The idiot's guide to the economy by Oliver Neilson

Economic rule number one applies to more or less everything not just money and oil.

Supply and demand, if a market (sugar, oil, money, cars, anything) has loads of supply but not many buyers, the sellers drop their prices.(buyers market). If a market has low supply, and high demand, prices rise as buyers effectively bid up the price (think ´Playstations just before Christmas)

CREDIT CRUNCH

The World economy is driven mainly by banks having cash reserves and lending it to each other and their customers, this is called LIQUIDITY

Over the past decade mainly US banks lent massive (100%+) mortgages to customers with low credit ratings, these are called SUB PRIME MORTGAGES.

Dealers for the banks sold these debts to other banks in the form of mortgage backed bonds this process is called DEBT REPACKAGING. They were bought by banks and investment funds and pensions all over the world (including UK and Spanish banks) who did not sufficiently understand the risks.

When large amounts of the sub-prime mortgage customers began to default on their mortgages the house prices fell meaning that the banks did not have enough money when the repossessed houses were sold.

The losses have amounted to trillions of dollars world wide. As a result the banks did not have enough money to lend to their customers or to other banks (they lacked LIQUIDITY), as a result, banks that rely on market liquidity (like Northern Rock) found their supply cut off. (e.g. you are a green grocer, you buy veg wholesale and sell it retail and keep the difference, if the veg wholesalers have no veg, you are in trouble). This lack of liquidity is called the CREDIT CRUNCH….So banks can´t lend morgages, people can´t buy houses, so sellers have to drop their prices if they want/have to sell QED house prices fall.

OIL PRICES

Oil is limited and running out, all the easy (cheap) to extract oil has been dug up and sold years ago. New oil reserves are harder (more expensive) to get to, so the suppliers factor this into the cost.

There is plenty of oil left to drill world wide but it is increasingly expensive to get at (under ice sheets etc) and at today’s prices, it is too expensive to make a profit out of, as prices go up, it then becomes economic for the oil companies to get at.

However the biggest factor pushing up oil prices are is the development of India, China and other developing countries. They are basically going through their own Industrial Revolution with people leaving the fields and heading for the towns in their 10´s of millions every year. An urban dweller uses 3.5 times as much oil as an urban dweller.

So with demand and supply rules in mind, there is a limited supply of oil, and loads more people want it, so up go the prices, and give or take, they will keep doing it, THIS IS NOT A TEMPORARY EFFECT. (until we can find alternative energy sources, solar, wind hydrogen or whatever). The price of everything (I mean that) in the world is affected by the price of oil, (example, of a factory making anything you like. factories run on electricity which is going up because its mainly made with oil, their employees probably drive to work and will want a pay rise as petrol is getting more expensive, all of their components will be trucked in, all their products will be trucked out to a distributor and retailer, who use electricity, and employees drive to work…..etc)

All of these increases in a company’s costs get passed on in the prices they charge to their customers. Rising prices are called INFLATION (this type of inflation is called COST PUSH INFLATION.

FOOD PRICES

More prosperous people in the third world eat more food, and so increase demand, and push prices up. Food producers are also subject to COST PUSH INFLATION as above, this also pushes up prices, as does the fact that large areas of prime agricultural land are now being turned over to growing biofuel, thus reducing the land available for food production (reducing supply as demand is increasing, see rule number one)

Keeping up?, good, last bit for now.

Finance ministers (Chancellors) and central banks (Bank of England and European Central Bank) can raise or lower interest rates to speed up or slow down an economy.

Interest rates up: Loans and Mortgages get more expensive and savings get higher interest so people spend less, if they spend less, demand reduces and prices come down, (rule #1). PRO Inflation reduces, CONS people feeling skint suddenly see their mortgage go up, and the electorate think you are a mismanaging the economy.

Interest rates down: Cheap to borrow money, no point putting it in a bank as you don´t get any interest, PRO, people feel a bit better off, CON fuels inflation setting up economic stress for the future.

Result, Dammed if you do, dammed if you don´t .

Questions, just call.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s