No one would disagree that the current financial crisis is neither the first nor the last. The economic data would show that the total number of recessions, including the current one, have been 12, in the USA, over the last 70 years. The situation turns grim when recession occurs, leading, lagging or concurrent, with the financial crisis and/ or banking crisis. Recession is a state of negative GDP growth in two consecutive quarters. Financial crisis is a state of the economy when real and financial assets lose substantial value (35- 50%) and the firms close down. A banking crisis occurs when the supply of bank credit dries up and the processes of funding become slow and tardy.
Are we in a state of recession or financial crisis or banking crisis? As of the day of this writing, U.S. economy is in recession. It has experienced financial crisis of a variable nature. And it has so far escaped banking crisis. Easy monetary policy of the Federal Reserve and relaxed fiscal policy by the Congress have definitely worked to avoid catastrophic financial crisis or banking crisis hitting the country.
So, are we through it? Certainly not. The situation is fluid and precarious. Till an effective solution to the coronavirus pandemic is found, it would continue to be the same. The continuation of the easy monetary policy in USA is a given. USA have had easy monetary policy for years since the 2007-08 economic, financial and banking crises. Easy monetary policy is good for banks more than anyone else. J.P. Morgan Chase had its highest quarterly revenue ever, in the second quarter of 2020. Relaxed fiscal policy and social security benefits do help households and businesses, in the short run; but certainly, these can’t be a long term solution.
The family finance is a matter concerning income, expenses, savings, net worth, liquid assets, of an individual family. At the macro level, family finance is influenced by GDP growth rates, inflation rates and unemployment rates. Social security benefits play a bridging role in shoring up family finance. Special relief and stimulus packages, of the kind, offered in the context of COVID- 19 are purely episodic and temporary. The timing of the arrival of the episodic relief can also be critical.
Of all the variables affecting family finance, earnings are the key most; and the key to earnings is employment and thriving businesses. This is the first time in the last 70 years that the unemployment rate in the USA has spiked so much, nearing 15 percent. The data of recent months would show that the rate of unemployment has come down from near 15% to near 11%. The trend of the last two months looks promising but certainly not secular or firm.
What is needed at the level of each family is crisis-proofing your finances. Crisis- proofing would essentially involve:
i) Every family must organize to provide emergency fund to cover 3-6 months’ average monthly expenses. Minimizing discretionary expenses and lifestyle expenses can help to build an emergency fund for vulnerable families. As you may know, a laundry basket in USA may be bought for $10 to $250.
ii) Never go for speculative investments unless have surplus over and above emergency funds.
iii) Those who have surplus over and above emergency fund, may pick up assets available for cents on dollars in such crisis. Crisis can actually be a wealth building time, if you have investible funds.
iv) While investing funds, never forget that the Return of Investment is more important than the Return on Investment.
v) The health insurance, disability income insurance and life insurance provided by the employer may not be available exactly when you need most. The insurance gap is important to know and plug-in time.
In closing, I would recommend you revisiting that short story readily available on internet, I can sleep, when the wind blows. The problem is not storm. Problem is preparedness!
Dr Sat Parashar, PhD is former Director, IIM Indore. He teaches at University of California, San Diego, and is a Financial Services Professional. He may be reached at email@example.com