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These Four Words Separate Financial Fact From Fiction
Only Bubble Psychology Could Complicate Something This Simple
It's impossible to understand the unfolding subprime debacle and credit contraction apart from the truth behind these four words:
Credit Is Not Money
Bob Prechter explained what this meant in his March 2007 issue of the Elliott Wave Theorist. It's been barely a year, but it may seem longer ago if I point out that the media then was full of headlines about "The Goldilocks Economy," meaning not too hot or cold but just right. Look it up. They never saw the debacle coming because they believed things were about as good as it gets. For anyone in that mindset, the suggestion that "Credit is not money" is no more intelligible than a radio frequency from outer space.
Even so, what Bob meant (and means) is easy to understand. Money is cash and cash equivalents. Credit, on the other hand, is an IOU. So, when prices fall -- in the stock market or in property values, for example -- money holds its value. But credit loses value in that environment, and can do so at an astonishing pace. When people assume and then behave as if credit IS money, their behavior creates a bubble. That is precisely what describes the real estate market -- until a year ago. Now prices are going down even faster than they went up. The value of credit depends entirely on the ability of the debtor to repay.
As Bob also said in that March 2007 issue, "Falling asset values and economic contraction thwart efforts to honor the loans. Debtors begin to default. When that happens, the game is up."
Once again, Bob's observation makes perfect sense, especially given what we’ve seen in recent months. Yet he said it a year ago.
The April 2008 Elliott Wave Theorist published today, and features a special section written by my colleague Alan Hall (on pp. 7-12). He carries Bob’s insights regarding credit and money to the next obvious level, namely commodities -- and then some. I only have space enough here to say that Alan reminds us of how abundant "liquidity" was the foremost component of the Goldilocks mindset; specifically, liquidity was supposed to be what would keep stocks and real estate from going down.
As for “and then some,” Alan goes on to show how the psychology that drives markets is part of a much larger psychology which shows up beyond the world of finance. In this case, in the "Expressions of Environmentalism" -- it's the latest demonstration of how Elliott wave analysis promises insights and perspectives you cannot find anyplace else.
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