The US economy is made up of two fundamental events which are expanding and contracting credit. While an economy is expanding credit typically it is a time of prosperity. When an economy is contracting usually it is a labeled a recession. The economic cycle of expansion and contraction describes an economy as a whole.
To best visualize this cycle you should imagine a wave. As you go up the wave credit is expanding which typically means more spending; when you go down the wave credit is contracting which leads to less spending. Since US consumer makes up about 70% of GDP, it is logical to imagine the consumer is the water that makes up the wave. As the old saying goes, “Life is full of ups and downs”. People are typically either going up or down the wave.
The world is made up of cycles. The sun comes up and then is goes down and seasons change. Peoples clothing and surroundings may change but history usually repeats itself.
Individuals have short and long cycles. Groups of people also share cycles. These groups could include 2 individuals to millions or even the entire world’s population.
Gustav Le Bon in his book “The Crowd” cited that individuals are smarter than the crowd. With this assumption one could argue that the larger the group included in a cycle the slower the cycles is to repeat itself since it will take the crowd longer to move to the next part of the cycle than an individual.
Individual’s private finances most of the time go through periods of expansion and contraction just like the economy as a whole. Actually if you believe that individuals are smarter than the crowd, then you should also believe that individual’s finances lead the broader economy, since they are more efficient at moving to the next part of the cycle.
With the current economic crisis the price of real estate skyrocketed to a point where more and more individuals no longer saw value and stopped buying. With less buyer and more sellers, real estate prices started to plummet. Once the first domino falls, the rest eventually do. Since the housing bubble was so widespread and included so many people, both in the USA and abroad, the cycle should take that much longer to progress.
