Sunday, November 16, 2008

Inflation or deflation?

This is one of the big questions that I see people asking these days. Everyone knows that something really bad is going on but there's a lot of debate about what's really happening. First you have to understand how our financial system works. Credit is really the driving engine. It allows people to buy things that they can't normally afford. If you only make x amount of dollars then obviously it'll take a while to save up enough money for that house, new (or newer) car or that big screen tv. You might not be able to afford to buy it outright but if you can convince someone to loan you the money then you can get it now and make payments on it over a period of time. Someone with a huge surplus of cash can take their money that they don't need right now and get a monthly income by loaning it to someone who can afford to pay back slowly over time. By the time that loan is paid back they get a lot more money than they loaned out in the first place. You have things like credit scores and past credit records that allow people who have money to loan to feel confident that they'll actually be paid back if they loan it out. It allows people who don't have the cash on hand to get the "money" to buy things that they need or want right now. The system works great when everything is working as intended.

Unfortunately, in recent years the government has stepped in and implemented systems that take away risk from borrowers to make sure that people who probably won't be able to pay back their loans can make the biggest purchase in their lives whether they can pay back the money or not. By creating Fannie and Freddie and allowing borrowers to sell the risky loans that they made to them they essentially allowed people with the capital on hand to make loans to risky borrowers and then sell those loans to Freddie and Fannie and eliminate the risk that they'd default.

By now everyone knows that the housing crisis is what has caused the monumental mess that we're dealing with today. The government basically told everyone that it was OK to give anyone who wanted money to buy a home that they had nothing to worry about by loaning out that money. It was even OK to push that loan through by any means possible via temporary, artificially low interest rates or even outright fraud. After all, the economy was doing so well that it couldn't possibly start to get any worse. Meanwhile, while it was so easy to get a loan for hundreds of thousands of dollars to buy a new house because it would assuredly be worth double that in just a few years credit card companies were seizing the opportunity to extend people thousands of dollars in credit to buy whatever they wanted to furnish those houses. Even if the person doesn't own a house what's the big deal? After all, they're still making money and even if they loan out too much they'll still get SOMETHING back when the defaulters go to bankruptcy court and all the while they'd keep getting paid by the people in houses that would assuredly keep gaining value who could just keep pulling equity out of their houses to pay their bills.

It would be one hell of a deal if it could keep working like that. It's too bad that the guarantee that the government was making by backing those bad loans is tied to our dollar that the world uses as the defacto currency. As the rest of the world watches all of these home values that our dollar is essentially backing go in the toilet they're starting to lose some confidence. Now people with money don't want to make loans to people with less than stellar credit, anymore. So the government wants to loan those people (ie banks) money at a very low interest rate so that they can take that money and loan it out again. That doesn't do much good when no one thinks that anyone will be able to pay it back, though.

So now we've got banks that are afraid to loan people money because they know that they probably won't be able to pay it back. At the same time they've got the federal government shoving money down their throats thinking that they'll take that money and loan it out like they've been doing. Why would they? Even with the full faith of the United States Government behind them they're still losing a ton of money because of all of the easy money that they were giving everyone. Banks are failing left and right and the big banks are just using the money that the government gave them to buy up those smaller banks. Now all of a sudden the government wants to buy up stock in those big banks that will probably end up surviving all of this mess?

The good news is that all of this money that's being "printed" is only really replacing the money that the big banks have lost. The government just thinks that it'll be a wash. This won't result in massive inflation. It'll result in massive deflation where normal people can't just buy a $1000 big screen TV, anymore. It'll mean that someone with no money down or a car that they financed 2 years ago that they're now upside down in won't be able to buy a brand new $40,000 car without taking a big hit. You already see cars that were selling for $30k a year ago selling for thousands less now (to those that can actually get the credit to buy them or who have a big enough down payment IN CASH to finance them). When any Tom, Dick or Harry could walk into a dealership a year ago and walk out with a new car with a reasonable monthly payment the economy was doing great because companies could keep making their products, charging whatever they cost with a decent profit attached and they'd get their money because some lending institution was willing to give any Tom, Dick or Harry with so so credit the money to buy it. Now all of a sudden that aint happening. The only recourse that the companies selling these high end products (from houses, to cars, to big screen TVs) have is to keep lowering their price until they can get SOMETHING for what they made and still have enough left over at the end of the day to maybe break even. This is deflation.

Here is where inflation will come into play. The only answer to this problem is to start giving money to the people. Obama has already made it perfectly clear that that's exactly what he wants to do. He wants to give "tax credits" to 95% of the "working class". That's funny, though, considering that 30% of that "working class" doesn't pay taxes in the first place. Another thing that I can see him doing is finding a way to make sure that anyone who wants a loan gets a loan. This will allow people to start making loans again. Unfortunately, in today's economic climate it will just empower people who can't pay back those loans in the first place to keep making loans that they can't afford in the first place. The government will just have to keep making money easier to get by giving handouts and by raising the minimum wage. This will destroy the middle class (honest, working class folks) who are just doing what they have to do to get by as it is because as the big "greedy" corporations who had to stretch themselves farther than they themselves could afford to be have to keep raising prices to keep up.

It's a vicious circle and a hole that keeps getting deeper the harder we try to dig it. This will be our ultimate downfall. We'll keep racing to keep up while other parts of the world who were already much worse off than we are see an opportunity to point the blame at us and earn credentials in the process. As the rest of the world loses confidence in us we'll continue on our decline and it won't be long before we have no other choice than to do things the way that other governments want us to do them.

Right now your best bet is to start to do the hard thing. Start scrimping and saving wherever you can (in tangibles). Make sure that your community is tight. Make sure that your food stash is squared away. Personally, I've been looking at foreign real estate but I don't make a whole lot of money and the good locations are relatively expensive (I REALLY like Costa Rica). Hopefully we'll pull an ace and still manage to stay on top despite all of the cards that are stacked against us right now. God knows that we have them with all of the natural resources that we still have and all of the rights that are granted to us via the constitution. I don't have a whole lot of faith in our "rights", though, since they're really just privileges that our government allows us until they decide that it's in our best interest to take them away. The only way to prove to them otherwise is with force and in that case we still actually have to beat them. If it ever comes to that then we're really screwed.

As far as our natural resources go it's not a far stretch to look at those as collateral. You know that foreign governments are looking at them that way. We're on top because we do have all of those natural resources. We've got the largest gold reserves in the world. We've got enough natural gas to power our country for generations if we make the necessary adjustments. We're still the bread basket of the world. Yep. Those things are all just collateral for all of the loans that the rest of the world has been making us via treasury bonds for years. When they decide that our dollar isn't worth enough to pay those back then they're going to come for our resources. Our government won't have any choice but to agree to those terms unless they want to incite a full scale war on our soil. When the world finally decides that they're sick of our shit and that they want what we've got then we're going to be hurting whether we try to fight them off or not.


jcarter said...

It's funny that I rather came to the same conclusion that you did, albeit with a slightly different scenario. From your treatise, it sounds like it could take at least a few more years to get to that point. Do you swagger a guess on the time elapse?

The Urban Survivalist said...

I've thought a lot about that and to be honest I regretted making the post when I reread it this morning. I assumed that most people would just look at this, roll their eyes and think that we're nowhere near that point yet. I do consider this a worst case scenario and it's something that won't play out to the point that I described for at least several years if we ever let it get that far. Just to coincide with the end of the Mayan calender and all of the crazy people that will be coming out of the woodwork between now and then I'll go ahead and throw 2012 out there just for fun. Realistically I don't think that it will happen that fast but things have been happening MUCH faster over the last couple of years than I thought that they could. To be fair we'd have to make a lot of bad decisions and political blunders to get there. I can't say for sure whether or not Obama will make them or not, though. The scariest thing about him is that he doesn't seem to be in it for his own political gain. I honestly think that he's convinced he knows what's best for the people. He's an idealist who doesn't think that globalism is a bad concept at all.

Anonymous said...

Ah, so many factual errors, where to start?

1) The theory that raising the minimum wage is a job-killer has been thoroughly disproved by the evidence. Google for it.

2) Blaming freddie and fannie for the housing bubble and crisis. Lord, give me strength.

Yes, some of the actions of freddie and fannie were less than stellar. But blaming freddie and fannie and not talking about the actions of private banks is like standing in a burning building and blowing out a candle.

For the most part, Freddie and Fannie were only _permitted_ to buy 'traditional' loans, i.e., good credit rating, employment verified, somewhere between 5 and 20% down. They didn't get involved in "ninja" (no income, no job, no assets) loans, or any of the other worst excesses of the subprime crisis.

The 'blame freddie/fannie' meme is promoted by people who oppose government-sponsored entities for ideological reasons. Now, there's a range of opinions on whether or not GSEs are a good idea, but they were not the biggest problem, nor were they remotely the cause of subprime. They were at worst, just following the crowd, not leading.

The Urban Survivalist said...

When did I say that raising the minimum wage is a job killer? In my area you can't even find a job that pays minimum wage. Unfortunately, there are other parts of the country where minimum wage is a lot of money to pay someone. Having a minimum wage in those areas stifles economic growth. Either way it's inflationary. If you don't think that giving EVERYONE more money to spend raises prices for everyone then you haven't been paying attention to prices when you walk into Wal-Mart over the last several years.

I also mentioned the "tax credits" and the future stimulus packages that are coming in the near future. Bush is as much to blame as anyone for this since he got the ball rolling with that first stimulus check. Obama wants to take the idea and run with it (*cough* failed Bush policies *cough*). You can't force the lower class up into the middle class by giving the lower class free money.

You absolutely cannot give Fannie and Freddie a pass on all of this. They were backed by the government. Once banks learned that they could make these bad loans and then sell them to Fannie and Freddie it was kind of hard for them to pass up the deal.

The moral of the story? When the government steps in and gives people free money or encourages people with money to make bad loans by backing them it ruins the free market.

Anonymous said...

I don't get the complaining about the economy. If you don't like capitalism, and the adjustments necessary to keep it alive, then move to North Korea.

Survival Spot said...

Wow anonymous, this isn't capitalism. When a government restricts trade and puts heavy regulation it becomes fascism. In a free market economy we wouldn't have gotten to this point. The government didn't just allow the sub-prime lending they strongly encouraged it.

A bank would not have taken on a risky lender because of greed, they are greedy enough to expect a good return on their money. They're not stupid.

Honestly I think we can expect major problems by 2012 but I think we are already in the midst of a recession that is leading to a depression (severe) within 1-2 years. Did anyone catch Celente? He's predicted many things correctly and is prediction food riots, societal turmoil and so on.

Valen said...

Where is this massive inflation occurring? No offense but you saying it is occurring is not exactly conclusive. The food stamp / government aid can be an indicator. But I would say that a number of those folks have no interest in looking for a job. Also keep in mind a number of those people do indeed have jobs but still qualify for these programs thus they are not unemployed. Same as it has been for years. Nothing new about that. Well the dollar is worth about 2% what it was hudred years ago and pay day loans online are sooo popular. I’d say that’s pretty massive. But that’s not what we’re talking about. I’ll bookmark this thread and come back to it this summer, or maybe the next, and we’ll see what happens.

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