financial crisis http://www.wisebread.com/taxonomy/term/9826/all en-US 5 Times It's OK to Pause Saving and Investing http://www.wisebread.com/5-times-its-ok-to-pause-saving-and-investing <div class="field field-type-filefield field-field-blog-image"> <div class="field-items"> <div class="field-item odd"> <a href="/5-times-its-ok-to-pause-saving-and-investing" class="imagecache imagecache-250w imagecache-linked imagecache-250w_linked"><img src="http://wisebread.killeracesmedia.netdna-cdn.com/files/fruganomics/imagecache/250w/blog-images/paper_boat_with_1_dollar_bill_sail_is_blown_onshore.jpg" alt="Paper boat with $1 bill sail is blown onshore" title="" class="imagecache imagecache-250w" width="250" height="140" /></a> </div> </div> </div> <p>In most circumstances, saving and investing should be a priority &mdash; one of your highest priorities, in fact. And we'd never advise you let short-term situations derail your long-term financial goals. However, there are a few particular times in life when investing shouldn't be at the top of your to-do list.</p> <p>That's not to say you shouldn't invest; just that you should focus on the particular situation, and how to handle it, before you turn your attention back to investing.</p> <h2>1. You don't have an emergency fund</h2> <p>If you haven't yet <a href="http://www.wisebread.com/change-jars-and-8-other-clever-ways-to-build-an-emergency-fund" target="_blank">built up an emergency fund</a>, your savings should go toward doing so before they go to investments or long-term savings plans. An emergency fund is a form of defense, a buffer that keeps a singular financial issue from becoming a big, ongoing financial crisis.</p> <p>With an emergency fund in place, you can handle unexpected expenses &mdash; like that dental work, or car repair, or emergency trip to help a family member &mdash; without depleting your long-term savings or accruing high-interest debt. Before you start investing, save as much as you can each month until you've built up an emergency fund to carry you through those unpredictable times in life. Experts recommend stashing three to six months' worth of salary &mdash; the higher your monthly expenses, the more you should save.</p> <h2>2. You have too much unsecured debt</h2> <p>If you are paying off high-interest, unsecured debt and struggling to make the minimum payments, now is not the time to start investing. Instead, you need to get your debt reduced to a manageable size so you can reduce the amount of interest you're paying. Otherwise you may end up losing money; if you're investing money in something with a 10 percent return, but you're paying a 21 percent interest rate on an equal amount of money, you're losing 11 percent each year.</p> <p>Focus your savings efforts on a <a href="http://www.wisebread.com/the-7-best-credit-card-debt-elimination-strategies" target="_blank">credit card debt reduction plan</a>, such as the snowball or debt ladder method. If you feel that your debt is at crisis level, consider debt consolidation (but <a href="http://www.wisebread.com/beware-of-these-common-debt-consolidation-traps" target="_blank">use caution</a> when considering your consolidation options) to get it under control.</p> <h2>3. You don't have a dependable income</h2> <p>Perhaps you're starting your own business, just starting your career, or you're self-employed and struggling to keep the monthly income steady. If you're unable to predict what your income will be from one month to the next, you may need to wait on those long-term investments.</p> <p>Instead, focus on regulating your income or using some smart strategies &mdash; such as setting up a slush fund, and having a minimum income budget &mdash; to establish stability on a fluctuating income. Once you feel that you have a good financial strategy in place, and can predict the amount you'll be able to save each month, start looking at your investment options.</p> <h2>4. You're in the midst of a financial crisis</h2> <p>It's always better to take a long-term view of the situation, when it comes to finances. However, when you're handling a financial crisis, the most immediate steps are the most important. You need to stop the financial bleeding, so to speak, before you turn your attention to long-term investments. Otherwise, you'll bleed out your financial resources and end up cashing out your investments early, before they can offer you any return.</p> <p>Therefore, if you're facing a <a href="http://www.wisebread.com/how-to-handle-a-sudden-loss-of-income" target="_blank">sudden income loss</a>, a potential layoff, a medical or family crisis, or other life emergency that has triggered a financial crisis, deal with the crisis and focus on stabilizing your day-to-day finances first.</p> <h2>5. You don't have enough information</h2> <p>The final reason to avoid investing is less about your financial situation and more about the investment opportunity itself. If you don't have adequate information, don't invest. Instead, take the time to do your due diligence: examine the risks, the potential return, and what the experts say about each investment opportunity.</p> <p>If it seems like a sure thing, and you're tempted to dump the entire contents of your savings account in, take a step back. Hold a counsel meeting with your financial planner and go over the questions they provide, questions you might not have thought to ask. Once you're confident that you have accurate information and understand the big picture of each potential investment, you're in a position to decide which ones are right for you.</p> <h2 style="text-align: center;">Like this article? Pin it!</h2> <div align="center"><a data-pin-do="buttonPin" data-pin-count="above" data-pin-tall="true" data-pin-save="true" href="https://www.pinterest.com/pin/create/button/?url=http%3A%2F%2Fwww.wisebread.com%2F5-times-its-ok-to-pause-saving-and-investing&amp;media=http%3A%2F%2Fwww.wisebread.com%2Ffiles%2Ffruganomics%2Fu5180%2F5%2520Times%2520It%2527s%2520OK%2520to%2520Pause%2520Saving%2520and%2520Investing.jpg&amp;description=5%20Times%20It's%20OK%20to%20Pause%20Saving%20and%20Investing"></a></p> <script async defer src="//assets.pinterest.com/js/pinit.js"></script></div> <p style="text-align: center;"><img src="http://wisebread.killeracesmedia.netdna-cdn.com/files/fruganomics/u5180/5%20Times%20It%27s%20OK%20to%20Pause%20Saving%20and%20Investing.jpg" alt="5 Times It's OK to Pause Saving and Investing" width="250" height="374" /></p> <br /><div id="custom_wisebread_footer"><div id="rss_tagline">This article is from <a href="http://www.wisebread.com/annie-mueller">Annie Mueller</a> of <a href="http://www.wisebread.com/5-times-its-ok-to-pause-saving-and-investing">Wise Bread</a>, an award-winning personal finance and <a href="http://www.wisebread.com/credit-cards">credit card comparison</a> website. Read more great articles from Wise Bread:</div><div class="view view-similarterms view-id-similarterms view-display-id-block_2 view-dom-id-1"> <div class="view-content"> <div class="item-list"> <ul> <li class="views-row views-row-1 views-row-odd views-row-first"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/how-to-save-for-retirement-when-you-are-unemployed">How to Save for Retirement When You Are Unemployed</a></span> </div> </li> <li class="views-row views-row-2 views-row-even"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/9-money-moves-to-make-the-moment-your-credit-cards-are-paid-off">9 Money Moves to Make the Moment Your Credit Cards Are Paid Off</a></span> </div> </li> <li class="views-row views-row-3 views-row-odd"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/heres-what-i-learned-about-money-after-using-acorns">Here&#039;s What I Learned About Money After Using Acorns</a></span> </div> </li> <li class="views-row views-row-4 views-row-even"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/6-parts-every-successful-budget-needs">6 Parts Every Successful Budget Needs</a></span> </div> </li> <li class="views-row views-row-5 views-row-odd views-row-last"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/9-smart-moves-to-make-after-getting-a-raise-or-promotion">9 Smart Moves to Make After Getting a Raise or Promotion</a></span> </div> </li> </ul> </div> </div> </div> </div><br/></br> Investment emergency fund financial crisis high interest debt loss of income money management saving money unsecured debt Wed, 06 Sep 2017 09:00:06 +0000 Annie Mueller 2012631 at http://www.wisebread.com How One Mediocre Investor Prospered After the Market Crash http://www.wisebread.com/how-one-mediocre-investor-prospered-after-the-market-crash <div class="field field-type-filefield field-field-blog-image"> <div class="field-items"> <div class="field-item odd"> <a href="/how-one-mediocre-investor-prospered-after-the-market-crash" class="imagecache imagecache-250w imagecache-linked imagecache-250w_linked"><img src="http://wisebread.killeracesmedia.netdna-cdn.com/files/fruganomics/imagecache/250w/blog-images/iStock-516182744.jpg" alt="Learning how a mediocre investor prospered after the market crash" title="" class="imagecache imagecache-250w" width="250" height="141" /></a> </div> </div> </div> <p>The <a href="http://www.wisebread.com/the-3-rules-every-mediocre-investor-must-know" target="_blank">mediocre financial advice</a> I've offered in my last few posts boils down to this: Use low-cost funds, establish an appropriate asset allocation, and rebalance it annually.</p> <p>It's not new advice. My own portfolio was strongly influenced by it back in the early 1980s. By the 1990s, it was pretty much the standard advice you would get anywhere. Many studies at the time showed that a very simple portfolio &mdash; just an S&amp;P 500 index fund, plus a long-term bond fund &mdash; tended to outperform managed funds, especially after the costs of the managed funds were taken into account.</p> <p>I haven't seen as many studies in the years since the financial crisis, so I thought I'd take a quick look at how this sort of basic asset allocation held up in the aftermath.</p> <p>Most people date the financial crisis from 2008, but I tend to date it from June of 2007, because that's when I found out that I'd be losing my job. For that reason, the graphs below run from then through the latest data available as of March 29, 2017.</p> <p>As it turns out, a <a href="http://www.wisebread.com/the-surprising-truth-of-investing-mediocre-advice-is-best" target="_blank">mediocre portfolio</a> held up pretty well.</p> <h2>Criteria for success</h2> <p>To decide whether a particular style of investing is a success, it helps to know what your goals are. Most people would include &quot;maximum return&quot; as at least part of their goal, but instead, I suggest that your portfolio provide an investment return that supports your specific life needs.</p> <p>A portfolio that comfortably beats inflation is part of that. It's also a plus if the portfolio doesn't swing wildly in value &mdash; in case your circumstances require you to cash out a significant amount on an emergency basis. It's nice, too, if the portfolio provides a mix of income and growth, so that if changes in what's in fashion among investors push one category of stocks up or down, the overall value of your portfolio doesn't take too big of a hit. (Personally I've always had a sneaking preference for income, even though tax policy has often favored growth.)</p> <p>With those criteria in mind, let's look at how some of the pieces of a mediocre portfolio have done.</p> <h2>Pieces of a mediocre portfolio</h2> <p>The most basic mediocre portfolio is just an S&amp;P 500 index fund and a long-term bond fund, with the ratio between those two gradually shifting from mostly stocks (for a young person) toward mostly bonds (for someone who has already retired).</p> <h3>Stock market investments</h3> <p>The value of an S&amp;P 500 index fund dropped dramatically during the crisis itself, but it hit bottom well before the end of the recession, recovered all of its losses by 2013, and is now about 50 percent above where it started &mdash; meaning that on stock price alone, you've got an annual return of well over 4 percent. With dividends reinvested, your annual return comes to nearly 7 percent (take a look at the 10-year average annual return of your favorite S&amp;P 500 index fund).</p> <p><iframe src="//fred.stlouisfed.org/graph/graph-landing.php?g=dyOc&amp;width=605&amp;height=340" scrolling="no" frameborder="0" style="overflow:hidden; width:670px; height:525px;" allowtransparency="true"></iframe></p> <p>(Source: <a href="https://fred.stlouisfed.org/graph/?g=dbdN" target="_blank">St. Louis Federal Reserve</a>)</p> <h3>Bond market investments</h3> <p>There isn't an exact bond-market equivalent for the S&amp;P 500 index fund, so it's a little hard to say how your investments would have done during the crisis and since. (I poked around at a few major mutual fund companies and found average annual total returns on various long-term bond funds for the past 10 years ranging from 3.6 percent to 6.1 percent, depending on the fund.)</p> <p>The return on a bond fund depends on interest rates. If you buy a bond that pays X percent and rates go up, your old bond is worth less (because otherwise people will just buy the new bond that pays more). Conversely, if rates go down, your old bond is worth more.</p> <p>With that in mind, here's a graph of the interest rate paid on a U.S. government 10-year treasury bond:</p> <p><iframe src="//fred.stlouisfed.org/graph/graph-landing.php?g=dyOf&amp;width=605&amp;height=340" scrolling="no" frameborder="0" style="overflow:hidden; width:670px; height:525px;" allowtransparency="true"></iframe></p> <p>(Source: <a href="https://fred.stlouisfed.org/graph/?g=dbfK" target="_blank">St. Louis Federal Reserve</a>.)</p> <p>Long-term interest rates dropped steadily before and during the recession. They rebounded modestly as the recession wound down, but then plummeted as it became clear that the economy needed, and would continue to need, extraordinary support from the Federal Reserve. Even now, long-term rates are about half what they were before the crisis began.</p> <p>The upshot is that the value of bonds purchased before the crisis would have soared during the crisis. Bonds purchased during the crisis would also have gone up. Bonds purchased in the aftermath might be up or might be down, depending on exactly when they were bought.</p> <h2>Rebalancing</h2> <p>If you'd just had a portfolio of stocks or bonds, you'd have done ok. Your stocks would have gone down a lot, but they'd have eventually recovered. Your bonds would have gone up a lot, and would have since eased off. But the mediocre asset allocation is more than that. The essence of a mediocre asset allocation is annual rebalancing.</p> <p>At the end of 2007, and again at the end of 2008, you would have sold some of your bonds &mdash; which would have jumped a great deal as interest rates fell ahead of and during the recession &mdash; and shifted that money into depressed stocks to restore your asset allocation.</p> <p>New stocks purchased on the last day of 2008 would have been bought with the S&amp;P 500 at 891 (down from close to 1,500 when you started). At the recent price of 2,359, those shares are up 165 percent. At the same time, you would have harvested much of the gains in your bond portfolio.</p> <p>Really, the rebalancing is where the magic is.</p> <h2>Success</h2> <p>As I mentioned at the beginning, the criteria I'm using as indicators of success are return, stability, and providing a mix of income and growth.</p> <p>The mediocre portfolio did a fine job of providing a return &mdash; especially if you rebalanced annually, thereby automatically buying stocks when they were at their lows.</p> <p>Stability is always a problematic goal, because it's almost the opposite of growth &mdash; the most stable portfolio would be one invested 100 percent in cash, which would show no growth at all. The point here, just as it is with return, is not maximum stability, but rather a degree of stability that supports your life goals. Here again, the mediocre portfolio did fine, especially for older people with a larger bond portfolio, which is where it is most important.</p> <p>Finally, the mediocre portfolio did a fine job at balancing income with growth. An S&amp;P 500 index fund has produced a pretty good yield, especially compared to cash and bonds during this period of historic lows in interest rates. Annual rebalancing will have automatically shifted money out of bonds as interest rates fell (reducing the fraction of the portfolio invested where income is low) and future rebalancing will be shifting money back into bonds as interest rates rise.</p> <p>I would hesitate to call its performance better than mediocre, but that's really the point: A mediocre investment portfolio, providing mediocre performance, is all it takes to support your life goals.</p> <br /><div id="custom_wisebread_footer"><div id="rss_tagline">This article is from <a href="http://www.wisebread.com/philip-brewer">Philip Brewer</a> of <a href="http://www.wisebread.com/how-one-mediocre-investor-prospered-after-the-market-crash">Wise Bread</a>, an award-winning personal finance and <a href="http://www.wisebread.com/credit-cards">credit card comparison</a> website. Read more great articles from Wise Bread:</div><div class="view view-similarterms view-id-similarterms view-display-id-block_2 view-dom-id-5"> <div class="view-content"> <div class="item-list"> <ul> <li class="views-row views-row-1 views-row-odd views-row-first"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/how-the-risk-averse-can-get-into-the-stock-market">How the Risk Averse Can Get Into the Stock Market</a></span> </div> </li> <li class="views-row views-row-2 views-row-even"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/the-3-rules-every-mediocre-investor-must-know">The 3 Rules Every Mediocre Investor Must Know</a></span> </div> </li> <li class="views-row views-row-3 views-row-odd"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/dont-be-fooled-by-an-investments-rate-of-return">Don&#039;t Be Fooled by an Investment&#039;s Rate of Return</a></span> </div> </li> <li class="views-row views-row-4 views-row-even"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/should-you-treat-your-social-security-benefits-like-a-bond">Should You Treat Your Social Security Benefits Like a Bond?</a></span> </div> </li> <li class="views-row views-row-5 views-row-odd views-row-last"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/start-an-investment-deathmatch-to-find-the-best-investments">Start an Investment Deathmatch to Find the Best Investments</a></span> </div> </li> </ul> </div> </div> </div> </div><br/></br> Investment asset allocation bonds financial crisis low-cost funds mediocre investments performance s&p 500 stock market Tue, 02 May 2017 08:30:11 +0000 Philip Brewer 1938294 at http://www.wisebread.com Understanding the Gold Standard http://www.wisebread.com/understanding-the-gold-standard <div class="field field-type-filefield field-field-blog-image"> <div class="field-items"> <div class="field-item odd"> <a href="/understanding-the-gold-standard" class="imagecache imagecache-250w imagecache-linked imagecache-250w_linked"><img src="http://wisebread.killeracesmedia.netdna-cdn.com/files/fruganomics/imagecache/250w/blog-images/gold_men.jpg" alt="Gold men" title="Gold men" class="imagecache imagecache-250w" width="250" height="188" /></a> </div> </div> </div> <p>I first starting thinking seriously about the gold standard back in 1980, when inflation spiked up over 10% (completely destroying my very first budget) and the value of the dollar seemed to be collapsing. (See also: <a href="http://www.wisebread.com/surviving-a-financial-panic-lessons-from-the-past">Surviving a Financial Panic &mdash; Lessons from the Past</a>)</p> <p>During the early 1980s, I read quite a few &quot;hard money&quot; books. Each of them included refutations of the arguments against a gold standard &mdash; refutations of arguments I hadn't yet been exposed to, so my experience was a little backwards &mdash; but I learned why a gold standard was good and got the gold bug chapter and verse on why the arguments against the gold standard were all bogus.</p> <p>(The term &quot;gold bug&quot; was originally a pejorative term for those who thought that only gold was &quot;real money,&quot;&nbsp;and was quickly expanded to include anyone who thought gold was a great investment. Over time, though, the hard money advocates embraced the term and started calling themselves gold bugs.)</p> <p>You will not be surprised to learn that it turns out to be more complicated than either the gold bugs or their detractors would have you believe.</p> <h2>Historical Gold Standards</h2> <p>Since ancient times, gold coins have circulated as money. That was always problematic, and gold was only rarely the main sort of money. Actual gold coins would be used by rich people and for certain kinds of transactions &mdash; in particular, to pay taxes and to trade internationally.</p> <p>For ordinary transactions, though, gold tended to be too valuable. The monthly pay for a Roman legionnaire was one gold aureus (a coin about the size of a nickel, weighing a bit less than a quarter of a troy ounce). It was a lot of money &mdash; a similar size coin right now would cost you about $400. (Back in those days it was similarly valuable, although relative prices have changed so much it's pretty hard to compare. The historical record shows <a href="http://info.goldavenue.com/info_site/in_arts/in_civ/in_civ_romans.html">8 aurei buying 23 acres of woodland in Kent</a>.) That's a lot of wealth to carry around in a short stack of small coins.</p> <p>Paper money was invented (gradually, with various intermediate forms) to solve some of the problems with gold coins.</p> <p>In the heyday of the gold standard, banknotes were issued by banks against gold held in their vaults and circulated in parallel with gold coins. If you had a banknote, you could go to the bank that issued it, present the note, and receive gold coin in exchange. Contrariwise, you could deposit your coins at the bank and receive banknotes in exchange.</p> <p>There were lots of reasons to go with banknotes. For one thing, you could have a $1 (or smaller) note &mdash; smaller than any practical gold coin. You could also pack very large sums into a reasonably small case &mdash; a bundle worth $50,000 could fit in your coat pocket. That amount in gold coin would weigh a couple hundred pounds.</p> <p>That sort of gold standard worked pretty well over a fairly long period. It doesn't prevent inflation (you'd have inflation any time the gold supply was growing faster than the economy), but it limited inflation. Importantly, it kept inflation from being a political tool.</p> <h2>An Inconsistent Standard</h2> <p>The downside of banknotes was that you were relying on the bank to be sound. Sometimes banks are, but the temptation to issue more banknotes than they have gold on hand is irresistible.</p> <p>Still, the real problem with a gold standard isn't unsound banks. That would be easy enough fix &mdash; a regulator could track the issue of banknotes and audit the gold supplies in the vault. The real problem is that there isn't one, true gold price.</p> <p>The price of gold is set by the market &mdash; and the market is strongly influenced by psychology. During good times, the price of gold is modest. (For example, during the 1990s &mdash; after the previous decade's inflation had been squelched and before the dotcom boom popped &mdash; the gold price hovered around $300 a troy ounce.) During bad times, the price of gold spikes up toward infinity.</p> <p>Since we're not on the gold standard, those price changes show up as changes in the price of gold. If you're on a gold standard, they don't show up that way. But that doesn't mean that they don't happen. It just means that the price change shows up as change in the value of the currency.</p> <p>Over the last decade, the price of gold has spiked up more than 460% (an annual rate well above 19%). That's a lot higher than the inflation rate over the same period. (The CPI is only up 27% over the same period, an annual rate of less than 2.5%.)</p> <p>Imagine that the value of your money had spiked up by that much! Of course, it'd be great if you had a lot of money. (I expect this is why gold bugs don't tend to worry about this scenario &mdash; in fact, with a bunch of gold in their portfolios, they're positively yearning for it.) But what if you didn't? What if you were a businessman who had to sign long-term contracts with customers and vendors? When the value of the money jumps around like that, you're totally screwed. Worse yet, what if you're in debt? If the value of the money spikes up, the cost of making your loan payments spikes up as well. Could you pay your mortgage if it took you a week to earn what you'd earned in a hour a few years ago?</p> <p>The gold bugs counter that we wouldn't see scenarios like that. The spike in the price of gold is due to a collapse in confidence in paper money. If the money were as good as gold, confidence wouldn't collapse and values would be relatively stable.</p> <p>There's some truth to that, but we know it's not completely true. During the gold standard in the 1800s and early 1900s, prices were pretty stable &mdash; but only on average, only over the long term. But short-term price swings produced just the sort of effect I'm describing.</p> <p>It could happen due to ordinary market forces. The supply of gold would fluctuate as new mines opened and old mines closed. The demand for gold would fluctuate as well &mdash; in particular, as exciting new overseas markets heated up, gold would flow to those countries to invest in the hot new thing. The result was a flow of gold out of established markets, producing just the sort of jump in the value of gold that I'm describing. Of course, it didn't show up as a price spike, but rather as <a href="http://www.wisebread.com/all-about-deflation">deflation</a>.</p> <p>So, it wasn't just a theoretical problem. It actually happened, over and over again.</p> <p>All these things &mdash; wars, financial disruptions of all kinds, inflation or deflation due to changes in the gold supply or changes in the demand for gold various places around the world &mdash; made the gold standard problematic. The worst was a particular kind of financial crisis called a panic.</p> <h2>The Problem of Panics</h2> <p>Panics happened when people began to doubt the soundness of their banks or their money and decided that they'd better turn in their paper and get actual gold coins instead. Because there was rarely as much gold in the vaults as there was paper in circulation, the result was a crisis.</p> <p>During the days of the gold standard, panics were perfectly ordinary &mdash; there'd be one every ten years or so. (We had something pretty close to a panic in 2007&ndash;2008, our first in something like 70 years. I wrote about it at the time in a post called <a href="http://www.wisebread.com/credit-squeeze-formerly-know-as-a-panic">Credit Squeeze (Formerly Known as a Panic)</a>.)</p> <p>Having sound banks that don't issue paper beyond the gold in their vault would reduce the severity of a panic, but that turns out to be a poor solution. There are reasons why banks issue more paper than they have gold, and it's not just because it's like printing money. Rather, it's because during good times, the amount of money that the economy can put to good use is larger than the value of the gold stock. The only way to have that much money in the economy would be to set the value of gold to be much higher &mdash; rather like setting the price of gold to levels that are only typical during a panic. That sounds great to a gold bug (who probably has a bunch of gold), but it doesn't work, because <em>that's not the price of gold</em>. The price of gold &mdash; the real, market price &mdash; is almost always much less than that.</p> <p>You <em>can</em> set a different price. You could, for example, set the price of a new gold dollar by dividing the US government's gold reserves (about 261 million troy ounces) into the total supply of currency in circulation (about 10,000 billion dollars) and suggest that a new gold dollar should be valued at $4,000 a troy ounce. Except that's not what gold is worth.</p> <p>You could set the current market price (about $1,600 a troy ounce), but even that is the price level based on the current near-panic conditions about the value of the dollar.</p> <p>If people weren't worried about the future of the dollar, the global economy, the deficit, the debt ceiling, the European debt crisis, etc., I suspect the price of gold would be pretty close to the $300 a troy ounce that we saw through most of the 1990s.</p> <p>(You'd think that gold bugs of the libertarian sort would understand that prices are set by the market, rather than by government fiat. But for all they rag on fiat currency &mdash; that is, money that only has value because the government says it does &mdash; they seem utterly oblivious to the notion that denominating gold in dollars is another fiat decision.)</p> <p>And that's the problem with a gold standard. There isn't one true price for gold. The right price &mdash; the market price &mdash; surges and collapses with the psychology of the market. You can let your whole economy get dragged around by that &mdash; most of the world did for centuries &mdash; but don't imagine that they did so without difficulty. They had panics, they had inflation, they had deflation, and they had all manner of crises when gold flows caused by booms in far off parts of the world threatened to crush local economies.</p> <h2>The End of the Gold Standard</h2> <p>When things got particularly bad &mdash; usually either a war or some sort of financial crisis &mdash; banks or governments would suspend convertibility into gold. If both the country and the currency survived, convertibility would eventually be restored. If just the country survived, a new convertible currency would be introduced (the old currency by then being nothing but waste paper).</p> <p>In the depths of the Great Depression, the U.S. took a slightly different path. In 1933, instead of suspending convertibility, the government banned the private ownership of gold, requiring citizens to turn in their gold in exchange for banknotes at the then current gold price of $20.67 per troy ounce. Shortly thereafter the value of the dollar was changed to a new parity of $35 per troy ounce. Convertibility was preserved (although only for foreigners), but at the new parity gold flowed into (rather than out of) the United States.</p> <p>Gold ownership by U.S. citizens wasn't legalized until 1974.</p> <p>In the run-up to World War II, the last few countries that had tried to stay on the gold standard had to suspend convertibility. Since then, essentially no currency has been convertible into gold &mdash; they're all fiat currencies. (For a few decades after the war, the U.S. dollar was technically convertible &mdash; but only for foreign central banks).</p> <p>It turns out a good fiat currency can avoid most of the problems of a gold standard. Our fiat currency hasn't always been good, but it's been doing sorta okay for a long while now.</p> <br /><div id="custom_wisebread_footer"><div id="rss_tagline">This article is from <a href="http://www.wisebread.com/philip-brewer">Philip Brewer</a> of <a href="http://www.wisebread.com/understanding-the-gold-standard">Wise Bread</a>, an award-winning personal finance and <a href="http://www.wisebread.com/credit-cards">credit card comparison</a> website. Read more great articles from Wise Bread:</div><div class="view view-similarterms view-id-similarterms view-display-id-block_2 view-dom-id-3"> <div class="view-content"> <div class="item-list"> <ul> <li class="views-row views-row-1 views-row-odd views-row-first"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/6-ways-to-get-paid-for-saving-money">6 Ways to Get Paid for Saving Money</a></span> </div> </li> <li class="views-row views-row-2 views-row-even"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/5-times-its-ok-to-pause-saving-and-investing">5 Times It&#039;s OK to Pause Saving and Investing</a></span> </div> </li> <li class="views-row views-row-3 views-row-odd"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/7-investment-accounts-all-30-somethings-should-have">7 Investment Accounts All 30-Somethings Should Have</a></span> </div> </li> <li class="views-row views-row-4 views-row-even"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/how-to-turn-25-a-week-into-almost-7000-in-5-years">How to Turn $25 a Week Into Almost $7000 in 5 Years</a></span> </div> </li> <li class="views-row views-row-5 views-row-odd views-row-last"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/how-to-earn-a-good-interest-rate-in-a-low-rate-environment">How to Earn a Good Interest Rate in a Low-Rate Environment</a></span> </div> </li> </ul> </div> </div> </div> </div><br/></br> Banking Investment financial crisis gold history Tue, 26 Jul 2011 10:00:05 +0000 Philip Brewer 631641 at http://www.wisebread.com Wise Bread Blogger on the NBC News with Brian Williams http://www.wisebread.com/wise-bread-blogger-on-the-nbc-news-with-brian-williams <div class="field field-type-filefield field-field-blog-image"> <div class="field-items"> <div class="field-item odd"> <a href="/wise-bread-blogger-on-the-nbc-news-with-brian-williams" class="imagecache imagecache-250w imagecache-linked imagecache-250w_linked"><img src="http://wisebread.killeracesmedia.netdna-cdn.com/files/fruganomics/imagecache/250w/blog-images/3456164717_7ce22c1fa7.jpg" alt="nbc studios" title="nbc studios" class="imagecache imagecache-250w" width="250" height="167" /></a> </div> </div> </div> <p>On Friday, September 24th, my family was on the NBC Nightly News talking about changes we've made in the way we use credit cards because of the financial crisis. We'd interviewed with one of their L.A. reporters, Kristen Walker, a couple of weeks previous.</p> <p>Filming was a blast. We were a little nervous, not knowing what they'd ask or, after the interview, what clips they'd use. While both my husband and I felt like we said some more intelligent, compelling things than were in the clips they actually used, overall the process was a blast. And shopping at Target with the camera guy was a trip, too!</p> <p>Check out my clip from the show:</p> <p><p id="video-player-sep2010-sarah-winfrey-abc-news">Sarah Winfrey on ABC News, September 2010</p> <script type='text/javascript' src='http://static.wisebread.com/files/wisebread/press/video/bin/swfobject.js'></script> <script type='text/javascript'> var s1 = new SWFObject('http://static.wisebread.com/files/wisebread/press/video/bin/player.swf','player','384','288','9'); s1.addParam('allowfullscreen','true'); s1.addParam('allowscriptaccess','always'); s1.addParam('flashvars','file=http://static.wisebread.com/files/wisebread/press/video/Sarah Winfrey ABC News.flv'); s1.write('video-player-sep2010-sarah-winfrey-abc-news'); </script> </p> <p>The topic was a timely one for us. My husband, a college professor, lost his job on July 1, 2010, because the college he worked for didn't have the incoming tuition to renew his contract. We knew it was coming and have cut back on our credit card use since early this year. While we've always been responsible with our cards, we wanted to be sure that we could pay the bill each month.</p> <p>We've also found that it's easier to limit our spending when we use cash or debit cards instead of credit cards. When you actually have to hand over bills or when you know that the bottom line in your checking account will take a direct hit, you're less likely to spend money on things you don't need.</p> <p><strong>Related Articles</strong></p> <p><a href="http://www.wisebread.com/the-best-kept-secret-to-frugal-living">The Best Kept Secret to Frugal Living</a> &mdash; Find out how to think differently in order to spend less. Turns out, spending is all about your motivations and your mindset.</p> <p><a href="http://www.wisebread.com/5-steps-toward-financial-independence">5 Steps Toward Financial Independence</a> &mdash; Credit card debt is often a problem for young people who don't know any better. Avoid this and other debt traps, and you're well on your way to financial independence.</p> <p><a href="http://www.wisebread.com/who-should-face-the-music-when-the-banks-fail">Who Should Face the Music When the Banks Fail?</a> &mdash; There's a lot of blame flying around during this financial crisis. Who do you think should be required to pay when things go this badly wrong?</p> <p><a href="http://www.wisebread.com/walking-the-tight-rope-of-financial-recovery-the-mental-game">Walking the Tightrope of Financial Recovery</a> &mdash; Do you need to get back on your feet because of credit card or other debt? Find some practical advice here.</p> <p><a href="http://www.wisebread.com/the-entrepreneurial-spirit-in-an-economic-crunch">The Entrepreneurial Spirit and the Economic Crunch</a> &mdash; Looking to start your own business even though the economic outlook is still bland? Hear from some people who've done it about the positives and the pitfalls.</p> <p><a href="http://www.wisebread.com/breathing-easy-on-the-financial-rollercoaster">Breathing Easy on the Financial Rollercoaster</a> &mdash; If you're struggling with money, stop and take a deep breath. Taking some time to reassess your situation will help you get out of it stronger and recover faster.</p> <p><a href="http://www.wisebread.com/dealing-with-financial-drought-a-recovery-plan">Dealing With Financial Drought: A Recovery Plan</a> &mdash; When things get tough, it's easy to panic. Instead of panicking, though, make a plan and stick to it.</p> <p><a href="http://www.wisebread.com/to-fafsa-or-not-to-fafsa-a-former-students-view-of-student-loans">To FAFSA or Not to FAFSA</a> &mdash; Looking at taking out student loans? Before you sign on to debt, here are some things to consider.</p> <p><a href="http://www.wisebread.com/feeling-poor-things-i-forget-about-that-dont-cost-a-thing">Feeling Poor: Things I Forget About that Don't Cost a Thing</a> &mdash; When hard economic times hit, it's easy to feel like nothing's going your way. Remembering the things that are can give you the perspective you need to get back on track.</p><br /><div id="custom_wisebread_footer"><div id="rss_tagline">This article is from <a href="http://www.wisebread.com/sarah-winfrey">Sarah Winfrey</a> of <a href="http://www.wisebread.com/wise-bread-blogger-on-the-nbc-news-with-brian-williams">Wise Bread</a>, an award-winning personal finance and <a href="http://www.wisebread.com/credit-cards">credit card comparison</a> website. Read more great articles from Wise Bread:</div><div class="view view-similarterms view-id-similarterms view-display-id-block_2 view-dom-id-1"> <div class="view-content"> <div class="item-list"> <ul> <li class="views-row views-row-1 views-row-odd views-row-first"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/top-seven-reasons-why-i-use-my-credit-card-for-everything">Top 7 Reasons Why I Use My Credit Card for Everything</a></span> </div> </li> <li class="views-row views-row-2 views-row-even"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/pre-approved-for-credit-card-offers-are-you-pre-qualified">Pre-Approved for Credit Card Offers: Are You Pre-Qualified?</a></span> </div> </li> <li class="views-row views-row-3 views-row-odd"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/3-smartphone-apps-that-manage-and-maximize-your-credit-card-rewards">3 Smartphone Apps That Manage and Maximize Your Credit Card Rewards</a></span> </div> </li> <li class="views-row views-row-4 views-row-even"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/8-things-people-with-good-credit-never-do">8 Things People With Good Credit Never Do</a></span> </div> </li> <li class="views-row views-row-5 views-row-odd views-row-last"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/10-tricks-to-save-money-with-credit-cards">10 Tricks to Save Money with Credit Cards</a></span> </div> </li> </ul> </div> </div> </div> </div><br/></br> Credit Cards Announcements brian williams credit cards economic crisis financial crisis NBC nightly news Sun, 10 Oct 2010 11:54:40 +0000 Sarah Winfrey 256010 at http://www.wisebread.com Looking On The Bright Side: How to Find A Silver Lining In The Current Financial Crisis http://www.wisebread.com/looking-on-the-bright-side-how-to-find-a-silver-lining-in-the-current-financial-crisis <div class="field field-type-filefield field-field-blog-image"> <div class="field-items"> <div class="field-item odd"> <a href="/looking-on-the-bright-side-how-to-find-a-silver-lining-in-the-current-financial-crisis" class="imagecache imagecache-250w imagecache-linked imagecache-250w_linked"><img src="http://wisebread.killeracesmedia.netdna-cdn.com/files/fruganomics/imagecache/250w/blog-images/515680_60090784.jpg" alt="Every Cloud Has A Silver Lining - Image Courtesy of Stock XChng" title="Every Cloud Has A Silver Lining - Image Courtesy of Stock XChng" class="imagecache imagecache-250w" width="250" height="188" /></a> </div> </div> </div> <p>There was a standard mantra in my house when I was growing up: &quot;make the best of what you&#39;ve got&quot;. If we were between paydays, that might mean eating grilled cheese sandwiches or eggs and biscuits for dinner, taking our lunch to school or foregoing that new outfit at the mall. To my Dad, it meant finding a way to make due in order to avoid even the smallest expenses. And my Dad lived what he preached, tying knots in his broken shoelaces and sewing up holes in his socks. </p> <p>Were we poor? Actually, no. We weren&#39;t rich by any means but as middle class families go, we were doing pretty good. My Dad just had a different perception of what qualified as a legitimate need for spending money and had no qualms about foregoing material luxuries in order to keep a few extra dollars in his bank account.</p> <p>Now that I&#39;m grown and have a family of my own, I&#39;ve realized that maybe Dad wasn&#39;t so far off the mark after all - don&#39;t tell him I said that, of course - he&#39;d never let me live it down.</p> <p>Granted, he went to the extremes to avoid spending money but his basic idea was right on. And the reason it worked is that he wasn&#39;t worried about wearing the &quot;right&quot; clothes or driving the &quot;right&quot; kind of car. He would have never spent $100 bucks on a pair of sneakers - not when he could get shoes that worked just fine at PayLess or WalMart for a mere ten-spot.</p> <p>Which brings me to the point of this article: as bad as the economy is, maybe there&#39;s a bright side after all.</p> <p>Now, before you start typing out angry comments to this post, hear me out. I&#39;m not saying that losing your job or your house is a good thing, although I&#39;ve known lots of people who lost their job and then later discovered it was the best thing that could have ever happened. But that&#39;s another blog.</p> <p>Nor am I saying that we don&#39;t all deserve to live the &quot;good life&quot;, because we most certainly do. But what exactly defines the &quot;good life&quot;? Is that really measured by our net worth or isn&#39;t it more based on the amount of happiness that we derive from our existence on any given day? And as we all know (and as we&#39;ve seen), if there&#39;s one thing money can&#39;t buy, its happiness. </p> <p>What I am saying is that this dismal economy has forced many of us to come back down from the clouds and start being realistic about the way we look at money.</p> <p>And maybe that&#39;s not such a bad thing.</p> <p>Our society has become a people of convenience. Our food is processed and microwaved so that we don&#39;t have to waste time cooking it. No-one carries money anymore - instead we just charge our purchases on that magical credit card because it allows us to worry about how to pay for the item later. That same mentality is a big contributor to the mortgage crisis we&#39;re now seeing as millions of borrowers bought houses they really couldn&#39;t afford because greedy lenders gave them a way to &quot;bump&quot; the higher prices to a future date through creative financing called adjustable rate mortgages and balloon notes.</p> <p>As a result, we not only stopped seeing the &quot;big picture&quot; but we became oblivious to its existence at all. We have been focused on the &quot;here and now&quot;, with the idea that the &quot;here and now&quot; was intended only to appease our flights of fancy without regard to the price we might have to pay later. Don&#39;t believe me? Just look at the environment. If that&#39;s not arrogance, I don&#39;t know what is.</p> <p>We distorted the proverbial &quot;American Dream&quot; to become something that represented an obnoxious amount of wealth that was free of any scruples or morality. And as long as Corporate America was willing to let us charge and extend our financial obligations, that skewed American Dream stayed in tact.</p> <p>But we should have known better.</p> <p>It doesn&#39;t matter who you are or how rich you are, reality will always come crashing in. Its just a matter of time.</p> <p>And that&#39;s what happened here. </p> <p>Our main export is actually debt - yes, debt... about <a href="http://www.time.com/time/magazine/article/0,9171,1844547,00.html?xid=rss-topstories">$700 billion per year</a> in financial securities that until recently were backed by a seemingly booming economy. But now that our economy is struggling, those financial securities aren&#39;t as appealing to foriegn investors which makes our economy worse, which makes our securities less attractive and so on and so on. But what&#39;s really sad is that we didn&#39;t diversify our incomes like we did our portfolios. America doesn&#39;t really &quot;make&quot; a ton of other things so when selling debt stopped generating cashflow, we had nothing else to take up the slack.</p> <p>The trickle down effect of the Wall Street fiasco is that your average Joe and Jane are suddenly faced with limited incomes and rising prices. Ridiculously rising prices I might add - I saw a guy bringing back a roll of foil at the grocery store the other day - it seems the store had failed to give him the sale price of $7.95 and instead charged him the full price of $9.59. $10 for a roll of aluminum foil? It better do the cooking for me.</p> <p>My point is, now everyone&#39;s feeling pinched and not just in the &quot;two more days to payday&quot; kind of way, but more of the &quot;what the hell are we going to do now?&quot; kind of dilemma.</p> <p>And that&#39;s a scary place to be.</p> <p>But before you throw your hands up in the air, take a deep breath and relax. While its doubtful that the big conglomerates have learned their lesson from this experience (visit AIG), you and I can actually come away from this with a new and enlightened perspective while managing to keep the shirt on our back. Its just going to require a little shift in perspective.</p> <p>For starters, while I don&#39;t want to encourage not paying your bills, the truth is that creditors are much more likely to work with you if you&#39;re falling behind. Stay current on your obligations and you aren&#39;t as likely to see that accomodation. So if you&#39;re staring at thousands of dollars in credit card bills, you need to make some decisions about your priorities.</p> <p>Your mortgage, your utilities and your grocery bill all come first. If you can pay something on the credit cards, great. If not, then you need to come to that realization and accept it. Yes, your credit score might tank before this is all over but take it from someone who knows, you can rebuild that credit. Its a long and winding road, but trust me when I say it can be done.</p> <p>Once you&#39;ve got your priorities in place, you need to learn, as my father did to make the best of what you&#39;ve got. Its okay if we can&#39;t buy all the latest gadgets on the market. Its okay if we need to keep driving the same car beyond two or three years. In fact, pay that puppy off and discover what its like not to have a car payment at all.</p> <p>Downsize where you can and believe it or not, start saving. Seriously... even if its only $10 a payday. That little emergency fund could definitely come in handy some day and if nothing else, it will give you a sense of security and accomplishment, something we could all use right now.</p> <p>Stop putting in so many hours at the office and start looking at the millions of other ways to make money. The truth is, there&#39;s still money out there. Its not as free-flowing but I can tell you as a freelancer, that this month may well be one of the best I&#39;ve had this year. </p> <p>The reason is that I diversified my skills and branched out into areas I don&#39;t normally tackle. And I&#39;m being rewarded for those efforts with enough funds to cover all my obligations. Did I strike it rich? No, but I do have a little breathing room which is really something considering where I might have been instead.</p> <p>You can do the same. Maybe start your own virtual assistant business. Clean out that garage and start selling on eBay. Go sling drinks at your local bar on the weekends. The point is, take action. Don&#39;t just sit there biting your nails wondering where the money will come from. The opportunities are there - you just have to act on them.</p> <p>And if you think now is not the time to start a new business, think again. Many small businesses are pulling in the reigns and downsizing. They&#39;re cutting services and products because they want to control costs. But you don&#39;t have any overhead and if you play it smart, you can keep it that way making any money you earn pure profit.</p> <p>Cancel your gym membership and start running or walking in your neighborhood instead. If you&#39;ve got the space, grow your own vegetables - lettuce, cabbage and broccoli are a few good winter varieties to start with. You can even plant a tomato plant in front of a sunny window in your house and enjoy fresh tomatoes all winter long. Don&#39;t think that will make a difference? Oh yes it will. At about $2 per pound where I live, tomatoes can do some damage to a grocery bill. </p> <p>If possible, wash and iron your own clothes instead of taking them to the cleaners. Learn to cook again instead of dining out and discover the beauty of a PB&amp;J sandwich and a glass of milk. Examine your lifestyle - can you rent DVD&#39;s instead of going to movies? Can you spend a Friday night playing cards with friends instead of going out on the town? There&#39;s is no shame in saying &quot;I can&#39;t afford that right now&quot; and certainly not in saying &quot;I don&#39;t need that right now&quot;. </p> <p>Look around, take stock and re-evaluate how you approach your money. You don&#39;t have to tie knots in broken shoelaces but you can start making changes in what qualifies as a necessary expense. You&#39;ll likely find that while your &quot;cuts&quot; aren&#39;t always pleasant, they are usually doable and make a noticeable contribution in your quest to survive our economic catastrophe.</p> <p>And then when the economy does finally bounce back (and it will) we&#39;ll have adopted an entirely new way of living. One that doesn&#39;t depend upon the greediness of others but relies solely on our own creative energies and practical state of mind.</p> <p>And then perhaps, we can start teaching that lesson to the powers that be.</p> <br /><div id="custom_wisebread_footer"><div id="rss_tagline">This article is from <a href="http://www.wisebread.com/kate-luther">Kate Luther</a> of <a href="http://www.wisebread.com/looking-on-the-bright-side-how-to-find-a-silver-lining-in-the-current-financial-crisis">Wise Bread</a>, an award-winning personal finance and <a href="http://www.wisebread.com/credit-cards">credit card comparison</a> website. Read more great articles from Wise Bread:</div><div class="view view-similarterms view-id-similarterms view-display-id-block_2 view-dom-id-4"> <div class="view-content"> <div class="item-list"> <ul> <li class="views-row views-row-1 views-row-odd views-row-first"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/chinese-money-habits-how-my-culture-influences-my-attitudes-toward-money">Chinese Money Habits - How My Culture Influences My Attitudes Toward Money</a></span> </div> </li> <li class="views-row views-row-2 views-row-even"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/do-not-buy-something-just-because-you-can-afford-it">Do not buy something just because you can afford it</a></span> </div> </li> <li class="views-row views-row-3 views-row-odd"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/oprah-asks-a-great-question-what-can-you-live-without">Oprah Asks A Great Question; What Can You Live Without?</a></span> </div> </li> <li class="views-row views-row-4 views-row-even"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/47-simple-ways-to-waste-money">47 Simple Ways To Waste Money</a></span> </div> </li> <li class="views-row views-row-5 views-row-odd views-row-last"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/what-is-keeping-you-from-a-life-of-financial-independence">What is keeping you from a life of financial independence?</a></span> </div> </li> </ul> </div> </div> </div> </div><br/></br> Personal Finance Frugal Living Credit Cards General Tips Lifestyle Real Estate and Housing Shopping budgeting Economy financial crisis Making Extra Cash making extra money Wall Street Sun, 19 Oct 2008 19:20:50 +0000 Kate Luther 2532 at http://www.wisebread.com What's the big deal about banks refusing to lend? http://www.wisebread.com/whats-the-big-deal-about-banks-refusing-to-lend <div class="field field-type-filefield field-field-blog-image"> <div class="field-items"> <div class="field-item odd"> <a href="/whats-the-big-deal-about-banks-refusing-to-lend" class="imagecache imagecache-250w imagecache-linked imagecache-250w_linked"><img src="http://wisebread.killeracesmedia.netdna-cdn.com/files/fruganomics/imagecache/250w/blog-images/men-on-bank-steps-1.jpg" alt="Men sitting on the steps outside a bank" title="Men on Bank Steps" class="imagecache imagecache-250w" width="250" height="194" /></a> </div> </div> </div> <p>Anybody--but especially frugal people--can be excused for thinking that the whole credit crisis thing is being overblown.&nbsp; After all, we get along without debt.&nbsp; In fact, we strongly recommend that others do so as well.&nbsp; If getting along without debt is the way to go, why make such a big deal over a credit crunch?</p> <p>For an individual, there's a reasonable debt-free path to some sort of prosperity.&nbsp; You earn money, you spend less than you earn and save the difference.&nbsp; Over time you accumulate durable items that raise your standard of living for years to come; your income rises (as you become more skilled and prove yourself a reliable worker); you earn a return on your savings and investments.</p> <p>So, what's the big deal?&nbsp; If everybody did that, we'd hardly need credit at all, and could just ignore credit squeezes.&nbsp; Right?</p> <h2>Consumer debt</h2> <p>That intuitive analysis really just covers consumer debt, which is not at the heart of the matter.</p> <p>Consumer debt is a factor in the crisis, in that it has let people live beyond their means.&nbsp; That has produced an illusory boost to the economy, even as it has produced a shortage of savings.&nbsp; But a cut-off in consumer credit is not what people are worried about when they say that banks have quit lending (even thought it's enough all by itself to produce a recession, simply because consumers who had been borrowers will have to become net savers, if only because their access to credit has been cut off).</p> <h2>Productive debt</h2> <p>The shortage of credit that has everyone in a tizzy is <strong>credit used to buy productive assets</strong>.&nbsp; When a farmer borrows money to buy seed, that's productive debt.&nbsp; When a baker borrows money to buy a second oven, that's productive debt.&nbsp; When a huge utility borrows money to build a power plant or a water treatment facility, that's productive debt.</p> <p>It's possible for farmers, businessmen, and giant corporations to get by without debt--but only as much smaller operations.&nbsp; So, there are two issues:&nbsp; the size of the enterprise, and the transition to being that size.</p> <h3>Enterprise size</h3> <p>WIthout access to debt, business size is limited by the amount of invested capital:</p> <ul> <li>The farmer can't plant more seed than he can afford to pay cash for (after budgeting for fertilizer, fuel, and so on). &nbsp;</li> <li>The baker finds himself turning away good customers because his one oven can only produce so much (until he saves up enough money to buy a second oven--something that might take years).</li> <li>The utility can't expend to serve a growing population (except by retaining a decade's worth of profits).</li> </ul> <p> This is not necessarily a bad deal for the business, if the enterprise is sized correctly.&nbsp; The baker with just one oven can only produce so much bread or pizza, so he only has to work so hard.&nbsp; Since demand is strong but supply is limited, it's possible to earn a good profit.&nbsp; You often see this sort of result in highly skilled crafts--a well-thought-of luthier might have an order book that extends out for months or even years.</p> <p>When credit is available, this sort of situation doesn't develop, except for things like skilled crafts.&nbsp; Credit makes it possible for the business to expand.&nbsp; And if the business doesn't expand, competitors will move in to meet the demand.</p> <p>When credit is tight, this sort of situation can persist for years (which can be very frustrating for customers, who can't buy what they want--because the guy who makes it is selling all he can produce to long-time customers).</p> <h3>Transition</h3> <p>Before we get to the tolerable (if sometimes frustrating) situation of businesses staying small even when there's strong demand, we have to get the businesses sized correctly.&nbsp; That can be terribly painful.</p> <p>Many businesses are utterly dependent on ready access to credit.&nbsp; This is especially true of businesses with large capital demands, such as farms (where huge amounts of money are tied up in land and equipment) and utilities (where the capital takes the form of power plants, telephone switches, well fields, pumping stations, water towers, etc.), but it can be true of any business.</p> <p>With much or all of their capital tied up in plant and equipment, the business uses credit to buy supplies and to meet payroll.&nbsp; If access to credit is lost, even for a couple of weeks, the business is no longer a going concern--invoices go unpaid and the payroll can't be met.</p> <p>That's even true of a business that's not really operating on the edge.&nbsp; A successful farmer, for example, might have enough cash to finance his whole operation--buy seed, fertilizer, fuel, pay for maintenance, and so on--for a year.&nbsp; But suppose a poor crop this year leaves him with less cash next year.&nbsp; Unless he has access to credit, he can't make full use of his land and his equipment.&nbsp; If he's only able to plant and fertilize half his fields, he can easily enter a death spiral, never making enough money one year to make full productive use of his capital the next.&nbsp; In theory he could downsize the farm--selling some land, selling a big combine and buying a smaller one, etc.--but that sort of transformation is hard at the best of times and can easily be impossible in any particular year, especially if his neighbors are in much the same situation.</p> <p>Other businesses face exactly the same sorts of issues--needing to sell equipment that they can't put to productive use because they lack the cash to buy raw materials, pay their employees and so on.&nbsp; But they too can't actually do so, because nobody else has the cash or the access to credit to buy the equipment.</p> <h2>Current situation</h2> <p>I mention all this because we're dangerously close to this situation now.&nbsp; Many businesses are unable to borrow.&nbsp; If this continues, they'll be forced to try to shrink--and many of those efforts will fail.&nbsp; Even where they succeed, the new business will be smaller--with fewer employees, less output, and lower profits.&nbsp; They (and their customers, and their suppliers) will all be buying less, meaning that other businesses--even ones that don't depend on credit--will have to shrink as well.</p> <p>That's what a recession is, and this is shaping up to be just that.</p> <p>For an individual, getting along without debt is a great idea--now more than ever.&nbsp; But for the economy as a whole, a credit crunch is hard on everybody.</p> <h2>What to do</h2> <p>Well, staying out of debt is a good start.&nbsp; Beyond that, it depends on how you make a living.&nbsp; Last year I wrote about <a href="/preparing-for-a-recession">preparing for a recession</a>.&nbsp; That advice still holds, and it's not too late to prepare, even with recession staring us in the face.</p> <p>If you're an employee, you're largely dependent on the success of your employer, and your employer's success will depend on its need for credit.&nbsp; If you have any visibility into that side of your employers operations, you can get a good sense as to how much risk a credit crunch poses. Note that being a great employee won't necessarily help in a situation like this.&nbsp; Many firms that lose access to credit will have to shrink by half or more, so plenty of highly productive employees will have to be let go.</p> <p>As a special case of being an employee, if you work for something other than a business--federal, state or local government, a school or university, a charity, foundation, or similar non-profit--you may be in much better shape.&nbsp; Those sorts of institutions tend not to be dependent on debt to fund their day-to-day operations.&nbsp; They may see their income drop as charitable contributions and tax receipts drop--and they may well have to let employees go--but the aren't in the position of having to shrink their business instantly down to what can be funded on a cash basis.&nbsp; They're probably already there.</p> <p>If you're a business owner, move as quickly as you can to get things on a cash basis.&nbsp; (I realize that this advice is coming rather late in the cycle.)&nbsp; If you've been using credit to bridge the gap between paying your suppliers and getting paid by your customers, this will admittedly require shrinking your business.&nbsp; There may not be time to wind things down gradually--you're probably better off immediately cutting whatever you can't afford without credit.&nbsp; A small business with one or a few employees is better than a medium-sized one with many employees, if the medium-sized one is in receivership.</p> <p>If you're retired, the future is especially murky.&nbsp; The collapse of credit is hugely deflationary, and if that's all that happens, your cash and government bonds will do very well, and you'll come out of this in fine shape (unless you have too much of your retirement money in stocks).&nbsp; The bailout efforts, though, are largely inflationary.&nbsp; To the extent that they succeed, those stock investments may do okay, while the cash and bonds lose purchasing power to inflation.&nbsp; Worst case, we get enough inflation to destroy your dollar-denomonated investments <strong>without</strong> preventing the deflationary recession that wrecks your stocks, and then drives the economy down to the point where you can't get a job either.&nbsp; In that situation you have little choice but to <a href="/opting-out-of-the-money-economy">opt out of the money economy</a> all together.&nbsp; Let's hope it doesn't come to that.</p> <p>No matter where you're starting from, though, recognize that these financial events affect <strong>production</strong>, but they don't affect <strong>productive capacity</strong>:&nbsp; The land is still there, the factories are still there, the equipment and workers are still there.&nbsp; Over time, things will work themselves out to put the productive capacity back into production.</p> <br /><div id="custom_wisebread_footer"><div id="rss_tagline">This article is from <a href="http://www.wisebread.com/philip-brewer">Philip Brewer</a> of <a href="http://www.wisebread.com/whats-the-big-deal-about-banks-refusing-to-lend">Wise Bread</a>, an award-winning personal finance and <a href="http://www.wisebread.com/credit-cards">credit card comparison</a> website. Read more great articles from Wise Bread:</div><div class="view view-similarterms view-id-similarterms view-display-id-block_2 view-dom-id-1"> <div class="view-content"> <div class="item-list"> <ul> <li class="views-row views-row-1 views-row-odd views-row-first"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/peak-debt">Peak Debt</a></span> </div> </li> <li class="views-row views-row-2 views-row-even"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/how-a-single-mother-in-debt-over-200k-is-fixing-her-finances">How a Single Mother In Debt Over $200K Is Fixing Her Finances</a></span> </div> </li> <li class="views-row views-row-3 views-row-odd"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/the-us-government-wants-you-in-debt">The U.S. Government Wants You in Debt</a></span> </div> </li> <li class="views-row views-row-4 views-row-even"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/whats-the-best-way-to-get-out-of-debt">What&#039;s the Best Way to Get out of Debt?</a></span> </div> </li> <li class="views-row views-row-5 views-row-odd views-row-last"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/how-does-the-fannie-mae-and-freddie-mac-bailout-affect-you">How does the Fannie Mae and Freddie Mac bailout affect you?</a></span> </div> </li> </ul> </div> </div> </div> </div><br/></br> Personal Finance Debt Management banks credit credit crunch credit squeeze Crisis debt Economy financial crisis lending Tue, 30 Sep 2008 21:15:16 +0000 Philip Brewer 2477 at http://www.wisebread.com Root cause of the financial crisis http://www.wisebread.com/root-cause-of-the-financial-crisis <div class="field field-type-filefield field-field-blog-image"> <div class="field-items"> <div class="field-item odd"> <a href="/root-cause-of-the-financial-crisis" class="imagecache imagecache-250w imagecache-linked imagecache-250w_linked"><img src="http://wisebread.killeracesmedia.netdna-cdn.com/files/fruganomics/imagecache/250w/blog-images/foreclosure-sign_0.jpg" alt="" title="" class="imagecache imagecache-250w" width="250" height="188" /></a> </div> </div> </div> <p>Several times recently, Treasury Secretary Paulson (and many others) have claimed that the &quot;root cause&quot; of the current financial crisis is &quot;the housing correction.&quot;  This is completely wrong--and unless policy makers realize that it&#39;s completely wrong, they&#39;re not likely to make the right policy decisions. </p> <p>Just today, in his <a href="http://www.treas.gov/press/releases/hp1153.htm">testimony before the Senate Banking Committee</a>, Paulson said:<br /> <blockquote>And that root cause is the housing correction which has resulted in illiquid mortgage-related assets that are choking off the flow of credit which is so vitally important to our economy. We must address this underlying problem, and restore confidence in our financial markets and financial institutions so they can perform their mission of supporting future prosperity and growth.</p></blockquote> <p>Now, first of all, the proposal doesn&#39;t address the housing correction--it addresses the illiquid mortgage-related assets (by buying them)--so it&#39;s still a step removed from what Paulson claims is the root cause.  (Directly addressing the housing correction would involve <strong>buying houses</strong>, not buying loans.)  But that&#39;s neither here nor there, because the root cause is not the housing correction.  The root cause was the housing boom.</p> <p>Roughly speaking, an average household needs to earn enough money to be able to afford an average house.  You can adjust that a bit--smaller, younger, poorer households can be left out of the calculation if you assume that they&#39;ll rent rather than own--but after leaving them out, it&#39;s just not sustainable for the average house to cost more than the average household can afford to pay--who else is going to buy it?</p> <p>Now, you can back things up yet another step in your search for root cause:  How did house prices get too high?  The answer to that question (which has mostly to do with bad interest rate decisions from the Fed interacting with bad public policy in financial market regulation) will help us prevent the next financial crisis.  But for addressing this financial crisis, all we need to understand is that the correction is <strong>not</strong> the root cause.  The root cause is that house prices got so high that the average household couldn&#39;t afford an average house.  Once that happened, a correction was inevitable.</p> <p>The way to address the root cause is to let house prices drop to where an average house is within the means of an average household.  (Or, alternatively, boost the income of the average household to the point that they can afford an average house.  But that&#39;s very hard.  Letting houses prices go on falling, although painful for everyone who owns a house or who has lent money to someone who owns a house, is very easy.)</p> <p>Now, some sort of bailout plan may be necessary to keep the financial system from simply collapsing under the weight of all that bad debt.  But if that plan is focused on keeping house prices from falling, it&#39;s a hopeless plan.  If you successfully kept house prices up, we would remain mired in this problem until incomes rose enough to make house prices affordable.</p> <br /><div id="custom_wisebread_footer"><div id="rss_tagline">This article is from <a href="http://www.wisebread.com/philip-brewer">Philip Brewer</a> of <a href="http://www.wisebread.com/root-cause-of-the-financial-crisis">Wise Bread</a>, an award-winning personal finance and <a href="http://www.wisebread.com/credit-cards">credit card comparison</a> website. Read more great articles from Wise Bread:</div><div class="view view-similarterms view-id-similarterms view-display-id-block_2 view-dom-id-2"> <div class="view-content"> <div class="item-list"> <ul> <li class="views-row views-row-1 views-row-odd views-row-first"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/low-interest-rates-do-not-make-homes-affordable">Low Interest Rates Do Not Make Homes Affordable</a></span> </div> </li> <li class="views-row views-row-2 views-row-even"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/is-it-the-end-of-6-real-estate-commissions">Is It the End of 6% Real Estate Commissions?</a></span> </div> </li> <li class="views-row views-row-3 views-row-odd"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/more-tax-credits-coming-for-homebuyers">More Tax Credits Coming for Homebuyers?</a></span> </div> </li> <li class="views-row views-row-4 views-row-even"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/your-equity-was-always-imaginary">Your equity was always imaginary</a></span> </div> </li> <li class="views-row views-row-5 views-row-odd views-row-last"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/refi-shy-how-to-determine-if-now-is-the-time-to-refinance">ReFi Shy? How to Determine If Now Is the Time to Refinance</a></span> </div> </li> </ul> </div> </div> </div> </div><br/></br> Real Estate and Housing bailout financial financial crisis government real estate Tue, 23 Sep 2008 18:21:19 +0000 Philip Brewer 2452 at http://www.wisebread.com