Feb. 22, 2022

How To Make A Two Tier-Economy.

The last time we had an economy like this was the 1970s.

As luck would have it, I was a cub broker, just starting out on my career. Back then we were paid strictly on commission. And as I didn't have many clients, I wasn't making much money.

But while my income wasn't climbing, my expenses certainly were. The cost of living steadily escalated. And I soon found it harder and harder to make ends meet.

I have a feeling that's happening to many of us today.

So I offer this as a sort of guide, on what we can expect ahead if the economy continues on this course.

Now the easiest thing to do is to simply borrow to maintain that lifestyle you've become accustomed to. I know, that's exactly what I did. When we started out, credit card interest wasn't too, too bad. So just put things on the plastic. Tide yourself over, until times get better again.

If I have one thing only that you hear, please try to avoid, to the extent you can any extra borrowing. Credit cards, home loans, student loans, it doesn't matter.

Because there are a couple of things that we know about loans. First, those banks and lending companies are pretty aggressive in wanting to get their cashback. Don't mess with them. They can ruin your credit, and thereby cut off any future loans you might want.

OK, you probably already knew that.

But there is another dimension at work here. During a time of rising inflation, like now. Those same banks are going to start raising their interest rates. Forget that the Federal Reserve tells you that interest rates are less than 1%.

The bogey for the banks is 7 1/2%. That's the current inflation rate. And that's the minimum that the banks will want to make on their loans. So it's 7 1/2% plus fees and profit margin, and you can see we're easily into double digits as the credit card fee and consumer loan fees of all kinds add up.

So as your loan balances increase, the payments on those loans will increase even more, because the banks inevitably will raise their rates, to cover inflation.

Unfortunately, you're not alone in experiencing higher loan costs. Your neighbors up and down the street will get hit with the same higher rates.

Grocers and all retail shops purchase their inventory primarily through inventory loans. And sure as we're sitting here the cost of those loans are going up.

Hence the cost of food, clothes and all the retail things we buy are all going up. Not just because they're becoming more expensive to produce, which they are. But also because they're becoming more expensive to put in inventory and sell to you and me.

So that's the first tier, of our two-tier economy.

But it's not just the small mom and pop shops who will have this problem, large companies should be going through the same thing.

I often like to point to Home Depot as one of the best, most well-managed retailers in the nation. It's also one of the most highly leveraged. Which, if I recall correctly, has more than 90% of its capital through borrowing.

Borrowing to carry all that inventory in their stores. Borrowing that should come at a much higher cost. But likely does not. 

That most definitely is the way things worked back in the 70s. And that's the way things are supposed to work. But if I'm being entirely honest, that is not how things work today, in 2022.

In 2022, there are really two economies. And if I'm at all correct about all this, the two economies are about to take two very different paths.

The first tier economy is the economy for you and me. We are definitely entering a high inflation period. Actually, we're already there. And you and I are going to have this hit like a ton of bricks. Prices will go up, incomes may not, and the cost of borrowing will definitely go up too.

However, it's an entirely open question whether the upper echelon of the economy will bear the same burden. Oh sure, as individuals, they will buy their groceries and retail goods, just like all of us. And the price of those items will definitely go higher with inflation.

But will the cost of finance, at the top level, also rise? Perhaps not. At least they haven't so far.

You've probably noticed the extreme reluctance of the Federal Reserve to raise interest rates. Any talk by the Fed of hiking rates is immediately met by a tantrum on Wall Street. Markets swoon. Dropping a few hundred points. And the Fed backs down.

And we not talking about raising rates very much.

Right now rates are fully 7% BELOW inflation. That's not fighting inflation. In fact, that's creating inflation.

We are living through one of the highest periods of monetary stimulus of all time. In fact, far greater than the 1970s. The Fed is pouring gas on the inflationary fires, by keeping rates this low.

So who, you may ask, can borrow at those low rates that the Fed is promoting?

The answer, Wall Street, those same people who are screaming every time the Fed talks of raising rates. Also, large corporations who are big borrowers, get those preferred rates.

So my earlier example of Home Depot is likely not the case right now. Home Depot, Apple Computer, Tesla, and all the big names you know, are most likely borrowing at levels you and I can only dream about.

When that will change, or even if that will change is an open question. One squarely centered on the Federal Reserve and its policies.

I could go into an open rant about how politicized the Fed is right now. And the undue influence that Washington holds over the Fed. But I'll save that for another time.

Suffice it to say, that right now we are creating a two-tier economy. As in so many ways we're creating a two-tier society. On the top are those who have accumulated vast sums. And are able to leverage that even further with their low cost of borrowing.

While here, in retail land, we are facing no doubt higher interest rates on what we borrow. As well as inflation has driven higher prices on the things we purchase.

This is how you make a two-tier economy.