Generational Dynamics: Forecasting America's Destiny Generational
 Forecasting America's Destiny ... and the World's


Generational Dynamics Web Log for 27-Jul-07
Dow plummets 311 points as shaken investors sell out

Web Log - July, 2007

Dow plummets 311 points as shaken investors sell out

European, North American and Asian stock markets generally fell 2-3% on Thursday and overnight Friday, amid increasing warnings about sharp credit contractions.

Reading and listening to the so-called financial "experts" today, it's hard not to wonder whether any of them have any idea what's going on.

I'm listening to some guy talk about how investors are losing confidence, and it may take a few days or weeks for investors to get their confidence back, so that the market can go up again.

No one ever asks the question that I've asked many times: Where SHOULD the market be? How much are stocks really worth?

If the value of stock market is based on fundamentals, then it's easy to get its "real" value. In a 2005 article called "The 11% Solution," I showed how to do it. And I've just updated my Dow Jones historical page, and at the bottom it shows that on Wednesday the "real" value of the market was at Dow 5253, meaning that it was overpriced by a factor of 262%.

Perhaps you don't believe that. Perhaps you believe that the value of the market is whatever investors say it is. OK, fine. That means it could be at Dow 14,000 or Dow 20,000 or Dow 100,000 or Dow 1,000,000. That's what you're saying, right? But it could also be at Dow 10,000 or Dow 5,000 or Dow 1,000. Why not? Can't it go up as well as down?

Most financial "experts" seem to look at it that way. So they talk about "investor confidence" as the only thing that matters, and increasing investor confidence is the only problem that has to be solved.

But what really affects investor confidence? What made investors so overconfident in the mid-1990s that they fed the dot-com bubble and

So here we are today, with pundits having NO IDEA WHATSOEVER what's going on. How do you increasing investor confidence? Who knows?

All that everyone's talking about now is that investors are LOSING confidence. They're getting panicky, the pundits are saying. But it's only temporary, the pundits point out.

What we're seeing in practice what was predicted theoretically by last year's article on "System Dynamics and Macroeconomics," and followed with an essay that I wrote on "A conundrum: How increases in 'risk aversion' lead to higher stock prices," based on work by Harvard economist named Robert J. Barro.

The dot-com bubble began in 1995, just at the time that the risk-averse survivors of the 1930s Great Depression all disappeared (retired or died), all at once. The younger generations were debauched in their use of credit, creating all those bubbles. and the huge liquidity bubble that the world has been experiencing.

But now those debauched investors are beginning to panic. They suddenly realize that they may be in over their heads, and about to drown. "You have a stampede of the animals away from the watering hole," said a pundit quoted by Bloomberg. Right now, everything that smacks of financial risk is backing out through the door."

So maybe there IS a "real" value of the stock market, after all. Maybe fundamental DO matter.

Index price of low-quality ABX-HE-BBB- 07-1 credit derivatives and high-quality ABX-HE-AAA 07-1 credit derivatives from Jan 19 to Jul 26, 2007 <font face=Arial size=-2>(Source:</font>
Index price of low-quality ABX-HE-BBB- 07-1 credit derivatives and high-quality ABX-HE-AAA 07-1 credit derivatives from Jan 19 to Jul 26, 2007 (Source:

I've been writing about the ABX index since February, when I wrote that the rapid collapse of ABX index indicates that investors may be starting to panic.

In fact, investors DID start to panic, ever so slightly. In the months since then, the level of panic and anxiety has been increasing.

You may wonder why I keep talking about this obscure ABX index, and also keep talking about those CDOs (collateralized debt obligations) and other credit derivatives. I realize that most people reading this web site have no idea what they are.

That's also true of ordinary investors. Whenever I speak to an investor, I start to tell him what's going on with CDOs, and I always get the MEGO look ("my eyes glaze over").

And yet, what's going on with CDOs is INCREDIBLY IMPORTANT. When this is all over it's the CDOs that will go down in the history book as having caused the crash.

And the graphs above show that the prices of these CDOs are already crashing. We're not waiting for some great worldwide panic or some generational change. They've been crashing since March, and they're continuing to crash every day, as more bad news about mortgage foreclosures comes in.

Ten days ago, Bear Stearns announced that its hedge funds are almost worthless. People had invested billions of dollars in those hedge funds, and many of those investors lost everything. Why? Because the hedge funds had invested in CDOs.

Think of the ABX index as a measure of the "value" of CDOs, and think of CDOs as certificates representing the mortgage market, as it continues to sink.

Here's another way to think of CDOs: Think of them as being similar to the certificates that people sold each other in the 1630s during the Tulipomania bubble.

I've quoted this paragraph a couple of times before, but it such a powerful paragraph that I want to repeat it. It describes the the last days of the Tulipomania bubble of the 1630s, as described in Edward Chancellor's 1999 book, Devil Take the Hindmost, a history of financial speculation:

"No actual delivery of tulips took place during the height of the boom in late 1636 and early 1637 as the bulbs remained snug in the ground. A market in tulip futures appeared, known as the windhandel (the wind trade): sellers promised to deliver a bulb of a certain type and weight the following spring, buyers took the right to delivery -- in the meantime, cash settlement could be made for any difference in market price. Most transactions were expedited with personal credit notes which also fell due in the spring when the bulbs would be dug up and delivered. Gaergoedt boasts of having made 60,000 guilders from his tulip speculations but admits that he has only received "other people's writing." By the later stages of the mania the fusion of the windhandel with paper credit created a perfect symmetry of insubstantiality: most transactions were for tulip bulbs that could never be delivered because they didn't exist and were paid for with credit notes that could never be honoured because the money wasn't there." (pp. 16-18)

This last sentence tells you exactly what CDOs have become. They're based on leveraged mortgage-based investments that no longer exist in viable form, and were paid for with other credit derivatives that could never be honored because they too were worthless.

But you don't own any tulip certificates, you say, and you don't own any CDOs either, so what do you care?

My response is: Yes you do, if not directly, then indirectly. There are tens or hundreds of trillions of dollars invested in these credit derivatives, in the portfolios of mutual funds, investment trusts, hedge funds, savings banks, pension funds, college endowments, money market funds, insurance companies, and so forth, meaning that in the next few months, millions of people are going to lose much of their life savings. And this is going on RIGHT NOW, not awaiting some other generational change. The panic has been going on for several weeks, and continues.

I've been telling people since 2002 that we're headed for a new 1930s style Great Depression, based on long-term forecasting techniques. I had no way of knowing what path we'd take to get there, and a lot of people thought I was loony, but there's never been any doubt that it was coming.

This is what I want to get through to you, Dear Reader. Even if you thought I was loony, this panic with CDOs is happening RIGHT NOW. Investors are getting increasingly panicky, and we're getting closer and closer to a new generational financial crisis, like the one that began in 1929.

From the point of view of Generational Dynamics, a generational stock market crash is overdue. If you go back through history, there are of course many small or regional recessions. But since the 1600s there have been only five major international financial crises: the 1637 Tulipomania bubble, the South Sea bubble of the 1710s-20s, the bankruptcy of the French monarchy in the 1789, the Panic of 1857, and the 1929 Wall Street crash. We're now overdue for the next one. It could happen next week, next month or next year, but it will come with absolutely certainty, and will come sooner rather than later.

I can't tell you when it will come, and I will admit that I've been fooled before when things seemed bad. But what I'm saying now, Dear Reader, is that the news in the last two weeks is VERY OMINOUS. And as I'm writing this, near midnight Eastern time, the Nikkei Index for the Tokyo Stock Exchange is down 400 points.

There's a pattern of increasing desperation among investors. Banks are being stuck with big loans, big deals are falling through, credit is tightening.

What I'm saying, Dear Reader, is that you have to prepare for this, and plan for it. Don't wait any longer. Put your affairs in order as well as you can. Don't spend a penny on anything that you don't absolutely need. That penny may save your life a year from now, or may save you or your daughters from having to go into a life of prostitution. Treasure the time you have left, and use the time to prepare yourself, your family, your community and your nation. (27-Jul-07) Permanent Link
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