THREE SIMPLE AXIOMS That Tell Us The Financial Market Mess is Temporary



AXIOM #1 Recessions are a Normal Part of the Business Cycle.


Booms and Busts are as old as the data available. The business cycle is something that every economy must go through. Although the news media outlets treat a recession as abnormal, to an economist it is as normal as a person exhaling. Because we have had an extremely good run of growth and productivity for the past 20 years, now that we are entering into a recession, there is a temptation to liken it to the depression of the 1930’s. This is a mistake. Things won’t get that bad.



AXIOM #2 Banks make money by lending money.

Just like a landscaper needs to plant trees and trim shrubs to keep his business going and a baker needs to bake and sell loaves of bread to keep her business going, a banker needs to lend money to keep his business going. Even though there is a “credit crunch” going on now, it can’t go on forever. Eventually, banks have to make loans. The lack of lending we are witnessing now is simply a normal activity of banks replentishing (i.e. recapitalizing their reserves). Banks have had a lot of reserves removed from their vaults (and books). The removal of reserves have taken the form of writing off bad loans (and investments) and depositors removing deposit. This is money they would have liked to loan out but couldn’t because they simply didn’t have it.

When reserves get built back up, lending will resume again. This is a temporary phenomenon. When the baker runs out of flour, she has to make a run to get supplies and during that down time, no bread gets made. It doesn’t mean the baker will never make bread again, it just means no fresh rolls while she replentishes supplies. This is true for the banks also.



Axiom #3 There is a Finite amount of money.

Our Federal Reserve Board controls the money supply (categorized as M1, M2 and M3). Even though it seems that the amount of dollars is endless, it’s not. When someone loses a dollar someone gains a dollar. While it is true there are declines in the stock market, when a stock sell off occurs, someone gains money from the sale. For example, when you sell your 100 shares of GM for $5, you get $500. The point here is that in the mass sell of stocks, sellers have received money. That money has to go somewhere (even in a mattress or buying chunks of gold). Eventually, that money will resurface into our economy. The rate of return under mattresses is historically zero and investors like to get some return on their money. Panic and Fear are emotions that subside. The incentives for profits and interest income remain.

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