3 Biggest Threats To The Economy
Think of the global economy as a big hot-air balloon.
Things were going along splendidly until August 6, 2007, when too much hot air—debt—caused a tear in the balloon. As the horrifying ripping sound spread, central banks of the world began pumping more and more of that hot air into the balloon in an attempt to keep it from crashing to the ground and causing a depression.
But it only made things worse, in the long run.
The same is happening again today. The central banks of the world are flooding the system with money, but it is not helping the poor and middle class because they cannot get loans for cars or houses. As the money supply blows up like a balloon, their access to that money shrinks.
Millions have lost much of what they spent their lives working for because they have no understanding of the new rules of money and how they affect our lives. And that is a systemic problem that can’t be solved by one charismatic politician.
Today as I write, there are three serious threats to the world economy. They are:
Threat #1: Interest Rates
Starting in the early 1980s, US interest rates started moving lower and lower and that’s because inflation also came down because the United States started buying things from low-cost countries like China. The trade with developing countries pushed down the US inflation rate. It drove down wages. It drove down the cost of goods that Wal-Mart sells.
At the time, US interest rates, on a government bond were nearly 15%. Now it’s .88%. As interest rates came down, it made borrowing more affordable for the Americans, so the Americans borrowed much more, and they spent much more. And that drove economic growth in America. Also, as interest rates came down, asset prices went up because it was cheaper to borrow money for buying real estate, and investing in the stock market. And so asset prices rose to extraordinary levels now because interest rates were low.
After 2008, the central banks of the world lowered interest rates to the lowest levels in recent history. The Central Banks needed people to borrow money. Cheap debt blew the world into massive assets bubbles. Stocks, bonds, real estate, and businesses became hot air balloons. Rising interest rates will bring these hot air balloons down.
Earlier, in March the Fed took the most dramatic steps since the 2008 financial crisis to bolster the U.S. economy in the face of the coronavirus crisis by cutting interest rates to zero with the purpose of keeping financial markets stable and borrowing costs as low as possible in hopes to prevent a recession.
In addition to rate cuts, the Fed announced it is restarting the crisis-era program of bond purchases known as “quantitative easing,” in which the central bank buys hundreds of billions of dollars in bonds to further push down rates and keep markets flowing freely. The Fed is also giving more generous loans to banks around the country so they can turn around and offer loans to small businesses and families in need of a lifeline.
Threat #2: China’s Economy
For decades China’s economy has been growing—export-led, and investment-driven growth. In 1990, China didn’t have a trade surplus with the US. It was a very poor developing country at that point. But now their trade surplus with the US was $370 billion. In other words, $1 billion a day and that export-driven growth has completely transformed China.
But now this model of export-led and investment-driven growth is hitting a brick wall. China’s become so large, and it exports so much, the whole global economy is simply not large enough to allow China to continue exporting more and more every year. The world is already saturated with Chinese goods. And that’s why there’s such a protectionist backlash all around the world against Chinese trade policy.
But China is in trouble. China may have the worst debt-to-GDP ratio of all major countries. China borrowed and loaned out more money than any other country. If China crashes the world crashes. China’s become so large, and it exports so much, the whole global economy is simply not large enough to allow China to continue exporting more and more every year. The world is already saturated with Chinese goods. And that’s why there’s such a protectionist backlash all around the world against Chinese trade policy.
China takes its $1 billion a day trade surplus with the US, and it uses about half of that money to buy commodities from the commodity-producing countries like Australia, Brazil, Indonesia, on and on. And it also uses that money to buy capital goods from Germany, Taiwan, South Korea, Japan. And it uses that money to buy luxury goods from France and Italy. And it also allows hundreds of thousands, millions of Chinese tourists to travel around the world, boosting the economies of countries like Thailand.
If that trade surplus goes away, then China’s not going to have the money to buy those things from the other countries, so all the countries suffer.
Threat #3: Strength of the Dollar
When President Trump lowered tax rates, especially for B-quadrant businesses, the United States became a tax haven. Billions poured into the U.S. economy, causing the U.S. dollar to grow stronger.
A strong dollar is not good for workers because U.S. products become more expensive, and jobs are lost if the demand for U.S. products drops. A strong U.S. dollar is not good for emerging countries that borrowed in U.S. dollars. A strong U.S. dollar means their currency becomes weaker. This makes it harder for these smaller countries and companies to pay off heir debt in U.S. dollars.
Also, when the dollar goes up, commodity prices go down. Food prices go down. Gold prices tend to go down. Oil prices go down. If you compare a chart of a commodity index with the dollar, they’re the mirror image of each other. Conversely, if the dollar goes up, commodities go down. If commodities go down, that’s going to damage the economies of all the commodity-producing countries. And as the commodity prices fall, then all of those economies tend to weaken, if not go into recession. And so their currencies also weaken. And as their currencies weaken, it makes it more difficult for all the companies in those countries to repay the dollar loans that they’ve taken out.
Find Your Insurance
Today millions of people have their fingers crossed, hoping the Dow starts climbing again. This is not investing. This is gambling. Betting your future on the ups and downs of any market is risky, very risky.
I was taught to diversify differently. I own assets in different asset classes, not just in paper assets. For example, I do invest in oil, but I do not invest in oil company stocks. I do invest in real estate. I love cash flow, infinite returns, and tax advantages, which is why I generally stay out of paper assets.
Bonds are paper assets. I do not invest in bonds. Rather I borrow the money that bonds create to buy apartment houses, especially when interest rates are low. When the Fed and central banks are printing money, I save gold and silver, not money. If the banks stop printing money, I will sell gold and silver and go back to cash.
Simply put, I diversify by owning percentages of the different asset classes. As Warren Buffett says, “Diversification is protection from ignorance.”
The question is, “From whose ignorance—yours, or the stockbroker and financial planners selling you the de-worsified portfolio?” Or your real estate broker who tells you your home is an asset and that real estate always goes up in value (capital gains)?
Editor, Rich Dad Poor Dad Daily