Last July, the International Monetary Fund issued the following statement (emphasis added):
"Global financial markets continue to be fragile and indicators of systemic risks remain elevated. The downside risks…[are] leading to a negative feedback loop between the financial system and the broader economy."
To paraphrase, "The credit crisis stemming from the U.S. housing slump has triggered a 'negative feedback loop' in the global economy that poses risks for growth." (Thomson Financial)
At first glance, it sounds like a typical statement from one of the world's financial authorities. But let's take a closer look. By claiming that there is "a negative feedback loop between the financial system and the broader economy," isn't the IMF essentially saying that we will be stuck in this bear market forever – literally?
Think about it. The financial crisis is dragging down the economy, goes the story. In turn, bad economy is dragging down the financial system – and they are doing it in a "loop": Each step lower by one creates an even lower step by the other!
What's more, if you continue this logic, not only will this bear market last forever – it will also get progressively worse as the economy and financial markets push each other further and further down – all the way down into the hazy, bottomless economic hell. Scary thought, isn't it?
Allow us to suggest that there are no "feedback loops" between the economy and the financial markets – certainly not to the extent that the above scenario suggests. Why? Because if they existed, both bull and bear markets would last forever: Good times would perpetuate everlasting euphoria, and bad times would propagate eternal pessimism. But that's not how it works in real life.
We have manias and crashes, economic booms and busts. Ironically, in bull markets, the better things seem to be, the harder we fall – just think back to the internet bubble, or to the housing crash. And in bear markets, the worst news usually comes at a bottom; "the night is the darkest right before sunrise," remember? If "negative feedback loops" were real, wouldn't "the worst news" continue forever?
I'm not the first one to pick up on this idea. Bob Prechter, EWI's founder and president, came to this logical conclusion years ago in his brilliant Pioneering Studies in Socionomics (Chapter 27):
"I used to think that mood formed a feedback loop with events, which in turn reinforced the mood. I have since seen that this idea is erroneous. … If events formed a feedback loop with mood, then social trends would never end. Each new extreme in mood in a particular direction would cause more reinforcing actions, and those actions would reinforce that same mood, and so on forever. This is an untenable idea."
Untenable, yes – but very seductive in its conventional logic.
We at EWI have been forecasting the markets and the economy for 30 years. From this experience, we know that it's not "loops" that create booms and busts – people's collective emotions do, in predictable Elliott wave patterns. And we also know that there is a light at the end of this tunnel.
If you want real answers about the causes and duration of the now proverbial "liquidity crisis," get started with Elliott waveanalysis now: Read the new, January issues of our four flagship publications – completely risk-free:
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