Macroeconomics (aka Macro) is a part of economics concerned with large-scale and general economic factors. It really describes how the economy is doing on aggregate total throughout the country. Yes, particular markets and submarkets can be doing well while all the rest are going down, but the overall outlook of the economy is of pivotal importance to understand. It doesn’t matter how good you are at your specific industry, if the industry takes a hit due to a macroeconomic factor, there is a high probability you are going down too IF you don’t understand the crosscurrents of the macro factors and tailor your approach or allocation accordingly. This is akin to people who made a lot of money in real estate in the mid 2000’s, and then lost almost all of it in 2008 to 2013. It is the ignorance of these factors that births these risks. Without an understanding of macroeconomics and why it is important, you might just be happily swimming in a pond, not aware of an alligator 3 feet from you below the surface.
What is economics?
Before we can discuss large-scale economic factors, an understanding of economics at its base level is required. Economics is the social science that analyzes the most efficient way to utilize scarce resources. It is important to understand that we have a limited number of resources on this planet. Oil is a great example of this. There is a specific amount of oil on the planet at a given time, now this supply is not fixed, that is one misunderstanding people have because we are told it is “non-renewable”. How do you think the oil was created in the first place? Living things died, decayed, and what was left went deeper into the ground as it was broken down until it congregates under an immense amount of pressure to become oil. This process is continuously going on, it’s just that people are using oil faster than we believe the earth is able to produce it, leading to a decrease in the amount at a given time. This is what is meant by scarcity. We have an unlimited want for oil, but there is a limited amount of it at any given time. This same concept can be extrapolated to any other resource. So, economics is the science of finding the most efficient way to allocate these scarce resources.
The above concept is really the fundamentals of any economic system such as socialism, capitalism, or something in between. Fundamentally, they are all processes in which scarce resources are used to produce goods and services that are consumed to allow a population to survive. Now, they can differ in the means in which those goods and services are allocated (through market forces or centrally planned), and they can also differ on who owns those means of production (private or public). However, those are just different means to the same end: producing goods or services to be consumed.
What is Macro?
With an understanding of economics, extrapolating that to macro is rather simple. It is applying this fundamental concept of economics on the scale of entire countries and the means we use to measure how the economy is doing. The analogy of an economy to a car is honestly surprisingly accurate. We have the engine, the creator of power, which is trade between two parties with the gas being the lending and spending of money. The transmission is interest rates and foreign exchange rates, the things that will help trade and lending get traction by creating incentives for people to produce goods and services. These are just examples, not an all-inclusive list.
A typical way to model this is with the circular flow model which can have anywhere from two to five sectors. The two sector version is the most basic and with the model becoming more accurate and in depth with each sector added.
Above is the most basic circular flow model. Households spend money by paying firms for goods and services, seen in the top set of lines in the model. In the bottom, households get factors of production, mostly labor in this case, and in return they receive wages, rent, or dividends depending on the type of relationship they have with the firm.
Above is an example of the five-sector circular flow model with the five sectors being Households, firms, government, financial markets, and foreign markets (overseas sector). As you can see this is more complicated than the two-sector model as this is where a lot of nuance starts to rear its head, but unfortunately there is much more to this as well.
This model doesn’t even show the repo market for the banks that provides liquidity (the lubricate) of the global financial system, and if that gets into trouble, whether in reserves or collateral, the entire global economy seizes up, literally. There is also the Eurodollar system where dollars are created and transacted in foreign countries. These are just a couple things that aren’t obvious in this model. However, going into this will have to be subject for future posts. I just wanted to make the point that there are significantly more crosscurrents in terms of macro-economic factors that are significant that most people have never even heard about.
How do we measure macro?
Continuing the analogy of a car, we need to measure certain aspects of the economy so we can know how it is doing. Major aspect of macro includes,
- Gross Domestic Product (GDP) – the dollar value of all the final goods and services produced within a country’s borders in one year
- Unemployment and how much of which type is present currently.
- Inflation vs. deflation and its causes
- money supply
- supply and demand
- fiscal policy (government spending)
- monetary policy (money supply policy regarding federal reserve system)
- commercial banking system
- foreign trade
- etc.
All of these are macroeconomic factors that are a part of or measure how the economy is operating as a whole. I will not explain each factor in depth here, as each of these could easily have multiple posts or even their own websites (some of them have their own government websites).
Conclusions
Again, it is called macro for a reason, it is considering things on a large scale. The phrase “A rising tide lifts all boats” might sound familiar when you hear about a bull market with any asset. Macro is what is dictating the tide. From the inner plumbing of the monetary system to demographics, it all shows up in the macro. Without a basic understanding of macroeconomic factors and how they interact within the economy, you leave yourself ignorant to something that could completely wipe out your finances. Not just investments, but even your savings. Risk is always derived from the individual person. Even holding cash in a safe isn’t risk-free, there are quite a few examples of that throughout history. That is why you must have at least a basic understanding of macroeconomics and why it is important.
There is also a book called Economics in One Lesson by Henry Hazlitt that is absolutely fundamental to any level of understanding of economics. I have read it a couple times and would definitely recommend it.
To your wealth and future,
James Forsythe
The Banking system is a very important part of macroeconomics. Below, find some posts about the founding and structure of the United States Banking System
https://jamesdforsythe.com/national-banking-act-of-1863/
https://jamesdforsythe.com/federal-reserve/
For more information of topics that effect your finances
https://jamesdforsythe.com/category/finance/
