Has your grandparent ever told about the good old days when you could buy a gallon of gas for a quarter? A good meal at a restaurant was $2.00. Do you wonder where those prices went? Inflation.
Inflation is the systematic devaluation of currency due to an increase in supply or decrease in demand for that currency. While the average price of a new house was $8450 in 1950, the average income of an American was $3210. Prices might have been lower, but incomes were lower as well.
Each year, our money becomes worth a little less. Some years, it becomes worth a lot less. This is caused by a chain of events linking to a nation’s central bank, such as The Federal Reserve or European Central Bank, and government policies.
Monetary and Fiscal Policy
The Federal Government in the United States is responsible for the country’s fiscal policy. Fiscal policy includes any type of government spending and economic intervention. The recent stimulus packages, bank bailouts, and budgets are all examples of fiscal policy. Government debt is also included in fiscal policy.
Any type of decision regarding the flow of money in the economy is called monetary policy. When the Federal Reserve sets the target interest rate or decides how much cash to print and circulate into the economy, that is part of the government’s monetary policy.
Government Actions Leading to Inflation
Today, the national debt of the United States is a little of $13 trillion dollars. See the Debt Clock for a real time snapshot. The government has to pay off the debt somehow, and the easiest, though least responsible, way to do that is through a devaluation of the dollar. If the Federal Reserve printed out $13 trillion one dollar bills, we could pay off the debt instantly. However, there are big ramifications.
The best example of this can be seen by looking at the price of a retail item. Let’s say a loaf of bread is worth $1.00 today. Let’s also assume that there are $10 trillion dollars out in the economy (this is really, really low). If the government were to print $10 trillion new dollars, everything in the economy would have the same value, but the dollar would be worth less. Because there were $10 trillion and now there are $20 trillion, the price of everything in the economy would double in dollar terms. That $1.00 loaf of bread will now cost about $2.00. In other words, each dollar would now be worth $.50 in terms of old dollars.
Currency Crisis in History
If you follow economic news, you have surely heard of the Asian Currency Crisis or the Argentine Economic Crisis. In the Argentina crisis, which took place from 1999-2002, the government issued so much debt that it could not afford to pay anymore. This is like someone defaulting on a mortgage, credit card, and car loan all at once, but on a national scale.
Because Argentina controls its own currency, it could just print money to fix its financial situation. However, there were both short and long term impacts of printing money. In 1989, annual inflation in Argentina reached 5,000%. That would mean that a $1.00 loaf of bread would cost $50 at the end of the year.
National Impact
Inflation is healthy for economic growth. It is a symptom of people getting annual raises, home prices increasing, gas prices rising, food costs growing, and business revenue growing. We all like to earn more money, but inflation is a result of that.
When inflation is out of control, it is horrible for economic growth. In 1984, Israel was in an inflation crisis. In that time, people did not save any money for retirement. They would not put money in the bank. They would cash their check immediately and go buy staples at the store immediately. At over 300% inflation in some months, the price of bread could literally double overnight.
International Impact
Doing business or traveling outside of the country becomes very expensive when your currency is dramatically losing value. In the first example above, your US Dollar might be worth one Euro today and one half of a Euro later. That makes traveling in the Eurozone expensive. That impact would be felt with every single currency in the world that does not peg to the dollar directly.
A farmer selling its product outside of the Untied States or a manufacturing company that exports its product would both be devastated by this inflation. Income levels in terms of local currency would drop dramatically. However, holding a foreign currency could protect them from losses.
What Does This Mean To You?
First off, don’t panic. If you live in the United States or Canada, you are pretty safe from a dramatic inflation crisis. In the US, we will likely see continued low level inflation for many years to come, with a slight increase when the government makes moves to pay off national debt more aggressively.
If you live in the Eurozone, you have a bit more to worry about. With Greece on the brink of bankruptcy, other countries, such as Germany, are helping pay for Greek debt. As currency supply and debt levels increase, the value of the currency will decrease. However, I don’t think any Western nation has to worry as much as Zimbabwe, which released a 100 trillion dollar bill in 2009 (see picture above).
I am sure I confused a lot of people with this lengthy look at inflation, so I am happy to answer any questions in the comments.
On March 30, President Obama signed a new law that redefines the roles of much of the student loan industry. The law appears to be better for the government and better for those taking out student loans. Big banks are going to take a hit, however.
In the old world, students (or parents) would apply for the student loan through a major bank approved for student lending. When I needed to apply, I found the best long term deal applying through Citi Group. In exchange for processing and lending, the government subsidized the bank to keep rates fixed at 6.8% with no application or origination fees.
The savings for the US Government will be about $68 billion over the next ten years. Some of the savings will go to increase subsidized Pell Grants, for student demonstrating financial needs, and other scholarship programs.
For existing loan holders, it doesn’t look like you will see any major changes. I am expecting to keep paying my loans as usual, which means new servicers every year or so that screw up my account and take over a month to fix it.
For anyone with a new student loan starting in July, 2014, there are some great new provisions. Student loan payments will be capped at 10% of annual income above a defined living allowance, where it was 15% before. If you make regular payments at that rate for 20 years, your loans will be forgiven, rather than 25 years under the old law. The forgiveness period is still ten years for certain government employees, teachers, health care workers, and the military.
If you are reading this, it is probably to late for the new laws to effect you directly, but your kids might have a much easier time dealing with student debt than you.
Ramit at I Will Teach You To Be Rich just published an interesting post with a quiz that can tell if you have a basic grasp on financial literacy.
1. Suppose you had $100 in a savings account and the interest rate was 2 percent per year. After 5 years, how much do you think you would have in the account if you left the money to grow?
a. More than $102
b. Exactly $102
c. Less than $102
d. Do not know
2. Imagine that the interest rate on your savings account was 1 percent per year and inflation was 2 percent per year. After 1 year, would you be able to buy more than, exactly the same as, or less than today with the money in this account?
a. More than today
b. Exactly the same as today
c. Less than today
d. Do not know
3. Do you think that the following statement is true or false? “Buying a single company stock usually provides a safer return than a stock mutual fund.”
a. True
b. False
c. Do not know
You have to visit Ramit for the answers and the rest of the post. Let me know how you did in the comments. I suspect most people who take the time to read a finance blog know the answers, but you never know. If I have failed you, let me know what I need to write about.
As I have disclosed in the past, I am a proud shareholder of Berkshire Hathaway. I have sold 40 shares since the 50 to 1 split, and I have 10 class B shares currently. I am a big fan of Warren Buffett. I like his style. One of my dreams has always been to see him in person.
Fortunately for me, one of the perks of owning stock in a company is an invitation to its annual meeting. Berkshire Hathaway is headquartered in Omaha, Nebraska, and has been holding an annual meeting there every spring for decades.
Not one to pass up on an opportunity to live out one of my dreams in life, I took Berkshire up on the offer, and I have two passes for the meeting, on May 1st, 2010, at the Qwest Center in Omaha. I talked a buddy into driving out there with me, and we plan to spend two nights in one of the biggest cities of America’s heartland.
Attending a shareholder meeting is not everyone’s idea of a good time, but having an opportunity to listen to Mr. Buffett, and his associate Charlie Munger, speak about the future of the company sounds like a blast to me. Berkshire owns a large number of businesses, and many of them are located around Omaha. Almost every business will be on hand to sell their wares, and the company is supplying shuttles to take you to places like the Nebraska Furniture Mart and Borsheim’s jewelry store.
If any readers are going to be in Omaha for the meeting, I would love to meet up at some point for a cup of coffee. If you are not going to be there, don’t worry. You will get a full report when I get back.
I just watched a funny segment on how little people know about finance from the Jay Leno Show (hat tip to Fabulously Broke). I thought I had better pass this on to Narrow Bridge readers. Please don’t tell me in the comments if one of my readers is featured here. I hope I did better than this.
On a side note, thanks to the lovely Fabulously Broke for including Narrow Bridge in the Carnival of Personal Finance.
It is nearing census season here in the United States. Every decade, the United States government puts together a report with details about every single person in the country. This includes citizens, legal residents, and illegal residents. The government then puts together population demographic and trending reports that tell you everything you could imagine about people living in the US. You can see these reports at census.gov.
Other countries have similar systems. In the UK, government projections show that the population in England will rise from about 51 million today to over 60 million in 2031. In the US, the population grew 8% between 2000 and 2008. That is over 22 million people. The 2010 census is projected to show continued population growth.
What does that mean to us? The average person will need a place to live. More people means more houses are needed. The simple “what it means” is that houses will have to be build, mortgages will be needed, and banks will make loans.
However, there is another segment where people stand to benefit. Not all people live in a single family house or a condo. Many Americans rent. In Minnesota, 75% of homes are owner occupied, leaving 25% as renters. In New York, on the other hand, only 55% of homes are owner occupied.
Jobless rates today are impacting those numbers. Many of the bad mortgages in the last year or so have been in owner occupied situations. People have to give up their home ownership and move into a rental. Property developers and investors have the opportunity to profit from this situation by owning rental properties with an increasing demand.
It is also important, though, to look at an often forgotten group of people. 3.5 million people in the United States, about 1% of the population, experiences homelessness at some point in any given year. Be sure to remember those in need even in tough times. If the economy is treating you bad, imagine how some people are doing. If you are able, support a local homelessness charity like the Colorado Coalition for the Homeless in my neck of the wood. Everyone deserves a home.
The rate of bankruptcies is still increasing, but the rate is slowing down. A British PriceWaterhouseCoopers study found that the rate of bankruptcies and Individual Voluntary Agreements is still increasing, but the rate of increase is leveling off. The cumulative rate for year to date is still lower than the comparable period from 2006 and 2007.
The UK has a program called IVAs (Individual Voluntary Agreements) that allows individuals to negotiate payment terms to avoid a full on bankruptcy. Debt Free Direct describes the IVA process:
The IVA or Individual Voluntary Arrangement was introduced in 1986 as an essential piece of legislation which allows you to avoid the trauma of declaring bankruptcy. It suits many people who are over £50,000 in debt, provided that they are in regular employment.
An IVA is a legally binding agreement which protects you against any further action from your creditors. Once you’ve committed to an IVA, you could become debt-free in sixty months.
With an IVA you agree with your creditors to paying only what you can afford in a single payment each month over the period of five years. Your creditors agree to write off your debt which you’re not able to repay and they will leave you alone.
IVAs are a good alternative to bankruptcy for UK citizens that have found themselves in a big pile of debt. While I have little sympathy, as they got there through their own actions, it is a much better option than calling it quits and declaring bankruptcy.
The United States does not have a similar system to IVAs, but you can negotiate with creditors and work with credit assistance companies (non-profits) to consolidate and eliminate debt. The goal here is not to just wipe your slate clean, but to help you clear out the problem yourself. Remember, a settlement or write off is terrible on your credit report, though not as bad as a bankruptcy.
The banks would rather recoup some money than no money. A settlement happens when a bank negotiates with a customer to take a lower amount of debt to collect something rather than risking a complete non-payment. Again, I have little sympathy here. People buy things themselves, the bank does not force you to. The bank only gave you the credit card, you make the choice on how to use it.
The best way to avoid insovency, bankruptcy, and mounting debt problems: spend less than you earn. It is that simple. Yeah, there are lots of excuses for why things went bad, but those always come back to the person who spent the money. Don’t be that guy. I know it is an “ugly truth,” but it is a truth.
Most people who read this blog don’t have this type of problem. Good for you. If you do, however, man up and deal with it. There is always a way to figure things out.
While we are still in a recession, the recession seems to be getting less bad. As a Wall Street fund manager told me today, it might go down in history as “the great recession.” As we all know, this recession has pushed down housing prices around the world. It looks like the worst might be behind us.
In May, UK housing prices increased by 1.2%. Housing prices are an indicator that the economy may be recovering. Housing is a major piece of a very large economic puzzle. Along with factors such as employment, consumer spending, inflation, manufacturing inventories, and the stock market, housing is a key factor in looking at economic health in the United States and abroad.
Housing purchases are a major indicator, and that rate drives housing prices. When people were afraid of losing jobs and income, home purchases fell. As people are becoming more confident that their income will remain constant in the future. That means that they are willing to spend more on homes and other goods and services.
While I highly recommend you all keep on saving, it is best for the economy if people spend. Spending moves money into businesses that moves on to create profits and job opportunities. That leads to more spending. The cycle will continue to grow when consumers are confident.
How does this impact you? When the economy is bad, stock prices and home prices go down. Interest rates are also at historic lows. When the markets are depressed, it is a good time for you to make investments. If houses are at the bottom, it is a good time to buy a home (to live in or invest depending on your own financial situation). Remember the mantra: buy low, sell high.
Hopefully things will start to turn up. In the global economy, housing recovery in the United Kingdom may be tied closely to housing in the US and the rest of the developed world. What do you think will happen next? Is the worst behind us or are we just at a hump in a longer downturn?
Employment numbers are proving to be as shaky as the economy. In some places and sectors, employment numbers are starting to level out, or at least not fall so quickly. In other places, the numbers are still looking bleak.
In the US, total employment has been down for 18 consecutive months. The most recent numbers indicated that 467,000 jobs were lost in June. That is not encouraging, though the number of jobs lost has been decreasing almost every month since December, 2008. The number of mass layoffs has also been on the decline since the beginning of 2009.
All of this talk about how bad the economy is can be really depressing, so it is a good idea to think about the positives. Many of us still have jobs. If you are out of work, this might be a good opportunity to continue with that college degree you always wanted.
If you are unemployed, this might be the time to turn your hobby into an income source. It might be a good chance to give that entrepreneurial idea a go, though don’t throw your entire savings into it. If you are out of work, but an expert in a highly skilled field, you might be able to find contract work as a consultant. You might be able to self teach web design or graphic arts and find freelance projects. If you enjoy writing, you can start a blog for income or do freelance writing gigs.
The point of this is to remind you all that, even if it feels like it, this is not the end of the world. The economy always turns around. You are smart and will recover. Be resourceful. Enjoy the vacation.
Some things to remember when you are unemployed, though, that could get you into trouble later on:
Do not, under any circumstances, take money out of your retirement accounts to fund your current needs. You will have to pay severe taxes and penalties on the funds you withdrawal.
Enjoy the vacation from work, but do not live like you are on vacation if you can’t afford it. Make sure your savings stretch as far as possible until you find a new income source.
Don’t freak out. Everything will be okay in the end.
The number of mortgages in foreclosure, or mortgage possessions, seem to have hit their peak. While foreclosures are still a problem, they are slowly turning around and fewer homes are being taken over by banks.
The perception of foreclosures is still high. That is because several states are still experiencing high foreclosure rates. Florida and California, for example, are still experiencing a large impact from foreclosures. Nevada is in the worst shape in the United States.
On the other hand, most states have begun to recover. This map, which references March, 2009 data, shows that most states have leveled out or turned around. Things are starting to look up.
This has a large impact to the overall economy. The recent recession was triggered by a spike in foreclosures, which led to bank failures, which also impacted investors and funds that bought into mortgage backed securities, which led to a sell off and stock market decline, which led to consumer spending fears, which led to the economy getting worse. I could go on, it is a big cycle of bad events. You get the idea.
Today, however, things are getting better. The stock market is up. Investing is on the rise. Spending is up. (But not by Narrow Bridge readers, right?) Companies are doing better. Profits are returning. Foreclosures are no longer on the rise.
This has been seen internationally as well. In the UK, for example, first quarter 2009 possessions were down 42% from the same time the prior year. It seems that the world is not going to end after all.
