And as a bonus question, how have we fallen into the same problem we did just 14 years ago, how did no one think “let’s do it differently this time guys!”
In: 6
Ok, first off there are few if any parallels between the Economy today and in 2008 so that’s a flawed question. As for the economic problems of today there are three problems. First, US inflation went high due to excessive government spending and supply chain issues. In order ro curb inflation the Fed is rapidly increasing interest rates to slow the Economy. This doesn’t just hurt the US either as so much global commerce and debt is denominated in dollars so the Fed raising rates also tanks economies across the globe. Secondly, Russia invaded Ukraine resulting in NATO imposing sanctions on Russia. These sanctions have caused energy prices to rise which is also bad for the economy. Third, China has been VERY aggressive at fighting COVID including shutting down whole cities. Since China produces so many goods these shutdowns have caused ripples across global supply chains.
PS: Take the media’s fear mongering with a big heap of salt. Unemployment is at the lowest point in most of our lives. The Economy isn’t really doing that bad.. although there are storm clouds on the horizon. Also remember the stock market is NOT the Economy.
It’s NOT the same problem as 14 years ago… a recession just means a period of negative economic growth. Recessions are a common economic cycle, and in reality going 14 years without one is unusual. Most of the time not nearly as painful as the one in 2008. There can be many causes and a range of severity. The 2008 recession was the deepest recession since the Great Depression of the 1930’s. And it was caused by a house of cards built upon real estate prices, mortgages, and financial system based off them. Increasing demand for mortgage-backed securities caused loosened lending, and mortgages were given to just about anybody for absurd amount of money. The idea at the time was that real estate doesn’t go down in value, so it’s safe even if somebody defaults here or there. The volume of defaults and snowball effect as prices fell, as well as the ways in which financial markets were intertwines were not well understood until it was too late.
This time, the recession will be caused by rising inflation caused by COVID, and the attempts to slow the economy to slow inflation. But cutting access to borrowing has the side effect of slowing growth. Real estate prices aren’t the cause, but a victim, as higher mortgage interest rates cut affordability. Home prices may level off or fall slightly, but it’s due to reduced buying power of new buyers not unqualified owners defaulting.
Recessions are a necessary part of the economic cycle. After a long period of growth (which we have had), economies tend to accumulate companies that are less efficient or poorly structured which are “kept alive” by easy credit and easy growth. A recession helps to weed out these poorer companies and frees up resources (capital, workers etc) for renewed growth.
Underlying all economic growth will be the deployment of new technologies and methods, hiring better and more educated workers. This is a fairly dynamic situation so this idea of “lets do things differently” occurs all the time in various individual firms and investment decisions.
What follows is the Official Story of most mainstream economists and government officials. Other ways of thinking are possible [1].
2008 problem: Too many bad debts cause a lot of banks to nearly collapse at the same time.
2008 Solution: Print a bunch of money to give to the banks so they didn’t all collapse.
2022 problem: Print a bunch of money because nobody’s going to want to buy anything because COVID, then COVID isn’t as bad as we feared, plus sanctions / Ukraine invasion / oil prices / China’s zero COVID policy means there isn’t enough stuff for all that money to buy so prices start to go up.
2022 solution: Un-print money by cashing in government bonds and shredding the cash. As a side effect of less dollars, everyone gets poorer — stocks, bonds, gold, Bitcoin — plus it’s harder to borrow money (higher interest rates). But that’s better than letting prices spiral out of control.
Actually 2022 is kinda the opposite of 2008. Both are gonna suck for the ordinary person though (your financial life becomes difficult through no fault of your own, by the operation of large scale economic forces that even experts barely understand, and you don’t have any direct control over.)
And there are difficult decisions involving tradeoffs, for example if it was up to you, would you raise interest rates if you know that means a couple million people will lose their jobs this year? The catch is if you say “No,” your data wizards and math mavens tell you that in 5 years people will need wheelbarrows of money to buy a loaf of bread and society will basically collapse like it did in the 1930’s.
[1] Some people think we shouldn’t have huge money printing parties, we should have let the insolvent banks collapse in 2008, and we shouldn’t have printed trillions to deal with COVID.
Since no one has ELI5 yet.
When you go trick or treating and you get all your candy and you get home and you trade with your brothers and sisters, that’s how it’s supposed to work. If someone isn’t playing well with others the grown ups will make them share or take their candy away or put them in time out. Well at some point a couple of your siblings teamed up to take almost all of the candy. That didn’t turn out well and in 2008 they got really sick but the grown ups didn’t do a good job of teaching them a lesson, so they’re still doing the same thing, trying to greedily take all the candy and not sharing. Now, because of Covid, there is a lot less candy, but to get you to come out and help them go door to door collecting candy they promised you a whole bunch of candy, but they lied, and they don’t actually have it, and they’re just going to try and take the little bit of candy you did collect.
To fight inflation, central banks are decreasing the amount of money that exists. As it turns out, a lot of banks, shadow banks, and hedge funds are in positions where they have to pay certain amounts of money, but they have uncertain amounts of money getting paid to them. Previously they made a nice profit since uncertain amounts of money come with a premium for coping with the uncertainty. Now they make losses. If they make much of a loss they go bankrupt, and then everyone they owed money to doesn’t get paid and goes bankrupt too, and so on. Yeah, this happened 14 years ago, although the reason that time was because people couldn’t pay their mortgages, not because the central bank started deleting money.
Why do we keep doing it? Because it makes a profit for the fund! … most of the time, and when it makes a loss the fund goes bankrupt so it’s not the fund manager’s problem ant more. He or she can start another fund and resume making profits from that one. It’s not really obvious whether a fund is doing this, either. It’s not like you could have said to avoid those funds.
Things are getting more expensive and fast (inflation).
To curb this the central bank is doing whatever it can to decrease demand (supply and demand: more demand means high prices, lower demand means lower prices)
With lower demand for things, people produce and consume less. Viola, recession.
(Totally oversimplified, but it’s ELI5)
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