Why the Global Economy Will Get Worse: The Multiplier Effect…and How It Impacts Your Money
I remember singing a version of this song at Scout camp when I was younger. Seems to be fitting with the current economic times we’re living in.
I’m going to try and explain how things went up, and why they are coming down so fast.
The Multiplier Effect
It’s called the “Multiplier Effect” in economics. Now don’t go falling asleep…bare with me.
Simply put, when someone spends money, they make someone else money. That person then goes and spends that money, helping someone else to make money.
Person #1 —-spends—-> Person #2 —-spends—-> Person #3
Around and around the money goes, increasing the perceived wealth of everyone as more dollars eventually flow back into building bigger buildings, investors invest back into companies to help them grow and hire more workers, and entertainment spending increases as people have more discretionary income to spend.
The Negative Multiplier Effect
This works the same in reverse. If someone stops spending money, whoever they would have bought from loses business. This means less money for them to spend on goods and services, and the ripple effect will continue downward.
Person #1 —-doesn’t spend—-> Person #2 —-doesn’t spend—-> Person #3
Before our world was so inter-connected, this happened usually on a country-by-country basis.
Now, it’s happening globally.
So where will the bottom be? How do we know when the downward slide is over? We’ll find out sooner or later.
The best way to imagine this in your mind is to think of a floor, with building blocks stacked on top of it. These blocks are arranged to make several building structures. It’s easy to start building the blocks up, and it happens gradually.
If you take your arm and hit them, however, they fall down quickly.
Underneath each market in the world, there is a “floor”…a price where the value to someone makes it worthwhile to buy. Only when the free market is allowed to find this floor – in housing, investing, and consumption spending – will we begin to build (grow) again…starting the next bubble and eventual pop.
This up-and-down bubbling and bursting is called the “Business Cycle” and it will continue to occur. The difference between now and previous bubbles…the world is the most inter-connected it’s ever been. Imagine if you had to try and blow a bubble with gum the size of this problem…you’d have to write to Bubble Yum and ask for an entire plant full!
How Will This Affect My Money?
Your money will rise and fall based on what’s happening the global market. Your earnings may be cut or wage increases frozen as a result of companies losing money.
Your stocks will be affected depending on what you invest in and your investment strategy. Mutual funds will suffer greatly.
Your real estate holdings will perhaps decline by a large percentage as well.
Remember : You always make your money when you buy , not when you sell . This goes for all investments, and should be your mantra no matter what the market is doing.
If you have made investing mistakes up until this point, it’s time to start getting smarter by asking questions.
Questions such as:
- What are you invested in?
- Find out what your mutual funds and 401(k) plans are invested in. Even if it’s a small. Know where you stand.
- How is your industry doing?
- Will you get fired sometime soon?
- How are you preparing for a layoff or for your business to stay afloat?
- How many months can I survive without working?
- Do you have adequate reserves built up to hold you over?
These are just a few questions that will help you get re-focused.
The Trend is Your Friend
One last note: follow trends.
If you position yourself in front of an upward trend, you’ll gain. If you’ve fallen behind a winning trend, you’ll continue to lose.
As Einstein said, “you can’t solve today’s problems with yesterday’s thinking.”
The best defense is a great offense. Perhaps it’s time to shed your old ideas and adopt new ones.