Understanding Classic Boom/Bust Cycles

Elaine Meinel Supkis

All bubble/peak profiles look similar because the psychology coupled with the technology/inventions that feul bubbles create not a smooth bell curve but an over-hyped/panic/recovery/failure four-stage profile. In the stock market, these eruptions and collapses are first triggered by new technologies.

In an attempt to stop the natural movement of events, pundits today are begging people to ignore reality and to have faith in eternally rising markets.

By Mark Hulbert, MarketWatch
Last Update: 10:36 PM ET Mar 15, 2007

ANNANDALE, Va. (MarketWatch) -- What does the Dow Theory have to say about the stock market's recent weakness?

You might wonder why we would even bother to check. It was just over a month ago that the Theory flashed a bull-market reconfirmation signal, after all. (Read Feb. 2 column) The Dow Jones Industrial Average ($INDU :12,159.68, +26.28, +0.2% ) closed Thursday nearly 500 points lower than where it stood then.

This man wants everyone to think this is still a 'bull market'. He points to a sudden drop just a month ago as proof, things are OK. Because the market then shot up after that pause, he imagines it will do this forever. The graph at the top of this page shows how all bull markets run: there are two significant drops before the big, off the cliff moment. Refusing to see this, many bullish commentators pretend these are aberrations and not signs of the coming collapse in asset values.

What is interesting in today's numbers is how the NASDAQ has still not recovered at all, whatsoever, from the Dot Com collapse.

By Steve Goldstein & Tomi Kilgore, MarketWatch
Last Update: 8:48 AM ET Mar 16, 2007

LONDON (MarketWatch) -- U.S. stock futures traded lower Friday, but pared earlier losses, as relief that core consumer prices for February, which excluded food and energy, rose in line with expectations, helped cushion the weakness carried over from overseas bourses.

In the previous session, wholesale inflation data was much higher than expected.
S&P 500 futures slipped 2.40 points to 1,401.00 and Nasdaq 100 futures slid 6.25 points to 1,758.50. Dow industrial futures gave up 16 points to 12,240.

Overseas, the Nikkei 225 dropped 0.7% in Tokyo, weighed down by the strengthening yen. The FTSE 100 lost 0.4% in London.

A refusal to understand history coupled with a refusal to understand basic human pyschology characterizes much of what passes for economic analysis. So time for a review of the history of boom/bust cycles starting with the greatest of all, 1929 and the Great Depression:

Just 1 week earlier, on Monday (October) the 21st, investors had their first glimpse of the three Black Days as the volume was high (6,091,870 shares) and the ticker tape fell seriously behind forcing people began to sell blindly. Over the next week, the market turned people into fools. Perhaps the biggest fool at the time was Professor Irving Fisher.

Well known, trusted Yale University economist, Irving Fisher stated on the 21st, “[the market was only] shaking out of the lunatic fringe” and went on to explain why he felt the prices still have not caught up with their real value and should go much higher. On Wednesday the 23rd, he announced in a banker’s meeting “security values in most instances were not inflated.” Fisher also announced “The nation is marching along a permanently high plateau of prosperity.” Before Black Thursday, Monday and Tuesday, Fisher was considered an investment prophet. Though he was recognized for his contributions to technical economic theory, monetary theory and index numbers in later years, these three Black days crippled Irving Fisher's reputation.

Crippled his reputation, indeed. When things go bad, people have to pay attention to reality but when things are going well, people indulge in fantasies. One recurring fantasy held dear by armies of economics professors is the belief one can control economic events simply by playing with monetary values.

The reason this has such a hold on the mind is because it is lazy and seemingly simple but involves magical number crunching so it is obscure to lesser minds who simply accept the high priests of the economy's pronastications. It is remarkably similar to the readers of totoise shells and sheep livers thousands of years ago.

When students go to business school they encounter all these high priests and their mighty numbers and they get converted to the ideology and then they end up with the same belief system and this is coupled with a simple lust to become very rich while merely jiggering some numbers. The messes created by these people constantly cause the same boom/crash cycle we see over and over and over again.

After the spectacular crash in 1929, more socialistic economics believers took over here in the USA and saved capitalism from its own high monetary priests. The whole point of Social Security was to prevent wild spending, wild investing and wild monetarist policies and beliefs. Instead, the Social Security programs would act like a regulator in a steam engine and it would release steam and then conserve steam depending on how fast the engine must move to pull the economic train.

Monetarists also worry about psychology but only in the sense that they want to keep people 'enthralled'. Here is an example of a typical 'Plunge Protection Team' effort from 1929:

Whitney asked for the latest bid on U.S. Steel. “195” someone shouted. Then he promptly announced that he was buying 10,000 shares of U.S. Steel at 205. He immediately received 200 shares and then left the rest of the order with the specialist. He continued to make similar orders for over a dozen more stocks. Fear evaporated as investors became worried that they would miss the new boom. The market would have closed much higher if stop loss orders from earlier that day hadn’t been triggered during the upward surge. Needless to say, the recovery on Black Thursday was impressive, but so was the massive sell off earlier in the morning that gave it its name.

This group effort, often hatched by some major bank or in the case of the system since 1914, the Federal Reserve and the Treasury Secretary, is put into action whenever the market looks like it is beginning to panic as reality begins to dawn. After a crash, they always deny they have such a team and laugh at anyone who dares to talk about it but it is always there and it does 'work' to smooth out various small falls. It also is part of the reason we see balloons. Once they set things moving upwards, they want to keep it going and being human, they eventually believe their efforts and magic will make wealth grow forever and ever and go straight up so they move every possible fudiciary lever to make this dream come true.

The chart at the top of the page shows the typical boom/bust cycle of not just the stock markets but it is the real shape of the Hubbert Oil Peak as well as the industrial manufacturing cycle, house building/selling cycles and indeed, the empire-building, empire collapsing cycles. The reason all these cycles are nearly identical if one subscribes numbers to describe events is because it is really a graph showing basic human nature.

Our brains are hard-wired to work on this scale! We collectively think the same way and react the same way. This is why cutting off this cycle always fails. The desire to milk opportunity to the nth degree leads to a lemming-like rush to the edge of a cliff and then oops! Over we go!

Here is a very good page to read written when the Dot.com boom collapsed:

NASDAQ 1929
Adam Hamilton December 7, 2001

Since both the short-term psychological winds and the long-term fundamental forces driving markets through history never change, contrarians like myself believe that the keys to unlocking the future direction of markets often lay in the past.

Way back in August 2000, when the NASDAQ was still above 4000 and very few folks would even admit that it was a bubble and even fewer that a crash had occurred, I wrote an essay called “To Crash or Not to Crash.” In that fateful essay I had the audacity to say (those darned malcontent bears!)…

“The most likely probability for NASDAQ performance in the next 18 months, weighing in at 80% in my humble opinion, is a multi-year bear market in the index. The brave tech investors (and we all know some) have more zeal and faith in their stocks and market than most religions can command. They will not give up hope easily, and are likely to slowly go down with their mortally wounded ship, the USS NASDAQ. The only likely way the backbone of irrational investor hope in companies valued at 100x to 3000x earnings will be broken is through a gut-wrenching and excruciating multi-year bear market. From a contrarian perspective, playing the market based on the human emotions of greed and fear, it is becoming increasingly evident that nothing can scare the NASDAQ disciples. They largely have no concept of critical fundamentals, exist in a blue-sky ethereal world where history is irrelevant, and invest based on hype, not cashflow prospects.”

The NASDAQ hasn't recovered from that crash and was just getting back on its own feet, the cycle typically takes at least 5 years, when it got hammered by the beginnings of the collapse of the DOW which has pretty much reached its own peak and is now on the verge of hitting the skids. But during the bubble run on the DOW, the optimism there didn't translate well to the NASDAQ because skeptisim from the still painful previous bubble there created too much natural caution.

Of course, people being human, they all were conned or let themselves be conned into believing the DOW was different. A new story. It will never fall or become foolish like the NASDAQ! Thus armed with fantasy and magical thinking, everyone rushed into the DOW and made dangerous deals that drove it up even as the economic base eroded away.

From the same webpage above:

“While the crash only took place six months ago, I am convinced we have now passed through the worst, and with continued unity of effort we shall rapidly recover. There has been no significant bank or industrial failure. That danger too is safely behind us.” – Herbert Hoover, President of the United States of America, May 1, 1930

Always, the danger is pronounced over just as the next step down is about to commence. Leaders always say, 'We dodged the bullet! We won't suffer the consequences that follow every crash!' just as things gear up for the next dire stage downwards. Because human psychology creates these bubbles, the leaders responsible for the reckless behavior then all imagine they can undo the mess simply by thinking positively and pretending nothing worse will come. The magical thinking that creates bubbles can't fix things when they pop no more than the people at the bottom of a collapsing Ponzi scheme can save their funds by conning new people into giving them money.

This is why Ponzi schemes are crimes and the founders can be arrested. Usually when bubbles burst in the stock markets, once-lionized leaders are suddenly discovered to be liars, cheats and con artists. Some day it will occur to people that bubbles are actually a sign that con artists and cheaters are at work!

We have seen quite a few global economic busts in the past, one of the bigger ones was in 1848.

Part of the global investment's shrinkage was due to the withdrawal of the railway investments. After deflation of the "railway mania" in 1846 to 1848, railway companies lacked financing. Their own available capital exhausted; call on new "paid-up" capital turned out to be delicate, and even more raising new assets on the financial market since savers could not be attracted: the value of stock exchange shares fell, quite often under their face value: compared with the 627.5 million in paid capital gathered by 20 railway companies , the losses to their stockholders was of 278 million francs between 1847 and 1849; only three other companies increased the value of their shares to subscribers, on the whole 30.3 million francs. Railway investment therefore became a highly speculative risk, which deterred issuing new securities or calling on bank credits. That explains why companies had to be sold off, taken over by the state, or operated only on completed sections without resuming work on projects to connect them.

This was a classic 'new technology=boom/bust cycle'. When railroads were invented they were instantly seen as a great revolution in the way societies would run and the speed of transmission of goods and people at a faster, more comfortable way fuelled an over-all wealth-building bubble. Since building and running railways requires many levels of industrial input, it caused many other businesses to soar.

Seeing this, all the con artists, money-magicians and swindlers poured out of the woodwork and sold everyone a bill of goods that was empty of promise. The rail builders went wild with all the investments pouring in and swiftly overbuilt their systems without waiting for sufficient profit of existing systems to feed the coffers and everyone got too deeply into debt to each other and all it takes is one person being unable to pay their bills and the whole thing crashes. The bell-curve for this crash was identical to the 1929 crash.

The steamship boom had the same effect leading to the 1860 crisis. Generally speaking, at the bottom of these busts, wars or revolutions convulse participating countries.

By Mark Hulbert, MarketWatch
Last Update: 10:36 PM ET Mar 15, 2007

ANNANDALE, Va. (MarketWatch) -- What does the Dow Theory have to say about the stock market's recent weakness?

You might wonder why we would even bother to check. It was just over a month ago that the Theory flashed a bull-market reconfirmation signal, after all. (Read Feb. 2 column) The Dow Jones Industrial Average ($INDU :12,159.68, +26.28, +0.2% ) closed Thursday nearly 500 points lower than where it stood then.

*snip*

The reason I say this: The correction that occurred from the Dow industrials' all-time high on Feb. 20 to its low on March 5 lasted just nine trading sessions, and less than two weeks of the calendar. Its magnitude was just 5.8%. There are some this length and magnitude of a correction does not qualify as being significant enough.

But even if you do think it does, that still would mean we're currently only in step 2 of the three-step process that would eventually produce a sell signal. As of Thursday's close, the Dow industrials had regained 109 of the 736 points it had lost between Feb. 20 and March 5.

Regardless of whether you think we're still in step 1, or have advanced to step 2, however, the message of the Dow Theory would appear to be the same: A sell signal has not been issued. And on one thing William Peter Hamilton was clear: We should presume that the previous signal remains in force until it is reversed.

And here it is! The refusal to understand is based on human psychology. The writers within major bourse houses or publications can't tell people to sell because their job is to con people into buying NO MATTER WHAT. Despite pretending we must crunch numbers and look at cold facts, they instead cherry pick numbers and fudge the facts so the truth will not show up. They have to do this even to themselves because deep inside, they know these bubbles can't go on forever. All over the economic news are stories of people 'discounting' stuff they are selling. Since everyone wants to sell at the highest possible profit this is a sure sign that profits are no longer to be so easily had.

Now people have to work harder to sell things and this is flying in the face of rising caution from frightened bankers who suddenly realized they are grossly overdrawn their own accounts and of course, in the back room is the Chinese Dragon and its giant hoard of gold and wealth in the forms of IOUs. If we don't pay them, the Dragon will be most angry with us and this is why wars always follow right on the heels of fiscal collapses.

Comments

[JSmith]

Ekaine, I am a bit surprised that you don't cite THE basic treatment of this subject.

You know this one, of course?

Mackay, Charles: Extraordinary Popular Delusions & the Madness of Crowds

http://www.amazon.com/Extraordinary-Popular-Delusions-Madness-Crowds/dp/051788433X

[D.F.Facti]

"When students go to business school they encounter all these high priests and their mighty numbers and they get converted to the ideology and then they end up with the same belief system and this is coupled with a simple lust to become very rich while merely jiggering some numbers. The messes created by these people constantly cause the same boom/crash cycle we see over and over and over again."

Amen, Sister.

I worked with these people for a long time. Their main preoccupation is not the business enterprise of which they are a part, but their own bank accounts.

Manufacturing companies started down the same path as the financial sector - GE Capital, GMAC, American Airlines at one point spinnig off its investment department and selling its expertise to other companies - all fine if CONTROLLED. But the tail is wagging the dog now.

This destruction has been engineered by the Wharton School, the University of Chicago business school, Harvard, Northwestern, Stanford, etc. Great schools - but tools of the people who have destroyed the social fabric and are destroying the basic infastructure of the United States of America.

[DeVaul]

I once spent about 5 minutes in an economics 101 class. I got up and left thinking: "This is for the birds," and that was in Germany! If the scientific minded Germans could not convince me that economics was a true science, then who could?

I also discovered that 50% of the students at my small college were econ majors. Most were unintelligent C average students whose only goal in life was to "get rich". They had no other interests other than sports.

[Elaine Meinel Supkis]

I never took an art class nor a business class. Both skills I learned via the School of Hard Knocks. Making money means understanding how money is made.

No Easy Street but the Rocky Road of Life. I highly recommend it. NEVER take financial advice from a kid right out of college.

[DeVaul]

I do not even want my children to attend college. The cost does not justify a lifetime of debt and misinformation. There are better ways to learning and living.

I sincerely hope they will reject the "go into debt up to your eyeballs because this is the only way to get a job" propaganda that streams out of overpriced universities, which are little more than extended social parties, in my opinion.

[Elaine Meinel Supkis]

No, they must go to college! I started when only 16 years old. I learned many things there including trying to overthrow several governments. Heh.

What you do with what you learn is a whole different thing but the main thing I learned in college was HOW TO WRITE. More or less.

[DeVaul]

I am sorry Elaine, but I must disagree with you here. Our children are supposed to learn to read and write in high school. That this does not happen is shameful, especially in light of the barrage of "homework" that kids must do today. (Where is family time?)

If a child cannot learn to read and write at school, then the school is useless. And so will the college be, as the cost of learning to read and write in college is far beyond the average person's ability to pay.

I can teach my children to read and write and think for themselves. This is the duty of all parents. It is not a governmental duty because the government will not do it. It will purposely fail in order to create a perpetual peasant class that will be abused and cheated all their lives by the government and those who control it.

[Elaine Meinel Supkis]

A high school library is peanuts compared to a college one. And the level of activity is much higher if one is smart and wants to learn.

[JSmith]

Both sides of the argument have merit. I agree with Elaine that most university-level education occurs outside the classroom, and what you get out of it is up to you.

But I also know a couple of plumbers who have vacation places in the Carribean - if what you really care about is having nice stuff, you can make plenty of money without a degree.

[Elaine Meinel Supkis]

um, not any more. Illegal immigration is killing the trades.