Wednesday, April 9, 2008

What Exactly Would a 'Prolonged Economic Downturn' Mean?

Yesterday Ben Bernanke and the Federal Reserve bank expressed fears about a 'prolonged economic downturn'. Bernanke is a scholar of Depression-era economic policy, and has tended to avoid his predecessor, Alan Greenspan's tendency to make strong, media-worthy statements.

For Bernanke to posit that we are about to hit an economic wall is big - really big - news. Not surprising news, most of us are feeling the pains both large and small of the constricting economy, but big news nonetheless. It means he's really really worried.

Now, just for a little historical perspective here, before the Great Depression, there were Panics. Throughout the 19th century, periodic panics collapsed banks and local economies on a frighteningly regular basis. Those pre-Depression and Depression era grandparents of ours had good reason to think their money was safer stuffed in a mattress. All too often it was safer there.

Credit was easy to come by in the 1920s, and it fueled purchases of cars, furniture, and rampant investment in risky ventures. There was a short-term spending spree in the US, after which massive deflation occured. Banks became afraid to lend. Heavy downturns in production and construction happened. Companies started laying off workers - at the height, there was 25% unemployment. People stopped spending in order to make their credit payments, which fed the downturn in production and construction.

Aside from the unemployment, and the deflation, it doesn't sound too different from today, now does it? And because of this, the Federal Reserve is being very, very careful.

There's some differences from then to now though, and they are important ones to keep in mind, before you pull all your money out of the markets and banks and bury it in the backyard.

The Fed did not intervene really during the 20s and early 30s, and when it did, it was ineffective. It was not until Franklin Delano Roosevelt took office in 1933 that a turnaround started, and economic policy changed for the better. The FDIC, or Federal Deposit Insurance Commission, which insures bank accounts up to $100,000.00 did not exist yet. In addition, the Securities and Exchange Commission was not created until after the worst of the Depression years.

On top of all that, the dust bowl of the early 1930s, the result of poor farming techniques and a prolonged drought made the food supply, as well as the ability for people in the midwest to earn a living, a complete wreck.

So what about now?

Bernanke and the Fed are deeply involved in creating liquidity in the tightening markets. They are cutting interest rates, brokering deals to keep investment houses from going under, like Bear Stearns, and taking many other actions to keep us from sinking. In addition, like it or hate it, both Congress and the President are taking action to keep the foreclosure ghost towns to a minimum.

The reality is, we could be sinking. But Bernanke, the Fed and even private banks are doing whatever they can to bail water out of our economic boat as fast as they can in order that we can make it to shore. This includes some things that may be unpalatable to those of us who pay our bills on time, such as bailing out irresponsible lenders and borrowers on an individual basis, but on a macroeconomic scale it makes sense. It is better to swim than to sink, and the crisis that faces us is not a small one. If we let people sink on a large scale to punish them for making bad decisions, we will all pay the price.

So what happens next?

No one knows. In my personal opinion, we're in for Bernanke's prolonged economic downturn. I think that we'll see layoffs, people cutting back on their spending even more than they currently are, more foreclosures, and a general lack of economic expansion for a while. It could be the rest of this year, or we might not have bottomed out yet. I'm betting on a year or two of this, but I could be wrong.

So how do I make it through this?

No one - no one - can completely reassure any of us that we won't be affected. But you can do things to protect yourself Live below your means - that means don't spend every dime you have! Save. Pay off debt. Save some more. Work harder and smarter at your job - volunteer for projects, submit ideas, and make yourself more valued. Unless things go really wrong in the workplace, the good ones often survive a layoff. You want to be one of the 'good ones'.

In short, every penny you don't spend, and don't owe, is one penny longer you can keep your own personal economic sphere afloat. Sure, you could run out and spend to inject some money into the economy, but don't. Not unless it's planned and thought out and you know you can do it. As the airline safety movies say, put your own oxygen mask on before helping others.

I know this is scary. We're one year into homeownership, and our debt for our home feels massive. We have only a single car loan that we're paying off aggressively, but between that and the mortgage I often feel pretty exposed. But the only thing we - all of us - can do is keep plugging. And try to remember that every downturn has been followed by growth.

The economy is cyclical. What goes up must come down. But it goes back up too.

Is there an upside to all this?

I think so. There's deals out there. If you've been squirrelling away a downpayment, now may be the time to score a deal while interest rates are low. There's some real investment deals out there, although I'd recommend sticking with index funds and highly rated funds rather than chasing the next big stock. Stores are putting things on sale.

So really, what does it mean?

In short, a prolonged economic downturn means that instead of our financial discomfort and uncertainty lasting a short time, it's probably going to be here a while. That stinks, to put it bluntly. But the spending party had to end sometime, and there are still jobs to be had.

Some good things may come out of this at the end. These types of crises make legislators pay attention to the average citizen, rather than corporate interests. We may see a sea change in policies. And we as individuals might decide that life is pretty good even without a flat panel tv and a new living room set. And those Joneses next door might decide the same.

And at some point, the crisis will end. Will we be wiser? Who knows? But we might be a little saner with our finances, and that would be a very good thing.

I can see clearly now, the rain is gone.....

1 comment:

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