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Raising interest rates is the quickest way to move the economy forward

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139445633 e2fabef491 m Raising interest rates is the quickest way to move the economy forward
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Suppose you buy a valuable piece of art for $15,000.  Further suppose that a month later a major economic slowdown occurs and as a result, the amount of money art buyers are paying drops substantially.  Perhaps today, if you wanted to sell the art, you might be able to sell the painting for $10,000.  If you intended to sell the painting, what would you do?  Most likely, you would try to wait for the market to correct and try to recoup the initial investment.  You aren’t motivated to sell the piece of art.  It’s not costing you anything not to sell it, so why not hang on to it.

But what if you bought that piece of art on credit?  Even at a relatively good interest rate of 5 percent, you would still be losing over $60 a month in interest and spending about $300 per month in total payments.  Having that piece of art costs you money every month.  In this case, you are much more motivated to sell the art for $10,000.

However, what if you had a credit card that carried zero interest (or in the range of 0 to 0.25%) and if you can borrow money on that card at will without fees.  In this case, you are not losing substantial money to interest and you can borrow more money whenever cash flow gets tight.  In this case, your debt no longer pressures you to move the problem forward.  Although the market has priced your painting at $10,000, you are behaving as if it is still worth $15,000.  You are arguably denying or deferring reality. 

Now I don’t think there is anything particularly wrong with this delusion.  Everyone can bury their head in the sand, but these people should be penalized to clinging to delusions.  But these days, banks do not feel the pinch.

In a market correction, asset holders need to substantially mark down the price of their assets to get them sold.  In a macroeconomic sense this is called “finding the bottom” where prices come down to a point where sufficient buyers are available to meet demand.  Once the market finds its bottom, new growth occurs. 

150x103 Raising interest rates is the quickest way to move the economy forward
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For years now, banks have reaped the benefits of policy based on monetary theory.  After making loans to millions of people who couldn’t afford them, banks should have been suffering from huge cash flow issues due to the lack of payments and loss of principal on these assets.  However, since banks can borrow money at will from the Federal Reserve at essentially no cost to them, banks have plenty of cash to meet their needs.  Banks have little motivation to turn around their growing foreclosure inventories by reducing prices. 

Because of this false support of overvalued properties, real estate property values continue to fall, not in a quick fashion, but a slow laborious multi-year fashion. When the correction could have taken a year or two, real estate values are still falling.  Wise potential home buyers see this and are choosing not to buy.  It is important to note that record low mortgage rates also played a huge role in driving home sale prices up.  Home buyers realize that once interest prices do rise, there will be even more downward pressure on home prices. 

These phenomena add up to one conclusion, sellers are hesitant to sell and buyers are hesitant to buy.  Raising interest rates, though painful in the short term, may offer the best hope for escaping the economic holding pattern we’ve been in for years.

 Raising interest rates is the quickest way to move the economy forward
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Managing Cash Flow

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I have always been interested in entrepreneurship.  In college, I took several courses that dealt with starting and running a business.  Though none of the material was exceptionally difficult, I was intimidated by assembling financial statements.  One would normally think that being an engineer and otherwise being very proficient in mathematics, this wouldn’t be difficult.  However, there is a world of difference between using math to solve an interesting problem and using math to keep a business solvent, feeding your family and keeping people employed. 

Like many people I was intimidated by assembling income statements and balance sheets and left the creation of these documents by other folks who were in traditional finance fields.  Looking back this is amazing since both income statements and balance sheets consist of nothing more than simple addition and subtraction.  The most difficult parts of preparing financial statements usually comes in the initial setup when you do not have a history that will guide you in making predictions moving forward.  Even in these instances, there are numerous ways one can estimate costs and incomes if one thinks things through.    I would have given myself a tremendous advantage earlier on had I chosen to apply myself more in facing my lack of confidence and learn it. 

Speaking plainly, you will never move forward financially until you learn to track your financials and make reasonable financial projections.  You need to learn to track your income and outflow so you can effectively manage the challenges of spending today and projections are needed to manage the challenges of spending in the future.

 Managing Cash Flow
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Water Works – Managing Personal Cash Flow

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Analogy is one of the most effective teaching tools.  By showing similar relationships in the familiar and concrete to the new and abstract, it becomes much easier to illustrate the relationships to the inexperienced.  One of the most concrete analogies I have seen to explain abstract concepts is in plumbing.  I have seen plumbing used to explain such diverse fields as electricity to organizational systemic behavior.  Plumbing also is a great way to illustrate the flow of money.

In every household, there is income which consists of the water source and a set of expenses that serve as a drain.  Most people have a drain that is large enough to drain the bathtub nearly as fast as the water flows into it.  Not only is one required to keep filling the tub by working hard, but also should something disrupt the flow of water, such as a bout of unemployment, the tub quickly drains and fundamental needs of food and shelter become difficult to have.

I started working when I was 13 years old.  I have always worked and worked hard.  One of the best things that can be instilled in a young person is a work ethic, but a work ethic without an ability to manage personal cash flow only serves to help make everyone else more well off.  When I started working, I earned some money and I was able to buy a few nice things, but one of the lessons I learned far too late is that when you buy something that doesn’t pay you back, that purchase only serves to make the seller richer and you poorer.  Diligent efforts must be made to make some portion of your earnings work for you over time and that only happens with a combination of saving and investing.

I will be discussing more about how to manage cash flow in the weeks to come.  But it is fact that one will never get ahead financially unless one learns to reduce expenses sufficiently to divert some income into savings and investments.

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Should young people see a financial planner?

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I found an interesting article in US News. The value of a financial planner to a young person depends upon how someone defines a young person and what kinds of services that financial planner is commissioned to provide.

If young person means someone under age 18, it is uncommon that a financial planner is needed to coordinate a large investment portfolio. However, a financial planner would still be very useful to provide financial education. Unfortunately, too many financial professionals are salespeople rather than trusted educators. Regardless of age, I would recommend finding someone who sees his or her primary role is that of educator. In that vein, seeking a fee-only financial planner is a good idea for people of all ages, provided you find yourself learning during your visits.

One good rule of thumb for any financial transaction pertains to who is paying this person. If one operates on commission, the company one sells for is paying the person and, therefore, the seller owes his or her allegiance to the company and not to you. However, if you are paying the person, there is a better chance that the advisor is keeping your best interests in mind.

I love financial planners. I provide financial counseling to many folks and I find it very rewarding to help some people discover better ways to manage their affairs. The most important thing to keep in mind is make sure they are working for you.

Here are a few warning signs to look out for:

1) The advisor wants to sell you something the first time you meet.
2) The advisor hasn’t asked you a bunch of questions to understand your situation.
3) The advisor seems to push you in the direction of one financial product.
4) The advisor starts marketing you investments before you’ve discussed your cash flow situation.

Remember that 80% of the game of personal finance has to do with cash flow management. Any advisor that isn’t addressing this is thinking more about selling you something rather than helping you solve your financial problems.

http://money.usnews.com/money/personal-finance/articles/2010/08/05/should-young-people-see-a-financial-planner.html

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