99.99% of people don't understand why recessions happen.
Here's what you need to know:
Here's what you need to know:
Let's start from the absolute basics.
In almost all countries around the world, banks take deposits from customers.
When you make a deposit at a bank, the bank offers you interest as an incentive for keeping your money deposited.
In almost all countries around the world, banks take deposits from customers.
When you make a deposit at a bank, the bank offers you interest as an incentive for keeping your money deposited.
You sign an agreement to lend your money to the bank and receive interest.
Banks generate profits by lending money to borrowers at a higher interest rate than what's being offered to customers.
Banks generate profits by lending money to borrowers at a higher interest rate than what's being offered to customers.
When you deposit money in your account, the bank adds it to a pool of money from all depositors.
If you want to withdraw money, the bank takes it out of the pool and decreases their liability to you (your bank balance).
If you want to withdraw money, the bank takes it out of the pool and decreases their liability to you (your bank balance).
To PAY interest to depositors, banks use deposits to EARN interest by lending it to customers who want to borrow money.
In other words, banks are an intermediary for people looking to lend savings and other people looking to borrow those savings.
In other words, banks are an intermediary for people looking to lend savings and other people looking to borrow those savings.
While YOU have to work to make money and earn interest on your savings, banks make profits because they can lend the money you save!
Fractional reserve banking makes it so banks can lend ALL of the cash they have WHILE STILL PROMISING THAT YOUR MONEY IS THERE!
Fractional reserve banking makes it so banks can lend ALL of the cash they have WHILE STILL PROMISING THAT YOUR MONEY IS THERE!
A mortgage is an example of a loan created through fractional reserve banking.
Let's think of it this way:
A bank has $100,000 in deposits. It lends 90% of that money to someone who wants to buy a home. Now there is $190,000 in the system.
Let's think of it this way:
A bank has $100,000 in deposits. It lends 90% of that money to someone who wants to buy a home. Now there is $190,000 in the system.
The money held by depositors is still "available to be withdrawn" - depositor accounts still hold $100,000.
The newly created money expands the economy but also leads to price inflation (because more money is competing for the same amount of goods).
The newly created money expands the economy but also leads to price inflation (because more money is competing for the same amount of goods).
This process of borrowing and lending money is the main reason for debt cycles.
A debt cycle begins when we start living beyond our means and spend more than we can afford, or start businesses with borrowed money.
A debt cycle begins when we start living beyond our means and spend more than we can afford, or start businesses with borrowed money.
A central bank is a national bank that provides banking services to its country's government.
The goal of a central bank is to achieve price stability (low inflation).
The main tool they have to achieve their goal is interest rates.
The goal of a central bank is to achieve price stability (low inflation).
The main tool they have to achieve their goal is interest rates.
Central banks control debt cycles by increasing and decreasing interest rates for borrowers.
These cycles lead to massive booms and busts. Companies are built then they fail. This badly impacts the average citizen, who may lose their job and their ability to pay for necessities
These cycles lead to massive booms and busts. Companies are built then they fail. This badly impacts the average citizen, who may lose their job and their ability to pay for necessities
In a fractional reserve banking system, recessions are INTENTIONAL.
FRB leads to overly leveraged positions, and recessions wash them out of the system.
Since March 2020, banks have NO RESERVE REQUIREMENT. This means they can lend out EVERYTHING they receive as deposits!
FRB leads to overly leveraged positions, and recessions wash them out of the system.
Since March 2020, banks have NO RESERVE REQUIREMENT. This means they can lend out EVERYTHING they receive as deposits!
A recession OFFICIALLY occurs when Gross Domestic Product (GDP - the market value of goods produced by a country) decreases for 2 quarters in a row.
The opposite of a recession is an expansion - an increase in the level of economic activity and GDP.
The opposite of a recession is an expansion - an increase in the level of economic activity and GDP.
The crazy thing is that these numbers can intentionally be manipulated to "avoid" a recession.
Eg. Inflation is 5%, prices rise, the Bureau of Labor Statistics tells you inflation is actually only 2%, so they get to pad their numbers by that difference of 3%.
Eg. Inflation is 5%, prices rise, the Bureau of Labor Statistics tells you inflation is actually only 2%, so they get to pad their numbers by that difference of 3%.
If central banks want an expansionary period, they decrease interest rates to increase borrowing and investing.
If they want to trigger a recession (it's intentional), they increase rates to decrease borrowing.
If they want to trigger a recession (it's intentional), they increase rates to decrease borrowing.
During an expansion, businesses and individuals are incentivized to consume and invest.
When rates go too low, more money is borrowed.
Some of these borrowers are corporations that take on more debt than they can pay off, not expecting rates to go back up again.
When rates go too low, more money is borrowed.
Some of these borrowers are corporations that take on more debt than they can pay off, not expecting rates to go back up again.
When inflation gets too high, central banks need to increase interest rates to decrease consumption and investment.
The same corporations that borrowed too much aren't able to pay back their loans, so they default on their debts.
The same corporations that borrowed too much aren't able to pay back their loans, so they default on their debts.
Everything is interconnected in our economy (companies lend assets amongst themselves).
Defaults lead to ripple effects throughout the economy.
Defaults lead to ripple effects throughout the economy.
The average person suffers because corporate defaults on loans lead to bankruptcies.
Bankruptcies lead to job losses.
Job losses lead to defaults on consumer debt and debt to purchase assets like homes.
Bankruptcies lead to job losses.
Job losses lead to defaults on consumer debt and debt to purchase assets like homes.
When homeowners default on their mortgage payments, banks take possession of the home and sell it on the market.
Debt cycles are a lot more painful when rates go up quickly.
Recessions make it so that instead of only a few houses going on the market, a lot of them are sold quickly to pay off debts.
Decreasing house prices lead to panic selling and a wave of houses being sold.
Recessions make it so that instead of only a few houses going on the market, a lot of them are sold quickly to pay off debts.
Decreasing house prices lead to panic selling and a wave of houses being sold.
Interest rates going up leads to a stronger currency, and a decreased appetite for risk (because interest rates are higher than returns on risk assets).
More borrowers need the currency to make debt payments, which are now larger due to higher interest rates.
More borrowers need the currency to make debt payments, which are now larger due to higher interest rates.
Signs that central banks will decrease rates:
- Consumers stop spending
- Business production declines
- Firms lay off workers
- Investment appetite decreases
- Foreign exports fall
- Consumers stop spending
- Business production declines
- Firms lay off workers
- Investment appetite decreases
- Foreign exports fall
Once central banks begin decreasing rates again, we start a new debt cycle.
Being aware of the cycle is the most powerful thing you can do as an individual.
Learning about market cycles and debt cycles leads to less panic in the market and investors make better decisions.
Being aware of the cycle is the most powerful thing you can do as an individual.
Learning about market cycles and debt cycles leads to less panic in the market and investors make better decisions.
During expansionary periods, everyone should be building an emergency fund.
An emergency fund prevents you from having to take serious action like selling your home in case you lose your job.
During good times, build a cash reserve of 3-12 months of expenses.
An emergency fund prevents you from having to take serious action like selling your home in case you lose your job.
During good times, build a cash reserve of 3-12 months of expenses.
I'm passionate about helping people to understand how the financial system works.
If you're interested in learning more, watch the video I created about the financial system being rigged against us 👇
If you're interested in learning more, watch the video I created about the financial system being rigged against us 👇
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