The economy has a rhythm. There are several overlapping cycles that play out over time. The pattern is erratic and irregular, but it persists over the centuries. Ray Dalio narrates a cartoon video that describes these cycles. There’s a short term debt cycle that includes booms and busts from decade to decade. And there’s a much deeper long debt cycle that plays out over about a century.
The harsh recession of 2008 is still fresh in people’s minds. Many of us remember the Dot Com Bubble of 2000 as well as Black Monday in 1987. The crash of 1929 persists in living memory. But how many people remember either the Panic of 1873 or the Panic of 1837? Further back there was the South Sea Bubble of 1720 in London, the Tulip Mania of 1637 in Amsterdam, and the devastating Financial Collapse of 1345 in Florence… In between were countless ups and downs. And these localized booms and busts occur in space as well as time, so one location might be thriving while another is crashing. So what does this mean for ordinary people right now?
When I was a teenager in New Jersey in the 1980s I worked as a housekeeper and gardener for the family that used to live in this house. At the time I thought they were rich. I remember when they put on the addition to the back and nearly doubled the size of the house. And I remember the summer they installed the swimming pool. They renovated the kitchen and baths and always had new cars in the driveway. The Reagan years were very good to them.
The family sold boats for a living. Each spring they would take out a multi million dollar loan to buy their stock for the coming year. Every fall they’d pay back that loan from summer sales. They kept the difference as their profit. They sold these boats to people on credit – typically home equity loans since people could then deduct the additional mortgage interest from their taxes. The government practically pays you to buy the boat of your dreams!
Then came Black Monday. Stocks dropped over 22% in one day. The market seized. Credit choked. Home values sank and equity went negative for a lot of people. Sales of frivolous items like pleasure boats stopped almost completely. And one day the family just… disappeared. The neighbors said they moved to Florida. Turns out everything about their lives was bought on credit. When they couldn’t service the debt everything simply evaporated and they skipped town. The bank eventually sold the house for less than what was owed. I suspect another bank found itself in possession of a lot of boats that year. Same with the credit card companies and auto lenders.
Right around the same time an old friend here in California bought this Victorian duplex when prices were artificially low due to that same Black Monday economic downturn. Back then the house was in poor condition and the neighborhood was decidedly lower class with a demographic composition that generally frightened middle class white folks. He was a bachelor at the time and wasn’t particularly bothered. He drove a bread delivery truck so he wasn’t exactly rich, but he’s handy and went about repairing the property on a tight cash budget. He rented out half the duplex and took on room mates to share the other half. He was able to live frugally and generate a surplus each month. He aggressively paid down the modest mortgage until the house was free and clear.
With cash on hand, no debt, and steady rental income he bought the bungalow next door, gave it an incremental cost conscious DIY renovation, and rented it out. He continued to live with room mates in the duplex always paying down debt as fast as he could until the bungalow was mortgage free as well.
In the late 1990s he met his wife. They didn’t know for sure where the real estate market was heading long term, but they understood the market was in their favor at that moment. They decided to sell both properties for substantially more than he had paid for them at what later was obviously the top of the Dot Com boom. And since there were no mortgages to pay off the sales were a cash windfall. They used the proceeds to relocate to the country where property was less expensive and bought three fixer upper homes all on a cash basis. Rinse. Repeat. By the time they were in their fifties they came to own five mortgage free properties with four of them generating steady rental income.
Looking back the financial crash of 1987 was a tiny blip. Even the Dot Com implosion in 2000 and the 2008 Global Financial Crisis have since been dwarfed by new growth in the economy and massive increases in asset values. So here’s the question individuals need to ask themselves. Is the current graph of endless upward expansion a permanent phenomenon, or is it half of a long debt cycle sine wave to be followed by an equivalent decline? We have no way of knowing. As statistician George Box once said, “All models are wrong. But some are useful.” So if you had to bet your future on it, would you rather be the family who sold boats on credit, or the bread delivery guy? That’s up to you…