“Money is better than poverty, if only for financial reasons.” (Woody Allen)
By now it should be clear to all but the craziest of optimists that we are in a recession, at least in US. What is not clear, however, is the severity of this recession and if this will turn into a depression. A technical recession is defined as the economic decline in two or more consecutive quarters. This means that the real economy instead of growing, contracts. This economic decline may involve a general decline in employment, investment and corporate profits. Recessions can be accompanies by inflation or deflation.
Sometimes when people are uncertain about their economic security, they tend to save, or at least moderate their spending. When the consumers, that are you and I, refuse to spend money, demand falls below the supply putting a downward pressure on the prices. This is called deflation. As an example one can think of housing prices. Today the demand for housing has suddenly dried-up, putting sever pressure on supply side (sellers) resulting in a marked reduction in prices (US, UK, Norway, Sweden, Etc).
Now if millions of people lose their jobs or think that they are going to lose their jobs and reduce their spending, the resulting decline in prices becomes circular. This means that as prices fall, so do the corporate profits which result in laying-off more people which results in more unemployment and insecurity which reduces consumer spending. This downward spiral if goes unchecked results in a depression. The depression of 1920s was deflationary.
One of the most recent deflationary recessions occurred in Japan. Japan's recession, which started in early 1990s (US and others also experienced the same recession), continued into the 2000s, with deflation being the main problem. Once deflation got hold of Japan it didn’t let go until 2005. By 2005 the yen had 103% of its 2000 buying power. Funny thing about borrowing money in deflationary periods is that it doesn’t pay to borrow money, even at 2 percent interest rate; since the asset that one is buying with the borrowed money keeps depreciating in real value.
Other times, a recession can occur for a short period of time followed by very low economic growth and high inflation. This combination of mediocre growth and inflation is called stagflation (stagnation plus inflation). Stagflation was a major problem around the world, especially in Europe in the 1970s. In general during this period the countries suffered low economic growth, high inflation and high unemployment. Stagflation can occur because of several factors such as unfavourable supply shock such as an increase in the price of oil in an oil importing country (as it is today), which tends to raise prices while slowing the economy by making production less profitable. Also both stagnation (recession) and inflation can be caused by inappropriate macroeconomic policies. For example, central banks can cause inflation by permitting excessive growth of the money supply, and the government can cause stagnation by excessive regulation of goods markets and labour markets.
What is coming?
So what should we expect? In general a recession, especially a severe one is deflationary in nature. But if the government tries to stop the recession or severity of it by pumping money into the economy, especially the money that is not backed by anything and depreciating in value (internationally), it increases inflation which will lead to stagflation. Many economies, the US economy included, today are especially susceptible to this problem. The problems facing these economies are twofold: one is the general macroeconomic policies of the governments and the other is the declining supply of vital commodities.
The government policies in many countries such as US, UK, Australia and others have been pro-business and pro-wealthy for a very long time; especially in the past 50 years. But in the past three decades these policies have been pushed to the extremes, culminating in the latest tax cuts to the rich while continually reducing the services to the less wealthy and the poor. This concentration of the wealth, in itself should have been a major concern for the economists and the governments since it increased the ability of the rich to accept and take bigger risks while at the same time reducing the ability of the less wealthy to cope with the consequences.
Economic bubbles always start with some rich people seeing an opportunity to make a quick profit. The speed by which the profit is made encourages the continuation of that activity. More importantly, other rich people join in. After a while, the rest of the population catch-on and want a piece of the pie. But by this time, the bubble is fully blown and is about to burst. Just when the average Mr. Smith thinks that he has discovered the sure way of beating the system, the bubble bursts. By this time the real wealthy have taken their money and left, leaving the majority of the population and the government to clean-up the mess. Cleaning will take time, sweat and tears.
OK, we are going into a recession, so what should we do as individuals?
The first thing that you should realise is that the world’s population is increasing while natural resources are either static or decreasing. For thousands of years human population was either static or increased very slowly. As a matter of fact this growth was so slow that the human population did not reach the 1 billion mark until ca 200 years ago. But suddenly it began to increase almost exponentially. In a relatively short time, 123 years, the population doubled to 2 billion. In the following decades this accelerated growth continued, so much so that it took only 33 years for the number to reach 3 billion (1960), and only 15 years (mid 1970s) to reach 4 billion. Today (2007) we have crossed the 6 billion mark, and if the current trend continues, by mid-century we will be close to 10 billion people.
While the population is growing rapidly the main source of our energy (i.e. oil reserves) is depleting fast. In addition we are running out of fresh water. Fresh water reserves are being depleted much faster than they are being replenished. Water, energy and land are the main ingredients of our food production. A few years ago the world’s total irrigated agricultural land began to shrink. If you combine the effects of the increasing population, diminishing water, food and energy, you’ll get the indication of how things will develop. In the long-term inflation is a given.
Ok. We now know where we are at and where we are heading; so how can I take advantage of this knowledge.
Things to remember
Before one can talk about investment opportunities, one should bring one’s economic situation under control. To start with get rid of your credit card debts. Credit card companies (including banks that support them) are the worst shylocks that ever existed. They entice you to spend the money that you don’t have and then charge you unbelievable interest rates. So minimise your exposure there.