The seeds of the crash are planted in times of the boom and vice versa

The proximate causes of these successive crisis are very different – emerging market debt problems, the new economy bubble, default on asset-backed securities, the political strains within Eurozone – yet the basic mechanism of all these crises is the same. They originate in some genuine change in the economic environment: the success of emerging economies, the development of the internet, innovation in financial instruments, the adoption of a common currency across Europe. Early spotters of these trends make profits. A herd mentality among traders attracts more and more people and money into the asset class concerned. Asset misplacing becomes acute, but prices are going up and traders are mostly making money.  …

… Yet reality cannot be deferred forever. the misplacing is corrected, leaving investors and institutions with large losses. Central banks and governments intervene, to protect the financial sector and to minimise the damage done to the non-financial economy. that cash and liquidity then provide the fuel for the next crisis in some different area of activity. successive crises have tended to be of increasing severity.

The above paragraphs have been taken from John Kay’s book “Other People’s Money – Masters of the Universe os Servants of the People”.

Different market cycles appear different, but there is a lot of similarity in each. I have written about the anatomy of a market cycle in the book “Riding The Roller Coaster – Lessons from financial market cycles we repeatedly forget” that echoes the above words to a great extent. If you observe, the parallels are often staring you in the eye. However, very often, we choose to ignore the signals.

The seeds of the crash are planted in times of the boom and vice versa. As Lord Krishna tells Arjun in the Bhagvad Geeta

Bhagvad geeta 2-27

#RidingTheRollerCoaster – 174

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Is it really Greek and Latin? Or is it just a game of musical chairs?

“The adoption of a common currency by these countries in 1999 (Greece followed in 2001) led to convergence of interest rates across the continent. Traders no longer discriminated between the euro liabilities of different Eurozone governments, believing that not only currency risks but also the credit risks that had once distinguished well-managed European economies from those with unstable public finances had been eliminated. …

… By 2007, yields on Greek government bonds were barely higher than those on equivalent German bonds. Several states, including Greece, took advantage of what appeared to be inexhaustible supplies of credit at low rates. …

… As European banks struggled with the global financial crisis, the quality of their assets was viewed more sceptically. Credit risks were appraised much more carefully, and interest rate differentials across the Eurozone widened again. Greek bonds appeared less attractive, as interest rates rose and the refinancing of Greek credit became more difficult. The country effectively defaulted on its debts in 2011.”

This is an excerpt from the book “Other People’s Money – Masters of the universe or servants of the people” written by John Kay.

The Greece government was playing the game of musical chairs. As we wrote in the book, “Riding The Roller Coaster – Lessons from financial market cycles we repeatedly forget”, liquidity was the music in this game. The only difference is when the music of liquidity stops, there are no chairs to be found.

Rolling the credit over and over again is a dangerous game. So long as the liquidity is abundantly available and at cheap rates, the game continues. A few victories in this game makes one believe that one is skillful. However, history is replete with examples of disasters when the music stops.

#RidingTheRollerCoaster – 165