“Today is already the tomorrow which the bad economist yesterday urged us to ignore.” — Henry Haslitt
Do you ever feel intimidated by economics?
Do you think it seems a little bit over your head?
It’s very important to pay attention to economics for many reasons.
One of the biggest reasons is because of the 2008 financial crisis.
If you were only focused on one asset class during this time, you could have been destroyed.
You need to pay attention to the global economic structure.
Another reason to pay attention is because of the currency situation happening right now.
Over 40% of all existing currency was created within the last 24 months.
Things are dramatically changing.
Today, I’m giving you a crash course in economics.
You will walk away with a better understanding of how economics work in three easy steps.
Let’s jump into it!
1. What Effect Does This Cause?
I recently read this book by Henry Hazlitt called Economics in One Lesson.
Even though it’s an older book, the principles are still true today.
The first question he asks is: What effect does this cause?
When you’re looking at an economic or policy decision a government makes, what is the long term effect?
There are many examples of this, but one we’ll talk about is rent control.
Rent control is the desire to fix a short-term problem.
When the rents are too high, the instinct is to stabilize so people don’t lose their homes.
This makes total sense from that perspective.
The challenge is that rent control over the long term has the exact opposite effect.
It can lead to less housing supply and substantially higher rent prices over time.
They did a study in New York City years ago and found that there were over 30,000 single people living in three or four bedroom apartments.
Why would these people do that?
They lived with artificially low rent for years because they were on rent control and couldn’t afford to move.
The one and two bedroom apartments were more expensive than the three or four bedroom apartments.
Rent control created inefficiencies.
If people can’t move out of a larger place because they would pay more money in a smaller place, it’s inefficient.
It also disincentivizes builders to build more because they’re not able to raise rent.
If there’s inflation, you’re not able to do what you want with your property.
Over time, there were many buildings in New York City that actually fell into disrepair.
We’re seeing this now in Los Angeles.
Los Angeles has had an eviction moratorium since March 2020.
It’s recently been extended until June of 2023.
That’s pretty crazy!
UCLA did a study and found that 49% of LA renters owed money to their landlords.
If you own a house or a small multifamily in LA, and your tenants have stopped paying, you’re probably experiencing some hardship.
Maybe you can’t afford your own payments.
Maybe you can’t afford to make the property nicer.
The city has also come out with a proposed new rule for landlords.
Landlords would have to register their properties to try and root out slumlords.
They’re doing this because some of these properties are getting run down.
This is an example of trying to solve short-term problems, but actually creating long-term problems.
You have to think about the long-term effects, not just short-term solutions.
You can apply this line of thinking to any decision you make:
What long-term effect does this have?
If I go to Starbucks every day and buy a $5 drink, what long term effects does that have on my finances?
If those daily coffees end up costing $150 a month, is that a long-term effect you can live with?
Now we’ll talk about why there’s such a short-term focus when it comes to economic decisions.
2. Policy Makers Are Concerned with Short-Term Solutions
Why are policy makers only concerned with short-term solutions even if the long-term effect is negative?
The main reason is because they want to get reelected.
They will quickly solve problems in order to give people what they want as soon as possible.
Even if there are greater problems later, it doesn’t matter, because reelection is a top priority.
Do I think they are all egomaniacs?
Probably not, but there are quite a few.
For them, it’s all about trying to stay in power.
The things meant to serve people in the short-term they either don’t understand or they don’t care that it has a very negative long-term effect.
We mentioned the idea of rent control, which is a form of price control.
At the time of this post, gas prices are very high.
Where I live, at the time of writing, it’s between $6-$7 a gallon.
If they say they will fix the price of gas and not let it go any higher, that will lead to gas shortages.
Companies will not go along with this and will lose money.
They actually started delivering less of that particular good.
This happened in the 1970s when inflation was super high.
Former President Nixon wanted to fix the price of everything for 90 days.
There’s a lot of problems with that because it’s very difficult to enforce.
What do you do if someone doesn’t abide by that?
If I have to sell my goods at a specific price, why wouldn’t I wait out those 90 days and then sell them?
This leads to less goods available.
Instead, it would penalize people that sell goods.
Then you wouldn’t be able to find any food at the store because nothing is available.
There’s no incentive to provide goods at what the market will allow.
There could also be some sort of price fixing scheme.
If this happens when I want to buy something like a pen, the quality can suffer.
They can sell me pens that have suffered in quality because the price has to be the same.
Another example of the government coming up with short-term solutions is tariffs.
Let’s use the example of the steel industry
A lot of jobs will be lost because of subsidies and tariffs on different steel shipments that are coming in.
That leads to a higher cost for the consumer.
You might think if there weren’t tariffs, then the consumers or the construction world would get steel for cheaper.
This would lead to lower cost for housing or other products.
You actually end up subsidizing an entire industry.
Is that really the right thing to do?
Should you subsidize a company that’s failing just to save the jobs and to save the company?
My answer is no.
Again, a lot of people look at the short-term results and not the long-term effects.
The downside of this short-term view is that the consumer pays higher.
Now, I’m not the hugest fan of Walmart, but I do shop there.
Their slogan is “Save money, live better.”
People think these large global companies are making so much money.
The average net profit margin for Walmart is actually 2.8%.
Not as high as you thought, right?
But what I get to do as a consumer is buy stuff for substantially cheaper than if I bought it at a local shop.
When you look at the long-term consequences of policies, it’s sometimes very different than the short-term decision.
Now let’s talk about pricing!
3. Prices are Magical
When I say prices are magical, I don’t mean Disney movie magical.
Prices give us so much information when they are set for a certain good or service.
It’s really a vote that says “I’m gonna pay this amount for this product.”
Prices fluctuate and create an efficient way of moving resources around.
One example of this is when the pandemic happened.
Remember the toilet paper shortage?
I know a guy who bought toilet paper in a parking lot after he couldn’t find any at Costco.
It was almost like a drug deal!
The seller approached him in the Costco parking lot and gave him a case of toilet paper for $50.
It was ridiculously expensive but the guy really needed toilet paper so he paid $50.
Prices can go up when there is a product shortage in the short-term.
We look back and see that companies created more toilet paper so the price eventually came down.
That up and down is generally what will happen.
If you’re a business and you decide you can’t make any money selling your product anymore, what will you do?
You’ll stop selling that product, right?
Maybe there’s too much competition.
Maybe you can’t make it cheap enough.
You can find something else to create that you can actually make money doing.
That’s the magic of business.
You need to look at the tradeoffs.
There are tradeoffs in your own income.
How much money you have is a fixed amount of income you can choose.
Do you want to buy this?
Do you want to go on this specific trip?
Everything takes money and there is a limited supply of many things.
There’s only so much beachfront property and everybody wants to live at the beach.
Because of this, those properties will cost a lot more.
So if you want to live there, you’ll have to fork over more money versus living somewhere else.
It’s basically a supply and demand situation.
The market will adjust and give us correct pricing based on how much it takes to create products or services.
This is what is so interesting about free market capitalism.
When you look at governments trying to set prices, all the prices are wrong.
We saw this in the USSR when they were setting all the prices.
The government tried to settle the prices but could never do that correctly.
After the USSR fell, there were these Russian oligarchs.
They had the ability to make purchases at this artificially low price and sell those purchases anywhere from 30-100x what they originally paid.
They were also able to export these goods somewhere else.
The market will generally give us the correct pricing, but governments can’t control it.
Nobody has the information to go along with the ups and downs of pricing.
If my shirt gets too expensive, I have a choice.
I can go buy a lower quality shirt or I can hold off purchasing.
I can also pay more money and get the shirt because I really want it.
If you can take one thing from this post, I hope you go and read Economics in One Lesson.
It’s a great book.
It’s truer today than it’s ever been.
Prices help us make wise choices.
Free market capitalism has given us a greater amount of wealth than any other type of governmental or economic process.
Be a supporter of that!
Now I want to hear from you.
Who do you listen to when it comes to economics?
Let us know in the comments below and let’s start a conversation!
Before you leave, make sure to check out our special report about investing. It compares the stock market to real estate, and it also includes how the pandemic affects your investment future.
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Disclaimer: I am not your investment advisor. This is for educational purposes only. I am not giving specific advice on what you can do. I am simply giving my opinions.
