US Takes a Tumble

The following is the first in a three part series about the US downgrade and the effects it will have on the consumer, investor, and economy.

What does the downgrade mean to me?

Friday evening after markets closed, the S & P (Standard and Poor’s) downgraded the US Credit Rating from AAA to AA+. Everywhere you look it seems that this is spelling catastrophe for the investor and consumer alike. However, let’s take a deeper look into the downgrade and what actual effects it has on the average American.

The Risk of Risklessness.

For a long time, the United States’s debt has been seen as an instrument of riskless investment. In fact, the US treasuries have set the precedent for the risk free rate. For the S & P to downgrade the US Debt rating, it would appear that investors are recognizing that the US potentially contains some default risk.

While any investment inherently contains some risk, it is generally accepted that US debt is a safe haven for money. This downgrade, however, has put that general assumption into question. With that said, nothing has really changed. The debt ceiling is still raised, politicians will still philander, and the US will continue to mint dollars to pay its debt. The downgrade hasn’t changed the balance sheets of the American Consumer or the government for that matter. It has no “physical” effect on the United States ability to pay its debts or sell debt instruments. Think of this downgrade as a bruise. The damage to the body has already been done, and what we’re seeing are just the cosmetic effects.

What we may see is that interest rates eventually will inch higher because a credit downgrade, which essentially increases the United State’s cost of borrowing. However, because the US is still widely seen as a “safe haven” it is doubtful we will see any real increase in cost of borrowing to the consumer:

• Mortgage rates are typically tied to Treasury yields which are at historic lows.

• Credit card rates tend to follow the prime rate, which the federal reserve has given no indication of raising any time soon.

Then why the stock market crash?

On the word of a downgrade, we saw the stock market loose significant points. With that said, any real cost to consumers will take months to be felt.

The stock market is a generally good indicator of investor confidence and overall market/economic health. What we saw today was a reaction of investors to the overall health of the economy. A good example would be the decline in oil to just over $81 a barrel. The price of oil went down on the speculation of a decrease in demand, not an actual demand decrease. The same thing happened with the majority of declining stocks on Monday.

If not this, then what?

Until we can see the actual effects of increase cost in borrowing, the pressure investors and consumers will feel will come from the slowly growing economy. The job markets will not take a change for the worse solely because of the downgrade. What we will see is a decrease in consumer uncertainty which could decrease spending and lead to cuts in the job market. With the economy already reeling from the last recession, if we were to see a “double-dip,” the impact would be very dramatic. Businesses and consumers alike are already running lean. Another wave of spending woes would leave them with next to nothing to trim down.

Thus, as a consumer and investor you have little to feel directly from the downgrade. What we’re feeling right now is the market’s reaction to the possibility of another recession.

In the next part of our three part series we will examine whether or not there will be a double dip recession. And, if there is a recession how will it compare with the last.

Capitalism

Education is the foundation upon which we build our future.
-Christine Gregoire

Thomas Sowell, a prominent American economist is quoted with saying: “Despite a voluminous and often fervent literature on ‘income distribution,’ the cold fact is that most income is not distributed: It is earned.” Essentially what Mr. Sowell is trying to say is that, income (money we make) cannot be distributed, but has to be earned. In a sense this embodies all that is Capitalism.

You may have heard the words Capitalism and Socialism thrown around together quite a bit. (We will go over Socialism in a later post.) The two, as I’m sure you have experienced, are not one in the same. In fact we can think of the two as opposites. Today however, we will look solely at capitalism.

What is Capitalism?

Capitalism is an economic system in which the means of production are privately owned and operated for profit.

That my friends, is one of the shortest definitions you will see on here. That is because Capitalism in itself is a very broad term and hard to define. There are many types of capitalism, and many ways governments choose to pursue it. However, there is one key reference that all capitalists can agree on, and that is private ownership.

Since everyone can agree on private ownership, let’s work on that. When a capitalist speaks of private ownership in an economic system they mean that all production, creation of goods, prices, profits and wages are held by the individuals involved with them. We’ll get back to that word “all” in a moment. For now, let’s have an example.

In Greenopolis (our made-up capitalist country), Farmer Joe is a green bean farmer. Joe buys all his tools and seeds to grow his green beans. He also spends all the money to take care of his farm. When the green beans are ready to be harvested, he sells them at the market (for a price he determines). When people buy his beans, assuming they do, Joe gets to keep all his profit. This is capitalism plain and simple.

Now that we have that down, let’s get back to that word “all.” In order for capitalism to be present not all of the above listed things need to be private, a mixture is completely acceptable. In fact, the majority of the time a mixture is what we see. For instance, in the United States, it is not uncommon for the government to set price floors on certain goods. A price floor is a price at which a good is not allowed to sell under. This helps people (like farmer Joe) stay profitable and keep producing goods.

Most capitalists will agree that property is a very important thing to remain private (when we say property we don’t just mean land, we mean things people own in general). Private ownership in capitalism implies the right to control property. This includes how it is used, who uses it, and getting the money that the property produces.

What you’ve heard.

Sometimes in the news you will hear of a new law that affects companies or has to do with the economy. Sometimes you hear it said, “Well, that’s just one step closer to socialism.” For now we can think of socialism as the opposite of capitalism, in that the government plays a very large role in the economy.

For instance, let’s go back to our Greenopolis example. Farmer Joe has grown his green bean crop. However, farmer Joe isn’t the only one. In fact many people grow green beans in Greenopolis. Lately people haven’t been too fond of them and have gone on to eat other things. Since less people want them, prices have dropped very low, and way too low for any of the growers to cover expenses. The green bean growers risk losing their farms if they can’t make any money! The Greenopolis government decides to step in. They put a price floor on the green beans higher than what people want to pay for them.

In the above example we see how government policies can affect people. Who’s likely to benefit in the above scenario? Well, the green bean farmers are now able to sell their product and remain in business. Staying in business is always good news. However, there is another side to this coin. People who buy green beans now have to pay a price that is above the “fair” market price (the price that people were paying at the market before the government stepped in. This is sometimes called the free-market equilibrium price). The people who are paying more for these green beans are probably not very happy.

(Extra Credit: Law of Supply and Demand dictates that setting a price below the equilibrium price is probably not a good idea. In all actuality, moving the price up would not guarantee that the farmers would make more money. They could risk people stop buying green beans all together, in fact.)

Now what exactly isn’t very capitalist about this? Well, the Greenopolis government is taking away something very important from the buyers. That’s their property (that’s right, money is their property too!). How exactly is the government doing this? By making it mandatory that the green beans sell at or above a certain price, they are adjusting the way the way the economy works. Essentially, Greenopolis is giving extra money to the green bean growers, that the economy said wasn’t theirs.

(Extra Credit: The term Laissez Faire (Lah-zees Fair), French for “let it be” or “leave it alone,” is used to describe a theory in which markets are allowed to behave automatically without price fixing or interference from outside sources, as our scenario showed. Some argue that this is a big component of capitalism. Some argue that a true laissez faire economy cannot exist.)

As you can see Capitalism is a very broad subject with plenty of it up for debate. Today we’ve scratched the very tip top of the surface. I hope you’ve enjoyed your time here and look forward to reading your comments.

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If you’d like to learn more about capitalism here are a few sites:

http://www.bbc.co.uk/programmes/p00545kv

This is a short radio blurb on the history of capitalism from the BBC.

http://capitalism.columbia.edu/theory-capitalism

Here is a short article on the theory of capitalism.

Welcome to FYInance

Morning, Afternoon, and Evening, and welcome to FYInance.

You’ve discovered a blog about the sometimes, muddy and complex inter-workings of finance, but made simple. Please feel free to read the following introduction, if you’re new here or just want to know what all this is about.

First, I’ll give a little information about myself. My name is Ryan Cosby. I currently live in Springfield, Missouri and will be graduating this December with a bachelor’s of science in finance from Missouri State University. I one day hope to have a family and settle down somewhere nice. I have a strong desire to learn and teach other’s what I know.

Secondly, I want to state my intentions with this blog. This blog is purely informative. I will not divulge the on goings of my personal life in anyway. It is also my objective to issue very little (if any) opinion. The majority of this blog will be for the layperson. By that, I mean the average American with limited knowledge of finance or the monetary system. The object of this blog is not to create financial whiz-kids (or whiz-adults as the case may be) out of anyone. This blog will merely serve to give readers a better understanding of the things they deal with (or hear about) in their everyday lives. With all intents and purposes I would like to update this blog about twice every week. If it appears that people want more I will do more accordingly. As of now, my time is limited because I am, after all, still a student.

Lastly, I want to welcome you to the blog. Thank you for taking time to educate yourself. I hope you enjoy your stay and come back to see us again.

(This post will be edited often when the blog changes, as to keep its continuity.)