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Wednesday, February 28, 2024

The Upside Once The Fed Destroys The Middle Class

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Bear markets and bank runs aren’t good for most people. But let’s try to look at the upside if the Fed destroys the middle class, shall we? Thinking in extremes provides clarity to help make better decisions.

To set the stage, we know at least these three things:

  • The Fed cares more about its legacy than supporting the middle class. All the Fed Governors are rich, so they will survive just fine if the economy goes down the tubes. To them, the economy is just made out of numbers, not people.
  • We’ve already heard the warnings about economic devastation if the terminal Fed Funds rate goes beyond 5% and stays there despite slowing inflation. Yet, the Fed hike again by another 0.25% on May 3, 2023 to 5% – 5.25%.
  • One of the easiest ways to be a savior is to first be the destroyer. People tend to appreciate what you’ve done for them lately the most.

The last time the Fed hiked to 5% – 5.25% was in 2007. Then the global financial crisis hit in 2008, ruining millions of lives. Although I lost about 35% of my net worth in six months, at least I started Financial Samurai in July 2009.

We cannot control what happens to us, but we can control how we respond. As a perennial optimist, let’s look on the bright side if we go through another deep recession.

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Effective Federal Funds Rate - 5% - 5.25%

The Benefits Of The Fed Wiping Out The Middle Class

Let me be clear. I would much prefer a bull market and a strong middle class. The middle class is the best class in the world. Even the rich prefer to be considered middle class because it feels good to be a part of the majority.

However, given the circumstances, we might as well try to list out as many positives as possible. With a Fed Funds rate range at 5% – 5.25%, we should expect more bank closures, more layoffs, and a dramatic slowdown in GDP growth over the next six months.

1) The unhealthy desire for prestige, money, and status takes a back seat.

I’m convinced the desire for prestige and status are important factors for explaining why many in the middle class feel miserable. After all, we have the saying, “Keeping up with the Joneses,” that encapsulates this struggle.

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Our living standards are as high as they’ve ever been. Yet we’re less happy due to comparison and the constant desire for more.

When you’re getting pummeled financially, you don’t have the luxury of seeking prestige or status anymore. Instead, you focus on survival. And when you focus on survival, you focus on what really matters.

Middle class income range by state

2) The student loan problem might get better.

The main reason why there is a student loan problem is because too many high school students pay too much tuition for a college education that isn’t worthwhile. If college overall was a good bargain, there wouldn’t be so much angst about student loans. Graduates would be paid appropriately and could more easily pay the loans off.

With middle-class incomes at stake, parents and students will be forced to choose more affordable colleges or trade schools. Perhaps more colleges will also begin offering more free grants as the need goes up. Maybe more students will read more books and use AI to learn more things for free.

This better alignment with cost and benefit will do wonders for a person’s finances and mental health. No longer will parents raising children in expensive cities feel as much angst for needing to accumulate generational wealth.

3) Better consumption and financial habits.

When you have less money or no money, you are forced to spend less and make do with what you have. As your frugal muscle strengthens, so will your survival skills. Ask those folks who went through the Great Depression and the 2008 Global Financial Crisis with a significant amount of assets.

Your financial habits will also improve after going through economic devastation. You will rationally survey your existing banking relationships and add to them for more peace of mind. You’ll review your net worth allocation to make sure you have the appropriate risk exposure.

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Once you’ve been through a financial crisis, you will likely be scarred for life. Some of your more disciplined financial habits will stick with you, helping you build more wealth over time.

4) Fewer cars, less pollution, perhaps more travel and world peace.

In America, we have a love affair with cars to the detriment of our environment. Even with the average new car price close to $50,000, we’re still willing to gobble them up like pancakes.

With the Fed-destroyed middle class, there will be fewer cars on the road. Traffic will ease, car prices will come down, and consumers will save money on car-related expenses. Not enough car buyers think about insurance costs, tickets, and maintenance expenses.

Air travel and accommodations will become cheaper as well with a weaker middle class. A global financial crisis may be the best time to be a digital nomad or backpacker.

The more we see of the world, the more empathy and understanding we will have for other cultures. Having world peace saves lives.

5) A chance to start anew.

Millions of jobs will be lost once the Fed gets done tightening. As a result, millions of people will need to find new jobs. During this job-hunting process, there will be an opportunity to try something new.

Due to inertia, fear, laziness, or lack of motivation, millions of workers are willing to continue working at jobs they don’t like. A job loss might be exactly the push you need to take a leap of faith.

I am so grateful to have negotiated a severance in 2012 at the age of 34. Despite being unemployed, I found a way to survive by doing something I love. Without the Global Financial Crisis, I would have stayed miserable at my job for another decade.

6) Less overcrowding in schools and more time with your children.

Public schools have often felt the strain of a boom economy. With an influx of more children and not enough pay to retain or attract enough teachers, classrooms get busier. Private grade schools also get more crowded and difficult to get into due to rapid wealth creation.

With a Fed-destroyed middle class, more spots will open up for all students. There may also be more teachers available given teaching is a relatively more secure profession.

In addition, if one parent loses their job, they might want to pursue homeschooling or at least provide more supplemental education.

If you are a middle-class parent who doesn’t make much more than the cost of childcare, losing your job may be just the catalyst to spend more time with your kids. Once they grow up, chances are high you won’t regret the time you spent with them.

7) A rekindling of current and lost relationships.

Once making money is harder to do, the natural inclination is to focus on all the things we’ve been neglecting for the sake of money. The best life consists of having supportive friendships and family members.

In our at times unhealthy pursuit of making money, we sometimes neglect our loved ones. It is during times of crisis that relationships grow strongest.

With more time being spent with friends and loved ones, our loneliness should naturally decline. When our loneliness declines, our happiness should commensurately increase. The 80+-year longitudinal Harvard study concludes the secret to a good life is having social connection.

Although, financial problems do strain marriages, perhaps there will be fewer divorces if couples spend more time on their relationships.

Once the Fed destroys the middle class, you can then better focus on your neglected relationships

8) A renewed focus on our health.

Some jobs are physically and/or mentally unhealthy. But we carry on because we need or want the money. However, when we are older, we may regret sacrificing our health for our jobs.

Manual labor is obviously tougher on the body than knowledge-intensive jobs. However, even knowledge-intensive jobs can take a tremendous toll on the body over time. Too much stress is a silent killer.

I went through teeth grinding, TMJ, plantar fasciitis, lower back pain, sciatica, and intense allergies for years while working in banking. A year after leaving, all of my chronic pain went away. I had been living with pain for so long I thought it to be normal. But it’s not normal.

Getting laid off, furloughed, or receiving reduced hours could literally extend your life. Use your time away from work to heal your body and mind. Perhaps relocate to a state that has a higher life expectancy. Every time I get off the plane at Honolulu International Airport, my stress melts away.

9) A change in political power.

If the Fed destroys the middle class, then whichever political party is in power tends to lose. Given America is divided equally along political lines, roughly half of the country will be happier after the next Presidential election.

Changing political power often creates new ideas and compromises. The issues voters were most unhappy with get addressed. Ideally, both sides meet somewhere in the middle for the health of the nation.

For now, we have another debt ceiling debacle to deal with. If the debt ceiling isn’t raised, then expect another stock market meltdown. Treasury bonds may also sell off, given Treasuries will suddenly seem more risky. As a result, mortgage rates will increase, thereby reducing the demand for real estate.

10) Borrowing costs will go back down.

If the debt ceiling does get increased, then during times of economic calamity, there will be a flight to Treasury bonds, the safest asset class. As a result, Treasury bond yields, mortgage rates and student loan rates will come down the most.

If the Fed eventually starts cutting the Fed Funds rate, then credit card rates will also decline.

As proof, the 10-year Treasury bond yield declined from 4% to 3.5% after SVB went under. In other words, SVB ended up selling ~$20 billion in bonds at the top of the market. Meanwhile, the 2-year Treasury bond yield collapsed from 5% down to 4% in the same time frame.

Given the middle-class takes on so much debt, a decline in borrowing costs is helpful. Housing is the most important asset for the middle class. As mortgage rates decline, housing prices get supported.

In fact, I see a window of opportunity to buy real estate in 2023. But the stock market and economy can’t tank too hard.

market expectations for the Fed funds Rate April 2023, 2024, and January 2025

11) Inflation will finally decline.

Once the middle class is beaten up, inflation will finally be conquered. Ultimately, this is what the Fed wants, which means it will finally stop hiking and maybe even start cutting.

It’s too bad the Fed has to go to such extremes to contain inflation since there are exogenous variables such as international supply chain issues and wars that are unaffected by Fed hikes. Boom bust cycles are unhealthy.

Many of us have the ability to combat inflation as well. It is clear inflation peaked in mid-2022, yet the Fed wants to continue to hike the Fed Funds rate to crush the middle class.

CPI Inflation by month since 2022
CPI (Inflation) – The Fed still wants to hike despite CPI coming down

12) Easier to generate more passive income and retire earlier

The good thing about higher rates is that it’s easier to generate more passive income. Earning more passive income also makes it easier to take things down or retire earlier if you wish.

Before the Fed started aggressively hiking rates in 2022, money market funds were paying less than 1%. Today, you can easily find money market funds that are paying over 4%. Treasury bills are also now paying over 5%.

With higher risk-free returns, there’s no need to take as much risk with our investments. As a result, more people will feel less stressed about the gyrations of the stock market or the uncertainty of the economy.

The Key Is To Be Slightly Above Middle Class

Although being a part of the middle class is great, it’s better to be slightly above the middle class to outperform during a Fed-induced economic crisis. Upper-middle-class sounds a little snooty. Hence, the proper term is to be apart of the mass affluent.

If you are a part of the mass affluent class, then you have an above average net worth and above average income for your age. For the median 38-year-old in America, we’re talking about a net worth of around $250,000 – $400,000 and an income of between $80,000 – $150,000.

With mass affluent money, you are able to survive unemployment longer and/or take advantage of better prices and opportunities during a downturn. The opportune time to take a sabbatical is when the economy is shaky.

But the real key is to hold onto your job and not have to sell assets at fire sale prices. If you can hold onto your seat during a bear market, you will better be able to reap the rewards during an eventual bull market.

Let’s hope 5% – 5.25% on the Fed Funds rate is the highest the Fed will go in this rate-hike cycle. Otherwise, prepare for the worst.

Reader Questions And Suggestions

What are some other upsides if the Fed decimates the middle class? I’d love to get as many positives on the list as possible.

Check out Fundrise, my favorite private real estate investment platform. You can invest in private real estate funds that specialize in single-family and multi-family homes in the Sunbelt region. Thanks to technology and work from home, the demographic shift toward lower-cost areas is here to stay.

Pick up a copy of Buy This Not That, my an instant Wall Street Journal bestseller. The book helps you make more optimal decisions so you can live a better, more fulfilling life. 

To become mass affluent, join 60+,000+ others and sign up for the free Financial Samurai newsletter and posts via e-mail. This way, you’ll never miss a thing.

For those who like to listen, subscribe to my podcast on Apple. A new episode comes out at least once a week to discuss the most important financial issues.



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