The World's Economy Part 1

A few days ago I was chatting to my mom about the world's economy, and why we're in the predicament we are and she had no idea why the world is slowly losing all worth. I don't know if it is because she hadn't taken the time to listen before, or if it didn't make sense, but I figured that she's fairly clever, which means that there must be quite a few people out there who have no idea what's going on. So in order to remedy the situation, here is my take on what's happened and why everything is slowly slipping further and further into a recession.

Before I start, there's something I want to stress: Economics is a lot easier than you think. Everything revolves around demand and supply, and because most of the money on the stock market is owned by average people, things are very 'sentiment' driven. So if the news tells everyone that platinum is useless, the platinum price will fall, because everyone believes the news and stops buying platinum. Because no one is buying platinum, there is more platinum than they can sell, causing a lower price in order to sell it all. It's as simple as that. Ok, so here we go.

It all started quite a while ago with the 'Dot Com' revolution. Business started by putting up websites and people were all impressed by the internet and invested heavily in technology. Things were going very well and money was flowing extensively throughout the entire economy. The IT industry was growing at an alarming rate and all the investors were very happy. But as with most stories, there was a twist. Someone came along and made a website, and took people's money because they were investing, and then it fell flat. People suddenly started to realise that the biggest downfall of the internet is credibility. Every website looks equally credible, irrispective of how the company is being run.

People lost confidence in the IT industry, and sold their shares. The IT industry took a hit, but continued growing at a slower rate. As a result of this 'credibility crisis' people wanted to invest in things they could see, and could trust, which gave birth to the property boom.

Everyone was happy, especially banks. Because of the fact that property costs a fair amount more, people were taking loans left, right and center, and this created another problem. You see, when you take a loan, the bank gives you money, putting it back into the economy's circulation, but it isn't really in circulation because it's actually the banks money. Because of this illusion, the American economy became very strong very quickly, causing not only other economies to strengthen but also people to buy Dollars, to make money and ensure security.

With a falsely strong Dollar, and people making tons of money in the property market all over the world, everyone was having a wonderful time. Banks were happy to continue to loan, because the knew that sooner rather than later the American (and other) Reserve Banks would have to raise interest rates, which would mean that they would get their money back plus interest at a higher rate than the rate they loaned at. So if they loaned $100k at 8%, they would get that money back at closer to 9.5% because of higher interest, meaning a nice and fat profit for financials.

Because of the confidence banks were showing, lots of investors starting buying shares in banks and financial institutes all over the world, which caused banks to give even more loans because they had disposable income. At this stage a few investors sat up and said "Hang on, this is going to go pear shaped. Not only is the property market overly strong [because people actually don't have money to spend], but the Dollar is overly strong, and financials are overly strong [meaning their actual worth is at 5, but people think their worth is closer to 9]"

Then something terrible happened. September 11. Investors heard talk about war, and lost faith in the American Dollar, and everyone started to sell, causing the dollar to lose worth. While the Dollar's worth was set to be at 5, it was actually valued at 9, but because everyone sold, the worth fell to 3.5 causing major trouble.

Knowing that the only thing America imports in large amounts is oil, people invested in it. Causing petrol / oil prices to go through the roof. Suddenly people in all areas of industry were taking a major hit, causing a slowdown in the economy. Fortunately for everyone, banks were still strong, and because people were losing faith, they invested even more in housing. This renewed resolve for the property market pushed house prices up even more, and banks gave even bigger loans, to more people. This was a bad move because they were still waiting for interest rates to rise, which still hadn't happened.

Check part two for the rest of the story.