Understanding the Market Boom/Bust Cycle (NYSE:IBM, NYSE:BAC, NYSE:C)

By Relmor Demitrius -

The year 2008 proved to be a very educational one for the average investor.  Due to the stock market downtrend, bank failures, and emergency FED meetings galore, we learned some interesting diction during this economic downturn.  Stagflation, inflation, deflation, recession, depression, V shaped corrections, W shaped corrections, FED rates, LIBOR rates, and what the hell is a CDO?  What is the boom/bust cycle?  What are cyclical stocks?  Value stocks?  All these concepts and words were being thrown around by so called “experts” on every news TV show to every financial bog and newspaper in the country.  The amount of half truths, misinformation, and just plain fear mongering was staggering.  I think as time has passed, and a clear mind can now be used to refocus on some of these past events, terms, and concepts.  We can use this to better understand where to put your money a year from now, or even tomorrow.  But first, you have to understand the animal.

At the core of all of this is having a basic understanding of the economic and monetary rules that are applicable to today’s world.  At the very core, the first concept that must be understood is what is fiat currency, the current monetary system we are using today.

Fiat currency is a currency that is backed by nothing, and measurable only to other currencies.  This is where the term “floating currency” comes from, which means it is only “floating” in apparent value up or down in comparison to other currencies currently backed by nothing.  The Euro, Yuan, Ruble, and most major foreign currencies are indeed backed by nothing but a promise.  In effect they are not assets, they are simply a way to pay debt.  Since we live in a world of debt, they should always have a use, however.  In 1941, with the creation of the Taft-Hartley Act, which Nixon revoked, we were on a limited gold standard.  When the U.S. dollar was implemented as the worlds reserve currency, we promised that an exchange for gold would always be possible.  Well in August of 1971, Nixon said, No more.  The dollar can no longer be redeemed for gold.  Costly war expenses, innovations in modern banking, and other factors lead to a huge influx in the money supply.  There soon simply wasn’t going to be enough gold to give out, if so demanded.

Meaning the value of our currency was redeemable in a small amount of real money, meaning gold or silver prior to Nixon’s policy change.  Paper currency can be backed or pegged to anything.  Oil, gold, silver, water, even sugar cubes, whatever.  The only condition is it must be something that must be created by “work”, be easily exchanged, and have an accepted world value.  Not many things apply to this standard.  Since wars cost money, Nixon decided he would just wave his magic wand, and create money out of nothing.  Gold must be mined, extracted from the ground, processed, and smelted into bars.  This costs effort and man hours.  Gold can also be easily stored and exchanged, and never breaks down.  It is an excellent accepted real store of value.  1 ounce of gold today or 1 ounce worth of gold 100 years ago, should have the same “purchasing power” then as it does now. The actual American Dollars it takes to purchase one ounce of silver or gold is representative of what is happening to our currency today.  It takes over 1000 US dollars to buy one ounce of gold today.  It was under $25 dollars just in this century alone.

The signs of massive dollar devaluing were there at that time.  We should not be surprised of the consequences of this decision.

Year in and year out now, we hear about how things are “more expensive” and the dollar just doesn’t seem to buy what it used too in real assets, such as food, gas, and energy.  Its not that these things are becoming more expensive to produce, its that the dollar is worth less than it used to be, requiring more of them to purchase the same amount of goods.

One would think the mass production of farmed goods, industrial materials, and faster transportation, as well as global competition would drive costs down

When the FED buys assets, they are taking money out of the supply.  When they sell assets they add to the money supply. When the FED bought all those assets that went bad,  such as from Lehman Brothers, the Bank Loans in 2008, or the Bear Stearns debt, it was massively deflationary, which means removal of money supply from the system.   To resell these assets would give back pennies on the dollar.

There are 3 main types of money supply.  There is M1, which is hard cash, bank deposits, and anything that can be converted quickly to cash, like money markets, etc.. or anything you can write a check for.

M2 includes all of M1 and most Certificates of Deposits, some mutual fund accounts, and under 100, 000 dollar amount savings accounts, and some other time based accounts.

M3 is all other creatable wealth.  Leveraged bank debt, margin on stocks, and other bank inflatable money and paper vehicles.  This is where the magic happens, in this money supply.  And of course the US government has stopped issuing data on M3, stating it didn’t add any new information.  Laughable of course, and we know why they wouldn’t want us to see these massively inflated figures.  M3 includes a lot of the major institutional leverage in the stock and bond markets, and mutual funds as well.

M3 is basically this.  Here is one example.  Lets say Bank of America (NYSE:BAC) uses their 10 to 1 leverage to “buy” stock in (NYSE:IBM) on the open market.  They are using deposits as collateral.  This cash from deposits does not create more money by sitting there.  Now lets say this stock they purchased increased by 100 dollars.  They used “non existent leverage”, lets face it if the stock tanks, there is no money there to cover it, to add $100 to the money supply.  They can now use this gain of $100 dollars, to leverage even more bets, and you can see how this problem was created. Bank of American can even loan money to Citigroup (NYSE:C) and create even more fake money.  Every time a bank loans money to another bank, less and less is leverage able however.
If the first bank has $100 in hard assets, it can loan out up to $90 against that.  That $90 Citibank loaned, they can now loan out a 10 to 1 ratio of that money.  And so on and so on.
When the values of these holdings drop, the real money to buy them was never there, creating massive deflation, or a  ”decrease in money supply”.   Its a basic case of hot potato, too many products for sale at once, being chased by too few real dollars, causing even more of a drop.  When everyone goes to sell something, look at the main market charts from 2008 and early 2009.  You will understand the concept completely.  Yes, things tend to drop in value quick.

Some people will say deflation is falling prices.  Not true at all.  Deflation is simply a drop in available money supply chasing the same amount or more goods.  If there are fewer dollars around chasing the same amount of goods, prices have to come down, to compensate for the fewer availability of debt notes.  Inflation is the reverse.  People say inflation is rising prices.  No.  Rising prices are simply a symptom of inflation.  If there are more dollars chasing the same amount or fewer goods, then prices will go up.  If more people  have money, then vendors, merchants, and business will charge you more for the same.  If your wages don’t go up to compensate in a situation of rising prices and we are in a recession or a contraction in money supply, then that’s called “stagflation”.  You are experiencing rising prices, yet less access to dollars.  Since the FED has refused to raise rates off the floor of zero percent interest, the FED is obviously trying to be inflationary, and have ease of access to new money.  They are obviously still very worried about deflation to keep rates this low, this long.  When you see the FED raise rates, the market will have recovered long before that, as they are now too worried about too much money in the market, and will try to contain it.

Greenspance for instance was accused of helping to fuel the Housing Boom of the 2002 to 2007 area, by refusing to raise rates in time to stop the massive influx of new money.  Well this new money sought homes (No pun intended), and drove up the prices of all asset classes, stocks, and other viable products.  Once wages, credit, and reality of the new global economy sunk in, the bets went bad, and housing prices didn’t keep going up and up, the market of course HAD TO correct back to reality.  So when you say the market tanked, I just say the market corrected back to reality.  Don’t worry, the market will get crazy again, new money will flood in, banks will loan again, investors, mutual funds and institutions will drive stock prices back up again, and we can do it all over.  It’s the boom/bust cycle.  Stocks that respond to this flow in accordance, are called cyclical stocks.  They do well when times are good, and not so well when times are bad.

Until then, stay sharp, buy on value alone, and watch the FED.

For great values in this difficult market, I will be giving various arguments on kingof alltrades.com periodically for stocks that are undervalued in any market.  Stay tuned value seekers.