The biggest crisis currently facing the world today is the state of the global economy.  People are losing their jobs, the cost of goods is on the rise, stock markets are crashing, and banks are failing.  In the late 1980′s, the market crashed, but people are starting to compare the economy today to that of 1929, the beginning of the Great Depression.

To understand the crisis further, you first have to understand how it happened.  In a nutshell, we are a society that survives on credit, from the federal treasury to the banks to the individual.  For those people who do not have credit, they may still feel the impact because they are lenders (through their investments or mutual funds).  Most people borrow money to pay for goods or services that they want or need.  They borrow from banks, or other financial institutions, or by paying via credit card (borrowing money from the credit card company).  The money that has been borrowed is to be repaid over time with interest.  The interest is the cost (to the individual) of borrowing money.

The banks, for the most part, lend out the money.  However, they do not necessarily have this money to lend out.  Through a process known as fractional reserve banking, the banks can lend out up to nine times as much money as they have on deposit.  For example, if a bank has $1,000,000 on deposit, they can lend out up to $9,000,000 to their customers!  Due to the likelihood of every single person not wanting to withdraw all their money from the bank at one time, this is possible and does not pose a problem.  The problems occur when the people spend their money to purchase goods, and the merchants they bought the product from re-deposit these funds in their bank account.  This enables the bank to re-lend out that deposited money again, retaining only 10% of the re-deposited loan.  This happens over and over and over.  Keep in mind that the banks always charge interest on these loans, and depending on the interest rate (let’s use 5%), they can make up to 45% interest on the lended amount (5% x 9).  If you have ever wondered why a bank grows faster than almost any other business, that is the reason.

By lending out so much money, the money supply has been artificially expanded.  The more money that there is on the market, the less purchasing power the consumer has.  Interest rates begin to fall because there is more money out there to lend.  This causes the price of goods and services to increase (inflation).  As a result, the currency falls relative to that of other countries, depending on their stage of money expansion.  To combat the currency falling, the federal government will raise the prime interest rate.

This is, as mentioned earlier, an artificial bubble.  It cannot continue indefinitely due to the fact that the rising interest rates (remember, interest is the cost of borrowing money) inhibit borrowing because it becomes too expensive.   This slows, or even halts, inflation.  Credit is more difficult to acquire, and people start saving their money instead of spending it, which causes the business sector to contract (as companies go out of business).  When they go out of business, inevitably their people are no longer gainfully employed.  They have no income, but they still have bills and loans to pay.  Additionally, home prices begin to fall, because people cannot afford the high prices (and they no longer qualify for significant credit to purchase them).  This continues until the dollar begins to rise in comparison to foreign currencies.  This attracts foreign investments and allows the federal government to lower the prime interest rate.  The cycle then begins anew.

This is the primary reason that the economy is so unstable.  A system of highs and lows that reward the lender (or lending institutions, if you will) with an extraordinary amount of interest revenue due to fractional reserve banking.  To put it blunty, it boils down to greed.  Money’s most powerful ability is to allow bad people to continue doing bad things at the expense of those who don’t have it.  This is the system that allows the banks to make record profits in the worst of times.