Below is the transcript for Charles Hugh Smith: Why Local Enterprise Is The Solution:
Chris Martenson: Welcome to another PeakProsperity.com podcast. I am, of course, Chris Martenson. And today, a very special guest, we have Charles Hugh Smith, who has been an independent journalist for over twenty years. And his excellent web blog www.oftwominds.com, offers very thoughtful unique analysis of global finance, social themes, the political economy — and he’s an accomplished author as well. Charles wrote the very impressive handbook, Survival +: Structuring Prosperity for Yourself and the Nation, which I highly recommend; I have read it. And he has just finished another book, An Unconventional Guide to Investing in Troubled Times. Charles, you know it's high time we had you as an interview guest; here you are. I am really looking forward to our discussion today. Welcome.
Charles Hugh Smith: Thank you, Chris; I am delighted to be here.
Chris Martenson: Well, there is so much I want to talk with you about, especially with all that is going on these days, but let’s start with your new book, if we could. Tell our listeners what it's about and why you decided to write it now.
Charles Hugh Smith: Okay, I have been working on the book for eighteen months for the reasons that are familiar with PeakProsperity.com readers and members, which as we all know is the present is unsustainable. So where can we put our resources and our capital and our labor that will be productive as the status quo basically defaults or crumbles? So the book, having come out in July, just happened to be good timing, as the market is, in fact, crumbling as we speak.
Chris Martenson: Yes, yes it is.
Charles Hugh Smith: And I think the basic thrust of the book is that standard or conventional financial advice that we typically hear is: well, we’ll balance your portfolio between stocks and bonds and overseas investing and domestic. I don’t think these metrics have any value anymore. Or they’ve lost their meaning, as all of the status-quo investments are coming apart at the seams.
Chris Martenson: So your general thesis is we’re on an unsustainable course, which, for those who are new listeners, may be shorthand for the idea that the past couple of decades, maybe even past four decades, have all been defined by the idea that we’re going to grow debt and accumulation of debt at a faster pace than the underlying economy. That means that we are living on borrowed money, we are living beyond our means — however you want to look at that at the national level, whatnot. So are you looking just through that first economic lens and just looking at it and declaring it unsustainable? Then saying because of that, this is going to devolve or shift or change. Is that the general macro landscape you are looking at?
Charles Hugh Smith: Yes, Chris. And of course, I learned from the Crash Course about the unsustainability of that exponential rise in debt. But also, as you’ve covered in-depth, we are running out of the idea that there are unlimited resources that we can exploit at ever-greater rates of consumption. So “Peak Everything,” as we call it – that’s also an issue. And also the unsustainability of a lot of our political and social structures that we’ve kind of grown fat and sassy and complacent based on this unlimited debt. It has allowed us to sustain things which are not sustainable. So there is definitely a social and political impact to the end of this kind of debt-plus-cheap-oil era.
Chris Martenson: So in your mind, what happens when that debt cycle ends, when the party is over, and it comes to the additional accumulation, exponential accumulation of more debt – which by the way, they are trying very hard in Europe and Washington, D.C. to perpetuate and keep that debt moving? Let’s say they can’t – what happens?
Charles Hugh Smith: There will have to be a renunciation of debt on a vast scale, and it could take the form of a forgiveness of debt, meaning that we deal with it as adults and write it off. Or it could be renounced in a very chaotic unplanned way, as people just default and that triggers a whole domino chain of the borrowers are defaulting and then of course, the lenders become insolvent and they default on their counterparty obligation. And so then it reaches the same point – that it’s written off.
Chris Martenson: So this would be a process of default. The Fed’s been fighting that tooth and nail, and we just found out through a formal request of Bernie Sanders that the Fed had put $18 trillion in cash and guarantees across the global landscape to prevent exactly what you are talking about from happening. By all measures, they kind of did. And so what’s to prevent the world central banks – by the way, we’ve had three interventions of central bank actions in the last twenty-four hours, so we are recording this on Thursday afternoon, August 4th — but we’ve seen the Swiss Bank come in and essentially print like crazy. We’ve seen the ECD come in and intervene in the Italian bond auction. We’ve seen the Bank of Japan come forward and attempt to bring their currency down. With all this intervention, what’s the trigger for this wave of debt defaults in your mind?
Charles Hugh Smith: Chris, I think we all sort of know that there are two end states here: The end game is either we consciously renounce the debt, or we get the hidden default of the currencies being wiped out in terms of what they can buy. So if we do the hidden default method, then everyone will get their Social Security check for $1,200 dollars and that will buy them like a loaf of bread or something. And so the government will be fulfilling its obligations, but the purchasing power of the money that it's distributing will have been lost. And of course, we all know that’s a possibility. And that’s just another way of reaching the same point that the debt in the system will be purged either by high inflation, hyperinflation, or by conscious renunciation — and that doesn’t seem possible at the moment, a conscious renunciation, but there could be political changes, say, over the next four or five years, that could bring that about if the people realize that’s a better solution to a hidden default.
Chris Martenson: Right, well, yes, it's possible. I find that history says hidden default is the preferred option by far.
Charles Hugh Smith: I agree. I agree, but I like to at least address the possibility that we could chose more wisely. I am not saying that lightly, but it's always possible.
Chris Martenson: Absolutely. So you wrote this book and it's got "unconventional guide to investing" in its title. What do you mean by “unconventional” investing here?
Charles Hugh Smith: I mean that it looks at investing as a form of expression, of personal expression, if you will, which is completely outside the normal conventions where we are – you simply seek the highest return from whatever mutual fund or the hot manager or hedge fund. But I think investing your capital, which includes your financial capital and also your human and your social capital, would not be a form of self-expression. And as a trader myself, I think the key to investing wisely is to align that with your own interests and your own personality. A lot of people have spent a tremendous amount of time and energy and money trying to find that perfect system which generates returns in all markets and that kind of stuff. And that kind of system doesn’t exist. And statistically, there is simply no system or manager who out-performs over a twenty-year period in both bull and bear markets. The number of people who do so is statistical noise.
Chris Martenson: Well, you would expect somebody is out at the end of that bell curve, of course, so I don’t know that there are statistically significant numbers of those people – they do exist. And some of them will have some sort of a proprietary mojo that’s awesome, but you are right, those are very rare and few and far between. And this is a main theme of mine, which is that almost all of the methods for investing that we’ve grown up with that you learn from your father, your grandfather, your grandmother, your mother – wherever you got the stuff from, your broker…it doesn’t matter. They are all predicated on this idea of these models and techniques and styles, all of which themselves are predicated on growth, which means that as long as we have this three, four, five percent economic growth with the occasional recessionary pick-up here and there.
But long-term, you could put a ruler on this thing and say, “Wow, there’s an upper slope to this economic growth.” That growth gives a lot of the value to the overall aggregated stock and bond markets and other financial paper-based assets. It's that growth that is baked in, and it's so baked in that most people don’t even consider it. They are not aware of the extent to which the current prices and values of these things depend on that future growth happening. But the correct question I think people need to ask if they insist on staying in the stock market is What is the correct price earnings multiple for a company or a stock index which has zero-percent earnings growth baked into it? I’ll give you a minute for that one, but it's lower than it currently is. Where do you place it?
Charles Hugh Smith: Well, if we just look at cycles and trends — a lot of people are targeting an S&P around 450 or thereabout, meaning a drop of two-thirds per year — that might work, but if you take what you just said and follow the implications, what if there are no earnings? In other words, what if oil goes to $200 dollars a barrel and a trade war erupts as everyone tries to protect their own national resources and so on? What I call deglobalization starts kicking in, and it may be extremely difficult to make profits in any way. And so it may be that a period of really low profits would then, of course, bring very low stock values.
Chris, the other thing I would say is the “unconventional” side of what I am describing in the book, is to look at how we value enterprises in general. To question the whole idea that it makes more sense to invest in a mine or a corporation six thousand miles away than to seek out a mine or a company in our own hometown, so to speak, or our home state or our home region that we can really understand. And that we would be drawing upon that productivity that we can understand, and we are not just trusting Wall Street to tell us about this company six thousand miles away. It's really a great thing.
Chris Martenson: Yes. You know I come from a banking family. My great-great-grandfather founded one, and on the male side in that family, there has been somebody involved with it since. They have been cranking out just excellent earnings all the way through this whole hiccup, and I had opportunities to warn them this hiccup was coming. They looked at me and said, “Look we know every single person on our balance sheet. Every asset on here is somebody we know. We are intimately familiar with all the businesses – here are our credit standards.” You just run it like my grandfather used to run it, which is just incredibly safe and sound and with that intimate local knowledge, and guess what? They’ve come through this period just fine.
As we get into this next period, though, if I understand you correctly, and I think I do, there’s going to be an even higher premium on really knowing where your money is and what it's doing. Because the easy returns of just anonymously tossing your money over a wall and towards a group of people who are going to manage it for you — let’s call that Wall Street, for now — when things get tight, one of my basic theories in life is that when there are ample resources for both Wall Street to earn its outlandish bonuses and make themselves feel good about themselves that way and for you to earn something of a return too, then you both win.
When there aren’t sufficient resources for both, guess what happens? Wall Streets gets its bonuses anyway, and there is nothing left over for you. I think we are pretty close to that moment in time, here. And so it's a fancy way of saying real conflicts of interest are at play – the people who work in the financial industry are often deeply conflicted in terms of what they can say and what they can’t say. They have fiduciary responsibilities, and they sometimes limit themselves from telling you about the entire universe of opportunities. I know people who have been – even as recently as last week – cautioned by their broker not to go anywhere near gold. It's just a silly investment and it's not an investment, it doesn’t have any returns, etc.
So there’s – I think the first stage of awareness for me was understanding the extent of it. Wall Street’s interests and my own interests were not aligned, not even remotely aligned.
Charles Hugh Smith: ,That’s extremely well said, Chris, and I think that’s a key point which you just described about the conflict of interest. And also that there’s just no payoff in trusting Wall Street to look for our money. And I think another topic that makes it unconventional, at least in my view, is that there is the issue of sustainability and resilience, which is a topic that you’ve addressed in depth on PeakProsperity.com. So it will be familiar to most of your readers and listeners.
I think the solution here going forward is to have a number of income streams to increase that resilience of your household, by having several income streams, which means having an enterprise or enterprises in which you are an owner or a major investor.
Chris Martenson: I am particularly enamored with the idea that energy is going to be going up in price, or, let’s say, ‘as a fraction of our disposal income,’ as we go forward.
Charles Hugh Smith: Yes.
Chris Martenson: Price is a relative thing. And so as that heads up over time, we are going to be discovering that the entire landscape changes. I find a very useful thought exercise is to ask myself the question What changes in my life happen when gas goes to $10 a gallon? Well, I can tell you I will be taking a lot fewer trips at a whim just to go do something. I will be thinking about consolidating those. I will be taking far fewer trips farther away, because those will become more expensive or I will think them through more carefully. At $20 a gallon, something even more profound happens.
And that’s when we discover, once we play that thought experiment, all the places that you probably aren’t going to go to personally anymore. Those are places that probably aren’t going to do all that well. That’s one way to look at it. They are going to be exurbs, distant strip malls, certain economic arrangements that just don’t make sense under a much higher energy cost than we currently have. And so those are the things that fall away. And then, as you are implying here, there are things though that will rise. Because now we are more local, and people are still going to have energy needs. We all still want to be warm when we want to be warm and cool when we want to be cool. And there are lots of opportunities to reconfigure our lives around that in reality.
Where I live in New England, wood seems to be our only local natural energy source besides the sun. A little bit of hydro, but not enough to even write home about. So I am looking at wood and saying, wow. It was a very important energy source as recently as a hundred years ago. It probably will be again, and here’s an opportunity for people who want to look at it that way — unconventional, but something I can get my hands around. I understand it. It's local. I can look at it and touch and make sense of it.
Charles Hugh Smith: ,Yeah, Chris, I think that’s absolutely right that each region will have a lot of enterprise opportunity. I consider my book hopeful, because I think that enterprise is completely possible in an era of declining resource consumption. In other words, just because we have to use less doesn’t mean that there is no opportunity for investing in enterprise. I think enterprise and investing, in fact, are the solution. And if we withdraw our money from Wall Street and put it to use in our own communities, to the benefit of our own income streams, then I think that things happen.
Chris Martenson: I completely agree. So let’s sort of focus in on where enterprises might look. I am interested, Charles, as you look at the current landscape and the financial markets, global credit system, geopolitics, maybe energy – whatever you are looking at — what do you see as the macro trends that will define how these next ten to twenty years are going to play out?
Charles Hugh Smith: I would start with the four “D’s,” I call them, like deglobalization. I think we’re now seeing that we are past the apex of globalization due to cheap energy and the sort of smoothing of corporate profits as the key metric of economic “growth.” I think that we are going to see a lot of nations starting to cut off access and flow of capital and resources to protect their own resources from exploitation by outside corporations. And I think we might even see that in the United States, where people will say, gosh maybe we shouldn’t be selling our coal to China. Or we shouldn’t be selling our property to country XYZ. So deglobalization will, I think, radically change people’s understanding of value and risk assessment.
And then the delegitimization of the loss of credibility of key institutions. People will realize that they can no longer trust the savior state — what I call the central state — to meet all their needs and do what it had promised all these decades. And the institutions that people have relied on as trustworthy will be revealed that they are either corrupt or incompetent. So that I think will play out over the next couple of decades, as well.
Decentralization, I think the whole idea of centralized concentrations of wealth and expertise that we call corporations, with super-long fragile supply chains to one or two factories on the planet that are “efficient” — I think that whole system is going to unravel and devolve. And so we’ll be seeking, in terms of investors, the safety. And lowering the risk element will be to choose local decentralized assets and income streams. So I think those are key dynamics over the next ten to twenty years.
Chris Martenson: And was there a fourth “D”? So far, we had deglobalization…
Charles Hugh Smith: Yes.
Chris Martenson: …and delegitimization and decentralization.
Charles Hugh Smith: It was probably shorthand for de-growth-ization.
Chris Martenson: [Laughs]
Charles Hugh Smith: In other words, that there is no way that we are going to keep exploiting resources at an ever-increasing rate.
Chris Martenson: Great, how about Deceleration then?
Charles Hugh Smith: [Laughs] Deceleration; I love it.
Chris Martenson: All right, that sounds good. Because that’s how I see it. It's not possible to continue to increase the rate of extraction and consumption of many things, and so as that rate falls, this is the uncomfortable period we’re in. One of the big macro trends is, of course, we have all our high priests and priestesses of money over there waving their magic wands, pressing a magic keyboard, making trillions appear out of thin air – that is supposed to work, and guess what? In the world of abundant and essentially unlimited resources, the limiting factor is the number of people available to work to extract them. Once you pass that threshold, it turns out that waving the magic money wand doesn’t do what it used to do and it's very confusing, I am sure, to everybody who has been infiltrated in that system. They grew up in it, it's all they studied, and they understand all of their differential equations around how the economy is supposed to work. They get the Taylor’s rule and interest rate spreads and they did all that and they put all that in and they waved their wands and the potion doesn’t work and it must horribly confusing.
And over here on the side are people who see this other point of view and say, well that’s what we would kind of predict would happen if we took the amount of available net energy. That is the energy left over after we invest some energy to go find some. We take that net energy, and whether we sell it for dollars or just hand it out for free, it wouldn’t matter. Society will go out and do awesome things with that energy. As that stream of energy shrinks down, the complexity theory will tell you that any complex system owes its order and ultimate complexity to the amount of energy coming through it. And once you decrease that energy flow, it will be simpler. Well, what is "simpler" shorthand for? Well, fewer job types, fewer job specializations, fewer stock-keeping units, fewer whatever-you-want. But ultimately, they are units of economic activity.
And so, as you throw more money into the fewer units of economic activity, that’s where I think economic textbooks can tell you what will happen next with reasonable assurance. And that is that hidden default that you talked about and [is] otherwise known as inflation. That’s one of the macro trends that I have an eye firmly fixed on, is the idea that we are printing money at pretty rapid, if not the fastest rates ever seen, and shoving that into a world where I see less and less units of economic activity happening. And it's a chaotic system, so we can’t predict all the wrinkles. We don’t know where every grain of sand is going to fall in this story, but predicting that the sand tower is going to crumble is an easy one.
Charles Hugh Smith: Yes, absolutely. And Chris, I remembered the fourth key which I had, which was definancialization, which is exactly what you are describing. This is the idea that we can financialize resources in some way that will make them larger. That’s over; just because we print more money doesn’t mean we are going to have more oil.
Chris Martenson: Right, right.
Charles Hugh Smith: So one of the concepts in my book that kind of follows is this: If we are doing a creative definancialization, what we want, of course, is real assets, and of course precious metals are the ultimate hedge. They serve an essential role in that. But I am not wealthy enough to, like, sell off part of my precious metals every month to buy food and stuff. So I am kind of focused on how I can get income streams. Like, what can I do in terms of social capital to set up a network of businesses and people that I know and that I can trust and value, where I can sell my labor for anything? I can just sell it for a quarter ounce of gold or an equivalent amount of wheat or whatever it is; my labor will have the same value as to what it can buy. If I have an orchard, if I know how to actually take care of my trees, then the harvest will have a value, irrespective of how we measure that. So I will have an income stream, whether it's measured in wheat, gold, rent, a new fiat currency from Mars – you know, whatever we have. So that is the focus of my book. To look at how we can invest in income streams.
Chris Martenson: A nd I think it's very wise and sad that we find ourselves here. Because the money of a nation, the money of a people – it's an agreement. Ultimately, it's an agreement between ourselves. So therefore, it is a social contract. That is what money really is. Forget that it's supposed to be a store of value and unit of account and all those other textbook things. Those are sort of features, right? But what it really is to me is the social agreement. So you and I agree that this piece of paper is worth ten dollars and this piece of paper is worth twenty dollars and that piece of paper is just a newspaper. So we have these agreements around what these things are worth, and what you are describing is that as we lose faith in that agreement, a lot of things in our social contract began to fray. And in that scenario, one of the things that we might consider doing is understanding what really intrinsic value actually is. An apple has an intrinsic value; regardless of how many pieces of paper we decide it's worth or agree upon, it's still an apple. And an apple still has a relative intrinsic value as compared to an hour of labor potentially or whatever. So you are actually talking about walking away from the money itself simply due to a loss of faith. Is that a fear characterization?
Charles Hugh Smith: Chris, I think you very well described the loss of trust as a social contract. So one way of looking at this is capital: It's not just financial. It's what we call social capital. And that is, in fact, the valuation of trust. So if you have a lot of social capital, what that is another way of saying is that you know people you can trust. You have an enterprise that has a trustworthy output and trustworthy sources of input. So what we are really talking about is revaluing trust away from the paper money and institutions that rely on that.
Chris Martenson: This is a really important point to me. I critique the Fed a lot in terms of their actual actions, but my largest critique of them is that they are ultimately operating a fiat money system of which confidence and trust are the two most important characteristics. We have to have trust that they are not going to overproduce this stuff, confidence that they are going to wisely manage it, and so when the Fed blocks every single effort for people to peer into that public balance sheet and ask the very legitimate question – What’s in there? Who did you buy it from? What did you pay for it? What are your plans for disposing of it? – and then we find out through a Foyer request years after the fact that the Fed basically supported every country, company bank in the world that needed access to dollars, without any regard to the trust or the confidence pieces.
They are, in my mind, playing with real fire here, because they are eroding the most important feature of any money, which is the trust people have in its stability and its utility and its store of value characteristics, and all of these pieces. And this is why I think this really describes, to me, much of the social angst, even of people who don’t quite understand all the mechanisms and the arcane and the jargon around what the Fed does or doesn’t do. They just know in their hearts somehow that printing up $600 billion dollars to buy Treasury bills out of thin air – there is just something wrong with that. And I think it's the trust that gets eroded that creates that anxiety. What are your thoughts?
Charles Hugh Smith: I agree, Chris, and it's what I call the legitimization process. The legitimacy of these institutions is being eroded, as you say. And the Fed has already lost a tremendous amount of credibility. I think that politically it is already mortally wounded, in my mind, because people realize that that printing of $600 billion in the QE II was a complete, utter, total failure. It did not help the economy. It did not help the citizens. It failed, and so the Fed has failed, and I think that people’s faith in the Fed’s god-like status has been taken down considerably. I think the same can be said of Congress and the banking sector. I mean, just a huge number of institutions are failing, and people are recognizing that and they are losing credibility.
So I think the answer is not to get depressed about it, but to relocalize the institutions that we can trust, which tends to be like our city council and the organizations that form our communities.
Chris Martenson: Right, so I agree with that, and I don’t really know how to counsel individuals to change the macro system. I look at it, and just looking through the energy lens alone, I see that every energy transition we’ve ever had in history took forty to sixty years. So we went from wood to coal to oil and so on. Each one of those took a long time, and there’s a really good reason for that, right? You have all this invested capital embedded in the old energy structure, and it takes time for that stuff to wear out and get replaced through normal mechanisms.
And I look at our current environment and I say, okay, we have an enormous energy challenge coming before us, and we haven’t taken any steps to really seriously address that. “Cash for Clunkers” was more of a joke than a serious sort of effort at that. Our fuel standards are still something of a joke, the pace at which we are going to put them on. We don’t really have mass transit. Anyway, there is no energy policy that I can look at and say, “Wow that squares up with reality.” And so that’s just one example, one slice where I am looking at current leadership and saying, I don’t see any leadership in terms of what to me would be a credible, adult-size response to just the energy slice of the story.
But there are other slices here, in terms of what we are doing with the deficit and how we are going to manage the entitlement programs and what we are really doing around education or infrastructure. Or the fact that we think nothing of spending a trillion on making sure banks are healthy, but we can’t seem to find the money to invest in what I consider to be legitimate alternative technologies. Or the next wave of farming that doesn’t involve big agribusiness, but involves permaculture and other practices that are legitimate and sustainable and understandably sustainable.
So that’s the delegitimization that I see, is that almost all of the actions that I see, I can only really understand and support, if what I am trying to do or what they are trying to do is perpetuate the status quo. They are doing a great job at that. I just don’t have any faith or trust that the status quo is either desirable or sustainable at this point.
So that is why I am personally very much out of step with the current machinery as it is architected and running. And that’s why I don’t spend any time trying to change it or tell people how to change it. I am glad people do, and they put a lot of energy there. My energy and focus is on helping individuals, compani