What Worries Me about the Economy

I do not have to tell you that the financial markets have been confusing these days. It has been chaotic as the world deals with a financial crisis. With everything that is going on, there is one thing that worries me the most about the economy, and it is the one thing that nobody is talking about. So in this video we are going to talk about the one major thing that is driving the current financial crisis: debt. And I am going to finish with some recommendations of things that we can do to address this crisis. WATCH NOW!

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VIDEO SUMMARY

When you are in the middle of a financial crisis, like we all are right now, it is difficult to understand what is going on, and even harder to predict the future. In situations like these, I find it helpful to go back to economic fundamentals. If you go back to the fundamental principles that drive economic activity, it can help put the current crisis in context.

The main concept I want to highlight in this video is that all recessions are about debt. Every single one. When I talk about debt, I am referring to all kinds of debt: individual debt, corporate debt, and national debt. Now it is true that different specific events cause each recession, but those events are just catalysts that start an economic collapse. But what is really causing the economic activity is defaults on debt.

Here is a list of recessions from recent history. We can go through each one of these, and you should quickly understand what I am saying. Sept 11 was the event that started the crash, but defaults on debt caused the recession. The dot com bubble started the crash, but defaults on debt caused the recession. The same thing with the Russian Currency Crisis, the Great Recession, all of these, there was too much debt, which led to defaults, which led to bankruptcies, which impacted the economy.

This is a normal part of the business cycle of recession and expansion. I think a better name for this process is the debt cycle. Here is a diagram of the Dow from the Great Recession in 2008 to the current crisis in 2020. We have experienced a decade of economic expansion, and are currently in a contraction.

The debt cycle starts at the base of a recession, and ends at the peak before the next recession. And you can split this period of time into three phases: conservative, normal, aggressive.

This approach makes sense from a human perspective. When you go through the hardship of a market crash, you are going to be more conservative with your money. The period of time directly after the crash, people are not going to take on huge amounts of debt. Then as time goes on, and the economy regains steam, people get more confidence. In this normal period, lending activities return to normal levels. And then we get to a more aggressive period. People become more confident. The economy is expanding rapidly, and people take on larger amounts of debt. In fact, you are encouraged to do so. Because if you are in business, and your competitor is taking on more debt and expanding their business, and you do not do the same, your competition is going to wipe you out.

It is in this aggressive period when people are taking on too much debt when recessions happen. These recessions happen about every ten years. The time period is important, because if you declared bankruptcy in the last recession, ten years later, that bankruptcy would be completely off your record after ten years.

Just to be clear, debt is good. Debt allows people to purchase homes, cars, and get an education. Debt allows businesses to build new factories and create new jobs. Without debt, you would have to wait a lifetime to accumulate the cash to purchase those things. The problem occurs, as with everything in life, that debt is only good in moderation. And during the aggressive phase of the debt cycle, there are some people who are not using debt in moderation.

What does it mean to use debt in moderation? This deals with how debt is structured. All debt is based on a prediction of the future. Let us use the example of a home loan. If you go out and buy a house, you are going to look at how much money you make each month. You will then decide how much of your monthly income, you can use for your mortgage payment. Based on that decision you will take out a loan and buy a house. That is a prediction of the future. You are predicting for the next 30 years, that your monthly income will remain at the same level or increase, so that you can make these monthly payments. If you suddenly lose your job, or have medical issues, your prediction of the future was wrong, and you will not be able to make your monthly debt payments. So any debt you take out, is a legal financial contract based on your prediction of the future. There are always two parts to debt: your productivity and the debt payments. A moderate approach would be to base your predictions of the future on a reasonable upside and downside to your future income.

So this is what is happening during the aggressive phase of the debt cycle. People are making bad predictions of the future. They are predicting too rosy of an outcome, and taking on too much debt. Then when some event makes those future predictions to be incorrect, it is the defaults on debt and bankruptcies that really cause the recession. This happens over and over again in the business cycle which is why we continue to see periods of boom and bust.

Right now, we just experienced a massive market crash and a substantial rebound. Everyone is trying to figure out what is going on. All kinds of financial markets are acting in strange and volatile ways. The US has issued $3T in stimulus, and all of it is new debt. The goal of the stimulus was to keep businesses afloat and push money into the economy.

A lot of people have praised the Fed’s action to print new money, because it has resulted in keeping the economy going. I think the Fed’s intention here was to just postpone the financial crisis, so we would not have to deal with two crisis at the same time. We could focus on dealing with the medical crisis first, and get an understanding of what was happening. Now that we are on a path to a vaccine, it will be easier to tackle the impending financial crisis. So the Fed’s actions have been successful in postponing a financial crisis.

And this brings me to my greatest worry about the economy. The current debt crisis has not been resolved. Everyone is so enamored that the market rebound, that no one is talking about the impending debt problem. Before the recession, all kinds of debt was at record highs. Credit card debt, student loan debt, home mortgage debt, car loan debt, corporate debt. A lot of the American population has been out of work for a long time, and any debt they were holding was probably not based on a prediction of the future that included that loss of income. There are companies that are operating at a loss that are only still in business because of temporary Federal money. There is a huge debt problem in this country that has never been resolved. You cannot solve a debt problem with more debt. The only thing the Fed actions have done is postpone the inevitable.

All of that aggressive debt must be paid or end up in default. Companies that default on their debt end up in bankruptcy. The latest bankruptcy this last week was the major rental car company, Hertz. Hertz is the first major casualty from the travel industry that has been hit hard. 16,000 employees (25% of the workforce) lost their job. That is not surprising because air travel has almost completely disappeared. Hertz’ biggest debts are going to be all the car loans for their vehicles. They cannot pay their debt if no one is traveling and renting cars. If Hertz cannot pay their loans, that impacts the car manufacturers, and the banks. There are more bankruptcies to come, which will impact financial markets and unemployment.

What the Fed has done is postponed all these bankruptcies, but they are coming. All these Federal programs are scheduled to end in June and July. At some point difficult decisions are going to have to be made. You can only postpone this for so long, because you cannot solve a debt problem with more debt.

You might be asking at this point, “What do we do then? Isn’t this an impossible situation?” There is a solution. If you remember the example before, there are always two parts to debt. Productivity and the debt payment. The Fed’s actions have been completely focused on the debt payment. Instead, we can change to focus on productivity. The solution to any debt crisis is to work your way out of it. Congress has been passing stimulus focused on sending people checks, and keeping companies with debt issues afloat. Instead of using that stimulus money to prop up company’s bad debt, why don’t we use that money to give people jobs. We know that bankruptcies are coming and more people will lose their jobs. Let us have new jobs waiting for them, because as long as American’s have jobs, they can work their way out of any mess.

I will give you a perfect example of what I am talking about. The commercial space industry. This is an industry that the US has a competitive advantage in. The US is ahead of any country in the world. In fact, a historic rocket launch is happening next week. SpaceX is launching the first US astronauts into space from US soil in a decade. The commercial space industry is a sector where the US can win. Why are we not taking this stimulus and funding infrastructure and building spaceports across the country to grow this industry. Why are we not taking the stimulus money and increasing NASA’s budget by 10 times? This would create many good aerospace jobs, most of which can work from home as we continue to deal with the medical crisis.

My message here is that 1) there is a solution by working our way out of the debt crisis 2) there is a choice between propping up the debt of failed companies and investing in economic development to grow new jobs.

I do not want to sugar coat this message. No solution is going to be easy. It is going to be painful. Companies will go bankrupt. People will lose their jobs. But we have been through this before, and we will make it through this again. This is simply the end of a debt cycle and the beginning of a new one.

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Neither Zach De Gregorio or Wolves and Finance shall be liable for any damages related to information in this video. It is recommended you contact a CPA in your area for business advice.