And Now, the Good
You Can Make A Lot of Money During a Super-Bear Market If You Understand What's Going On
During the super-bear market of the 60's, 70's, and early 80's, once I tumbled to the rules of the game, I made money like a bandit. I would have made more money had I known then what I know now. But here s how that game was played.
We had galloping inflation during the 60's, 70's, and early 80's, presumably because the government "printed" more money to finance the Viet Nam war. Actually, this wasn't accomplished by printing more dollars, but by using the Federal Reserve's monetary machinery to expand and contract the money supply. But first, I need to mention:
The Fiscal Economy vs. the Monetary Economy
In dealing with money on a national level, one has to distinguish between the fiscal economy, which is the "tangible" economy of material goods and services, and the monetary economy, which is the symbolic economy of money, as a proxy for goods and services. Now the prices of goods and services tend to be established by the law of supply and demand. When there is a shortage of goods and services relative to the money that's chasing them (e. g., for "hot" items like Playstation 2 or Nintendo at Christmas time), prices tend to rise. Merchants have more trouble getting enough of the most popular items than they do selling them, and there is little incentive to cut prices to move the merchandise. On the other hand, after Christmas, there tend to lots of sales, as merchants try to get rid of excess Christmas items.
The amount of money in circulation at any given time is indirectly but effectively controlled by the Federal Reserve Board, both in the United States and in other countries. Increasing the money supply stimulates the economy, but at the cost of planting the seeds of inflation.
The Four-Year Boom-Bust Economic Cycle
When the Federal Reserve wants to stimulate the economy (when the economy is in the doldrums), it increases the money supply by lowering the interest rate on the loans that it makes to banks. Banks respond by lowering their prime rates... the rates they charge on commercial loans to their best customers. These customers know by now that when the Federal Reserve lowers its interest rates, the economy is going to pick up. Now is the time in the business cycle to take out that low interest loan and build that new factory in West Lafayette or Bakersfield. So borrowed money begins to flow through the economy and the economy begins to percolate. People are hired to handle the increased business, and they in turn have more money to spend upon goods and services. Prices tend to firm up. Wages tend to rise in an effort to attract and keep good people. But when wages rise, so do the manufacturing and service costs for goods and services. Consequently, employers have to raise their prices to cover the increased costs of production.
If prices tend to rise for more than a year, people begin to demand pay raises to keep up with inflation. This can lead to an inflationary wage-price spiral. Left unchecked, a wage-price spiral can lead to runaway inflation and monetary collapse.
At this point, it's time for the Federal Reserve to step on the brakes.... to cool the economy and rein in wage and price increases. It does this by raising the interest rates it charges to banks. Banks raise their interest rates, and businessmen say, "Uh-oh! It's time to pull in our horns and batten down for the winter. A slowdown is coming." Expansion now becomes expensive. So they tighten up in anticipation of the coming slowdown or recession. The Federal Reserve keeps raising interest rates until it sees unmistakable signs that the economy is slowing. Then for a short while, it holds interest rates constant until we enter a slowdown or recession. During this slowdown or recession, people cut their spending (partially in fear of layoffs or terminations), which helps lower prices. Unemployment increases because companies no longer need as many people to handle their reduced volume of business.( Left unchecked, this can lead to a depression in which the economy "freezes up", with hardly anyone working, widespread mortgage foreclosures, a collapse of the real estate market (because of all of those empty buildings that no one has the money to buy), and very little flow of money. Out of fear, everyone who has any money hoards it.)
Once the Federal Reserve is sure that inflation is under control, it lowers its rates to the banks again, the banks lower their prime rates, and the economy begins to thaw. The economic cycle has come full-circle.
There is a lag of about two years from the time the Federal Reserve begins to "snug up" the money supply and the time when inflation is clearly under control. Similarly, the reappearance of inflation lags expansion of the money supply by about two years. This is part of what makes controlling inflation so challenging. It also leads to situations in which the Fed is criticized for raising interest rates to fight inflation when no inflation is visible to the general public (including Congresspersons).
Knowing when and how much to increase the money supply, and when and how much to loosen it is a tricky process that has been characterized by an expensive learning curve. I have read that the Great Depression, with all of its horrid consequences, including, probably World War II, occurred because the inexperienced Federal Reserve Board of 1929 raised interest rates after the Crash of '29 instead of lowering them. (A similar situation faced Federal Reserve Chairman Alan Greenspan the day after Crash of 1987, but Dr. Greenspan drew a lesson from history and lowered interest rates, as well as guaranteeing banks against runs on their deposits. Reassured, the financial world reverted to business as usual.)
These Monetary Maneuvers Have Profound Impacts Upon Politics and People's Lives
Recessions and layoffs are very painful for us all. Gradually, over the decades, Federal Reserve Chairmen have learned to fine-tune this adjustment process so that we face slowdowns rather than recessions.
(To be continued)