You're reading an email, in THIS economy?
Good afternoon, fellow bacon enthusiasts!
What’s on the menu today? 3 strips of steamy bacon.
Number of the day: -5
Lesson of the day: Economics 101
The Economic Cycle
Productivity & Debt
What this tells us about our present and future
Savory selections
Number of the day: -5
As in, the US’s Gross Domestic Product (GDP) for Q1 was -5%, which is known as a contraction.
Contraction: a stage of the economic cycle where growth declines and unemployment increases.
This was worse than what many pundits predicted, but, I mean, can we really be that surprised? It’s not often we experience widespread social restrictions and an unemployment rate of ~15%.
Economics 101
Don’t worry - I’m not going to bore you with supply and demand principles. I’m not taking attendance, and there won’t be an exam.
But I think it’d be worthwhile to talk through the stages of an economic cycle and how they tie into our reality.
The Economic Cycle
First, let’s define the other stages of the economic cycle (besides a contraction): expansion, trough, and peak.
Expansion: growth increases and unemployment declines (i.e. more people get jobs).
Trough: the country’s output bottoms out, unemployment is high (lay-offs galore).
Peak: the country produces at maximum output and unemployment is minimal.
This means, from an economic perspective, what we’re experiencing is totally normal. The root cause is unprecedented, but the economic decline isn’t anything new.
Productivity & Debt
Now, let’s add a layer to this big picture perspective. At the base of our economy is productivity - we grow over time as we learn more and discover better ways to do things. But this is a slow process.
Our economy’s infrastructure is built on borrowed money. Debt facilitates growth. It allows people to spend more than they have and businesses to invest in new projects and developments.
But, debt also amplifies economic decline during contractions. So, debt creates cycles (periods of increased spending followed by periods of decreased spending).
Let’s break down the pieces of GDP’s growth over time.
#1 Long-term productivity growth: the economy’s growth over time due to learning and associated advancement (better technology, deeper understanding, increased efficiencies, etc.).
#2: Long-term debt cycle: roughly 50 years of borrowing, spending, and repayments (i.e. a long debt cycle).
#3: Short-term debt cycle: roughly 8-10 years of borrowing, spending, and repayments (a short debt cycle). Combined, these mini-cycles create the long-term debt cycle.
Together, we get something like this:
In short, debt accelerates growth (raising our output ceiling) but also accelerates decline (lowering our output floor).
If you have 31 minutes, I highly recommend Ray Dalio’s simple explanation of the economy. It explains the most basic principles and ties them all together. A fourth-grader could understand it. It’s worth your time.
What this tells us about our present and future
Right now, we’re experiencing a contraction - and an increase in unemployment. That means less income and less spending. The question on everyone’s mind: have we hit the trough?
While we won’t know the answer until after the fact, we can take a guess based on the current environment.
I recently wrote about our economy’s fragile situation; here’s a relevant excerpt:
“Social restrictions keep the full labor force from working, which means a lot of businesses and people aren’t making money. This problem gradually trickles up the economic food chain. Lack of income leads to the inability to make loan payments. In turn, loan defaults increase in frequency (and aggregate size). Then banks must bear the financial burden of these bad loans, which may cause them to fail.
When our financial infrastructure fails, consumer confidence erodes, business developments and investments diminish, unemployment climbs, and the economy shrinks.”
So, it’s reasonable to say that the answer to that question depends on when these social restrictions will be lifted.
The first quarter of 2020 was bad (remember that -5% GDP figure?). The troubling part is that the second quarter will likely be worse since we’ve had social restrictions and business closures throughout April, May, and (safe to assume) June.
Technically, we’ll enter a recession (which is defined by two consecutive quarters of economic decline).
I don’t say any of this to paint a bleak picture of an unstable reality and hopeless future. Quite the opposite, actually. My hope is that by understanding the economy’s cycles, you’ll be more prepared to maneuver through the rough patches.
…
If you’re wondering what any of this has to do with personal finance, the answer: a lot.
This might be a big picture explanation, but economic decline ultimately impacts each person's personal finances. Some more than others (especially if external factors cause you to lose your job)).
To optimize your personal finances, you have to understand how you (and your money) factor into the big picture.
Savory selections
If you enjoyed the lesson, you might enjoy these posts about the economy:
Monopoly: Board Game or Our Current Reality?
The 90% Economy: Indefinitely Temporary?
Stay sizzlin’,
Carter Kilmann