What happened to the economy — and what it portends for the future

From the Boston Globe:

“Minsky called his idea the “Financial Instability Hypothesis.” In the wake of a depression, he noted, financial institutions are extraordinarily conservative, as are businesses. With the borrowers and the lenders who fuel the economy all steering clear of high-risk deals, things go smoothly: loans are almost always paid on time, businesses generally succeed, and everyone does well. That success, however, inevitably encourages borrowers and lenders to take on more risk in the reasonable hope of making more money. As Minsky observed, “Success breeds a disregard of the possibility of failure.”

As people forget that failure is a possibility, a “euphoric economy” eventually develops, fueled by the rise of far riskier borrowers – what he called speculative borrowers, those whose income would cover interest payments but not the principal; and those he called “Ponzi borrowers,” those whose income could cover neither, and could only pay their bills by borrowing still further. As these latter categories grew, the overall economy would shift from a conservative but profitable environment to a much more freewheeling system dominated by players whose survival depended not on sound business plans, but on borrowed money and freely available credit.

Once that kind of economy had developed, any panic could wreck the market. The failure of a single firm, for example, or the revelation of a staggering fraud could trigger fear and a sudden, economy-wide attempt to shed debt. This watershed moment – what was later dubbed the “Minsky moment” – would create an environment deeply inhospitable to all borrowers. The speculators and Ponzi borrowers would collapse first, as they lost access to the credit they needed to survive. Even the more stable players might find themselves unable to pay their debt without selling off assets; their forced sales would send asset prices spiraling downward, and inevitably, the entire rickety financial edifice would start to collapse. Businesses would falter, and the crisis would spill over to the “real” economy that depended on the now-collapsing financial system.

Whole article here.

This is what it means for you:

  • We are going back to much more of a ‘pay as you go’ economy. You know, the one you grew up in if you’re over 40.
  • Retail sales (remember, 70% of the economy is consumer spending) are going to be at a much lower level for a long time, first because people have to pay off their debt, and then because they’ll have to save to buy things, because credit is and will be harder to come by.
  • We are actually experiencing deflation now. We all know real estate prices are down, sharply in many locations. But you know all those ‘sales’ at stores, even grocery stores? Those are deflation in action. Here’s a personal example: I bought my first GE toaster oven around 1977. I think I paid $29 for it. It broke and I bought a new one, sometime in the early 90’s — I think I paid $49. It broke and I bought a new one around 2001, again $49. It broke and I’m going to Target later today to buy a new one — ‘on sale’ at $15. Looks like pretty much the same model I’ve had, over and over again.
  • In deflation, people hang on to their cash. This makes sense, because you can buy an asset cheaper later than you can buy it now. Yet another reason for lower consumer spending.
  • This may not change for a generation or more. My grandparents were adults, raising their families during the Great Depression. My parents, who were kids then, were part of the ‘save before you spend’ crowd, and I am too, because they trained me well. People who got caught in a debt trap this time around, and their children, will remember this painful lesson for a long time.
  • You have to give people a REALLY good reason to buy something now, because they’ll begin to expect that they can get it more cheaply later. Or it has to be something for which they’re desperate.
  • What are people desperate for? Food, shelter, and clothing (although most of us have enough clothing to last us a few years). And end to their physical suffering, i.e. health care (though I understand that even Kaiser Permanente’s business is off). A way to stretch a dollar. A way to make more dollars to pay for food, shelter and clothing. Transportation to get to those places where they make the dollars. After that, it’s all ‘nice to have’. So how do you relate what you do to one of these things?
  • When people need things, they’re more likely to turn to the underground economy — paying in trade (I have a friend in rural OR who gets paid for some of her services in pot, which she then uses to pay other tradespeople), or in untraceable green cash.
  • People are more likely to buy things used — that’s part of the rise of craigslist and eBay. Flea markets will be busier, too, because people still like to handle the merchandise.
Hollis Polk is a personal coach (www.888-4-hollis.com), who has been helping people create lives they love for 15 years, using neurolinguistic & hypnotherapy techniques, decision science, clairvoyance & the common sense learned in 20+ years of business. She is an NLP Master Practitioner, hypnotherapist & has a BSE in engineering from Princeton & a Harvard MBA. She is also a successful real estate broker, investor & business owner.