Without the US juggernaut pushing us toward prosperity, the world economy is about to fall into an abyss. Don't let people talk about the rise of Chindia (China and India) and economic decoupling from the US. World growth has been powered by the US Fed dumping money into the financial markets, since 9.11. Just as the Soviets crumbled economically during the end of the cold war, the US is now making the same mistake. This will be the last world economic cycle they drive, the next boom will almost certainly be out of Asia.
If you're into investing, the holiday period is a great time to reflect on the year passed and look at developing some short term financial strategies for the year ahead. While any good investor always has a long term plan quietly working to consolidate their wealth, it's the short term opportunities that can really boost your growth.
Examine the global economy's performance over the last few years and BOOM!- that says it all. Since the central banks poured money into the global markets post 9.11, the world has been awash with money. The resultant excess liquidity made money cheaper and therefore credit easier for both business and personal loans.
Of course there were several factors that came into alignment and ignited the boom. Growth in China, India and Russia lead a resource resurgence, and interest rate cuts by the Fed in the US created an American led economic revival that triggered growth around the world. The US markets are 25% of the global economy- and although some analysts talk of an economic 'decoupling', the truth is that world economic fortunes are still very much dependant on conditions in America- at least for this economic cycle anyway.
So with ample money available on the world bourses there was plenty of money made available for lending. The way these international money markets work is not unfamiliar to those of us with our own loans, except that deals are done on a much larger scale. In the international arena anyone with enough security can acquire millions or billions of dollars in credit at a wholesale interest rate. These borrowers, usually banks, then on-sell the credit as loans or mortgages to businesses and individuals adding a margin to the interest rate that provides them with a profit.
While interest rates are low, the borrower's ability to repay the loan increases, allowing the lender to offer more money. Offering more credit also allows the lender to increase their profit margin. If credit is cheap, available and used wisely, it becomes a marvellous tool that can help you increase your wealth very, very quickly.
If you were to have borrowed money at the very start of the housing boom, you would have not only been able to buy a house cheaply, but you would enjoy a small mortgage at low interest rates- and for some it meant they could buy a house cheaper than they could rent one. But even if you bought at the peak of the housing market early last year, while your loan would much larger, low interest rates kept repayments at a manageable level.
Economic conditions between 2002 and 2007 assisted the growth of credit. Low unemployment, wage increases and on-going low interest rates meant that the banks could continue to issue more and more affordable credit to borrowers. For many home owners, the purchase of big ticket household items and even cars could now be added to the home mortgage.
Correspondingly, many well known financial institutions issued a range of new credit cards. It was now possible to get $50 000 unsecured at rate of 10%! In fact credit was available for anything from margin loans to buy shares with, through to plasma TVs. Credit had never been seen before on a scale like this, and practically any employed person was eligible to join in.
With all this credit available to be spent on all manner of things, the world economy was boosted thereby feeding the system- more credit equalled more spending. You didn't need to have a million dollars to live like a millionaire any more, you just needed to borrow the cash. As long as you could afford the repayments, the millionaire lifestyle was yours today.
Of course, if a borrower had been diligent during this period by not over committing to credit and working hard to reduce their loan currently they will have increased their wealth. The value of the assets acquired will have risen while they have worked to reduce their debt, thereby increasing their equity and eventual returns on their purchase.
The importance of this strategy can not be underestimated. The principal of using a credit to advance your position is a fundamental building block of wealth creation. The most basic of all errors that brings down companies and individuals alike is the accumulation of too much debt. Unfortunately like most things, for one reason or another economic booms can't last for ever. And when the good times end, the lenders need higher returns on their money- so up go interest rates.
Is there anyone out there who hasn't heard the alarm bells ringing since last June? The "credit crunch" is on its way and here comes the pain. If you think things are bad now, just wait, they are going to get worse. Sub-prime mortgage defaults in the US wiping out billions of dollars across the board. Stifled growth, falling employment, and dampened consumer spending are pushing the US economy toward the brink of recession. And rather than let things take their normal course, by letting interest rates rise, the US Fed is subsidising the losses itself, by lowering interest rates. The party is over!
So if you haven't been working hard to pay off your mortgage or loan, now is a good time to start. Or if you're getting nervous now about the future now is equally as a good a time to downsize your home, car, or lifestyle. Sell for what you can at the top of this market and sit on the cash in the meantime. Another 6 months might be too late. While world governments will stave off disaster as long as they can, it's only a matter of time before it all crashes down around us.
All the signs are there. Gold prices are up, institutional investors are running for cover. Anyone with any market savvy is seeking to cut debt and cash up as fast as they can. When the bust comes, interest rates will finally rise and the borrowers that can no longer service their debt will be forced into a sale of assets. Credit will tighten. Money will become expensive and when the sellers outnumber the buyers, demand drops and prices fall. Who can forget the pain of the late 80s and early 90s.
Unmanageable debt is not something you want to be stuck with come 2009. If you are in debt, use this year to get yourself in a sustainable financial situation. Long term, it can only be to your benefit.