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Posts Tagged ‘economic collapse’

The Crushing Power of Debt

If you’re like me and a lot of other people, you’re a little concerned with the ever-increasing government debt.  According to the most recent estimates, the U.S. Government will rack up a record-breaking $1.6 trillion deficit this year.  This doesn’t include the billions of dollars of current deficits and $2.4 trillion of debt by our state and local governments. 

I would encourage you to read this Washington Post article.  It analyzes the current debt levels with those in 1946, immediately following World War II.  Keep in mind that the Washington Post doesn’t have a reputation as a conservative news organization.  In my opinion, it’s significant that people from both ends of the political spectrum are sounding the alarm about the national debt.

I particularly liked the quote by Robert D. Reischauer, former director of the nonpartisan Congressional Budget Office.  He said that the debt accumulated by 1946 “was for a very different purpose, which was to preserve freedom and democracy versus totalitarianism rather than to throw a huge party and put it on the credit card.”  Like every other party, the celebration eventually ends and someone has to clean up the mess, which I think is a good description of our current times.

I’m not a pessimist or an alarmist, but I do agree with the general premise of the article – there are tough times ahead. I believe the economy is incredibly resilient, and I don’t think an economic apocalypse is on the near horizon. However, I do believe that it’s possible.  Call me crazy, but I know that we can’t continue overspending at the current rate without severe consequences.

You only need to look at the devastating effects of the recent mortgage crisis to realize the power debt has to inflict financial and personal ruin.  You may believe people are suffering from the consequences of their poor decisions, and you may be right.  However, a lot of innocent people have also suffered, through no fault of their own.

If you’re a student of history, you know that the fall of mighty and powerful nations can have far-reaching impact.  The fall of the Roman Empire was followed by the Dark Ages.  The Great Depression may have been born in the U.S. but soon affected people worldwide.  The economy is much more globally intertwined than ever.  Although the mortgage meltdown was primarily triggered by the collapse of the U.S. housing market, investors all over the globe lost billions.  As the largest economic engine in the world, the U.S. economy and government have tentacles that reach into the lives of people worldwide.  The faltering of the U.S. economy and government will have a global effect.

You may believe it would be a good thing if America lost some of its dominance in the world, and that may happen.  However, if history repeats itself, which it often does, the process of transition may not be very pleasant.

The overall economic recovery that has occurred over the past 18 months has been a mixed blessing.  The good news is that it proves the resiliency of the economy.  The bad news is that it can give us a false sense of security that we as a nation are invincible and too big to fail as well.  As strong as our economy and government may be, debt has the power to crush them both.  It’s not inevitable that it will occur, but if we don’t’ change course soon, it might.  If debt has the power to crush you, it can also crush our nation.

U.S. Credit Rating at Risk

If you’re concerned about the long-term ramifications of the growing federal debt, you’re not alone.   Two major credit ratings agencies, Moody’s Investors Services (Moody’s) and Standard & Poor’s (S&P), issued a warning to investors about the possible future downgrade in the credit rating of the U.S. Government.

 Moody’s report issued this week stated that the U.S. Government “must reverse the expansion if its debt if it hopes to keep its ‘Aaa’ rating.”  Separately, the head of S&P France said that “the firm could not rule out lowering the outlook for the U.S. rating in the future.”

A downgrade in the rating is not imminent, but these statements can be seen as a warning signal to investors. 

Credit rating agencies are supposed to provide an independent and objective opinion of the creditworthiness of publically-traded debts.  The credit rating impacts the interest rate and the value of the bonds when they are traded on the secondary market.

The following are a few of the factors contributing to the forewarnings by Moody’s and S&P.

  • The rapid and continued growth in the federal debt over the past 4 years
  • Rumblings in Congress over the reluctance to increase the debt ceiling
  • Sovereign debt issues roiling Western European countries and the Eurozone
  • The recent backlash to Moody’s and S&P for giving high credit ratings to mortgage-backed securities that turned out to be the equivalent of junk-bonds

Moody’s and S&P may have their own selfish motivations for these advanced warnings, but it’s a message to be heeded.  There were early warning signs that the housing market was in trouble, but most people brushed them aside.  Likewise, there are warning signs that the size and growth of the federal debt poses serious financial threat to us that you should not ignore.  The recent comments by Moody’s and S&P are one of those signs.

So… what does this mean to you? Probably not much at the moment.  However, the long-term consequence may be significant.

A downgrade in the credit rating of U.S. Treasury securities would likely cause an increase in the interest rate on future debt issues. Increasing interest payments will further exacerbate the current budget crisis.  Since more money is required to pay interest on the debt, less money is available for other spending, thereby further increasing the deficit or causing larger spending cuts.

A downgrade in the credit rating would also impact what it costs you to borrow money.  Virtually every loan in the U.S. in directly or indirectly tied to Treasury rates.  Be it credit cards, auto loans, home mortgages or business loans, you can expect the cost of borrowing to increase for any type of credit you obtain.

Moody’s and S&P may have intended their statements to be a “heads-up” to investors, but the audience is much larger.  Hopefully it’s a message our political leaders will heed regarding our current fiscal situation.  It’s also a message to you as an individual.  You may not be able to control what happens in Washington, but beware and be prepared.  A future downgrade in the U.S. credit rating may be coming, and if it happens, it’s going to cost you.

The Unemployment Rate: An Economic Indicator

 The unemployment rate is probably one of the most frequently talked-about economic statistic of 2010.  Despite all of the discussion and efforts to put people back to work, the rate has hovered between 9.5-10.0% all year.  What can you interpret from the unemployment rate?

Bottom line:  If you’re unemployed and looking for a job, any number is too high.  

Aside from that, the rate means little by itself, but it can be useful in understanding the economic conditions when the rate is increasing or decreasing; the percentage change; and assessing the general sentiment of economic conditions.

Did you know that the unemployment rate is only an estimate?  The rate is calculated from two monthly surveys.  One is a survey of 60,000 households seeking employment information about the inhabitants.  The other is a payroll survey of 140,000 employers, who are required to report certain payroll information.  Statisticians will contend that survey samples of this magnitude are extremely reliable.  They may be correct, but it’s still only an estimate.

The process is even further complicated by adding the seasonally-adjusted factor.  What’s that?  It’s a statistical adjustment that is applied to the raw data to account for things like holidays, the effect of inclement weather or highly seasonal businesses (think beach and ski related industries).

The unemployment rate is often thought to be a leading economic indicator, but it’s not included in the Conference Board’s composite index of ten economic statistics.  Instead the Conference Board looks to the average manufacturing workweek and the number of initial jobless claims to determine the direction of the economy. 

Beyond the initial jobless claims, I believe that the number of jobs lost or created in a given period is a good indication of economic direction and health.  Adding jobs is a good sign, and job losses are troublesome.  Taking it a step further, you should look at the types of jobs being added or lost.

This secondary level of analysis led to a lot of discussion in the summer of 2010.  The unemployment rate dropped and the number of jobless claims declined, but it was primarily due to a substantial increase in temporary US census workers.  The rate has subsequently crept upward over the past three months, as those workers have been terminated. 

Public sector jobs are considered good jobs these days.  Base pay has increased to be more on par with the private sector, the benefits are usually quite generous, and there is generally better job security.   Government jobs may be good jobs, but they aren’t a sign of a robust or healthy economy.  An increase in full-time private sector jobs is an indication of economic growth and stability. Private sector job growth has been anemic over the past two years, which has led to a tepid outlook on the overall economy.

Changes to the unemployment rate make great news headlines and political fodder, but it’s probably not the best indicator of economic health or direction.  The number of jobs lost or created in the private sector is probably a much better measure of what’s currently happening in the economy, and what’s about to happen.

Currency & Commerce (The Value of Money – Part II)

One of the primary values of money is the facilitation of commerce.  A common currency is the medium of exchange which facilitates your ability to buy or sell something.   The buyer and seller know what they are giving up in value and what they are receiving in return.

What would you do if you didn’t have money or your money had no value?  You might try bartering for what you need.  Try that the next time you go to the store to buy groceries or stop at the gas station to fill up.  Imagine the look on the cashier’s face when you ask if you could pay with your watch or a sack of potatoes, rather than cash or your debit/credit card.

The current economic climate and concerns for the future have caused some people to suggest that you should stock up on gold and silver to preserve your ability to continue buying things in the event of a complete economic collapse.  Dave Ramsey is one prominent opponent to this idea.  His contention is that gold would be as useless as paper money because people would resort to bartering instead.

Without addressing the point of whether or not gold is a good investment.  I see his point. Even when gold was the principle form of money, it was still transformed into a common currency.  No one carried around bags of gold rocks or bullion. They used gold coins… minted into identical sizes and shapes representing specified values (just like our silver coins today).

At the same time, I don’t think that even in a complete economic collapse bartering would last long. It may occur for a short time following a major catastrophe or natural disaster, but our society is far too complex and advanced to function solely through bartering.  Most of us would be in deep trouble if we had to barter for our existence.  Urban society doesn’t lend itself to providing food yourself and most of our skills have a limited marketplace.  My family would be in trouble if I had to barter tax and accounting services with everyone necessary for us to live.

Gold, silver and other precious metals are commodities and may have a place in your portfolio as a hedge against inflation.   However, I don’t think it should be seen as a replacement currency to purchase goods and services.  Gold and silver coins might be easier to barter, but I doubt that they would become a replacement currency.  How would a merchant know what your gold coin is worth?  How would they know if it’s pure gold or just gold-plated?

In the event of a major economic catastrophe or collapse of the financial system, I would prefer to have a stash of cash in a safe deposit box than try to barter with gold and silver.  Hyperinflation may cause the cash to be worth less, but at least it’s a standard that everyone know how to value.

As long as we’re talking gold, the Value of Money – Part III will address the paper money and the gold standard.