A Crash Is Coming

Got your attention didn’t I?

This may be one of the few times I title an article in this manner, and I will contend that I’m doing it to prove a point … well, two points.

If you’re like most people, you saw that headline and immediately felt a small rush of adrenaline. Either that or you immediately wrote me off as a loony, which I wouldn’t blame you for.

If you did feel a sense of hyperarousal, it’s because your hypothalamus (a section of your brain responsible for hormone production) activated two systems in your body: your sympathetic nervous system and the adrenal-cortical system. These two systems work together to produce the fight-or-flight response.

When activated, your fight-or-flight response prepares you for action. A threat to your survival has been identified and your body engages in a series of readiness measures to better facilitate your escape.

Earlier in our evolution, it was situations like a wild animal appearing that would trigger this response. While these physical stimuli still produce their intended fight-or-flight response, we have adapted and evolved to the point where now, we perceive threats to our non-physical selves in a similar fashion.

Take money, for example. Whether we want to admit it or not, money means everything to us. It dictates what we can eat, what we can do, see, and enjoy. It affects who we socialize with, how others perceive us, and how we perceive ourselves. It controls how well we can take care of our families and friends. It determines how we spend a significant portion of our time on this earth, and it heavily impacts our self-esteem and sense of self.

Now, I’m not saying that money is everything, nor is it the path to happiness. Far from it. You and I both know this. And if you don’t, read some of the latest studies by organizations such as Princeton, which show that emotional happiness rises in sync with money only to a certain extent (annual income of about $75,000). Emotional well-being levels off around that figure, whereas life-evaluation tends to continue increasing.

My point is that in modern times, a threat to our money or net worth is perceived by the body in a very similar fashion as a threat to our physical well-being. It elicits a chemical chain reaction in our bodies that triggers effects such as increases in heart rate and blood pressure, pupil dilation, blood-glucose elevation and more. Our muscles tense up, nonessential systems such as digestion and our immune system shut down, allowing more energy for emergency functions, and our level of alertness rises dramatically.

It’s an emotional and physiological response that is difficult to control, and many marketers, especially in the financial industry, use this to their advantage.

The first reason for using the article title that I chose is to reinforce that fear tactics are used prevalently throughout the financial industry to get you to pull out your pocket book. Who hasn’t read the 30-page dissertation on why the markets will crash tomorrow, only to be presented with an opportunity to save yourself, using their methods, for a not-so-insignificant one-time fee? We all know that fear sells, and yet we succumb to this stimulus time and time again.

There are absolutely some folks out there who believe in what they are saying, but many of these folks are talking their book, trying to enhance their financial status by playing with your emotions. Please beware of their tactics.

Regarding tactics, it may help to understand the strategy behind using fear to sell, so that you can be on the lookout for times when your best interests may not be at heart. It is said that three considerations must exist for fear to “sell.” First, there must be a perceived vulnerability: it must impact us. Next there must be perceived severity: “it’s going to hurt, bad.” Finally, the third and most critical component comes down to efficacy: you must be convinced that you can do something about the threat (by purchasing a product, typically). If one or more of these considerations is absent, fear is unlikely to prompt our purchase.

When reading the litany of information available today, these items can help you distinguish the main goal of the author. A well-crafted piece that targets each of these considerations is likely to have a sales motivation behind it.

Last note on this before we move on: It’s actually a good idea to read the opinions of doomsayers from time to time. I still do, because while I won’t purchase their program for saving myself, sometimes they discuss ideas and issues that the mainstream media won’t, which I can then investigate. I’ve always been an advocate of reading predominantly the opinions of those who disagree with me, because that’s the only way to learn and improve. If someone shares the same opinion I do, they are of little value other than an ego boost.

Moving on, the second reason I titled this article as such is because, well … a crash is coming. I don’t think it will happen immediately, for reasons that have been discussed here over recent months and years, but we know that a crash is inevitable.

How do we know? Because every boom in history has been followed by a crash, and because Minsky tells us so.

Hyman Minsky was an economist and professor who focused his research on understanding and explaining the characteristics of financial crises. He attributed these bouts of crisis to fragile financial systems created, oddly enough, by stability.

Minksy has been popularized throughout the years, particularly by the use of the term “Minksy moment,” which refers to the sudden collapse of asset values as part of the credit or business cycle.

In a paradoxical twist, Minsky hypothesized that crises were simply the result of a normal and well-functioning economy. This stood in contrast to many other ideas at the time, which credited “shocks” such as policy errors or wars, as the underlying cause for financial instability.

In 1976 Minsky wrote a paper called, “A Theory of Systemic Fragility.” In it he described his belief that normal, stable economies breed optimism, which leads to excessive risk taking, which inevitably leads to instability.

It may be some type of shock that ultimately causes the house of cards to collapse, but the root of the instability is derived from, in a sense … complacency.

He wrote that, “Success breeds a disregard for the possibility of failure,” and discussed at length how long periods of success and stability resulted in consumers and businesses taking on massive debt in pursuit of profit.

I think few of us would argue with this notion. We witness it in microcosms of our own lives as well as on the grander scale of our global economy.

If you’ve spent any time in a casino then you can probably relate to seeing (or being) the person who hits a nice winning streak. More often than not, as the winning streak continues, the gambler becomes overconfident; he can’t lose. His bets start increasing in size and instead of walking away from the table a winner, he eventually gives it all back to the house.

On a larger scale, think of the most recent housing bubble. Years and years of steadily rising home prices left everyone with the feeling that “housing will just keep going up.” Those who internalized that belief had no concerns taking out enormous debt to purchase real estate because they had been lulled into complacency by years of stability. They were engaging in excessive risk taking, but they did not realize it at the time because a stable economy had bred an overwhelming sense of optimism.

I think you get my point here. By understanding our own weaknesses and susceptibilities, we can muster a small advantage in being able to move against the herd when the time comes. We must be able to sit back and watch the euphoria engulfing society during periods of stability, all the while realizing that it is the breeding ground for the next collapse.

Once again, I apologize for luring you into reading this article by using a fear mongering title, but hopefully your hormonal system has returned to its prior state by this point.

The preceding content was an excerpt from Richard Russell's Dow Theory Letters. To receive their daily updates and research, click here to subscribe.

Read next: Minsky’s Financial Instability Hypothesis

About the Author

Chief Investment Strategist
matt [at] modelinvesting [dot] com ()