How to Manage Your Money in Any Economic Condition

It's hard to figure out what you should be doing with your money during normal times.  But learning how to manage your money in any economy is key.  After all, what happens in a depression or during times of deflation or inflation?  What should you be doing with your money then?  

The economy should not be some esoteric thing that you ignore because you have no idea what it means.  It is the life blood of a country and can determine whether the country's citizens are living a squander or luxury.

Your country's economy is very important to your money and your livelihood.  It controls how much your money is worth and determines what you can buy with that money.

So more than anything it is important to understand the economy and how it affects your money.  More specifically, we need to understand the economic cycle and how certain economic conditions affect our livelihood.  

After all, an economy isn't stagnant.  There are ups and downs then ups and downs again.  And, occasionally, through these changes certain conditions arise.

But first, let's define what an economy actually is and then what makes up the economic cycle.

What is the Economic Cycle?

The Oxford dictionary defines economy as the state of a country or region in terms of the production and consumption of goods and services and the supply of money.  It is not constant but is always changing due to a changing culture, geography, laws, etc.

In fact, economies tend to move in cycles.  There are periods when the economy is expanding and periods when the economy is contracting.  This cyclic movement of an economy is called the Economic cycle, or the business cycle.

To determine which part of the cycle we are in, we would typically look at a country's Gross Domestic Product (GDP) which is the value of all goods produced minus the cost to produce them.  

A country's GDP reveals the health and wealth of the country.  If the GDP is high, it indicates that the country has a healthy economy and its citizens are pretty well off.  (Here's the current GDP for several countries.)

In addition to the GDP, a country's employment rate, income, interest rates, and consumer spending can also be used to determine which part of the economic cycle we are in.

The 4 parts of the Economic Cycle are expansion, peak, contraction, and trough. Let's take a look at each of these separately.

Expansion

During this phase the economy is expanding.  This is that let-the-good-times-roll kind of stage.  It is marked by strong economic growth, increasing production of goods, and low unemployment.  

Corporate profits are rolling in.  Companies are hiring more people which means families have more disposable income which, in turn, leads to more spending and a continued expansion of the market.

In the beginning of this part of the economic cycle, interest rates are low and inflation is relatively small.  As the expansion phase continues, interest rates will start to rise as will inflation. 

Peak

Eventually the strong economic growth slows until it reaches a plateau.  This is the peak in the economic cycle.  It is when the economy's time of expansion has reached its highest level and now has no where to go but down.  

Usually this peak is brought on by inflation that has gone too high and needs to be corrected.  This correction comes in the form of a contraction of the economy, which is the next part of the cycle.

Contraction

During this phase the growth of the economy slows.  Interest rates are high and there is not as much money to go around.  As a result, the productions of goods and services decrease, corporate profits decrease, and the unemployment rate begins to increase.

As more people lose their jobs, families have less disposable income floating around so spending decreases which causes further contraction of the market. And the cycle continues until it reaches the trough. 

Trough

This part of the economic cycle is where the contraction phase bottoms out.  It is the lowest point of the cycle and from here the economy will rebound and begin to expand again.

Interest rates will come down to encourage more borrowing, lending, and spending.  And eventually, the market will pick back up.

How to Manage Your Money in Any Economy

As we go through the ups and downs of the economic cycles, conditions arise that can have drastic affects on your money and livelihood.  Some of these conditions are inflation, hyperinflation, deflation, and stagflation.

Let's take a look at these economic conditions and see what they mean for your money and your investments.

Inflation

Inflation occurs when the price of products in a given economy increase over a period of time.  So when milk goes from $2 to $4 or when gas prices jump from $1.50 to $5.50, that is due to inflation.

In general, it is said that a little inflation is a sign of a healthy economy.  But inflation can strike you, the customer pretty hard.  Especially if the prices of goods are increasing but your income isn't which is typically the case.

This means you'll be left footing an ever increasing bill without enough income to support the increase.  As a result, during inflationary periods people are not able to save or invest their money.  And many will go into more debt in an attempt to keep up with ever increasing costs.

Causes of Inflation

There are a number of reasons why prices may go up.  One reason is due to changes in the money supply.  

For instance, if the government decides to print more money, then this increase in the money supply will cause the value of the money to decrease and the prices of the goods to increase.  This means your money won't be able to stretch as far as it once did.

Another reason for prices to go up is due to a change in the supply of products.  Maybe the costs to make the product has increased or there's a sudden decrease in the supply due to an embargo or other trade agreement.  In both cases, the costs of the goods in question will increase.

In the first case, the increased costs of producing the product is just passed on to you, the consumer.  And in the latter case, the sudden decrease in supply results in increased demand.  So prices will go up accordingly.

What to Do During Times of Inflation

During inflationary periods, you will want to start cutting back on your spending so that you can maintain your savings rate and continue to invest.  You should be investing in assets that do well during inflation such as consumer products (like toilet tissue and food), gold, cryptocurrencies, and real estate.

Borrowing money during these times is not wholly bad so long as you invest it in things that will give you money back.  And the best part about borrowing during inflationary periods is that you will be paying back the loans with money that is worth less later on.

What you don't want to do during this time is get into more debt for things that will not give you a good return.  You know yourself better than anyone else.  So if that is you, lock away the credit cards and only spend money on the things you need and can afford.

Hyperinflation

An economy is in serious trouble if hyperinflation sets in.  This is when inflation has just run wild.  Prices are increasing rapidly and are simply out of control. Hyperinflation is marked by an inflation rate of more than 50% a month.

Prices may become double, triple, 100 times more expensive than they once were.  People may begin to hoard goods creating shortages and thus, making the inflation even worse.

There is one excessive case of hyperinflation in Germany where you needed an entire wheelbarrow of cash just to buy one loaf of bread.  And in Zimbabwe during their period of hyperinflation, the price of goods were doubling every single day.

Causes of Hyperinflation

There are two main causes of hyperinflation.  Both of which are causes of regular inflation as well.  First, hyperinflation can occur from the government printing an excessive amount of money.

The drastic increase in a nation's money supply causes the value of their currency to decrease dramatically.  Goods and services start to cost more.  Then people begin to hoard those goods making them scarce and thereby increasing the price of the goods further.

The other way hyperinflation can occur is from increased demand but a decreasing supply.  Because the supply is limited or unable to keep up with the demand, prices will rise.  As this state of affairs continue, the prices will continue to rise unless strategic measures are taken.

Hyperinflation tends to occur during times of war and during recessions.

What to Do During Times of Hyperinflation

Pray.  

Then pray some more.  

Okay, in all seriousness, should you find yourself in such a situation it is best to be prepared beforehand.  That means having your money in a well-diversified portfolio of stocks, bonds, commodities, cryptocurrency (if you'd like), and real estate.

What's more, unlike in other economic conditions, having debt or taking out more debt just before hyperinflation sets in is great for the borrower as you would be paying back that debt with money worth less and less.  

What some people did in Germany was take out loans then use it to buy assets such as stocks and real estate (assets that tend to do well in inflationary periods).  Later, they would pay back their loans with money that was worth much less than when they borrowed it.

Some experts also advise keeping your passport up-to-date and ready should the hyperinflation in your country become so bad you need to escape.

The key here is to be ready before hyperinflation sets in.  So make those strategic investments we talked about now.   And, if it's right for you,  you could buy those assets, that give you a nice monthly income such as real estate, with borrowed money to make the deal even better.

Deflation

This economic condition is the opposite of inflation.  In fact, when the inflation rate is negative, we are in a deflationary period.  This means that the prices of goods are going down.

From the consumer's perspective this is great as now it will cost you less to buy the same things.  However, governments and central banks don't like deflation because it makes it harder for them to control the economy through their usual means of printing money or adjusting interest rates.

While a little deflation seems good, the problem will come if it enters a deflationary spiral.  As the prices decrease, the production of goods and the demand decreases as well.  

Consequently, there are less profits for businesses who now can no longer afford to pay their employees.  So wages decrease and unemployment increases which leads to an even bigger decrease in supply and demand and the spiral continues.

Note: Deflation is not the same as Disinflation.  Disinflation is the decrease in the growth of inflation.  So instead of the inflation rate going up 2%, it will go up just 1% in a disinflationary period.

Causes of Deflation

Deflation is a rare occurrence in the overall economy but it does occur more often in certain industries especially in tech.  This is usually the result of increased efficiency in the production of the goods due to technological advancements.

As production becomes more efficient, companies are able to make more goods for lower costs and so we, the consumer, benefit by paying lower prices.

Deflation can also occur when there are lots of goods and services but a decreasing demand for those goods and services.  So, businesses must lower their prices to, hopefully, increase sales.

Finally, deflation occurs when there is just not enough money going around.  With little money in circulation, the value of the money will increase and so goods cost less. 

What to Do During Times of Deflation

Even though prices are lower during deflationary periods, people are not out on shopping sprees.  Why not?  Because when money in scarce, people tend to hoard it out of fear.

To combat this scarcity, you should find ways to diversify your income and increase your skills.  Getting a side hustle to increase the amount of money you have coming in could be just what you need.  

Not to mention, having more skills makes you more desirable to employers who hopefully will keep you around when it comes time to lay people off.

Also, during deflationary periods, you may want to consider refinancing your loans.  That way you can have smaller monthly payments as well as take advantage of lowered interest rates as the FED tries to fight deflation.

As far as investing is concerned, cash is truly KING during a deflation as its value will continue to rise.  But, depending on your situation, this may be a good time to go to a minimal budget and invest some of your money into the stock market as you can grab stocks at a discount.

When investing, you should dollar cost average into the stock market during this time because you don't know where the bottom is and waiting around for it could make you miss some good stocks while they are on sale.

If the stock market isn't right for you, then you can consider buying treasury bonds.  After all, with bonds, at least your principal is safe and you may be able to get a little in the way of interest.  Also, should the interest rates decline further, the bond you hold will be worth more. 

Lastly, debt is definitely not your friend during deflation.  Having debt will hurt you the worst during deflationary periods because you will be paying back your debt with money that is worth way more than when you got the debt in the first place.  

So, if you can, try to pay that debt back fast or defer debt payments until the economy recovers.

Stagflation

This is an interesting but rare economic condition where you have both inflation and stagnation in the economy.  Thus, they've called this phenomena 'stagflation'.

During stagflation, inflation is high while at the same time unemployment is high, production is down, and there isn't much economic growth.  This is a huge problem for governments since one of the ways they fight inflation is by increasing interests rate.

However, doing that will cause costs and profits to drop and in turn, would lead to even more unemployment.  Further, anything they do to try to decrease the unemployment rate is likely to cause the inflation rate to increase even more.

Talk about being caught between a rock and a hard place.

Causes of Stagflation

There are a few theories that exist as to how stagflation can occur in an economy but the two main theories are bad economic policies of the government or a supply shock.

If the government decides to lower interest rates, print more money, while at the same time passing laws that restrict company growth, stagflation could occur. 

Furthermore, if there is a shock to some critical part of the supply chain, the economic output of a country could slow while at the same time prices for the products would increase. 

An example of this being America in the 1970s after OPEC declared an oil embargo on the West.  This sent oil prices soaring as well as the cost of many other commodities. 

The inflation rate was in the double digits.  People cut back on their spending and production slowed.

What to Do During Stagflation

As always, you will want to be careful of where you put your money during stagflation as the value of your money will decrease as inflation rises.  Reel in your spending as prices will rise while your income will not.

If you are thinking about investing, you will want to invest in companies that do well during high inflation and slow growth periods.  These companies may include companies in the utilities, consumer, and industrial sectors as well as companies who are self-reliant and not so dependent on outside suppliers.

Consumers will always need food, toiletries, etc. so those tend to make for a great investment no matter the economic condition.

All in All

Learning how to manage your money in any economy is key to creating and building that long-lasting wealth you truly desire.  The economy, its cycle, and the conditions that arise in economies affect how you should manage it.  

Hopefully, you now know what to do when inflation, hyperinflation, deflation, or stagflation strikes.  And you'll be better able to protect your wealth and continue to grow your money despite the economic conditions.

Have you lived through any of these economic conditions?  What did you do?  Would love to hear your story! Let me know in the comments below! 🙂