Thank you for such thoughtful questions, and I hope I haven't put everyone to sleep in answering them.

If you have not yet seen the other articles in this series, you can find them here:

PeakProsperity.com readers can submit their preferences for future Straight Talk participants, as well as questions to ask them, via the Straight Talk forum.

Economy

Society