Thursday, October 2, 2008

Economic Crisis: To be avoided?

As J.D. put in his post The Market Meltdown, when things are getting more and more gloomy, it comes down to a matter of principles. Can you stick with you budget, your spending plan and your moral obligations?

Is anyone safe from this downturn? I believe the answer is no. People, rich and poor, have to face rising inflation from the flood of money coming from the Fed, increased cost of capital from banks tightening lending policies, and lastly, unbelievable propaganda from both sides of the situation.

As Trent over at The Simple Dollar said, the only thing we have to fear is fear itself. While I agree with Trent that the average consumer is grossly uneducated about the current market situation, I do not agree that there is nothing to fear.

Inflation is real and it hurts. When was the last time you checked the price of milk or bread. It seems that everyday it gets more and more expensive. As the government pumps money into the economy, it essentially devalues the money already in circulation. That, coupled with poor exchange rates with countries around the world, has crippled the dollar, causing prices to go up. Oil is a major factor here for consumable items, but it is not the only reason. Inflation is absolutely something to worry about with your investments.

The financial market in Today's world is very circular. The very simple version is this: One bank lends to another bank, who then lends the money to a consumer, who then purchases a home from a home builder, who then pays his suppliers, who finally deposit their money back into the original bank. Banks are now tightening lending standards for two reasons; they cannot afford to make any more risky investments (sub-prime debt) and they need to hold onto as much cash as their assets lose liquidity. With the credit market tightening lending policies, banks are unwilling to loan to each other, correspondingly making it more difficult for consumers to get money. Businesses can't get credit required for investments to grow, and individuals can't get credit to buy cars or homes. When consumers can't get credit, the economy can't grow.

With the media pushing Congress's actions as a bailout, I think it really needs to be referred to as a stimulant for the economy. Congress is not wiping the noses of people who misstepped, they are simply trying to kick-start the credit market. While there are no guarantees, I believe by removing the bad debt in the lending arena, banks will be more willing to lend, people will have access to credit and the Federal Reserve will stop pumping money into the economy, thereby slowing inflation.

No one is safe from the current situation. Everyone needs or has desires for money, even the rich. When the money isn't there, it hurts us all.

Moral of the story: Stick to your principles. Understand your financial picture and maintain your focus. Work to secure additional income if falling short and to cut expenses if necessary. The economy will recover, but only YOU can control your financial house.

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