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Economic Crisis of 2008 and What It Means for the US Expat
If you are anything like me, you’ve been confused about this economic crisis of 2008. I am not the typical US Expat. I had a head start over many people. I had, at least been educated on such things 25 years ago. Of course, in the day to day lives of most American’s the need for high finance that I learned back then was limited. I wasn’t working as an accountant any longer. For the last 15 years or more, my main professional interest have been computers. Though I admit, I’ve been torn between financial issues and computers. The mundane task of finance had left me hating the site of any form, especially income tax forms. But, accounting in general was causing me to break out in virtual hives. 🙂 Still having spent a lot of time studying such issues, may have helped me to recall the fundamentals I learned in my youth.
This crisis though, it didn’t make a lot of sense to me and it sparked my interest and helped me to recall some of what I learned from Dr. Walter Neely way back during my college education. While Dr. Neely taught me facts, he also taught me how to think which was far more important. You might want to visit his home page. You can get an idea of what his classes are like by visiting the Louis Wilson Fund page. Take a look at the write ups the students are doing. Those are both undergraduate and graduate students. We wrote similar papers but we didn’t have computers or webpages. Boy could I have used a computer. Dr. Neely really gave me a hard time about my hand writing and rightly so.
Hopefully, I remember enough to get this article mostly correct. Yet hopefully I have forgotten enough to write in a language the rest of us can make sense of. That is the non-financial uber geek. I need to define a couple of things though. Generally
- Short term means less than one year.
- Long term means more than a year.
- Assets are items that are purchased that retain a value.
- Expense are expenditures that don’t have additional value, they are gone or used up when purchased
Before I started researching the issue, I wasn’t at all sure the crisis was really a crisis. With age, many gain a lot of skepticism about anything the politicization tell us. I may have gained more than most. But, there is a crisis and I understand it now that I’ve done the research.
What caused the current economic problems?
A Credit Contraction.
So what caused this economic crisis? Mostly the crisis has been caused by business improper use of credit. What set this up is that credit has been historically cheap. So cheap that it might be better to hold on to your cash and borrow borrow borrow and that might make sense but only if you had the cash in case those debts had to be paid. That was the safe way of dealing with this. Having cash makes you a take over target though. A company in need of cash might acquire your company to raid its cash and thus leaving the acquired company in an unstable position.
Say a company saw this boom in consumer spending and decided it was time to open more stores. You wont have to think hard to recall some companies in the US that have been expanding. For the most part, I have not even studied their financial statements much less do the in-depth analysis that would be needed to comment on any of the companies. Those that come to mind are Walgreen’s and Wal-mart. Again, I don’t know what kind of condition these companies are in. I’m just using them as an example that most Americans living in the States will recognize.
A company could greatly improve their financial statements by buying instead of renting. Rent is an expense and lowers your income. Buying a building though removes the expense and puts an asset with value on your financial statement. These buildings are expensed a little at a time over 30 years or so. You have more assets and less expense. Plus you can sell these buildings at a later time and likely gain income through those sales too! What could be wrong with that? Nothing if it is done correctly.
If a company finances these long term (buildings) assets with short term debt that has to be paid off and re-borrowed in less than one year and that company finds it can’t borrow money at any price or excessive long term interest rates, how are they going to pay off these short term loans? They may not be able to and the banks may refuse to make them new loans. The lenders may decide I’m better off getting what money I can get out of this even if I force you into bankruptcy. Now, if the business has the cash to pay off these short term loans, then they will be okay though they may be cash strapped. Will they be able to meet payroll? Will they be able to maintain inventories? Probably not at current levels.
Businesses will have to reduce inventory in order to raise cash. That causes layoffs at the production and shipping levels. Those layoffs cause fewer purchases by the consumers as they have less cash after loosing their jobs. The fewer purchases cause more layoffs. You can see the cycle that develops. Further, these reduction in inventories take some time to help a business decrease its cash outflows. So many businesses have no choice but to turn to layoffs which can give it an immediate reduction in cash outflows. Obviously, that means fewer people to buy the goods off the shelf which increases the need for retailers to buy even fewer goods. So the retailer has less need to have inventory of some items, luxury items are almost non-existent further decreasing demand and thus more layoffs at the production and shipping locations. AS there is less shipping, more layoffs occur at the factories that make parts for vehicles and other shipping related needs It is a vicious circle. Even a growing circle that can continue for a long time.
In the worst of times, these retailers will start selling off some of their assets by closing stores. Buildings are non-liquid, real estate is considered a risky investment because of this lack of liquidity. It can take a long time to convert real estate into cash. So even if you close and put the store on the market it may sit there for a long time. Now you have this asset sitting there, earning no money and you still must pay the short term debt coming due on it! And of course, by this point in this article, I hope you can see that with the store closed, there are more people out of work and thus more people with a loss of spending power. Causing even more damage to the demand for inventory and shipping levels.
So what happened?
Many businesses counted on being able to turn their short term debt into long term debt. But with banks failing borrowers are finding it impossible to borrow dollars at any rate and therefore, can’t pay off their loans. When they can find credit it is at a much higher cost than before. This higher cost reduces income and shareholders are not happy! And worse, banks are not happy. The banks become more skiddish about loaning more and another vicious cycle is working to do more harm to the ability of Main Street to buy the goods that make Wall Street happy.
I find it difficult to put blame on the finance directors of companies or the small business owners that wears all the hats. Would you want to pay more for debt than you had too? Maybe if your risk avoidance is high. If you are the person that looks at the end of the loan and worries about how you pay it, then you opt for the long term loan. Then you get fired because your income statement is not as high as the competitors! If you’re wise and know how to keep your job longer, you know how to get that lower costing debt. if you’re really wise, you make sure that enough cash is on hand to meet your short term needs! If not, your head is still going to roll but it might take a little longer to get there.
Short term interest rates were lower than long term because no one thought these low rates could last and long term debt is considered a higher risk as over time, more things can go wrong. As I pointed out before, in the current situation borrows have found they can’t get loans at all!
Politics of 2008
Bush and McCain have been saying up until a week or so ago, the fundamentals of the economy were strong. Perhaps Bush didn’t know. He would only know if his advisers explained it to him. Does McCain know better? I hope so. I hope it was politically necessary for him to stay the economy was strong since it was his party in power. If he doesn’t know, that’s scary. So much for the straight talk express though. I believe he knew and just hoped everything would hold together until after the election.
Obama has been saying this has been caused by speculation and greed. He’s right. What do we do, take the profit motive out of the system? After all, that’s what speculation and greed is all about. How much government involvement do we want?
History has shown over and over again that those who thought they could prevent a contraction were badly mistaken. Things can be done to lesson it and that’s what the bailout is about. How much we need to soften the blow is for people smarter than I. I don’t know. Even most of the conservatives want government intervention in the markets, they are not at all for the invisible hand taking care of this situation alone.
Can regulations be put into place to prevent it? Maybe, but so far, no one has been able to do so. This is not new. It is a normal business cycle but it promises to be more than just a recession unless there is government intervention to cushion the blow. I don’t think the government should completely remove it this correction. Part of this is natural to the capitalist system. Will there be pain, yes. But we need to lessen that pain.
It is not just Wall Street that is suffering, people are loosing their pensions. I’m not talking about golden parachutes. I’m talking about the average woman working the assemble line at a parts factory that feeds the transport truck makers. I don’t want to see that company fail and take away 20 years of work and planning for your average joe. The American Joe! Hey Joe! Hope you’re having a good life.
What does it mean to the expat?
The demand for the dollar is rising. The expat with loads of cash in the bank should very likely keep it there for a while. Next week is going to tell us a lot. This contraction started in the summer of last year. If you have been following the US dollar to the Philippine peso exchange rate, you might remember the dollar starting to fall about the same time. Where these two things related? Probably not, as it is the reverse of the behavior one would expect. So why did it take so long for the exchange rate to react?
It takes time for the effects of a credit contraction to make its full impact felt. For a while there is a lot of cash out there but over time the crunch in cash is felt. Eventually there are fewer dollars as the dollars have been used to pay off debt and the banks refrain from lending. As the demand for dollars rise, and the supply diminishes, good old capitalism kicks in and drives the value of the dollar up. But be careful or you’ll find yourself falling into the same trap giant money managers fell into to cause this problem and you can bet, no one is going to bail you out but yourself! The trap? In part, things get so good that people think they will continue to be good. Greed become blind and good judgments are not made.
Investing in currencies is a risky business. On the other hand, if you have a good steady pension that will always be there, like a government pension from the old civil service system you can be in great shape. You’d probably be in even better shape if the government had done nothing and not passed the so called “economic bailout bill.” I don’t personally want that, while I do hope this all puts me in a better position but again, i don’t want to see people loose 20 years of planning.
So in short, as the demand for the dollars increase and the supply is limited, my pension is worth more. There are so many factors that determine how that plays out. The Philippines have been going through a period of inflation so my dollars are worth less for that reason. But the rise in inflation here has been much lower than the increase of my dollars. Here is an example.
Say you earn $1000 around March of 2008 when the dollar to Philippine peso exchanged at $38 to 1Php or 38,000 Php. The same $1000 is now worth about $47.1 to 1 Php or 47,100 Php. That’s over $200 USD a month more to you. If you earn $2000 USD then you have $400 a month more. That’s a substantial gain.
I’ve looked back over the last 10 years and this $38.00 rate is quite low. That would make sense if there were too many dollars out there. Even though the contraction had started it was not yet felt by the market. That took time. As banks and insurance companies began to fail, and as investors realized the contraction was coming, the demand for dollars increased. The savvy investor would be willing to pay more as they would know what was likely to come. These forward looking investors knew that a shortage in dollars was coming and thus the price we expats would earn in the exchange went up.
The Php38.00 was lower than it first appears as I didn’t adjust for inflation Doing so would make the Php38.00 a staggeringly lower price. As that was Php38.00 in 1999 funds. These are round numbers and I really need to look far more in depth than I have. Some of those computations are a bit beyond my memory. Especially the compound adjustments needed to restore the value to 1999 funds. I may even have the exact years off. I only glanced at these numbers.
My purpose was to make sense out of this mess, not for investment purposes. You would need to do a lot more research and should probably seek the advice of a professional. Most people do not have the time it takes to do the kind of analysis needed even if they do have the knowledge. And always remember to never risk more than you can afford to loose. If you’d like to obtain more historical information it is available here.
For many, it means that you will have enough disposible income to have some fun with. The tide will turn but we should be at a low point with things looking up for our exchange rate for some time to come.
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