The Swinging Pendulums of the Economy
by Bill Sardi by Bill Sardi
The startling but predictable economic downturn has produced news reports of bankruptcy, bailouts, inflation, deflation, home mortgage foreclosures, declines in the value of homes, crashing stock prices, bargain stocks, increases and decreases in the foreign trade balance, and ups and down in the price or value of gold, oil and the U.S. dollar. How to interpret all this?
Is deflation good or bad? Isn’t the fall of home prices good for new buyers? Don’t falling stock prices represent bargains? The financial demise of one represents opportunity for another. These are the swinging pendulums of the economy. To help sort this out, I have prepared the following chart.
The Swinging Pendulums of the Economy
Spend more money
Stimulates consumer economy, usually at the expense of savings, and too often with a rise in credit card debt. Banks lack capital when consumers spend instead of save.
Save more money
Provides capital for the banks; banks can lend more money; depositors can lose value of banked money via inflation; best current rate of interest on saving acct is ~4%, while real rate of inflation is more than 10%.
Weak US dollar
More foreigners buy U.S. goods or travel to the U.S. More exports as U.S. goods become relative bargains elsewhere. Balance of foreign trade evens out.
Strong US dollar
Foreign countries bid for business with U.S. to capture strong U.S. currency; less exports from U.S. to foreign countries; increase in foreign trade imbalance; currently, foreign countries are propping up value of US dollar to stimulate export of their goods to U.S.
Rising costs for manufacturers results in higher retail prices and lower demand via lack of affordability of goods; bank depositors experience erosion of the value of their savings accounts if inflation rate exceeds saving deposit interest rate.
Bargains for consumers, possibly emanating from lower cost of production, with increasing profit margins as well; or could represent "fire sales" and falling profit margins for manufacturers in a collapsing economy and bankruptcy of companies and widespread unemployment.
Move debt off of bank, insurance and investment company ledgers onto the public; companies avoid bankruptcy. (Technically, this should be illegal. Some bailout money reportedly used for bank executive bonuses, stockholder dividends, asset strength and to buy out competitors.)
Renders a portion or all debt owed to creditors as a loss; in the case of corporate bankruptcy, workers lose jobs unless company is acquired after bankruptcy
Provides banks operating cash for daily demands of commerce; reserve requirements for banks were relaxed prior to recent financial crisis; banks generally have no more than 10% of depositors money held in reserve.
Lack of cash for banks to conduct daily business; forces banks to fail and FDIC to insure depositor accounts to $100k ($250k till end of 2009); any bank run threatens survival of a bank because it only holds a small portion of depositors’ money in reserve. Most U.S. banks today only have reserves they borrowed from the Federal Reserve.
Home prices fall below purchase price
Bargains for home buyers; owner cannot re-sell without a loss; owners unable to obtain equity for loans; if unable to make mortgage payment, home loan is foreclosed and full ownership reverts back to the lender; excessive loan foreclosures can cause insolvency of lending institutions.
Home prices rise above purchase price
Owners can sell home at a profit, or use equity to borrow; some American homeowners chose to use 2nd mortgage as a piggy bank in lieu of an income.
Stock prices fall
Bargain stocks to buy, but maybe debt-laden companies that will become insolvent soon and last holder of stock will suffer complete loss.
Stock prices rise
Dividends delivered or stock sold via profit taking; some stock holders may elect to sell stock, called profit taking.
Gold prices fall
Generally, demand for gold declines in sour economy times. However, supply and demand of gold is being manipulated (for decades) so as not to give investors an option to invest in the stock market.
Gold prices rise
Generally, gold prices rise as currency appears weak or nation approaches insolvency. Recent shortage of gold coins did not result in gold price rise; gold price may rise if currency is going to be officially devalued (currency is unofficially devalued every day due to inflation).
Oil prices fall
Adds billions of dollars to consumer economy that was going for gasoline.
Oil prices rise