Business advice

How does the government mess with the economy?
December 28, 2008, 7:47 am
Filed under: Blogroll, Business Advice | Tags: , ,

We have all heard that our credit problems are because of the government. I don’t think so. Prior to the depression, the government’s attitude towards the economy (aggregate market), was to leave it alone. We all know the results.

Now we have a government that uses fiscal policy (public spending) to adjust the economy. If you have never heard of this, simply Google the term and you will get a brief definition. Previous to the government spending aspect, the only way governments could get money if they needed it was either taxation or seizure of private property.

Fiscal policy/government spending is a tool used by the Federal government. You know the government allocates a good portion of money every year to government contracts. If all this was left to the private sector, things would be worse than they are. Now, I am not saying that I endorse the way the government awards contracts. I’m just saying that they do.

They also have the right to either lower or raise taxes and institute new ones if they are able to get such a law through Congress.

The other side of this coin is monetary policy. Monetary policy refers to how the Federal Reserve’s use of interest rates and the money supply to guide economic growth.

The overall theory goes like this: once interest rates go down; there will be more activity in the aggregate. If interest rates are down it is a green light for borrowers to go ahead and apply for more loans. It also makes it easier for the lenders to get customers to sign on the bottom line. It is an encouraging sign for the stock market. If there is more borrowing, there will be more corporate expanding and an increase in products sold (GNP). When such announcements come out, they, the stock market, respond by having a day where there is more buying than selling.

The Fed has other tools by which to expand the money supply. An expanded money supply encourages growth. (In case you are wondering the definition of the money supply is so complex, it takes an economist to try and explain it. There is also controversy over which figure the Fed uses to make its decisions. Enough already.)

When the Fed feels there isn’t enough money in the money supply, they can lower the banks reserve ratio. All banks have a reserve ratio. The rest of the money they take in, they put out in loans to earn money. You really didn’t think they kept all that money right there all the time I hope. When they are allowed to loan out more, then there is more money in circulation.

Then there is the business of government securities. You have all heard of T-bills and other treasury bonds. The Fed has the right to buy and sell them. If they want more money in circulation, they issue a buy order. Customers with bonds they had been holding go to the nearest Federal Reserve Bank and sell their bonds. They are issued a check, which they are going to go and deposit in their bank. This money prior to this deposit never existed. There is, as we know, nothing to back it other than the full faith of the United States government. The bank, on receiving the seller’s deposit, only keeps its reserve requirement portion of the deposit. The rest is circulated to others who apply for loans. They then take the loan check and deposit in their personal bank. The same thing is repeated until that original check for the sale is exhausted. Now, that money is in circulation, less whatever the reserve ratio was for the individual banks.

As bad as things are in the current economy, if the government didn’t have the tools of monetary and fiscal policy, we would be a lot worse off and have fewer options. When things are bad, we always tend to blame the government. They are doing all they can to keep the wildfire that’s sniffing out our financial system from causing a complete collapse. As I said, the only thing that keeps the monetary system going period is that we have confidence in the United States government. Once that confidence is gone, everything will collapse and we will be looking at a situation that makes the depression of the 30s like child’s play.

The only thing we can do now is take care of our own personal finances and write to the legislators if we don’t like what they are doing at their end. Their adjusting the system is not what caused the mess we are in. We had a bunch of greedy corporate bigwigs who thought they could do what they want and we had a whole financial system that came very close to mirroring Enron.

If the government didn’t have the tools it did when those banks collapsed, we would be looking at a situation close to the end of the movie, “Rollover” in 1982. The whole economic system collapsed and there were worldwide riots.

The title of this article was me being factious. We better be glad that the government ‘can mess’ with the economy. This doesn’t mean that we shouldn’t be watching their actions. There is more on the horizon. We need to be dutiful watchers.

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The times; they are confusing
March 26, 2008, 6:57 pm
Filed under: businness advice | Tags: , ,

Prices are rising, credit is crunching and unemployment is rising. The Fed is dumping money into the system more vigorously than previous. We see nonstop headlines about rates cut and worries over cheap money. What’s it all mean? What’s it going to mean; and most important how is everyone going to cope?

There is no way to know all the answers. There are certain things that are different than previous economic crunches. Monies are being offered to investment banks to keep them from folding. Legislation is in the wings in an attempt to minimize the mortgage rate mess.

The credit crunch is trickling down to credit card companies. A tighter hold on credit means a slow down in buying, investing and jobs. Slow downs or the threat thereof usually means demand in all markets slows. A decrease in buying prompts a decrease in prices, the exact opposite of what’s going on.

This influx of money into the system, better known as the money supply, has a nasty side effect. It has been referred to in the media without an adequate explanation. The more money in circulation, the cheaper the money. This means it takes more to buy the same amount of goods: rising prices, not good.

How all of this pans out is anyone’s guess at this point. There are some things you can do to ensure you make wiser choices.

Uncertain times means you need to be more careful with purchases of durable goods. Think of this as anything that will still be around after you are finished paying for it, hopefully. Making long term commitments, tying up funds, long term payments, is not wise now. Things may change where you have to move in a hurry. You may be forced to move out of your home. You may be forced to change jobs. Investors may also see chances at making money when stocks, gold/silver, make a quick change in prices. All this boils down to a needed shift in your liquidity preference. Can you get your hands on cash in an emergency or will you have wait until your escrow closes. If you are employer and you are forced to cut back, it is much easier to get rid of temporary workers than letting go long-standing employees. Having more liquid assets means you are equipped to move quicker when changes come and come they will.

Sellers of durable goods are keenly aware that buyers are thinking harder before signing on the dotted line. They are up nights thinking of lures to bring you into their market. The latest I heard was a radio commercial offering car deals with no payments for 12 months. The announcer also encouraged listeners to get themselves pre-approved before arriving at the showroom. Car dealers’ aim is to get your signature. They create an atmosphere with promises that make you not think past tomorrow. The problem is they want you to forget about extra charges they have in the contract. Anyone promising durable goods without payments in the beginning is going to charge you at the end of the contract. Don’t be lured into thinking the salesperson is your friend. The only person they are looking out for is themselves. Bigger lures are bound to appear in our future.

The best thing you can do for yourself is to ask whether or not you can get out of a commitment easily six months down the road if your finances change. If not, forgo the purchase or the hiring of the extra employee. This also applies to investments that wouldn’t allow you to withdraw your funds without a stiff penalty.

Long-term planning has probably never been so important. Think twice and wait a day or so before signing any contract. You’ll be glad you did.

For examples of my work:

Laura Bell