How to ride the boom-panic cycle

Reaching for returns

Dig down another level and I think you'll find the global trends that produce and reproduce these similar panics.

First, the financial markets are being asked to redistribute massive amounts of cash. Higher oil prices have produced a gusher of cash flowing from the developed economies to the oil-producing economies. All that cash has to be reinvested somehow, often in the financial assets of the developed economies, thus completing the cash cycle.

But that's only a part of the global gusher. The massive trade surplus reaped each year by China -- and to a lesser extent by other developing economies -- has to be recycled, too. And again, much of this money goes back into the developed economies because even a developing economy such as China can't -- or won't, by government policy -- absorb all this cash.

Reinvesting this much cash without inflating asset values in some part of the market is probably impossible given investors' propensity to chase returns. Many of the countries with the cash are also relatively new to the investment game and haven't developed reliable in-house methods of assessing risk.

Second, the globe is at a demographic turning point. Like an individual in middle age, the globe as a whole is in its prime earnings period. Taken as a whole -- largely thanks to China and the developing world -- the world is a net saver. That saving adds to the global cash flow. But everyone from the savers (China) to the relatively older spenders (Europe, Japan and the U.S.) feels the need to get the most return on each of those investments. That has produced a global search of any potential extra penny of return and an understandable willingness to underestimate the risk of reaching for that extra return. (See my Aug. 10 column, "How Wall Street got into this mess.")

And third, with the aging of their populations, the economies of the developed world are slowing, both absolutely and relative to the younger and faster-growing economies of China, India and the rest of the developing world. That may be completely natural in the life of an economy, but that doesn't mean it sits well with the governments of those aging, slower-growing developed nations. Engineering economic growth and preventing recessions has moved up on the agenda of every central bank in the developed world, whether they admit it or even recognize it themselves.

That means more active efforts to help the economy after a bubble bursts and more willingness to turn on the cash spigot to head off any slowdown.

Dealing with the new normal

These underlying trends mean that the boom-panic-boom-panic cycle isn't going away anytime soon. The world is likely to see another decade or two of positive global cash flows that have to be recycled before aging catches up with the globe as a whole. The search for that extra 10th of a percentage point of return will go on with current or heightened fervor. And any slowing of growth in the developed world will be met with a wave of cash, and, if growth starts to flag in the more developed parts of the developing world, we can expect central banks there to turn on the cash spigot as well.

That cycle, including the panics that scare us so much, is likely to be normal for quite some time.

So how do you live with this kind of financial market? I'm assuming that you haven't put away enough cash to simply bury it in the backyard.

Continued: Some guidelines

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