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Thursday
Jun162011

The Growth Ponzi Scheme, Part 4

The great American experiment in suburban development entices communities to take on long-term liabilities in exchange for near-term cash advantages (see Part 1). But as those liabilities cost the community more than the development creates in overall wealth, the approach ultimately results in insolvency (see Part 2). To forestall the day of reckoning, more growth is induced, setting up a Ponzi scheme scenario where revenue from new development is used to pay liabilities associated with old development (see Part 3). This is unsustainable, but that has not kept us from trying desperately to keep it all going.

Much of my thinking in this post was shaped by my reading of Richard Florida's The Great Reset, as well as follow-up research I have done into the causes of the Long Depression of the 1870's and the Great Depression of the 1930's.

While these events defy simple explanation, the Long Depression included an over-development of the nation's railroad system and a corresponding malinvestment in speculative real estate associated with railroad expansion. Also, the increased access for farmers to broader markets helped create a commodity price crash, which was exacerbated by overproduction. Farmers with declining profits produced more to compensate, driving down prices. Price drops were so dramatic that some crops became more valuable for burning than eating.

The depression persisted until there was, as Florida calls it, a "spatial fix". In essence, our capital and productive capacities were redirected from farm expansion and railroad-based speculation into industrialization and building of the industrial city. The result was the Industrial Revolution, a dramatically different living arrangement than the formerly-agrarian America had known up to that point. For many people of that era, this was a painful transition.

Fast forward to the 1930's. Economists and social scientists argue over the causes of the Great Depression as well as the factors that ultimately ended it. What is clear is that the lack of fundamental growth in our real economy was made up for with an expansion in the paper economy. Industrialization had brought huge gains in productivity, production-capacity that actually outstripped our consumption-capacity. Leverage-driven speculation on continued profit gains created a financial bubble that, when deflated, proved destructive.

Years of New Deal spending failed to create enough demand to correct the imbalances. Spending for World War II provided a temporary recovery, but economists at the time were concerned that the end of war spending would send the United States back into depression. What happened next was another spatial fix; suburbanization. We redirected our capital and productive capacities to building suburban America and created the greatest economic advancement the world had ever seen. It was a very painful transition, especially for our major cities.

This is where I (humbly) depart from Richard Florida. It is not that I think he is wrong -- he argues that suburbanization has run its course and that the new, creative economy requires a spatial fix that will favor highly-connected mega-regions -- but that there is a pivot point critical to understanding our current situation.

That pivot point comes roughly one life cycle into the suburban development pattern, the time when the financial structure of the Growth Ponzi scheme starts to have outflows (maintenance costs) in addition to inflows (new suburban growth). This would have been roughly during the mid-1970's, when we were forced to leave the gold standard, had an energy crisis and experienced a convulsing economy characterized by the new term "stagflation". Another new term -- the Misery Index -- was used to measure the painful impacts of high inflation and high unemployment.

Once again, there is a ton of complexity here and I'm not trying to oversimplify things, but ours is an economy that relies on growth and, in the post-WW II era, growth has largely meant horizontal suburban-type growth with all of the related consumption. We embarked on a path that makes us reliant on new growth to generate excess wealth. When that new growth becomes old and starts to cost us money, it puts contraction pressure on the economy that counteracts the near-term, financial benefits of new growth. (See Part 3).

The critical insight today is to understand how we reacted to the end of the first life cycle of suburban development, when those maintenance costs started to come due and cut into our growth-generated wealth. This time there was no spatial shift as seen in the other large, economic corrections. Instead, we made a choice to double down on the suburban experiment by taking on debt.

We used debt to drive additional growth and sustain the unsustainable development pattern for a while longer. A lot of this debt was public debt, but we facilitated mechanisms for increases in private debt as well (for example, Fannie and Freddie early on and then subprime mortgages and securitization later). Here is a graph showing our public and private debt levels since the beginning of the suburban experiment. I have noted roughly the first and second life cycles of those initial investments.

Debt levels post WW II as compared to GDP. Note that the green line is private sector debt, which far exceeds public sector debt..The first generation of suburbia we built on savings and investment, but we built the second -- and maintained the first -- using debt. Unprecedented levels of debt. 

And in the process, we transformed our industrial economy into one based on consumption. As James Kunstler has noted quite often, when you take away the suburban-growth-related jobs from our economy, what you are left with is "heart surgery and KFC workers" (his way of saying highly-skilled professionals and low-skill wage earners).

This strategy is a disaster of monumental proportions for the United States. Not only have we created an entire economy based on a growth model that can't be sustained, in the process we have highly indebted our population. The quality employment opportunities available for the masses rely solely on the perpetuation of this unsustainable model, so we can't even work our way out of this mess. We've tied up our individual wealth into homes -- homes whose value is tied to community infrastructure that we cannot afford to maintain without continued hyper-growth, which we are now powerless to induce. So as our wealth disappears and our economy painfully grinds to a halt, we're left with no options to continue on this path.

And to top it all off, we've tethered our national psyche to the suburban ideal we call the "American Dream", our auto-based, utopia where everyone gets to live a faux version of European aristocracy on their own mini-estate. 

Oh, and by the way, the American Dream, as so defined, is absolutely non-negotiable.

Our national economy is "all in" on the suburban experiment. We cannot sustain the trajectory we are on, but we've gone too far down the path to turn back. None of our dominant political ideologies can solve this problem. In fact, there is no solution.

This is why tomorrow we will offer some rational responses -- ways that communities can begin to prepare for the spatial shift that is coming.

 

If you are finding value in this series, please consider making a donation to support our efforts. Strong Towns is a 501(c)3, non-profit organization run by three professionals largely volunteering their time and resources to have this dialog about the future of America. If you would like to help us, please consider making a supporting, tax-deductible donation.

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Reader Comments (5)

I agree with pretty much everything spelled out here, but there's one thing I need...explained to me. What jobs are solely related to suburban growth? People would still procreate, we'd need to build some homes and maintain the ones we're leaving behind now, I guess that's some construction workers gone, and obviously the roads wouldn't be built at the same prodigious rate, but if we weren't building burbs it would probably mean we were keeping the infrastructure we have up a little better, which would employ a lot of those people. Most of the service jobs would still exist, we still need teachers, police officers, realtors, and the like. What jobs are being lost?

June 16, 2011 | Unregistered CommenterMarty Walsh

Marty, consider just how much of our economy is tied up in the business of sprawl. On the surface, there's car companies, road construction crews, and production home builders. Digging a little deeper you find just how deep the tentacles of those industries go. Those three industries also support, or are entirely the basis for other industries like: steel, plastics, upholstery, leather, rubber, gasoline, oil and other fluids, car insurance, auto body and mechanics shops, gas stations, convenience stores, concrete and asphalt suppliers, gravel pits, engineers, architects, plumbers, drywallers, carpenters, electricians, tile setters, lumber suppliers, cabinetmakers, appliance manufacturers, retailers, truckers, logistics managers, etc. That barely scratches the surface. We build so much stuff, and have to make that much more stuff to go into it, compared to previous generations that it boggles the mind. Sure we always need SOME plumbers, carpenters, concrete, steel, etc., but not nearly the amount we need when we're wholesale abandoning large swaths of major cities and building new greenfield developments.

June 16, 2011 | Unregistered CommenterJeffrey Jakucyk

Jeffrey - Thank you for jumping in and providing a really good list in response to Marty's question. It is a difficult question that I thought might come up, but did not have the time and space to answer in the article.

Here's what I said:

The quality employment opportunities available for the masses rely solely on the perpetuation of this unsustainable model, so we can't even work our way out of this mess.

Marty has asked what are these opportunities and, most importantly, why do they rely on the suburban model. Don't we need homes, etc... whether they are suburban or not?

My point was less about the jobs themselves and more about the source of capital at the top of the food chain. House construction is something that is done in support of growth. When colonists came to America, for example, they didn't come because there were opportunities to build homes. They came for other, productive reasons and the homebuilding became a support industry for that endeavor. Today we have that switched around - growth is the industry.

Let me explain further by giving an example from my hometown. Thirty years ago, the local economy in my hometown was fueled by two things: tourism and paper manufacturing. I live in the Central Lakes region of Minnesota, a popular tourist destination, and we had a paper mill that took wood and turned it into paper. These two endeavors brought hard capital into the community from outside of town. People came and stayed at resorts, went to restaurants, golfed, etc... and they exchanged their outside money for our services. We exported paper and exchanged that value-added product for outside money. Workers in these sectors needed homes, they needed food and clothes, they got haircuts, they enjoyed movies, etc... The money brought in to the community was paid to these workers and they in turn passed it around the community. Construction was a part of this, but it relied on the overall growth of the capital inflows, which were driven largely by tourism and paper.

In the last generation, the economy here changed. The paper mill closed (it has reopened, up a much less significant scale) and most of the resorts were split up and sold off for land development. We still have tourism and I would not completely discount that, but 40% of our work force was either directly involved in construction (contractors, builders, etc...) or directly support construction (engineers, surveyors, rental companies, Home Depot, etc....). They also needed homes, food, clothing, etc... and so their incomes created a secondary demand in the market that they also helped fill.

Here is the key question to understanding the difference between today and a generation ago: Where is that inflow of capital coming from? The answer is from the export of IOU's. Debt.

Yes, we have people who sell their homes someplace else and move here with their equity, and we have people who spend their savings on retirement homes in the lake country, but even then, those are one-time capital flows. The bulk of the construction has been supported by IOU's.

And since we've supplanted our exporting industries -- the ones that brought in capital -- with construction growth industries fueled by debt, we have a entire local economy, from the carpenter to the person who cuts hair to the teacher at the school -- that needs construction growth to continue.

In a macro economic sense, we've shifted from a manufacturing/export-based economy to a service/import-economy with consumption making up over 70% of GDP. We export IUO's to the world to keep this going. These IOU's are a promise against future production, only we don't produce a lot of exports (at least not nearly as much as we import in this arrangement) and so it is not clear where this future production will come from.

In short, construction is a support industry that is bolstered by a growing economy. The same with financials. When construction and financials become the basis of the economy, as they have for us, it is not financially sustainable. We have to produce something of value so as to bring in capital. Or we have to be self-sufficient. Either way, building suburban homes to sustain an artificial growth bubble is not going to work.

June 16, 2011 | Unregistered CommenterCharles Marohn

Great series so far. Informative, engaging and chilling. Can you detail how other countries or regions have met these challenges?

June 23, 2011 | Unregistered CommenterAndy

Thanks Andy. I wish I knew more about development in other countries, but besides what I've read and experienced as a tourist, I would not be able to offer much. I would not call myself an expert on areas outside of the U.S., although there are a lot of interesting things there to learn from. -Chuck

June 24, 2011 | Unregistered CommenterCharles Marohn
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