Econ 101
There’s an old joke about economists (or lawyers. I can’t remember, but for the purpose of this post, it’s about economists):
A physicist, an engineer and an economist are arguing about creation and the nature of God.
The physicist says “God is a physicist because He had to create the fundamental laws and equations that enabled order to emerge from the chaos of the Big Bang.”
The engineer says: “God is an engineer. It’s one thing to create and interpret the law to divine order from chaos, but you need an engineer to apply those laws and create practical, working models and mechanisms for galaxies, solar systems and planets to form.”
The economist says: “God is an economist because who do you think created the chaos in the first place?”
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There is no shortage of information on what makes the modern global economy tick. In fact, just like with every other topic, we are drinking from a firehose. So, I put together this convenient guide to spell it all out, sort order from chaos and help us all to make the best possible decisions on investing, saving and spending.
Higher interest rates
Bad: When the Federal Reserve raises interest rates, as it is doing now, it increases costs for everyone and everything. It costs companies more to borrow and they just pass that along to us. It means mortgage and personal loans cost more, and it means that we will likely end up with a recession as these increased costs slow economic activity to crawl. Boo!
Except that…
Good: Higher interest rates mean that people earn more on their savings and get better yields when they invest in bonds. Also, higher interest rates result in people receiving bigger cost-of-living increases on Social Security and other fixed income sources. Plus, increasing interest rates are likely to slow down the economy and reduce inflation. Yay!
Bear Markets
Bad: Bear markets (that is, stock markets that are going down) are terrible for investors because they are losing money every day and watching their retirement accounts go down in value. Boo!
Except that...
Good: Bear markets are a necessary correction that return asset classes to more normal, rational, and sustainable valuations AND provide an opportunity for investors to buy assets at reduced prices, thereby maximizing returns on investments. YAY!
Low unemployment
Bad: When unemployment numbers are at all-time lows, as they are now, it makes it difficult for employers to find qualified workers. The only way to get the best people is to increase wages, which is inflationary because it increases a business’s costs, which are ultimately passed on to the consumer. Boo!
Except that…
Good: When unemployment numbers are this low, pretty much anyone who wants a job can find one. And since employers are so desperate to hire, workers can demand higher wages and better benefits, which is great for them as individuals and for our country as we seek to bolster the middle and working classes who are the engines of our consumer economy, while reducing income inequality. Yay!
Hot housing market
Bad: Rising home prices are forcing lower and middle income buyers out of the market. For those willing or forced to compete, it means bidding wars and prices spiraling upward to the point where larger and larger portions of our take-home pay is needed to cover housing costs. The rest of the population is forced into the rental market where there is also more competition (demand) and fewer rental options (supply), thus raising prices for them as well. Boo!
Except that…
Good: Rising housing prices are great for homeowners as they build equity in what is, for most people, the single biggest expense/investment they will ever make. This also increases “generational wealth” wherein parents can pass along their earned equity to children and grandchildren. Further, rising property values are good for tax bases in communities where municipal and school budgets are based on those property values. Yay!
High oil prices
Bad: Obviously, high oil prices are bad for everyone. It costs people more to drive cars and heat their homes. In addition, high oil prices mean higher transportation costs, so everything from freight to airline tickets cost more and we all end up paying this oil surcharge in higher prices. Boo!
Except that…
Good: Higher oil prices means people are encouraged to buy higher mileage, smaller cars, and electric vehicles, which means lower tailpipe emissions. Also, the higher gas prices go, the fewer miles people drive. All of this helps to slow climate change. And as oil prices rise, more producers jump into the market to get in on the oil gravy train and that means higher supplies as demand weakens, thereby lowering oil prices. (Just to be clear, I am saying higher oil prices means lower oil prices. You are starting to get the gist of all this…) Yay!
Economic stimulus
Bad: All that money that Congress and the Fed threw at the economy during the pandemic increased money supply and put more money in people pockets to spend. They were trying to spend all this extra money just as the supply chain was falling apart, so there were too many dollars chasing too few goods which means… INFLATION! Also, cheap or even free money means investors were chasing returns by buying stocks and pushing up prices to bubble levels and bubbles eventually must burst. Boo!
Except that…
Good: The economic stimulus helped people make ends meet when they were in real trouble. Many had been laid off and those stimulus checks made the difference in grocery shopping, making the rent and paying medical bills. Further, the rising stock market that resulted from all that free money going into investments meant that retirement accounts reached record highs, placing people in better financial shape for the future. Yay!
Free trade
Bad: Free trade means high paying jobs here in the U.S. are easily converted into low-wage jobs in China and Bangladesh. Further, it took the pandemic to make us realize how fragile our supply chain is and how easily it can break down. We need to manufacture everything – from iPhones to n95 masks - here in the U.S. to better protect ourselves from macroeconomic, global disruptions. Boo! (I MEAN YAY!)
Except that…
Good: Free trade means that we can afford things that would otherwise be out of reach. That $750 Chinese-made iPhone would cost $4,000 if it were made in Cupertino. A pair of $130 Nike running shoes made in Vietnam would probably cost 5-10x if they were made in Oregon. (Is that a “yay” or a “boo?” Anyone know an economist?)
So, there you have it: A simple, concise explanation of how the economy works so that you are no longer confused by the pundits who say this is good, that is bad and vice versa.
And, c’mon: Why you were so confused in the first place?