Here’s an interesting thought experiment for you: imagine that your friend asks you for a small loan. He promises he’ll pay you back in full in six months. You consider this friend to be quite trustworthy, so you agree to loan him $1,000.
Little do you know that you just started up a good old-fashioned game of hot potato…
I’ll show you what I mean in a moment. As you’ll see, this simple concept is the perfect analogy for what’s happening in the world economy right now.
Plus, I’ll show you one of the moves you can make today, to make sure you’re not left holding the hot potato.
Depression and Deflation
Over the past few weeks, we’ve talked about the history of money. It’s so important to understand where we came from to know where we’re likely headed next…
As I’ve mentioned before, I believe the incredible run in the global economy since the last financial crisis is coming to an end.
Officially, North America is in a recession. And it won’t be too long before the mainstream media start using the word “depression” more often. But that’s not the only bogeyman for financial writers and stock market observers…
There’s also “deflation.”
Right now, journalists and TV personalities will do everything to avoid saying that word out loud. Instead, they’ll say things like “negative inflation.”
The truth is that depressions and deflation go hand in hand.
Now, we’ll look at deflation. You see, I believe this next phase of the economic cycle will be devastating. If you want to preserve – and grow – your wealth, understanding deflation is crucial.
And the first step in that is understanding the role of debt in the world economy. That’s where our game of hot potato comes in…
Chain of Lunatic Lending
You’ve probably heard of this game before. You gather in a circle and toss a potato around to the other players in the circle while music is playing.
The last player to hold the potato when the music stops is the loser. The real question, however, is who are the winners?
To answer that, let’s go back to that loan between you and your friend that I mentioned at the beginning…
The two of you draw up a contract, shake hands, and the matter is settled.
Now, if someone asked you how much money you have, you wouldn’t subtract the $1,000 loan from your net worth. You’d include the $1,000 you just lent out.
But if someone asked your friend the same question… he’d also include the $1,000 you lent him in his calculation of his net worth.
How can this be possible? Two people think they each have a $1,000 claim to the same $1,000. But of course, that $1,000 hasn’t magically doubled.
If your friend uses the money wisely, he’ll be able to pay you the loan back in full. But what happens if he loses the entire loan… and he has no way of paying you back?
You’d be out your $1,000. (And, being smart, you’ll never lend money to that friend again.)
Now let’s take this scenario a step further…
Imagine your friend does misuse the money you lent him. Desperate, he goes to a family member for another loan to cover the initial debt he owes you.
We can stretch this out forever… or at least until your friend runs out of people willing to lend him any money.
When times are good and business is booming, your friend can probably keep this juggling act going for quite some time.
But all it takes is for one fault line to crack this fragile foundation. Then, the entire house comes crashing down.
As it becomes obvious that your friend can’t manage his debts, his creditors will come calling. Maybe you’re the first one to ask for your money back. If you are, you’re the lucky one.
Your friend is able to give you back $700. Considering you could have lost your entire $1,000, you feel relief that you’re only taking a 30% haircut on this whole affair.
But one by one, as the creditors come marching in, each one gets back less money than the one before.
Everyone in this chain of lunatic lending gets hurt.
Your friend will be broke by the end of it. And many of the people that lent to him will have lost what they thought might have been a good and safe investment.
So now you see, there are no winners in this game of hot potato. When the music stops, everyone gets burned.
This same logic applies to the global economy as a whole. Let me show you briefly what I mean. Then I’ll tell you about the one move you can make today…
What to Do Before the Music Stops
Small businesses, corporations, and even sovereign nations are all trying to keep this same juggling act alive. Meaning it’s not just you and your friend playing hot potato. It’s the global economy.
If demand in the economy slows down… corporate revenues decline… or the cost of goods rises, the cracks start to show.
And the cracks are already forming.
Neel Kashkari, the President of the Minnesota Fed, believes unemployment is already as high as 24%. That’s almost as bad as the Great Depression. Back then, unemployment peaked at 25%.
Meanwhile, major airlines are losing $40-50 million per day. And out of all U.S. mortgages, nearly 8% are in forbearance.
What all this tells us is the music will end soon. How soon? That’ll be the subject of our next issue… so stay tuned.