GRM 139: How Your Spending Impacts The Economy
The health of our economy impacts all of us. When the economy is strong, we reap the financial benefits; higher wages, cheaper goods, and many others. Of course, the opposite is also true. A weak economy hurts our finances. But, did you know that your personal financial choices play a crucial role in the health of our economy? In this episode of GMR, we discuss debt cycles, what they are, how and why they happen, and what this means to your personal finances and our economy.
Show Notes
Economics = the branch of knowledge concerned with the production, consumption, consumption of goods and services, and transfer of wealth.
Productivity Growth
In a transaction, you have to give something to get something. How much you get depends on how much you produce.
Those who are inventing and hardworking, increase their productivity and their living standard faster than those who are complacent and lazy or have cognitive disabilities that cause them to not increase productivity at the same speed.
Productivity Growth
Labor productivity - the amount produced by labor vs. amount input.
One piece of wood + 1hr of labor = a wooden toy worth $10.
A new tool might allow me to take the wood + 1 hr of labor and create 3 toys, each at $10, so now I earn $30 an hour. Productivity increased through the use of the tool.
One of the measures of productivity in a country is the Gross Domestic Product (GDP) - a very simple definition: everything the economy produced in a year (that’s a very simple definition, there is a lot more complexity out there.
Ways to Increase Productivity
Investment is in physical capital — machinery, equipment, and buildings.
Innovation & new ideas. New technologies, new products.
Skills, new skills, or sharpened skills increase the quantity and quality of labor.
New businesses that compete with existing firms through new ideas and new technology, increasing competition.
Competition improves productivity by creating incentives to innovate and ensures that resources are allocated to the most efficient firms.
Productivity matters most in the long run
Without productivity, everything falls apart.
Working harder and or smarter/more efficiently will always result in improving the economy (personal as well).
Credit matters in the short run.
GMR Episodes to Increase Productivity
GMR 28 – Get Hired: Tips for Landing Your Next Job
GMR 45 – Unleashing Your Superpower: Persuasion & Communication
GMR 101 – RAMP System for Life-Long Success: Chris Missimo Interview Part 1
GMR 102 – RAMP System for Life-Long Success: Chris Missimo Interview Part 2
Credit/Debt is what creates cycles
This is because productivity growth does not fluctuate much, so it’s not a big driver of economic swings. It’s typically a long-run slow growth in productivity.
Debt creates a lot of economic swings because it allows us to consume more than we produce when we acquire it and it forces us to consume less than we produce when we have to pay it back.
Remember, when you borrow in order to get something you can’t pay in full today, you’re agreeing to spend less of the money you earn in the future.
Borrowing (debt) creates big short-term swings. I can buy a $200,000 house with only $10,000 of today's money.
That’s a big personal swing...imagine that action times 10 Million people in the U.S. buying homes...This creates a short-term economic cycle swing upward.
The economy didn’t increase productivity, it just increases debt (which added a lot of spending in the economy, but also added risk if people aren’t able to pay).
Debt swings occur in two big cycles:
5 - 8 years - short term debt cycle
75-100 years - long term debt cycle
`Most people don’t see these cycles because they look at them too close, day by day and week by week.
It’s important that we look at these 3 forces (productivity (long-term), short and long term debt cycles).
Swings are primarily due to how much credit is available
When credit is available, spending goes up - that’s an upcycle.
When credit is not available (too expensive - high-interest rates), spending goes down - that’s a down cycle.
In an economy where credit is not available, the only way I could increase my spending is by increasing my income (personal productivity), which means I would need to produce more.
Increased productivity is the only way for growth.
Since my spending is someone else’s income, the economy grows any time I or another person is more productive. If we follow the transactions, we will see a progression like the productivity growth line.
Because we borrow we have cycles, which is not due to any laws or regulations, it’s due to human nature and the way that credit works.
Borrowing is pulling spending forward
In order to buy something you can’t afford, you need to spend more than you make.
To do this you have to borrow from your future self.
This causes a time in the future when you’ll need to spend less than you earn.
This resembles a cycle of more spending and less spending, which is caused by any time you borrow.
This is true for you individually as it’s true for the economy.
Understanding credit is important because it sets into motion a mechanical, predictable series of events that will happen in the future.
The short term debt cycle
Economic expansion is due to borrowing.
When the amount of spending and income grows faster than the production of goods, the price rises (inflation).
Interest rates increased (central bank) reduces borrowing, which changes the cycle (deflation).
Too much deflation (no spending due to no available credit, or too expensive to borrow) will lead to recession, which will lead the central bank to decrease interest rates, beginning the upward cycle once again.
Cycles are determined by available credit (cheap - short term debt).
When credit available there’s an expansion.
When credit is unavailable there’s a recession.
This is controlled by the central bank.
The problem is human nature pushes it! People borrow more than they should.
As long as income rises debt is manageable.