History Repeats . . . History

11810730_s“The Dow tumbled 390.23 to 8,019.26, bringing the 30-share index down 1,360 points over the past two weeks and leaving it at its lowest since October 1998. It also closed 216 points below its Sept. 21 close following the first full week of trading after the Sept. 11 attacks.” [1]
That was the report from CNN in July of 2002.
“Stocks tumbled Monday, with the Dow and S&P 500 ending at fresh 12-year lows, as Merck’s $41 billion purchase of Schering-Plough failed to distract investors from worries about the economy. Since closing at its all-time high of 14,164.53 on Oct. 9, 2007, the Dow has lost nearly 54%. The S&P 500, which also hit its high of 1565.15 on Oct. 9 has lost around 57%.” [2]
This is how CNN reported the stock market collapse of 2008 five years ago this week.
Now that I have your attention please hear me out. We know that historically, every 5-6 years our markets have gone through a major correction. I cannot tell you when or if there will be another, but be mindful that we are into the 6th year of a recovery.
Six years . . . that’s how long the Federal Reserve has been pumping money into the U.S. economy. In fact, during that time, the Fed has printed over three trillion dollars. Think about this. Three trillion dollars is more than the GDP of all but four countries — the United States, China, Japan, and Germany. The Fed has given us several reasons for its decisions – saving us all from financial Armageddon, pursuing its mandate to effectuate maximum employment, and performing its general duty to oversee U.S. currency.
We might not like it. Some of us might downright hate it. But the Fed gets to make these decisions, not us.
Nevertheless, the Fed’s decision to “create” money has not had the effect of lifting the economy. Let me explain why. Banks essentially create money through loans via the fractional reserve system. They ‘borrow’ money from savers (depositors, those with extra cash) and lend that money at a higher rate to borrowers (those in need of cash). For example, if a bank has $100 deposited in it, it’s only required to actually maintain $10 or 1/10th. It then loans out the other $90, bringing total money in the system to $190. The $90 it loans ends up in another bank as a deposit. This bank keeps the required $9 or 1/10 in reserve and loans out the remaining $81. Rinse, repeat. So, while the Fed has been busy pouring money into the economy, consumers have been deleveraging themselves either by paying off debts or by having them written down and forgiven. Houston, we have a problem.
Since 2008, the Chinese have expanded credit by 89 trillion yuan, which is roughly 14 trillion U.S. dollars. This is more than four times the amount of money the Fed has created. In fact, it is equal to the total of all deposits that commercial banks in the U.S. held at the end of the third quarter of 2013.
Think about that for a second. Over the last six years, the Chinese have expanded their loan base by an amount equivalent to all deposits in U.S. commercial banks!
Chinese investors have used a significant amount of this credit to chase real estate and invest in dubious trusts that buy stock in coal companies. The only thing holding up the value of those assets is the next crop of investors taking out even more loans to buy real estate and invest in such trusts.
But the Chinese government is nervous. The recent announcement by the Chinese government that it wants to see lending curbed sent a tidal wave through its financial system. Overnight borrowing has become harder, with lending rates spiking as borrowers try to figure out their next move.
This is part of what’s causing investor anxiety in China, and it should cause anxiety here at home. As China tries to wean itself off of excess lending, it’s a sure thing that someone’s going to get hurt. As less credit flows, the most obvious candidates for loss are developers and property investors. Sound familiar?
If a rash of bankruptcies begin to sweep across China, it could ripple throughout the world as they adjust to a lower level of economic activity. The Chinese would need to slow down its purchasing of raw materials and goods from other nations, thereby leading to smaller orders and lower earnings in those countries.
This is why so many businessmen and political leaders want the Chinese central bank to keep credit flowing. They don’t want the negative effects of the Chinese credit crisis to wash up on their shores.
I cannot tell you what will cause the next significant market correction. But, the next time you hear that everything is fine in China, read the small print. As things begin to unwind in foreign markets, we may feel the ripple effects, and it could be swift and furious.
The questions I have for you, Cutter Family Finance readers, are these . . . What is your strategy to avoid a market loss? What was your strategy to avoid loss in 2001, 2002 and 2008? Did you have one? Do you have one now? History does repeat . . . Itself.
Be vigilant and stay alert . . . because you deserve more!
1. http://tinyurl.com/o2qu97q, 2. http://tinyurl.com/mhsvuza