Personal Finance Blog by Debit versus Credit

What Everyone Who Has US Dollars Needs to Know About China

November 19, 2008 | Filed in: Economy | No comment

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Today we’ll be featuring a guest post from Simit Patel, a contributing analyst at InformedTrades.com

As the recent economic turbulence has shown us, we live in a global economy. And thus, if you want to astutely manage your finances, you need to know about how global factors can affect your wealth.

And if you hold US dollars, there’s one factor that you should be particularly wary of: China.

The US government is currently running record levels of debt, and with government spending continuing to rise given the bailouts, entitlements, and foreign policies that have been promised, the debt will likely rise — especially when we remember that the tax base is diminishing due to rising unemployment. And right now, one of the biggest lenders to the United States is China. To put it in consumer terms, China is like the bank that gave the US a credit card to finance its expenditures.

Of course, how much longer China, as well as other buyers of US Treasury bonds, continue to buy US debt is increasingly becoming an issue — particularly as the global economy is contracting, thus making lenders more wary of lending. Accordingly, China and the rest of the world may not be buying US debt — just at the time when the US government is looking to increase its expenditures.

So the question: is the US on the verge of maxing out its credit card?

Well, one way the US government can attract more lenders is to raise its interest rates. Currently rates are moving in the opposite direction; the Federal Reserve, the organization that establishes the monetary policy of the US dollar, is moving interest rates to near zero in an attempt to encourage borrowing and spending as a means of stimulating the economy. However, if the US has trouble securing more debt, it may need to raise rates — i.e. the amount it is willing to pay for the privilege of borrowing — to attract the debt. This does, however, introduce greater problems down the road, as it will increase the overall debt burden on the
US government and its taxpayers.

Alternatively, if the US government is not able to secure more debt — if, to put it in consumer terms, it’s credit card is maxed out — it will need to print more money to pay off its debts. This will result in currency devaluation. Personally, this is the scenario I am more concerned about.

If more money is printed and the currency is devalued — meaning it will cost more to buy the same goods and services — how can you protect yourself? Well, just as we now need to monitor the global economy for signs of problems, we can look to the global economy for solutions as well. Foreign currencies and precious metals — particularly gold and silver — have historically served as ways to protect against currency devaluation. For individuals looking to preserve and grow their wealth, diversifying globally may be a path worth embarking upon.

Simit Patel is a currency trader and contributing analyst at InformedTrades.com, a site that offers free courses on trading the world’s financial markets.

Tags: Debt, Economy, Globalization, Guest Post, wealth

Why Another Rate Cut Could Do More Harm Than Good

November 17, 2008 | Filed in: Economy | 1 comment

It’s clear that the root cause of the financial difficulties that we’re facing in the United States is not related to credit being too expensive. It’s quite the opposite in fact - credit is cheap right now but many banks are actually cutting back on lending. So what gives? Why are we sliding into a recession when the Fed has done just about everything that they could to avoid the “r” word?

To be honest with you I don’t truthfully understand everything that’s gone wrong to put our nation and the world in the situation that it’s in. It’s been a long and a drawn out process that some say has been 25 years in the making. Therefore it’d be near impossible for me to cover such a heavy topic on a blog.

Another Rate Cut May Be Near

Something did catch my eye while I was skimming the financial headlines that’s basically directly related to this current crisis and I want to talk about what I read and what I think about it. The Federal Reserve of the United States recently alluded to the fact that they may be making another rate cut in December.

What?

Didn’t we already establish that credit is not expensive? If you remember the last time the Fed cut rates to where they are at now I complained about the rate cut. I was a little annoyed, but to be honest now I’m upset. I think the central bank has forgotten some important details about the current crisis. They’ve forgotten that the American consumer has a great deal of influence in the state of the economy.

Let’s talk about this. I want to hear your opinions and I want your feedback, but more importantly I want to tell you why I think that another rate cut would be foolishness of foolishness.

Why Another Rate Cut Won’t Do Any Good

Another rate cut truly won’t have any affect on how willing financial instituations are going to be to lend money to one another. They aren’t likely to lower consumer loan rates. They will however have a near-immediate impact on consumer savings rates. You think your savings and cd rates suck now? Another rate cut will drop those even more.

It seems to me that these cuts are being made on a purely psychological basis. Almost as if they’re saying that they’re willing to do anything to get the economy back on track. That’s great and all, but is this really going to excite the average consumer? Are they going to see another rate cut and sigh a sigh of relief thinking that their money is going to be safe and we won’t go into a deep, dark recession? Not likely.

Uncertainty Leads to a Recession

The cause of just about any recession goes far beyond actual slowdowns in lending and consumer purchasing. It’s almost always intensified by uncertainty.

People are afraid right now. Truly afraid. If that’s the case then does it seem best to drop rates? I’m actually of the opinion that leaving rates the same could be more beneficial than a rate cut.

The news reports rate cuts nowadays as if they are some sort of super relief element used by the Fed to stop a recession dead in its tracks. Therefore the consumer thinks that a recession is a likely scenario. They stop spending and they start worrying. Suddenly we’re facing a recession. Why? Self fulfilling prophecy.

My Hypothesis on the New Psychology of Rate Cuts

I’m proposing then that a rate cut is more devastating (psychologically) to the average consumer in times of financial crisis than it would be to leave rates the same. By cutting rates the Fed is signaling that they’re afraid and they don’t know what’s going to happen. Let’s leave rates alone for once and see what happens.

You never know.

Tags: Economy, Federal Reserve, Rate Cut, recession, saving

Fed Cuts Rates to 1%

October 30, 2008 | Filed in: Economy | 3 comments

Many of you may have heard by now that the Federal Reserve cut their key fed-funds rate to 1%, bringing it in line with the lowest level that it’s ever been at. Interestingly enough the last time that the rate was at 1% was within this decade - from June of 2003 until June of 2004. Even more interesting is that many people and economists have laid partial blame for the housing crisis on this low rate, essentially saying that the fed made money too cheap and caused people to be greedy and take unnecessary risks. If all of this is the case, then what of this time? Will having such a low rate now cause unexpected hardships in the near future? Besides that what does it mean for me and you now that the fed funds rate is at 1%?

Let’s look at the facts…

First of all a description of what the fed funds rate is, from CNN Money.

The fed funds rate is used to set rates for a wide variety of consumer loans, including home equity lines and credit cards, as well as for many business loans.

You’ve likely heard of the prime rate.  The prime rate changes in line with the fed funds rate.  It is almost always 3% higher than the fed funds rate, which would put the prime rate at 4% sometime in the near future.  Almost all of the banking products that you use are based on the prime rate.  Both deposit accounts and loans change along with a change in the fed funds rate (and therefore the prime rate).  You can expect savings rates of all flavors (cd’s, money markets, savings) to drop and on the flipside you’ll likely see some loan rates to drop as well.

Keeping all of that in mind let’s take a look at what the lower fed funds rate is likely to do for the economy.  There are two options.  It will do nothing, as in not help at all, or it will hurt the economy.  There is no other option.  It most definitely will not help matters at all.  Why?

The problem with the current credit crisis is not that loans are expensive.  They’re actually pretty inexpensive.  At the credit union I work at an auto loan starts at about 5.5% and if you look at bankrate.com the national average for an auto loan is about 6.5%.  No, loans are not expensive, banks are just unwilling to lend, especially to each other.  They are afraid that if they lend out too much of their cash that they could end up in an illiquid situation and go bankrupt just like Lehman Brothers, WaMu or any of the other failures we’ve had as a result of this crisis.

One economist said it best, as quoted again from CNN Money.

“The latest Fed move is not going to hasten the economic recovery by a single day or accelerate the cleansing of bank balance sheets,” said Bernard Baumohl, executive director of The Economic Outlook Group. “What is needed more than anything else at this stage is simply patience.”

Be Patient Mr. Bernanke, Be Patient World.

This thing is not going to fix overnight.  There is no easy fix.  The fed funds rate at 1% won’t do a single thing to fix it.  So why lower it?  It’s probably purely psychological, and at this point it shouldn’t do much harm but I’m afraid the problem is that they won’t raise rates until the crisis cleans out completely, at which point it may be too late.  By then there may have begun another lending bubble.  Let’s hope Bernanke is smart enough not to let it come to that.

In the meantime let’s all practice a little patience, shall we?  It is after all a virtue, and shouldn’t we all strive to be virtuous?  If we were you can bet we wouldn’t be in the mess we’re in right now.

Tags: Credit Crisis, Federal Funds Rate, Federal Reserve, Prime Rate