At the time of writing this, it almost is completely forgotten that just 10 years ago the world faced the worst financial crisis since the 1930s.
Hardly anyone really understands what happened back then and why. And much less did I understand it when the crisis took place while I was still in school.
Without going into much detail, had the government not bailed out the debt with taxpayers money, we all would have experienced a financial meltdown across possibly the entire globe.
The world was basically at the verge of disaster back then, but just a decade later with low interest rates in most Western countries, the trouble seems already completely forgotten.
Crisis?
What's a crisis?
Why should this happen again?
Interestingly, financial crises have existed already centuries ago, when kings and emperors were not able to pay their funds for insane armies or ridiculously luxurious palaces anymore. A lot of things have changed since then, especially in money and finance.
But the central mechanisms and laws that guide finance are still the same and will always remain that way.
Since World War 2, there have been a number of major crises across the globe in all kinds of nations, economically developed or not.
There have been 18 crises altogether since this period, with an additional large number of major ups and downs on several markets. If throughout history there have always been ups and downs and markets built up and imploded suddenly resulting in a crisis, we can expect it to continue like that.
That means: we might just be right before our next financial crisis!
The factors that lead to a crash are manifold, but just to give you a glimpse of what we can expect: as the numbers show dating back to 1890, housing prices in the United States over a century to the year of 1996 have risen 27%.
That means in an entire century, housing prices only climbed 27%!
But then something started. During the next 10 years, between 1996 and 2006, housing prices in the US soared 92%! That is more than three times the increase we had in an entire century!
What followed was the biggest financial disaster we had for more than 70 years, fuelled by financial instruments on over-priced real estate.
And the situation now? What happened after the disaster from 2008?
Since the Western World is now flooded with zero-interest loans, housing prices have hit a new high and risen especially in urban areas for 300% or more.
Just let those numbers sink in for a moment and consider what might happen next…
Sure the economy is more than just the housing prices.
And sure as long as we have such low interest, the vast part of it will clearly be stable as the growth from recent years shows. But sooner or later, we will have another set back. It is not the question if it will hit, but rather when it will hit.
To be honest with you I have no idea when it will hit and how hard, I am not a magician. It might be just a move in the financial markets average people wouldn't even recognize, or it could also be another disaster that could prove to be much worse than that of 2008 or even Black Friday in the 1930s.
And since interest rates cannot go below zero, also a major financial stimulus that the central banks usually can use to prevent crisis or to soften it, is not available anymore.
Now one might think yeah alright, but we have learned from past mistakes and those are troubles of the past that will never happen again.
We have better banks, better technology and a better overall economy than anytime in history.
In their brilliant book “This time is different”, Carmen Reinhart and Kenneth Rogoff have gathered data from the last 800 centuries, showing that financial crises are not only cyclical and partly predictable, but also expectable and recurring.
If you are interested in financial data, I highly recommend this book (although I admit you have to be a kind of “financial pervert” like me, to voluntarily read a 500 pages book filled with financial data in your leisure time).
It shows that throughout history, people tend to forget after a certain time that good financial times will always come to and end sooner or later. And that every time before a crisis took place, highly skilled and knowledgeable people were convinced that such things from the past could not happen in the present time.
Until they do one day.
Here is for example what kind of debates and news were spread just months before the fiasco of 2008, from national bankers to financial gurus:
The US has the best financial regulations worldwide
Its success is based on brilliant financial innovation
The US has the largest and most powerful capital market in the world
The system is a stronghold of financial power and can defend any inflows or outflows without concern.
The monetary policy and policy makers are the most brilliant available on the planet
Rapid innovation in financial products (leverage) multiplied the cash flows and brought new players into the market, who further increased the game
Globalization leads to more capital flows worldwide and thus such a progress is necessary
And so on.
Until one day……. BOOM!
A crisis follows a long, steady incline over many years usually with an abrupt decline.
The problem is, once it is known in the markets and the media it will be too late for most people to take any action to prevent themselves and their family from losses.
Thus there is no “I start saving money when times start to be bad”.
As soon as the bad news has spread, a vicious circle often starts that leads prices of many assets tanking, which leads to again lower prices since no one buys and on and on.
And what starts in financial markets has a kind of domino effect across the entire economy and thanks to globalization as we have seen in the subprime crisis of 2008, a problem in the United States became a problem in the whole world.
It all started with the collapse of a single investment bank, the now bankrupt Lehman Brothers. A company with over 100 years of experience in its field, thousands of employees and an AAA rating at the day of its crash.
Financial crisis can affect us in a number of ways, among them:
Since people are buying less, companies lose their orders and have to cut costs. this translates to: they will fire people, and those poor guys will be unemployed just when times start getting tough
Currencies can devalue, making imported goods more expensive
Prices for basic foods can go up drastically leading to panic buying, which makes prices go up even more
People think they have lost their savings in stocks or real estate, causing them to sell in panic which destroys assets that will again be valuable after the crisis is over. Such behaviour can ruin people's entire retirement options and wipe out all lifetime savings in an instant, and it further amplifies the downturn for those prices.
Poor people always tend to be more affected as they have less options than rich people. If you live paycheck to paycheck and lose the job, you are in deep trouble. But if you own 5 streams of income and 3 of them might temporarily be down, you can still live from the remaining two.
Of course there can be a number of other factors as well that take on all kinds of unforeseeable forms and effects. In any way: It will be bad. And it you did not prepare for it in advance, you will be affected by it.
And now you can see why this affects your spending habits:
If you are used to using 100% of your paycheck or even more than 100% of your paycheck for our lifestyle, and suddenly the rules of the game change leading you to lose some of your income, you will be in trouble.
You might think okay I just sell the expensive car when things get bad.
Prices are created through demand. You will be selling when nobody wants to buy. This will leave you with often a high loss, making you lose more money when you already have none, if you can sell it at all.
This does not sound like the situation anybody wants to be in.
But on the other hand if you always remain a 1.000$ surplus at the end of the month, or even just 300$ which you then use for investments, savings and building long-term assets, in case of a crisis you can make a stop on these long term investments and use this surplus of money to compensate for a potential loss of income.
Although I personally love the crisis since it offers you to buy stocks and real estate on a bargain, when the going gets tough it is better to not invest for 1-2 years than not having food in your fridge for the same period of time.
Keeping an eye on your spending habits and constant discipline over years will also lead to having a large sum of money in your savings account.
When the time is right, you can buy wonderful assets such as real estate and stocks at a massive discount when the crisis hits.
Many people have made their fortunes in the worst economic times with just this little trick, such as Sir John Templeton who bought in time of greatest depression when the best companies worldwide were sold for pennies.
And if you have prepared to do the same, a crisis can become the largest chance in your lifetime.
Provided of course, that you have lived within your means and have saved and invested. Remember: those who have money in a crisis will be the ultimate winners.
And from that capital gains, you can buy yourself 20 of those luxury cars with straight cash that otherwise eat up all your financial surplus.