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The Tale of André Prenner, a Parable for our Times


John Butler

Today, we take a brief pause from our normal economic and financial market commentary with this tale of common sense economic calculation and action. And no, we do not believe that the world is any more complex than we present it here. If you want to understand economics, you need first understand two things: That the human condition is one of scarcity and uncertainty; and that absent rational economic calculation and a certain degree of passionate risk-taking, nothing good can ever come of it.

Yeoville was a small Midwestern town of farmers, a few shops and cottage industries. It had grown slowly through the years and had not changed much. Once in a while there was a good year, less frequently a bad one. On occasion these were related to poor weather or other reasons for a poor harvest. There was also the difficult time when a large portion of the young men went off to fight in a war. Fortunately, most returned, although their absence put a huge strain on the remaining residents to make ends meet. But on the whole the townsfolk thought well of their position and went about their business with a healthy mix of realism for today and optimism for the future.

Mr. André Prenner was one of the more successful small businessmen in Yeoville. He was now in his 60s. His father had been a baker and manager of the town bakery, Yeoville Bakers. He was descended from immigrants from France, or so he was told by his parents, hence his first name.

André learned the baker’s profession from a young age, at first informally, assisting his father outside school hours and, after graduating the local high school, working part-time while taking a degree course in business at the local community college in the larger town a few miles downriver. As time would tell, André was not only given to work, but to greater ambition.

Taking advantage of youth, some savings from his part-time work, and a strong dollar, André celebrated completion of his business degree by taking an extensive trip to France – back to where, supposedly, his family was from – and also around various other countries in Europe. What he found astonished him: Unlike at home, where bread was simple, white and cheap, in France and in Europe generally, there was an endless variety of breads, in all shapes, sizes and even colors. It was as if the bread changed village to village. Even breads that looked the same tasted somehow different.

André returned to Yeoville some months later with a passion and a plan. He was going to turn Yeoville Bakers into something far greater than just a typical, small-town Midwestern bakery. He was going to introduce a range of European breads for distribution all over the state!

Now this was easier said than done. Anyone could, with enough searching around in a large city library, find a book with recipes for various types of European breads. But where to source the ingredients? And just because he loved the variety, would a range of pricey European breads sell well to a customer base which had lived its entire life chewing on the basic, cheap white stuff?

André promptly answered each such question with his passion. He was just going to have to give it a go. He was young; he knew the trade; he had learned to love European breads in short order; he had the support of his father even, who had a soft spot for his presumed French heritage. The worst that could happen is that he would go bankrupt and, as an experienced young baker, would then seek an assistant manager’s job at one of the many small-town bakeries in the state. In other words, his worst case was really quite similar to what he would do if he didn’t even give it a try. So give it a try he did.

It didn’t take long to discover that, if you knew where to look, ingredients for European breads were not difficult to come by. Indeed, the bigger US cities, in particular on the mid-Atlantic coast, were home to some well-established bakeries producing European-style breads. He soon found how to get access to those same ingredients, transported to Yeoville for what he believed reasonable cost. He also researched the cost of distributing his breads to other towns in the region and how to partner with local shopkeepers to sell his product. That was the easy part. More difficult was that he was going to need to expand the existing bakery by adding new equipment. If he simply stopped producing basic white bread, the bakery would generate no income at all during an uncertain transition period and risk losing its client base. No, he would need to develop the new range of breads in parallel.

As the bakery had not generated enough retained earnings to cover the purchase of the required new equipment, André was going to have to go to the local bank for a loan. Business plan in hand, he took his years of experience, good local reputation and enthusiasm into the bank. When he departed that day, he had secured a business loan, itself secured on the new equipment he was about to acquire.

Once he had arranged for the purchase of the new equipment – which would be delivered, installed and operational within just two months – he set out looking for the three new employees that would be required to run it. Only one needed experience, as he had that himself in spades. The other two could just be hard-working, reliable and willing to learn. He found the experienced employee at a bakery in a nearby town who was keen on a new challenge. The other two he found locally, both of whom had been doing odd jobs since graduating high school a year before, but according to their references they did quality work when they could get it and were quick to learn new skills.

For the first few months André didn’t give a thought to making a profit from the new operation. He wanted to sample customers’ tastes and make the decision regarding on which breads to focus for the first year so that he could secure the needed ingredients in affordable bulk rates. He travelled to many towns and even some small villages in his bakery truck, giving away free, fresh samples everywhere he went. Once it became clear what people liked and were willing to pay a bit more for, he contacted his suppliers, ordered the necessary ingredients for regular, weekly deliveries over the coming year, arranged for the printing and distribution of promotional material, finalized agreements with shopkeepers all over the state, and sent the new baking operation into high gear.

Already in the first year the new breads were contributing a substantial portion of the overall Yeoville Bakers’ profit and André repaid one-third of the bank loan. The business was growing rapidly, but now all costs were variable, internally-generated cash was substantial and, as such, the loan was no longer required. He paid it down fully within three years, two years ahead of schedule. This freed up additional cash which was used the following year to finance the lease for a new bakery, in another town about 50 miles away, which would make full statewide distribution a reality.

André was pleased with his success as a businessman but nothing pleased him more than when he entered the bakery at 5am each morning – bakers are notoriously early risers due to their need to prepare for everyone else’s breakfast – and smelled those European breads that he had first encountered several years prior on that auspicious trip to Europe. Bread was his business but remained his passion.

Many years later André was the most prominent baker in the state. He even distributed some to neighboring states. He employed nearly 100 bakers and a handful of young apprentices. But then came hard times: A major national recession. Budget cutting was the norm and, when it came to bread, customers were buying far less of his gourmet European breads. The operation was losing money rapidly and something had to be done.

Setting his passion aside for expediency, André took immediate action to protect his business. Having learned his trade by baking the simplest, cheapest bread possible, he went back to his roots. He cancelled his contracts with his suppliers for the gourmet ingredients and, once existing supplies were depleted, reoriented his entire operation toward making basic bread again. A dozen employees focused on the gourmet breads business were let go on the understanding that they would be re-hired once business turned for the better again. Other staff was expected to take a temporary pay cut. A few resisted but, once it was clear most of their fellow employees were willing to accept it, they went along.

At least there was still plenty of demand for basic bread, which provided for a reliable if less profitable business. This period lasted nearly two years. Yeoville Bakers was never at serious risk of bankruptcy, in large part due to Andrés swift reaction to the downturn. But it had been a hard time nonetheless and taught André some important lessons. When he felt the time was right and sensed rising demand once again, he returned to his passion of baking gourmet European breads and re-hired most of his former employees, several of whom had made do with odd jobs in the interim. Business began to grow again, but André was a bit more of a businessman now and a bit less of a passionate visionary. Yes, he had now managed to save a good deal of money, but he told himself he would always be cautious, never expand too quickly and always make certain he had the flexibility to change and/or reduce operations as required to face challenging circumstances.

It was three decades later when things got really bad. Not only was the nation in recession; tax and regulatory policies had made André’s business considerably more costly to run. Although he had not expanded the business by much in recent years, he now had to employ three accountants to handle Yeoville Bakers’ more complicated affairs. The US Department of Agriculture (USDA) was now quite active in screening foreign grain and flour imports for bad quality or what they sometimes referred to as “irregularities”, as if André or his more experienced staff would be unable to determine quality for themselves. The Commerce Department occasionally imposed foreign duties because of what they called “dumping” which to André seemed rather arbitrary. And the regular or, on rare occasion, surprise inspections of his own facilities, imposed a cost unseen by anyone but André and his core team, who always needed to be prepared just in case, with any and all requested documents, tours of facilities, product samples, etc.

As such, running the business had become more complex, with supplies harder to secure, prices more volatile and higher overhead costs. Adding to the challenges, it was now difficult to hire new employees, not because of a shortage of those able or willing to do quality work; rather, because payroll taxes and required healthcare and other benefits were much higher than before. Also, he had had some difficulty reducing staff during the most recent downturn, with one employee accusing Yeoville Bakers of unfair dismissal, including claims of workplace discrimination. The ensuing legal tangle was resolved in favor of Yeoville Bakers but cost André much valuable management time and taught him an important lesson about how careful he needed to be when hiring new staff. Unless he was absolutely certain that they were qualified, reliable and unlikely to complain if let go, he wouldn’t hire anyone, no matter how rosy future business prospects.

So now, André found himself facing the familiar situation of slack demand he had faced several times before in his long career, but he lacked the flexibility to respond as effectively. It was one morning when he was contemplating what, exactly, he should do in the current instance, when he received an email from the Small Business Administration (SBA) offering him a loan.

Now this had never happened before. André knew of many businesses that had received government subsidized loans through the years. Most of those businesses had grown and thrived, at least for a time. But he could not recall the SBA offering loans pro-actively in this way. It was the businesses that normally did the asking. So why was this happening? Could it have something to do with what he had heard about many banks turning small businesses down for new loans? Or cutting existing lines of credit? Everyone knew that banks had lost a huge pile on residential and commercial lending. Although André had no use for a loan at present, he was intrigued by the very existence of the program and inquired anyway, picking up the phone.

“Small Business Administration, new loans division, may I help you?”

“Yes, I’m calling to inquire about an email I received offering me a low-interest loan. Please could you let me know some of the terms and conditions, as well as the purpose of the program?”

“Of course. We are offering subsidized loans to small businesses that can demonstrate that their access to credit has been reduced, or that have viable expansion plans yet cannot get access to new credit. Specific terms and conditions vary with the size and proposed use of the loan. Those uses pertaining to environmental or green technologies receive the most favorable terms. The overall purpose of the program, other than supporting small businesses generally, is to ensure that credit is available, in particular for investment related to environmental or green technologies.”

“Thank you.”
“Have you recently been denied credit?”
“No.”
“Do you have plans to expand your business?”
“No.”
“What then is the reason for your inquiry?”
“Just curious, thank you.”
“Well if your circumstances change, please don’t hesitate to give us a call.”
“Thank you. I will do so. Goodbye.”
“Goodbye.”

André hung up the phone and thought to himself. “So this is the way the government goes about trying to restore economic growth: First, they cut interest rates to near zero, following the residential and subsequent commercial real estate bust. But apparently that isn’t enough to stabilize the big banks, several of which are at risk of failure, so the central bank bails them out, assuming some illiquid, toxic debt that André knows will never be sold back into the market. Then the government enacts a massive stimulus plan, which seems primarily to funnel money to a bunch of big businesses with strong connections to government, most of which probably have little difficulty accessing credit. But none of this seems to help smaller businesses, which is where most hiring in the economy normally takes place and where worker productivity tends to be highest. So now it appears they’ve got some fancy new program to extend credit to small businesses, but the favored terms are reserved for those that are keen to invest in the sorts of projects that the government wants, for whatever reason, and which are already being done in some shape or form by the large, government-connected businesses that received most of the stimulus money in the first place.”

“In the meantime, they have raised payroll taxes, in part to pay for increasing healthcare costs. The state has also raised sales taxes to cover an unprecedented revenue shortfall. They are threatening now to raise income and corporate taxes. The regulatory regime was already uncertain and is likely to become more so as Congress seems unable to resist the temptation to respond to each new lobbying effort by this industry group or that. Workplace discrimination suits are now so commonplace that I need to do full background checks on potential employees to make certain that, in the case I need to let one of them go, they are unlikely to take legal action. Customer demand remains weak as unemployment remains high. Now my input costs are soaring because of the weak dollar – which I understand is the result of so-called “quantitative easing” – which pushes up global grains prices. These costs I can only partially, if at all, pass on to my customers, implying lower margins and profitability ahead.”

“And these guys think that I, a small-town baker, might be interested in a loan? In expanding my business? In hiring new workers? Business is risky enough in good times. It is riskier in bad times. But even in the bad times – and I’ve had a few – there have been occasional opportunities to hire a good employee; acquire some good equipment at a low price from another bakery closing its doors; adjust the product line to better suit changing consumer attitudes. Yet now, not only are times bad; the uncertainty is higher than ever and the priority of the government is really not about getting the economy going again with sensible, sustainable, predictable tax and regulatory policy but rather about subsiding their pet programs and government-connected firms, which in the end is only going to raise the overall economic debt burden, implying even higher tax rates in future. No thanks.”

He went for a long walk and thought. The next day he went for another long walk and thought some more. He spoke to a few other small businessmen he knew who were getting by but not doing particularly well. He shared a few thoughts with his wife and with the two oldest of his three children. And he made a decision, perhaps the most difficult of his life.

The next day, after he arrived at work, he assembled all of his senior employees in his office. He let them know that he was going to put the business up for sale. If they wanted, they could buy him out over time, financing the purchase with a loan that he would provide at a low interest rate. He was retiring, he said.

“This seems rather sudden,” said one of his assistant managers.

“No, actually, it’s not. It is the result of trends that have been in place for a long time. It’s just that I think about things differently than I used to. I’m getting older. And as you get older you begin to realize that some things may change for the better, some for the worse, but some things don’t change at all. I’m tired of waiting for some things to change. I’ve had enough. It’s your turn now. Good luck.”

His employees were stunned. They respected the man, who had a fine reputation. He had kept his business profitable and, more often than not, growing, for over 40 years. And now it was their turn. They were going to need good luck all right. Lots of it.

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Bernanke Clips the People’s Coin – From Bakersfield to Burma

Bernanke Clips the People’s Coin – From Bakersfield to Burma
Fred Sheehan

Ben Bernanke: The Chauncey Gardiner of Central Banking” examined the Federal Reserve’s November 3, 2010, decision to save the economy by inflating the asset markets. Chairman Bernanke shared his unpardonable rationale for QE2 in the Washington Post, on November 4, 2010. His deadly cruise missiles, QE1 and QE2, were described in “Chauncey Gardiner.”

The subject of CG2 – Chauncey Gardiner, Part 2 – is Bernanke’s ignorance of the United States’ unavoidable association with the rest of the world. The consequence of Federal Reserve money expansion is not only disrupting foreign economies; the backwash from dollars piling up overseas is raising food prices in the U.S.

In his Washington Post commentary, Bernanke never mentioned the dollar, the currency that is being aggressively depreciated by the Federal Reserve. In the Post, Bernanke resorted to “price stability,” a deceptive phrase invented to justify inflating prices, in the present instance, by 2% a year. No Federal Reserve chairman before Bernanke claimed he needed to inflate prices to prevent them from deflating. Congress has not addressed this new coin-clipping mandate of the Fed, nor will it. Bernanke could declare tomorrow that a 5% annual currency debasement is necessary for price stability. This, too, would be met by silence. What is the point of paying the House of Representatives since it does not represent?

Depreciation of the dollar at home is handcuffed to depreciation of the dollar against other currencies. (This is a “competitive devaluation” in which most countries are participating, but the U.S. is the most assertive aggressor.) Even before the Fed’s announcement of QE2 on November 3, denouncements from overseas warned Bernanke he was about to rouse a new round of anti-Americanism.

On October 13, 2010, the China Securities Journal (an affiliate of the Chinese government’s official news agency Xinhua News) warned: “The U.S. expansionary monetary policy could hijack the global economy, and emerging markets are the most likely to suffer the consequences.” After this and many other declarations from the Chinese, the Congressmen and Senators who demand China cooperate in currency adjustment said and did nothing about the Fed’s QE2 operation. The politicians either want to launch a trade war (goading nationalism could help beleaguered office-holders) or are unable to rub two thoughts together at the same time.

Speaking of the untutored, the (London) Daily Telegraph targeted Bernanke on October 16 when it warned: “America’s attempt to print itself out of trouble…is far from proven [and] could actually make things worse. QE on this scale now being proposed has never been tried. It is beyond the realms even of economic theory.” (In the aftermath of QE2, Germany’s Finance Minister Wolfgang Schaeuble seconded this opinion: “However you look at it, my impression is the U.S. is in a state of desperation.”)

The broadsides did not stop: On October 23, 2010, German Economic Minister Rainer Bruederle addressed both the European Central Bank’s balance sheet and the well advertised intention of the Federal Reserve to commence its attack on the world economy: “An excessive, permanent increase in money [supply] is, in my view, an indirect manipulation of the (foreign exchange) market.” China Commerce Secretary Chen Deming warned on October 26: “Because the United States issuance of [dollars] is out of control and international commodity prices are continuing to rise, China is being attacked by imported inflation. The uncertainties of this are causing… problems.”

The flow of Federal Reserve Notes overseas is indeed causing problems. Commodity prices are at all-time or generational highs when quoted in the most overabundant currency on the world, U.S. dollars: natural rubber, synthetic rubber, corn, soy, wheat, cotton, iron ore, steel, and cattle. It is always the case when prices become distorted that shortages develop. Today there are scarcities of palm oil, vegetable oil, soybeans, diesel fuel, engineers, welders, pipe fitters, electricians, and coal. Federal Reserve officials, operating as they do in a theoretical world, certainly did not consider before this latest act the food riots that spread across at least 20 countries in 2006 through 2008, as commodity prices (food, in particular) were doubling and tripling.

Chairman Bernanke is an ignorant man, evident whenever he speaks, but wondrously displayed in comments after his November 3 launch. Bloomberg news described a talk by Simple Ben in Jacksonville, Florida on November 5: “Federal Reserve Chairman Ben S. Bernanke said the central bank must focus on the U.S. rather than overseas economies when trying to spur the recovery by purchasing an additional $600 billion in Treasuries.”

Ben is deaf to anger that has been directed against the U.S. since his latest dollar dump. The gathering trend towards rising trade barriers, capital controls and protectionism shifted into a higher gear after the Fed’s announcement. This is not good for the United States. These tendencies did not work out well for the U.S. in the 1930s and that was a time when the world admired America. The insistence of his fellow, establishment economists to still call Bernanke “an expert on the Great Depression” shows this so-called profession is gurgling its death rattle.

After his Jacksonville address, Bernanke was asked how his duplicitous description of inflation (it is too low) could be true given “skyrocketing” commodities prices. The disoriented cosmonaut replied that rising commodity prices are “the one exception” to a broad reduction in inflationary pressure. He went on to say the “excess slack in the economy” will make it “difficult for producers to push through higher prices to consumers.”

It will be difficult for producers to stay in business if they don’t. Over the past year, the price of wheat has increased 74%; corn: 14%; oats: 68%; heating oil: 29%; gasoline: 25%; pork: 60%; coffee: 27%; beef: 18%; sugar: 44%; copper: 37%; and cotton: 66%.

Some companies have been unable to pass on costs. Kimberley Clark, Wendy’s/Arby’s Group, and CKE restaurants (among many others) announced third quarter 2010 profits fell even though total sales rose. Squeezing profits out of companies contracts the job market; it does not “spur” it. Some companies, including General Mills, McDonalds, and many supermarket chains have raised their prices, in defiance of Bernanke’s contention that it will be “difficult for producers to push through higher prices to consumers.”

It is the consumers who can least afford who suffer the most from rising commodity prices, especially since personal income in the U.S. continues to fall, as it did once again in September, 2010. According to the Bureau of Labor and Statistics, the 20% of Americans with the lowest wages spend nearly 60% of their after-tax income on food and energy. The highest 20% of earners spend about 10% of their after-tax income on these necessities.

Only a celebrity economist could think rising commodity prices will be “contained.” (A reminder of Federal Reserve Chairman Ben Bernanke’s consistent record of being wrong: “At this juncture . . . the impact on the broader economy and financial markets of the problems in the subprime markets seems likely to be contained.” – March 28th, 2007). UPS just announced it is increasing shipping rates by 4.9%. College tuitions for 2010-2011 rose 7.0% at 4-year public colleges. Holiday airfares in 2010 are expected to be 18% higher than a year ago (FareCompare.com).

Like coin-clippers of yesteryear, Bernanke denies any wrong doing. In the Post, he claimed inflation is so low it is “unhealthy.” But this is one of the gravest crimes one can commit against the People. (Coin-clipping was the practice of clipping small amounts of gold or silver from each coin and then selling the shavings.) We have become so refined, the crime goes unmentioned. It was not always so.

In 1278, King Edward I raised the penalty for coin clipping to execution. There were 298 offenders who were hung for offenses against “our Lord the King’s Coin.” Under Queen Elizabeth I in 1576, “a goldsmith named Thomas Green was drawn from Newgate to Tyburn, and was there hanged, beheaded, and quartered for the clipping of gold and silver coins.” On June 21, 1776, Phoebe Harris was burned at the stake, at Tyburn, for High Treason. The specific crime was coin clipping. A crowd of 20,000 gathered to watch. The odor from her body smoke left some spectators gasping.

The People – from Bakersfield to Burma – should settle for the disestablishment of the Federal Reserve and send Ben and his silly friends back to college campuses where they can teach students who are silly enough to believe their disgraceful professors whose empty-headed curriculum they will someday teach.

Riots in France a Symptom of Declining Western Wealth

Riots in France a Symptom of Declining Western Wealth
Byron King

The French nation was hobbled by strikes, rolling strikes, street violence and other protests. It sprung from the proposal of French Pres. Sarkozy to raise the minimum retirement age to 62, by 2018 – or so the newspapers tell us. Let’s think about it, though.

As a long-time follower of the world oil industry, I was immediately struck by how one key target of the rioters and protesters was France’s petroleum distribution system. Clearly, the protesters understand the ideas of the 19th Century military theorist Karl von Clausewitz, who advanced the concept of finding the opponent’s “center of gravity,” and then bringing force to bear on that point.

The protesters were going for the jugular of modern societies, which is the energy supply. In France this week, over 3,000 – out of 13,000 – gas stations ran out of fuel after panic-buying by motorists. Also, eleven out of France’s 12 oil refineries remain on strike. Add to this that “flying pickets” are moving around, blocking fuel distribution depots. Thus has lack of fuel shut down major sectors of the French economy.

Indeed, the Charles de Gaulle Airport in Paris – a key transportation hub for the world, and not just France – suffered from a severe shortage of fuel for arriving aircraft. French authorities advised air carriers to land with enough fuel to take off, and fly somewhere else to gas up.

Pres. Sarkozy sent riot police to confront the blockades of refineries and fuel terminals. He knows that his response to the energy-based tactics of the opposition will make or break his political power. The jury is still out, but my hunch is not to bet against the power of the French state on this one.

What’s the Real Issue?

On the surface, the French rioting seemed like a political squabble over a high-visibility social entitlement. Considering the passion of the protesters, it’s like the current retirement age in France – 60 years – is some sort of sacred number. The protesters make it sound like Pres. Sarkozy wants to destroy a deep-rooted individual right that dates back to time immemorial of which, to use an old phrase, “the memory of man runneth not to the contrary.”

But the age-60 retirement number is not exactly some icon of bloody struggle, hewn out of the rock of revolution and war. No, the age-60 retirement eligibility dates only back to 1983 when the Socialist Party, under then-president François Mitterrand, reduced the former age of retirement from 65.

That is, the age-reduction for retirement was just a vote-buying political move during a time of relative peace and prosperity in France. Which gets us closer to identifying the real core issue behind the social unrest in France. It’s a lesson for all of us, in fact.

Times Have Changed – An Earthquake Across History

Neither France, nor the Western world generally, is living in a time of relative prosperity. Not anymore. Maybe not ever again.

Things have changed in this world, probably forever. The economic rise of China has caused an earthquake across history. That, coupled with the self-inflicted collapse of much of the Western way of running capital markets and managing economic growth over the long haul.

In just the past 15 years or so, China has evolved into a nation of immense demand. China has become the key player in a world of fierce resource competition. Look around. Things like energy, minerals, water and food are scarce, and getting scarcer. China is driving a long-term bull market in resources of every sort, from oil to iron, copper to cotton, cement to soybeans.

No “Value” in Value-Creation

On the other side of the coin, China is a land of mind-boggling, low-cost productivity. In almost every industrial arena and sector, the overall competition from Chinese firms has driven costs for many things. How low? Well, often down to right around the intrinsic value of the inputs – the plastic, the copper, the steel. As for the labor input? It’s not too much to say that Chinese competition has removed much of the “value” from value-creation.

Indeed, one of the major global economic issues today is that when Western businesses go head-to-head against Chinese competition, in almost any industry, nobody makes much money anymore.

So if this is the world in which we live, how can France remain a wealthy country? How can the West retain its status and historical standards of living? Tough questions, eh? But well worth asking.

What Can Nations Afford?

It takes us back to those French retirement riots. In France – and in the U.S. as well – government has promised far more than it’ll ever be able to deliver.

Retire at age 60? Who can afford that? Who’ll pick up that bill? Where’s the money? The government will collect taxes from who, exactly?

Really, when it comes to the French riots, it’s NOT just that the age-60 retirement idea lacks any sort of serious historical pedigree. Not at all. The problem is that the days of an entire nation retiring early are over.

Age-60 retirement is an idea that’s ridiculous and unsustainable in a world of Peak Oil – and Peak “Everything Else,” for that matter. We in the U.S. – and Canada, U.K, Australia, and so many other places across the world – need to take heed.