Hello everyone..!!! Welcome to "INTROSPECTION". Today I'm back with another post BOOM OR BUST- III which is the final part for a couple of our previous posts. I can say without any hesitation that you are not going to understand this part if you have not read the first 2 parts. Kindly check them out and here are the links: BOOM OR BUST, BOOM OR BUST-II.
Continuation from 2nd part...Deleveraging is the situation for which the central government and the central bank must come out with a way to retain the normal functioning of the economy. The main problem in deleveraging is the debt burdens are too high and they must come down, and 4 ways can make it happen. These 4 ways have happened in every deleveraging in modern history. They are:
CUT-OFF IN SPENDING: People have already started to cut-off their spending to pay back their debts. It is expected that if spending is lessened then the debts are supposed to decrease. But it does not happen in that way because spending is cut, it affects the incomes also(as one person's spending is another person's income). The fall in income is faster than the fall in the debts. Debt burden goes to worse because incomes are decreased. So cut-off in spending is obviously deflationary and also painful. Even businesses are forced to cut costs which results in fewer jobs and unemployment.
All these impacts the central government because lower incomes and unemployment means lower taxes. Also, the government needs to increase its spending as unemployment has risen. In addition to that, it needs to create stimulus plans to balance the loss that occurred. So the government's budget deficits increase in deleveraging due to lower taxes and increased spending. This is what happens when you hear about the budget deficit in the news. To fill the deficits either it needs to increase taxes or borrow money. But with the fall in income and more unemployment, where's the money going to come from? THE RICH, which leads us to the 3rd way.
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KEY STATEMENTS TO BE REMEMBERED:
- One person's spending is another person's income.
- Spending drives the economy.
- More spending causes an increase in demand leading to "INFLATION".
- Less spending causes a decrease in demand leading to "DEFLATION".
- Productivity is the income earned by working which does not include the credit.
Continuation from 2nd part...Deleveraging is the situation for which the central government and the central bank must come out with a way to retain the normal functioning of the economy. The main problem in deleveraging is the debt burdens are too high and they must come down, and 4 ways can make it happen. These 4 ways have happened in every deleveraging in modern history. They are:
CUT-OFF IN SPENDING: People have already started to cut-off their spending to pay back their debts. It is expected that if spending is lessened then the debts are supposed to decrease. But it does not happen in that way because spending is cut, it affects the incomes also(as one person's spending is another person's income). The fall in income is faster than the fall in the debts. Debt burden goes to worse because incomes are decreased. So cut-off in spending is obviously deflationary and also painful. Even businesses are forced to cut costs which results in fewer jobs and unemployment.
RESTRUCTURING OF DEBTS: The increased complexity in a 1st way has lead to a 2nd way which is the restructuring of debts. Many borrowers find themselves unable to repay their debts and the banks have realized this. If borrowers don't pay debts the banks get squeezed as much of their money is in the hands of the borrowers. Not wanting to lose their money banks make a restructuring of debts which means that they get paid back less amount or paid back over a long time frame or paid at low interests than that was first agreed. As we all know that something is better than nothing. This means that people are forced to repay their debts by sweeping their pockets. Even though debts start to decrease, there is only the repayment of debts but no borrowing which results in low spending and disappearance of incomes. That is why like cutting spending even debt restructuring is also deflationary and painful.
All these impacts the central government because lower incomes and unemployment means lower taxes. Also, the government needs to increase its spending as unemployment has risen. In addition to that, it needs to create stimulus plans to balance the loss that occurred. So the government's budget deficits increase in deleveraging due to lower taxes and increased spending. This is what happens when you hear about the budget deficit in the news. To fill the deficits either it needs to increase taxes or borrow money. But with the fall in income and more unemployment, where's the money going to come from? THE RICH, which leads us to the 3rd way.
DISTRIBUTION OF WEALTH: Since the government needs more money and since the wealth is heavily concentrated in the hands of the small percentage of people, the government raises taxes on wealthy people. This helps the government to take from the wealthy and spend on the inadequate. If this goes on for a long time the 'haves' starts to oppose the government saying that, their hard-earned wealth is being taken away. While the 'have-nots' start to resent the 'haves' for not helping them despite being wealthy. Social tensions arise and within no time the focus shifts from the economical aspect to the social aspect which is an insult to the already existing injury. More importantly, the money taken from the rich is only sufficient to meet the minimum requirements of the economy which is feeding the inadequate. And apparently, this is not enough to boost economic activity. Hence redistribution of wealth is also deflationary again.
- In the 1930s a similar situation has resulted in Hitler coming to power.
And this leaves the government with the only way, that is:
PRINTING NEW MONEY: The pressure to do something has forced the central bank to print new money. Although the central bank can print money it can only use the printed money to buy financial assets and the government bonds. So the central bank does buy the financial assets and government bonds. By buying the assets it helps in raising the asset prices. This benefits the people who own financial assets as they become creditworthy again. Only the central bank is limited to its actions but not the central government. It can buy goods and services and put the money in the hands of the people. So to repair the damage both the central bank and the central government must coordinate with each other. Now, by buying the bonds the CB(central bank) lends the money to the CG(central government) and allows the CG to run the deficit. While The CG increases its spending on buying the goods and services, on stimulus plans, and on lowering unemployment.
To summarize, as I said at the start of the post that in deleveraging the debt burdens are too high and they must be brought down with minimum possible trouble. When I say minimum trouble, it means that debts must be brought down without disturbing the required spending and also increase in incomes. What actually happens with the above-discussed methods is by "CUTTING OF SPENDING" people stop overspending and control their non-essential expenses. And to facilitate their debt repayment "RESTRUCTURING OF DEBTS" is implemented. But cutting spendings and debt repayments cannot go long without raising income levels and economic activity, to achieve this government uses "REDISTRIBUTION OF WEALTH" and "PRINTING NEW MONEY" which facilitates incomes and economic activity as well. Hence the policymakers must take good care in balancing all the four ways.
Hence not one or two but the right balance in cutting-off spending, debt restructuring, redistribution of wealth, and printing new money can achieve both economic and social stability. Yes..!!! people might ask that printing new money may cause inflation. Not when it is off-setting the falling credit. Because I hope you remember that spending is what actually matters which can always be boosted by the credit. The spending of a rupee with money is equal to the spending of a rupee with credit. The key here is to not print more money leading to inflation as Germany did in the 1920s.
TAKEAWAYS FROM ALL THE THREE LENGTHENED POSTS:
- Never allow debts to rise more than your income because they eventually eat your income and crush you.
- Never allow your income to rise faster than your productivity.
- Try to put your best possible efforts in increasing your productivity, because that's what matters most.
Here's what the basic template of the economy looks like. My reason for choosing this topic(even though it is drainingly long) is because I feel that understanding our economy is very important for us to handle our money in a better way. No..!!! I'm not suggesting that everybody must be an economical expert but having a basic idea of how it actually works is apparently helpful. I am hoping that people who have read this post have found this helpful(and not that entertaining).
Thank you..!!!
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