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Wednesday, January 30, 2013

Stock market crash

You are looking at s&p500 chart. I wanted it to date back to 2000 so that you could see where the stock market is at the moment. Now, what you see is that the index has almost reach its’ 2007 peak, the level where market stopped advancing and in the middle of 2008 crashed. If you went back to 2000 chart of the same index you would see the same picture. Market reached 1500 level in s&p500 and then collapsed sharply. It bottomed very close to the bottom of 2009 bottom that you can see in the chart. 


You most probably know that 1998 saw tremendous rise in internet stocks, which led to an explosion of a bubble in 2000. 2007 saw an explosion of a housing market bubble. What bubble we are in at the moment? I do not see any. It is just ‘fools hope’ bubble. All financial system is on the verge of a global crash and market participants are buying shares like crazy. On the other hand, we should not be surprised by that as there usually are most investors on the boat just before a collapse comes. Study all major market booms and crashes and you will quickly see that tendency. 

Now, I genuinely believe that we are going to see a major collapse of stock markets in the nearest future and it will probably be even more severe that we saw it in 2000 and 2008. And the collapse will have influence not just to stock market, but to whole global economy.

Causes for stock market bubble and crash in 2000

If you look at the bubble that developed in technology stocks from 1992-2000 you will see that there were quite clear causes for such over extended optimism. One of the major reasons for the rise and crash was corruption. Companies were deliberately hiding their losses and outlining only bright future prospects. Most of them never had profits and did not have a chance to have any in the future. However, rating agencies were giving them favorable ratings and this inspired trust in investors. What a joke! Looks like those rating agencies are some of the most corrupt institutions in the world. Do not follow their recommendations. Forbes and Wall Street journal encouraged to invest in those risky stocks. Most of the companies tried to become big before they started making any profit. ‘Become large or get lost’ was a motto of most of the companies that existed than and are mostly forgotten now. A few got lucky to realize the motto in practice. 

Low interest rates increased capacity for those companies to borrow and expand beyond their capacity. Most of their shareholders did not have any cash, just their shares which they could pledge and borrow even more. With FED increasing interest rates again and again it became more difficult to borrow and pay principles as well as interest on the loans. Economy started cooling off and a lot of investors came to their senses. Unfortunately, most of them too late as they realized that they were holding heaps of worthless securities. If you look at the chart you can see how things started going off the hill after that. Only a handful of companies survived. A lot of others went bankrupt. Furthermore, a tiny percent of those who survived showed substantial growth: Amazon, Cisco and a few more. 

Construction market boom and crash in 2008 had even more underlying reasons behind it. Let us look at some of them as some of them were the same as in previous market bubble.

Favorable and easy credit conditions created a bubble and caused the financial crisis

I have already talked about this cause in my previous hub, but I consider it as one of the top reasons for both bubble and crisis creation and want to stress the danger of economy that runs on debt. I do not know about you but I see money which is lent as causing more trouble than giving benefits. You see, money does not fall from the sky. Central banks print money from time to time. You cannot do this unless you want to go to prison. So, if you borrow money from a bank, you will always have to give back more. This means that you will have to get the amount that you borrowed, plus interest. You know that many people buy houses, cars and etc. on credit. You also know that most businesses borrow money from banks for working capital and other reasons. Now, in order for all that money which is borrowed from banks to be paid back there has to be an increase in money supply from central banks. Otherwise, money will never be paid back, because there will not be enough money in the economy to give back that extra interest which you need to give back to a bank. That leads us to a conclusion that central banks always print money and the amount of money in the global economy increases every year. When the markets are flooded with money a bubble is born. When it explodes we have a crisis. If loans would not have an interest attached to it, we would have a completely different situation. Then there would not be banks any more. However, as long as economic expansion is based on debt creation we will always have booms and crises as a result of those booms. 

Housing bubble made a huge contribution to the crisis creation

I am deeply convinced that construction sector was a catalyst in the previous boom and as such it was also one of the main culprits of the 2008 crisis. A collapse in the field made a dent in the ship of the global economy. If you understand housing sector you can see how it is connected with other market spheres. When it prospers, a lot of other sectors blossom together with it as the sector increases job creation in other sectors. When it collapses very many secondary sectors go bankrupt, because people stop using various services or buy goods which are not of primary importance (food). Construction is a vast field in economy and much of easy credit went to this specific field. As we know the market never needs uncountable number of houses and buildings. Space for houses is limited and it will never come a day when everybody will have a house as not everybody can afford one. So, when a demand for houses is met, construction booms always end and the sector can be suppressed for decades. Now, I hope you can see that when money stopped going into the sector due to bankruptcies, exaggerated supply and severely decreased credit, the sector collapsed causing crisis to overwhelm other market fields as well.

Rise of oil

When prices of oil rise you will definitely have a financial crisis sooner rather than later. We could say that oil is a global currency. All the other prices can be measured to the price of oil. Why? Because oil is used in almost all industries and when oil price increases it has affect on the prices of all primary need products and services. I hope you remember what the price of oil was when crash came and what the prices of all products and services were. There was a huge inflation in all possible market sectors, with a few exceptions. It usually happens that oil rises together with other commodities. Some say, that gold pushes all commodities up and is the best instrument to save your money when inflation comes. I think that the same thing can be said about oil. Although gold and silver can replace world currencies and world currencies can replace gold and silver, what is going to replace oil? I think that nothing can do that at present. There will pass a lot of time when the world will switch to some other source. Not sure if it ever happens though. So, you can hedge against the risk of inflation by buying oil in the futures market. You will preserve your capital in this way. 

Absence of regulation in derivatives’ market and complex financial instruments

Alan Greenspan was warned about the possible crash in the derivatives’ market and urged by some members by Commodity Futures Trading Commission to interfere in the complex and mysterious market. However, as Mr. Greenspan was strongly holding to the position not to interfere and to allow markets to regulate themselves; nothing was done and deregulation caused a wave of crisis across the board. If you asked any economist what derivatives market is I think most of them could not give you an explicit answer. The same can be said about various complicated financial instruments like CDO’s and MBS’s which average person does not understand. Those instruments were offered to the general public to buy and the makers of those instruments were selling them in the market profiting from these operations and causing imbalance in various sectors and expediting the crisis.  One thing for sure: there has to be absolute transparency in the derivatives market. Otherwise, it can cause much bigger problems than we saw in 2008.

Sudden decrease in credit supply

In my previous hub about market bubbles I indicated large money supply from banks as one of the reasons for a bubble development. Now, I will say that the sudden cutting of that supply brought about crisis that we saw. How is that? In the times of boom money from central and commercial banks floods financial markets and global economy. This causes all economy to boom. However, when there is a sudden cut in money supply everything stops, because money is the blood of any economy. Money starts coming out of the system and everything starts collapsing as there is no power to keep market standing. When a human being loses a lot of blood he faints and can even die. When economy loses a lot of money it collapses and can go into stagnation for a decade or even more. That’s why a sudden decrease of money in any economy as well as increase is not ‘healthy’. Increase of money as you know causes inflation and decrease usually causes deflation. We want none of those. We want global economy functioning ‘normally’. 

Massive bankruptcies 
Most economists think that Lehman Brothers bankruptcy was that dent that really triggered crisis. I would agree with that, but I am absolutely sure that crisis would have come anyway, even if Lehman Brothers survived. However, bankruptcies like this had a lot of impact on acceleration of the crisis which was already inevitable. Still one bankruptcy can cause a chain reaction and the result would be a lot of companies out of business and a huge number of people out of work. This is particularly felt when some giant company which employs thousands of people goes bankrupt. Consequences of this can be hard to predict. That’s why there was a question raised about necessity of reducing the size of this kind of companies, especially banks. If one company would split to a number of companies and bankruptcy of one would not necessarily influence bankruptcy of another, then the danger of massive bankruptcies could be avoided. Can you imagine what happens if a bank which is bigger than country’s annual GDP goes bankrupt? Terrible! Having this in mind some analysts coined a phrase ‘too big to fail’. They had in mind those mega banks and companies which lined up to get bailout money from governments and central banks. However, it means that these companies have good excuse to take tax payers’ money and dictate their rules to the governments of the world. Is that how capitalism supposed to work? I guess not. That’s why I think all governments should promote small and medium business. If small and medium business were strong there would never be a crisis like we saw in 2008. Now, when everything is ‘global and big’ sinking of one big guy causes a lot of trouble for everybody. We need less dependence on large corporations. It would decrease risk of global economic failure.

Over optimistic analysis of the economic situation from expert analysts did not allow people to see what was coming

Most people rely on ‘expert’ analysts and acknowledged market gurus. People do not spend enough time to analyze the ongoing situation in economy. They simply trust that if ‘such and such’ economist said ‘this and that’, it is for sure. And what were the expert analysts doing just before crisis hit the global economy? They were painting a very bright picture of expanding economy, showing good statistical data from various market sectors and suggesting which stocks or commodities to buy. All the guys that were trying to warn us about the coming collapse were ridiculed and kept out of media. I think there is a psychological problem attached to the entire story. People want to hear only good news and that’s what the experts were doing. The experts were like musicians from the Titanic. They were playing music and amusing people till the very end. Do you want to hear only good news? What if bad news can save your wealth, business, savings and etc? We should learn to be both optimists and realists and see things as they are. You can turn your life wherever you want, but you are not at the wheel of global economy and being optimistic about it is quite dangerous. You cannot turn the wheel. So, you should know what to do about your ‘home economics’. And if you know what you are doing, then you can be very optimistic about it.

Crisis came and will always come because this economic system is extremely flawed and will not sustain itself for a long time

Some economists see it and they called the previous crisis – a systemic one. It means that there are too big flaws in the system and crisis simply had to come. It is not enough to change a few laws or rules in trading, lending and etc. It can be said both about global economy and social security system. In my opinion they will both collapse. Why? Firstly, I think that economy that is built on borrowing cannot be sustained. It will always end up in booms and crises. Secondly, nations have too big governmental bureaucratic apparatus which sucks too much tax payers’ money. True democracy should give more power to ‘the people’ and less to governments. Present social security and medical system is very flawed and also sucks too much public money. If governments have to borrow to pay pensions, there is something wrong with the system. It cannot last for a long time. Thirdly, most countries will have to default if they intend to continue operating in the same way as they are doing now. National debts of the countries will most likely sink those countries. 

So, I think that the crisis of 2008 is not over and we are going to see the next wave of crisis which would end up with a complete economic collapse. I wish it did not happen, but I fear that my wishes will not be fulfilled. Time tests all ideas and opinions. I believe we have to be careful about money management and risk taking. It will help us to go through the coming changes in global economy. 

False reasons for a collapse

It is also important to understand that some of the reasons that are identified by some guru experts as key in leading to crashes are not real reasons at all. One of them is electronic trading and automatic trading programs. Nothing could be further from the truth. These do not create as much volume as those created by huge mega banks trading in billions and really moving markets.

Stock market crashes are not connected to what China or other third world country does. These may influence a little of what happens in the world, but not much. They are not responsible for extensive borrowing that West countries practice and extraordinary corruption in government and corporate banking sectors in the West. 

Natural disasters have very little impact on stock markets nowadays. They usually are temporary: day or two corrections, but nothing more than that. So, if a hurricane comes your way do not that it should be a reason for stock market to crash.  

2013 may see another collapse in financial markets that would surpass any other even 1929, 1987 or 2008 crises

I hope you see that nothing has really changed since 2000 and 2008 crashes. We still have easy credit conditions, low interest rates that allow big boys ‘too big to fail’ to gamble on financial markets and risk global economic security. Corruption is spread from governments to rating agencies to huge mega commercial banks. National debts have reached unsustainable levels. What else except crash can we expect? 

We would probably have seen collapse of the stock market coming earlier if Federal Reserve not been stimulating economy by buying bonds. However, when they cease the process the drop in stock prices would be even more severe. They should have left markets for themselves to find bottom, clean up and start growing naturally, not by stimulating growth. 

We are going to see a crash sooner rather than later and this would cause world economies to go bankrupt, because they will fail to get rid of their astronomical debts.

Ok. I hope you benefited from the post. If you liked the post I would also be happy if you gave a plus on Google+, tweeted, liked it on Facebook and other social platforms. Have a nice day. 

Trading financial markets carries a high level of risk, and may not be suitable for all investors. All information on the blog is of educational nature and cannot be considered as advice, recommendation or signals to trade in any financial markets.