Taking Advantage of Economic Cycles
Here I am, ready to offer my "two cents" worth of wisdom about economic cycles and in particular what we have to expect in the next five years. Lucky you!
My thoughts are likely worth less than two cents! But, as you have nothing better to do, you may as well read my article. After all, what else do retirees have to do but pontificate on every subject in which they have made every mistake? Hey, it isnít all that bad, but I do count myself among those forged through a "baptism by fire."
I have written many articles and my book based on a lifetime of remembered information and a fair amount of analysis and originality. Alas, in this article I draw on recent material from other sources and only about half of what I plan to say comes from my assessment of the last century. No, I was not around in 1900! Anyway, all of us with a few grains of intelligence are most interested in improving our circumstances in the near future Ö and that is always true Ö so it makes some sense to hear John out and see if what he says can be used personally and effectively.
If I were to summarize the fundamental personal economic question it would be this: "Is it time to expand or contract my expenditures/savings etc.?" The fundamental answers are "yes" and "no" with nothing in between making much sense, though few of us live sensibly. Note that I use the word expenditures in a very limited and careful way. Proper timing in buying a new home is one example, in which the choice of low interest rate and expectation of inflation coalesce to form an obvious yes, even when the employment issue is shaky near the end of a recession. In the reverse, exiting the stock market after a long run-up is the right thing to do even when it means you have to put your money at simple interest for one or more years. Ditto with regard to home buying Ö usually it is a bad idea to buy real estate at the beginning of a recession, for prices and interest rates are high, but great to sell it.
Letís take a look at the employment issue relative to the present time. Jobs that pay well have been scarce in the last three years. We have indeed experienced a serious recession and for reasons good or bad it is ending. The job picture for professionals during the next four years looks bright relative to the past three years. In short, you do not have to worry about income certainty for the next four years, as jobs will become available. That simply means that it is okay to expand your expenditures in intelligent ways, for we do have low mortgage interest rates and low borrowing rates for new automobiles. So far as I am concerned, we are about to enter a period of at least four years of hellish inflation, and that means the time is now for making the larger important purchases.
I will justify the inflation projection later. For now, let me simply say that deferred gratification in all things other than real estate and an automobile is the way to go. If you are a first time home buyer, do it now and stretch yourself to the limit to buy in a good neighborhood. If you are a second time buyer, look for the areas that will become desirable in an expanding economy, i.e., those semi-rural areas outside large cities that will become expensive bedroom communities. Alternatively, buy the more expensive home with less features in the areas around a city that historically have been uppercrust/upper middle class. Do not buy a new automobile until you are already in your new home. Then, buy something new, cheap and reliable, like a Hyundai Sonata, which combines luxury, low cost and reliability. Do not spend any money on new furniture or any other item that you can buy later and cheaper in the next economic downturn, after your income has inflated.
Forego all types of vacations that have significant cost. Go camping, go fishing, drive to the beach, play softball, hold family picnics. If you have any credit card balances, pay them off before the interest rates go up and do not use your credit cards for any purchases unless you pay off the balances entirely each month. Note that the days of zero or very low interest credit card rates are about to end for a very long time. People stuck with large credit card balances now will get a screwing unlike anything they could imagine. Contract all gift expenditures and form your social life around friends and family visiting each other. Forego restaurants and fast foods. Do not buy prepared foods. Learn to cook from scratch and use bulk purchase discount stores like Costco to severely restrict food and other household consumables costs.
These actions will allow you to take maximum advantage of an inflationary period by riding the increasing equity curve and paying low interest, while incurring no short term high interest rates or unnecessary expenditures. Direct as much of your income as you can into principal payments, for you will likely sell your home and possibly downsize near the end of the inflationary period. That action will support you having a much lower mortgaged amount in your next, possibly cheaper home, which will allow you to continue paying off what you owe rapidly, even with higher interest rates.
Note that there will be monetary instruments during a period of inflation that will yield higher interest than what you are paying on your mortgage. Ignore that bullshit! Your earned interest rate would have to exceed the combination effect of your mortgage interest rate combined with the your marginal income tax rate effect on total earned interest (Are you really that reliably good picking investments?). The overriding goal is to be secure by owning your home as soon as possible so that economic conditions cannot force you to sell. In a nutshell, paying any unnecessary mortgage interest is stupid, chasing financial rainbows is silly, and in the case of your future home/employment relationship and tax laws, risky.
Do not save any money except within a 401K plan or itís equivalent, and then only the amount to which your employer provides an incentive contribution. If you can, direct your 401K plan savings to financial instruments, e.g., the banks will have windfall profits during an inflationary period, while other traditional earnings growth companies will have a bad time as they spend heavily for people and all other inflation related materials and services. Think of your home, as one of my friends put it, as a "drive-by IRA!"
If you are about to retire, buy a final home for cash, or, with a mortgage you can comfortably pay off within five years from now, on your retirement income. That allows you to use a variable rate five-year mortgage (ARM) with a very low and effectively fixed interest rate. You do not have to think about appreciation so make your purchase in terms of what you really want for the rest of your life, which means amenities combined with common sense about things like stairways. Yes, do buy the new car as described above, and do follow the gift, food and vacation recommendations.
For those of you who will work many more years, note that your gross income will rise with inflation. It will lag inflation by about one to two years but in general you will appear to be earning much more money at the end of the inflation cycle. Of course, for those of you who are wise enough to buy your real estate at the beginning of the inflation cycle, your monthly mortgage payment will appear small and your equity will have grown handsomely on a relatively low amount of investment. But do not under any circumstances tap the equity. Let your college bound students take student loans, which are relatively low interest and which you can help pay off some years down the road when you have good cash flow from having no debt or loss risk of any sort.
Put some money into that car that you bought five years ago and drive it another five years. That period of time will likely allow you to pay off your mortgage in its entirety, making a later new car purchase painless. If possible, do have a two-income family for the next five years as both of the earners will gain from salary or wage inflation and the net obligation of your mortgage will be even smallerÖ or zero.
One last word about why we work Ö MONEY Ö to retire as young as we can without sacrificing fun after retirement or along the way. Any action that adds to your net worth is fair game for you want to be well off, and deferred gratification is the only reliable way to get there. H. L. Hunt and other wealthy people have noted that learning to live on less than half of their income allowed them to invest to become rich. For most of us, that method is impractical as we have spouses, children and our own appetites to enjoy life along the way. One need not live like H. L. Hunt, who died fabulously wealthy while still driving an old pickup truck and brown bagging his lunch. He was a perfect example of what not to be, and he was the extreme opposite of those who canít manage their debt, credit card or otherwise. Idiots populate both extremes.
Frankly, it doesnít matter whether you are the richest person in the graveyard or the poorest Ö dead is dead. What does matter is the life you enjoy during your few years here. That means prepare, execute responsibly and then enjoy the fruits of your labors. To die wealthy is silly. To live poor is silly. Seek balance, and do not worry about the future when you are 75 Ö there is no future, dammit! The declining balance of your assets should make you poor by the time you are 80. Of course, some of that effect should be realized by legally and aggressively and regularly transferring assets to your loved ones to avoid inheritance tax. I recommend a joint checking account into which two or more people make deposits Ö and they donít have to be equal in size, merely evident via a paper trail over five to ten years. You can help the process by annually gifting $10K to each of your participants.
Okay, that is enough said about what to do for the next five to ten years and beyond. I did not, however, justify my assumption that we are entering a long and nasty inflation cycle. The remainder of this article provides the necessary explanations to support the rather conservative financial recommendations in earlier paragraphs.
First, lets look at unemployment over the long haul Ö the last 100 years. Then lets relate that to who was unemployed and why. We will look at the key parts of economic growth and decline and the distribution of wealth. We will consider how economies are stimulated and then cyclically depressed by design. We will look at inflation in terms of cause and effect. Finally, we will learn how to anticipate change and how to take advantage of it.
If we listen to the news media we would think that unemployment problems periodically threaten our whole country. That is bullshit. With few exceptions, periods where unemployment rates ascend to 6% or more affect primarily those who had marginal jobs. It means, allowing for lying through statistics by our federal government, that 90% of the employable people remain employed. Salaries and wages may not go up but 9 out of 10 earners do not lose their jobs and their financial security is not at risk Ö else, how could all the people around you continue to live in those nice houses and drive nice cars during economic downturns/recessions?
Did you ever drive by a large marina and wonder just who those many people are who have so much money as to be able to afford wonderful boats? There arenít that many millionaires around, so the answer is that some people really do know how to manage their financial life to both acquire good income and spend or invest it wisely. Those people and their success should be seen as proof that deferred gratification and careful investing can lead to a lot of later fun. Do the moderately well off people worry about unemployment? Most do not.
Typically, the event of economic downturn is preceded by expansion fueled by cheap borrowable money from the Federal Reserve banks for commercial banks, then businesses and subsequently individuals such that everyone is kept busy producing and earning and buying. The bubble breaks when inflation or fear of inflation or some other sign like a stock market that is simply too hot occurs. At that point, we have funded new irrational businesses and kept old inefficient businesses running via cheap money, and it becomes time to pay the piper. The interest rate for bank borrowing goes up and the ripple effect ultimately results in the least important employed people losing their jobs.
Thus, we cycle from wanting to boost the economy to wanting to contain it, and on and on. Never have we seen any event even distantly like the Great Depression, nor are we about to Ö for the controls over our economy are highly sophisticated and operable with the cooperation of government and businesses using the Federal Reserve system. What Alan Greenspan did in 2000 with interest rate increases was to kill an absurd stock market advance and thus later avoid a very large total economy crash as happened in Japan. The Japanese have yet to recover. We are recovering now, and rather nicely. Jobs will follow in 2004 and 2005 and the recession of 2001-2003 will become a minor memory, with the caveat that government spending must be severely reduced for events like the Iraq war and itís aftermath.
Note that historically items like houses and cars inflate in price every thirty years by a factor of ten. That ratio is an approximation that applies to some consumables and not others. For example, ordinary televisions did not inflate. Bread did, but not at a 10X rate. If you read between the lines, it becomes obvious that intentional stimulation of the economy, periodically, is the cause, along with deficit expenditures by the federal and state governments, which must be eliminated through higher taxes without impoverishing the tax payers. Inflation is indeed a planned event that is, for the most part, controlled. Ultimately, inflation allows us to be "irresponsible" in that todayís mortgage debt will be paid later in cheaper dollars.
Unemployment need not be a problem for you personally if you have the basic intelligence and demonstrated wisdom to become educated and employed in any area that is unlikely to be outsourced to a different country. Think about medical services and the sciences, teaching and construction. Remember that what is possible is not necessarily what is likely. Think about outsourcing jobs from the USA as a limiting and ultimately negative behavior that cannot be allowed to displace too many jobs without screwing both the government and the businesses here. Yes, some jobs are lost, but all of us should realize that the process cannot advance very far without having severe economic consequences for businesses as well as individuals here in the USA.
For example, we are already experiencing serious inflation for computer systems people in India Ö they leave their jobs in a heartbeat to work for another company, and steal the unprotected company secrets of the USA company that hired them Ö all for an hourly wage increase of a few cents. The federal government loses significant tax revenue for each exported job so that process will soon have limits applied.
We appear to be moving to a tax structure that reduces corporate taxes without decreasing government expenditures. The simple and accurate conclusion is that revenue from individual income taxes will have to increase proportionately, and that cannot happen if the job base continues to erode. Think about it. It is a political football.
Restraint in unnecessary spending is essential to governments, businesses and you as an individual. The Iraq war and the associated deficit spending, along with ridiculous income tax rate reductions, are once again causing us to have a huge federal deficit. Unless that is stopped quickly, it will become very much like the example of a sorry and irresponsible individual who can't seem to control credit card impulse buying. In short, we all have to pay tomorrow for our excesses today, and one cannot decrease income and increase expenses without ruining the future. Bush and company are irresponsible idiots, and they must be removed ASAP.
Now letís look at income distribution. In a capitalistic system reward is supposed to be proportionate to contribution towards earnings. That means management will have the higher paying jobs forever as the little people do not contribute much at all in the way of imagination, research, engineering, market penetration, etc. Little people employed in the so-called "service industry" are actually nothing more than slaves with allowances. What might at one time have been seen as a relatively even distribution curve for population Vs income is now becoming strongly skewed. There is no reason to assume that the change is temporary. There is no evidence of a budding new technology that will gainfully employ our ordinary citizens like the automobile industry did during the 20th century.
Rewards will continue to accrue to those found most useful and those found least useful will live on the margin. That is not a very good place to be, yet it is easy to understand our evolution, for low contributors reproduce and stress our environment without advancing us economically or technologically. They are seen as drones and the economy will be built around having lots of them to do servile work with little income and high taxes. That is the real reason behind uncontrolled immigration of people who will work for almost nothing to live in the USA. Like it or not, we need fewer little people except to be low paid laborers because of automation. We will see more of this as the future unfolds. There will not be a day of reckoning, in fact, the differences between the contributors and non-contributors will become more obvious as we move into the future. The bar keeps getting higher.
Now about the hellish years of inflation I mentioned earlier Ö we have experienced an unprecedented period of no to low inflation for going on ten years. The Federal Reserve has lowered the interest rate on bank borrowings to the 1% range to help stimulate the economy and end the recession. It will work Ö too well, and coming jobs and corporate expansions will create inflation in the 5%+ range starting one year from now. We have actually had considerable inflation in medical costs, fuel and housing that havenít yet been properly counted. Look out, my friends, for food and clothing will begin to catch up, along with automobile prices and higher borrowing rates for automobile loans and for home mortgages. I forecast four years or more of 5%+ inflation per year in consumer goods, and that will hurt.
Follow the steps I recommended earlier, however, and you will be in a fine financial position. Ignore them and you will have to wait another ten years for the next opportunity.
Yes, you can take advantage of economic cycles if you understand and are realistic about cause and effect.