Chapter Six - Booms and Crashes

  • Thread starter CaptainDan
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Aug 2, 2020
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Have you ever noticed how things in the economy seem to move with a sort of mass agreement by the populace? What I mean is that when bubbles in the market occur, everyone talks about them. Everyone wants to get in while the stock prices are moving up, usually when they reach the peak. I've actually experienced this myself. When there's a big run-up in anything, there's a voice inside of me that tells me to get in on the action. The problem is, by the time I notice what's going on, it's usually too late. The run-up has already occurred and I'm a day late and dollar short. Far too many people have lost far too much money trying to get in on a boom. They spent everything they had and took out loads of debt to purchase something that was way overpriced. I guess it's just the way it is. The real problem here is that booms sometimes take decades to come to fruition and mere days to bust. What's person to do when they think the stock market or the housing market is simply going up, up, up like it normally would? The average person thinks whatever is going on is normal. They have no idea they're living in a fabricated economy that's ready to deflate at any moment.

Do you remember the stock market crash of 1987? I only do a little bit. I was pretty young back then. I remember hearing about it, but I honestly wasn't too concerned about global finance in my early days. They say it was the largest one-day crash in history. The weird thing is that no one has ever come up with a definitive reason for the crash. Some say it was caused by day traders, others say it was a lack of liquidity in the market, and others say a simple overvaluation was to blame. When traders began to sell, there was a cascading effect in the market and the resulting plunge was huge. Most intelligent folks believe it was a psychological event that wouldn't have occurred if the general public along with their trading counterparts weren't spooked by rumors swirling around the econosphere. I just made that word up, but you get the idea. When a few people get spooked about their money and rumors begin to make it out into the mainstream, the entire herd goes nuts. This isn't the type of thing the stock market wants or needs. It causes massive sales and even more massive repercussions.

Personally, I think market manipulation by the Fed was to blame. Knowing what I know now about how markets get hot and then cool off, I know that the Fed is behind a lot of the terrible things that happen. I also know that the Fed has helped tremendously throughout history, so I don't want to act as if it's some sort of awful institution. I really don't know enough about it to make that call. What I do know is that the global economy is very large and it has many, many players. Some of them are good and some not so good. Powerful interests can bankrupt entire counties in one fell swoop. If there was a glaring deficiency in how things are traded, it would be that some individuals and corporations hold far too much power and are accountable to no one. This probably won't change any time soon.

Back in the late 1970s and into the early and mid 1980s, the Fed had to adjust interest rates upward to first get inflation under control and then adjust them again downward to stimulate the economy because of the suffering those earlier high interest rates caused. While this was happening, injections of currency were flooding the economy, which caused massive overvaluations of everything from stocks to homes to businesses. As prices were rising, herd mentality set in and people became very comfortable with those price increases. They invested in the stock market and bought and sold homes. The economy was hot. Actually, it was too hot because on October 14, 1987, the market began dropping and when it was finished dropping a few short days later, the Dow has fallen over 22%. That's pretty big. I guess something had to give.

Because so much liquidity had been removed from the market so quickly, the Fed had to push more of it into the same market. This additional currency caused real estate bubbles to spring up all over the country. What's interesting to me is that liquidity didn't actually "evaporate" from the market and find its way into thin air. As far as I know, when the stock market goes down, it's because people sell their positions in businesses. The money the sellers get from their sales is parked in something akin to savings accounts. So really, there's the same amount of money swirling around the economy, it's just that a lot of it isn't active. So when the market goes down and the Fed pumps it back up, isn't the Fed really just exacerbating the problem? Won't the money that was pulled from the market eventually return, only to pump it up even more? Unless, of course, the Fed's pumping is only temporary with the intent on steadying things out until they see the market return to normalcy. When that happens, the Fed can sell whatever it is they bought and everything will be good again. I really don't know, but I do find it fascinating.

This post is part of a series: Guide to Investing in Gold & Silver by Michael Maloney
Chapter Six - Booms and Crashes was posted on 06-03-2021 by CaptainDan in the Economics Forum forum.
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