Financial Cycles and How They Work

Why do gasoline prices shift dramatically? Why is it sometimes so easy to find an apartment to rent and other times almost impossible? Why is the stock market a roller coaster of ups and downs? 

What drives the twists and turns of finance and economics? How can we use that information to improve our finances?

Patterns of Money

So much of our lives revolve around the seasons. Without climate knowledge, we’d bring a snow shovel to a barbecue, wear short sleeves in January, schedule a picnic during a hurricane, and walk into a wedding with rain dripping off our clothes. Often, we don’t know exactly when a storm will hit or what temperatures will be. Even so, a general sense of climate cycles and the ranges of future weather possibilities makes our lives much smoother.

Similarly, there are general financial cycles which follow distinct patterns. Basic laws of supply and demand drive much of the financial world around us. Learning to recognize these patterns makes them much less mysterious and discomforting even if it’s hard to know precisely how they’ll unfold. And if you do get good at recognizing financial cycles at work, you may also be able to use them to make money or avoid losses.

High Prices: Bring Supply, Kill Demand

Consider a possible cycle in the supply and demand for cups of ramen noodle soup in a mesivta. Boruch brought a soup cup to yeshivah but wasn’t hungry, so he sold it to a friend for $1.00. Figuring he may be on to something, the next day, the entrepreneur cleaned out the pantry and sold 10 cups at $1.25 each. After he explained to his mother what was going on, she bought him a case of soup in Costco, and Boruch began steadily selling 25 cups a day for $1.50. But one morning, he saw a sign on the bulletin board saying that Rabbi Rich, a yungerman, was now selling an array of soup cups out of his car for just $1.25. Also, a bunch of Boruch’s steady customers had realized that for the same money they could get a fresh Danish from a boy in the other shiur, Gedalia.

And the Cycle Continues

Boruch started to shvitz. He’d just convinced his parents to order 1,000 ramen cups, and their guest room was now jammed. Sales were already down, and once word would get out about Rabbi Rich’s soup smorgasbord and Gedalia’s danishes, customers would go running. What was he going to do with a room full of soup cups? He quickly put up a big sign: “Boruch’s Bargain Soup: Just $1,” figuring he’d clear just a small profit but sales would rise quickly. However, Rabbi Rich also didn’t want to be stuck with a load of noodle soup cups, and he lowered his price to just 75¢, the wholesale price. While sales picked up for both soup sellers, there still wasn’t enough demand to quickly dispose of what had become an unprofitable headache.

Low Prices: Kill Supply, Bring Demand

Boruch decided to bite the bullet even if it meant losing all his past profits plus a bit more. He convinced his weary mom to leave her minivan in the yeshivah parking lot and hung up another sign: “Soup Cups 50¢—My Loss Is Your Gain! 500 Must Go Today!” This giveaway price unleashed a lunchtime ramen-soup frenzy like never before. Everyone bought and bought. Gedalia’s regular customers all purchased three soups instead of one Danish, leaving him with 50 unsold pastries. Boruch’s inventory disappeared in 60 minutes while Rabbi Rich quietly unloaded his remaining stock to the local grocery for pennies. Pockets emptied, stomachs filled, and lessons learned, everyone went back to the beis midrash, and yeshivah settled back to normal.

Until two weeks later, when Efraim began offering soup cups for just $1. He’d picked them up during Boruch’s fire sale and knew he was on to something!

Bigger Business, Same Ideas

A yeshivah’s soup economy is quite simple, with very few players and variables, but this little parable highlights the fundamental rules of economics. These laws influence billions of transactions daily, from barrels of oil to the supply of lawyers, the stock market, and even how crowded your doctor’s office will be! Low prices increase demand and decrease supply. High prices drag down demand and push up supply. Spikes in demand may create unusually high prices (like the short period when Boruch got $1.50 per cup). Supply gluts may force some to dump their stuff below cost (such as Boruch, who ultimately sold out at a loss). And decisions about the buy and sell quantities and pricing are made automatically out of everyone’s self-interests, as if by a hidden hand (in the words of famous economist Adam Smith).

Aiming for Imprecisely Right

It’s challenging to know precisely how high or low a cycle will go. But great investors such as Warren Buffett, Howard Marks, Sam Zell, and George Soros pay very close attention to market cycles. They’re aiming to at least get the general pattern right, even if they can’t time it precisely. Logic and history make it inevitable that at some point, exceptionally high prices force demand lower and supply higher. This new market reality will then lead to lower prices, circling back to higher demand and lower supply and then again to rising costs. And so the cycle turns. If you keep an eye out, you’ll notice the supply-and-demand cycles all around you!

Want to dig deeper?

Try these related articles

Compounding: A Major Key To Success

Inflation Risks: Is This the Perfect Storm?

Bubble Trouble—Investing during an Illogical Boom

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