A Simple Explanation on The State of The Economy

[Yavin4]

Normally, when things get slow, the Fed cuts interest rates to boost consumption. Increased consumption leads to more hiring because producers need to re-stock and re-build inventory to meet the demand. This, in turn leads to more consumption as the newly hired workers get more money to buy more, etc. When hiring reaches a certain level, the Fed raises interest rates to cool off the economy. That's how it's supposed to work.

It's not working this time because the economy never saw the increased hiring. Due to globalization, offshoring, and outsourcing, the job growth following a huge consumption boom happened overseas, mostly in India and China. These nations manufacture the products and design the information technology processes now. The only jobs that this latest consumption boom created were the low-level, temporary customer service like jobs.

For example, homeowners took advantage of the low rates by taking out equity from their homes for say a home improvement project. They'd buy the materials at Home Depot. Home Depot would then have to order more products to re-fill inventories.

For example, the factory making hammers would hire more workers because Home Depot has had a run on hammers. However, in this last cycle, the factory making the Home Depot hammers is in China, and the only domestic job that the low interest rates created was for the Home Depot customer service rep and cashier that rung up the purchase.

Now, the Fed has to raise interest rates because inflation is over-heating the economy, but there's been no big job growth that normally follows lowered interest rates. In sum, we entered into a recession in 2001, from which we never really recovered. All that's happened to our economy since 2001 is that whole lot people borrowed a whole lot of money at very low rates, spent it, and created jobs overseas.

[patrice]

1. Append to the last sentence . . . .

And wiped out what Savings they had by borrowing against their home equity.

I wonder what the major political persuasion of all of those home equity loaning companies is.

[TheFarseer]

2. yep, that's the deal n/t

[toymachines]

3. well said

I will have a talk with my econ teacher

[sendero]

4. To refine your point a bit...

... we never saw the expected increase in consumption. Lack of hiring is probably the main reason for that, but there are others, such as increased energy costs and the ever-more-tapped-out condition of consumers in general.

If it werent' for an artificial surge in homebuilding, created by low mortgage rates and misguided lending guidelines (no down, qualify anything that breathes), this economy would be much much worse.

And of course cash-out refinancing.

The Fed has been "pushing on the string" for 5 years now and it hasn't done much. One wonders what the next phase will consist of :)

[Yavin4]

5. Energy Is The Wild Card In All of This

Going back to my example, the hammer factories in China have increased the world's demand for more and more energy. Higher energy costs is just one of the many downsides to a rapidly growing world economy.

Sluggish job growth means depressed wage growth. Add in higher energy and you get consumers cutting back like hell on spending.

[sendero]

6. Agreed...

... it is very, very difficult to find a silver lining in this scenario. It seems that oil reserves are being downgraded just as oil demand is at the knee of a rise.

I'm hoping to buy a few more solar panels soon :)