The amazing similarity between storms and stock markets

And why we cannot control either of them

We’ve had some stormy weather around the UK recently.

Strong winds, flash floods, thunder, lightning and a hailstorm that set off the alarm on my car.

And as ever this reminds me of what thunderstorms can teach us about economies, stock-markets and house prices!

Luckily, here in the UK, our thunderstorms don’t tend to produce hailstones big enough to cause this sort of damage.

Hailstone damaged cars

Storm clouds that do this only tend to build up in warmer climates.

But the basic design of a Thunderstorm Cloud is the same, the world over.

The one story about ‘hot air’ you need to understand

We all know that the air around the earth is in constant motion.

And that there are different types of ‘air mass’ at different places at various times – even within the British Isles.

Some air masses are warmer (and less dense) than their neighbours. So, for example, the air that comes down from the north pole is a lot colder than air coming up from Africa.

And some air masses are wetter than others. So, the air that arrives from Europe and Russia is generally dryer than our ‘prevailing’ Westerly winds which come from the Atlantic Ocean.

These are the features of air masses (their relative temperature and moisture content) which make them either stable or unstable.

And today, we’ve had lots of unstable air over the UK.

That’s what gives us these storms.

With me so far?

Okay, so let’s dig a bit deeper now – to see how thunderstorms can help us understand economies (and asset markets)

And to make this easy to follow:

I’ll separate out the ‘economic’ bits into italics.

Comparing thunderstorms to asset markets

Air that arrives over the UK after a long journey over a (relatively) warm sea – will carry a lot moisture.

And it’s this sort of air that gives us thunderstorms.

The power of a storm depends, largely, on the amount of moisture that’s carried in the air.

You can’t normally see the water in the air – it’s carried as invisible water vapour.

But what we know is that the ‘wetter’ the air – the bigger the potential storm.

And even if you’ve not studied the science of weather systems (I had to study it for my pilots licence) it makes perfect intuitive sense anyway right?

I mean, we’re all familiar with those ‘muggy’ (moist air) conditions that warn of storms on their way.

Okay, now for our comparison with an economy, we’ll swap ‘moisture’ level for ‘credit availability’ from the banks.

Why would I do that?

Well, just as ‘moisture’ content is what drives thunderstorms – it’s credit availability that drives economic booms and busts.

And in either system, once you have the right conditions, all you need to get the storm started is some kind of trigger event.

The trigger event

If you’ve got the right conditions for a storm (a nice, moist, unstable air mass) then the trigger event is simply something that lifts the air up away from the ground.

And that can be done in various ways:

  1. by the sun heating the ground,
  2. by frontal lifting (as one air mass is pushed up over the top of another) or
  3. by ‘orographic’ lifting (where the air is pushed up over hills as it travels across the land)

And in our unstable economy or asset markets, the same is true.

All we need for a storm to get started is an initial lift in asset prices.

And we’ll certainly get that when hordes of people ‘grab at easy credit’ to buy more assets.

Now, you may have noticed that, as the air gets lifted upwards and clouds start to form they carry on rising – often at an increasing rate.

Watch closely, and you’ll see this happening on showery sunny days.

Just look up to see those big fluffy storm clouds growing vigorously at their tops.

And here’s an interesting fact . . .

These thunder clouds can sometimes grow faster, (vertically) than many aeroplanes can climb

What’s more, the vertical winds (up and down) inside these clouds (and the hailstones they carry) are so violent that they can destroy an aeroplane!

Flying into a storm

Yes, that’s perfectly true.

As I said, I’ve been trained on this stuff as a pilot.

So, it should reassure you to know that pilots are very well trained on weather systems.

And they avoid these storm clouds like the plague.

Airline pilots do not fly straight into storms.

They go around them – to get you safely to your destination.

World travel

Nice job guys 🙂

Now let’s look at what goes on inside these clouds to make them so violent.

In simple terms – this is how it works.

1. The moist air is lifted – by any of the ways I listed above.

2. This air cools as it rises – because the air ‘aloft’ is generally cooler than at sea level.

3. Clouds start to form – as the moist air cools enough to condense into water droplets. This ‘condensation’ process is the same as when droplets form on the inside of a cold window.

4. And this condensation releases heat

Yes, that does sound strange . . . but think of it like this.

A puddle will disappear on a sunny day – because the water takes in heat to become invisible water vapour.

And that process also works in reverse. Heat is given off when the invisible water vapour turns back into water droplets (cloud and rain) to make puddles.

5. This heat expands the air mass.

6. And that makes it float higher – like a hot air balloon that’s lighter than the air around it.

And now . . . we’re back to step 1.

So, in a nutshell – what’s going on is this . . .

The rising air cools – but then gives off heat as it condenses water – and that causes it to expand and to rise again.

So it just keeps going higher and higher.

Make sense?

Okay, well after all that technical stuff, I think we deserve a break.

So grab a cup or glass of your favourite drink and sit back to enjoy this song on the same theme!

Okay, so if you’re refreshed – let’s carry on with the lesson

When do thunderstorms stop growing higher?

Well, that’s quite simple.

Thunderstorms stop growing when the (credit) moisture runs out.

In the tropics, where the air is very warm – and can carry lots of water vapour – these thunderclouds can keep on growing up to heights of 60,000 feet or more.

That’s about 4 times the height of Mont Blanc – Europe’s highest mountain – so that’s ruddy high.

Mont Blanc

It’s also about twice the typical cruising altitude of an airliner.

And that’s another reason why pilots go around them rather than trying to climb over them. They simply have no choice 😉

Of course, these thunder clouds collapse eventually – in an explosion of rain and/or hailstones.

The collapse comes when there’s not enough (credit) water vapour left to (lend)  evaporate to create the heat and vertical winds to support all the assets water and ice inside them.

Now, we all know that after a storm has dumped all its rain and ice on the ground, the weather calms down. Right?

And we also know that we can’t prevent thunderstorms kicking off in the first place – because we can’t control the amount of moisture in the air.

All we can do is to find somewhere safe – to sit back and marvel at these wet and icy and sometimes fiery monsters.

And this is where economies are different.

Because governments and central banks could, if they chose to, control the levels of credit pumped into our economic systems.

They just haven’t bothered to control it much lately.

Indeed over the last 30 years or so they’ve persistently encouraged more credit to be extended – in an attempt to prevent an economic storm.

And that credit has created a series of booms and busts in asset markets over that time.

First in Stock markets (between 1995 and 2000); then in property (up to 2008 – in the greatest housing bubble we’ve ever known) and more recently in bonds and Stock markets once more – although in these latter cases we’re yet to see a bust.

The authorities, it seems, will try anything to avoid the “end game” of the storms that they start.

And they do that by tempting investors into yet more borrowing at ultra-low rates.

Or, as with the UK housing market, with various house buying incentives.

The trouble is that total global debt has been rising since the crisis of 2008-09 and has grown faster than economic activity over that time. 

This neat chart comes from the excellent global debt report by McKinsey & Company

Global debt rising

And then we have these images

Of private debt in the UK and USA – borrowed from- from Professor Steve Keen’s awesome new book, ‘Can we avoid another financial crisis?’

UK Private Debt

Debt in the USA

So the burden of debt is much higher now than it was 30 years ago

And we clearly need a way to lower the moisture debt levels in our economic systems.

Unfortunately, there is currently no one (with political power – or any understanding of these issues) who can tell us whether that debt reduction can be achieved smoothly and quietly (perhaps with some modest inflation to erode the real value of debt over many years) or whether it’ll take another great storm.

And this, despite the fact that some of the world’s greatest economic thinkers are offering some radical ideas to get us out of this mess.

Such as professor Steve Keen (Head of Economics, Politics and History. Kingston University London) 

He’s one of only a small number of economists who really understand this debt problem. 

Check out this interview – it might just blow your mind 😉

And here’s another person who can explain this debt problem in plain English.

Lord Adair Turner used to be the head of the Financial Conduct Authority here in the UK.

(and he was handed the job just as Lehman Brothers was collapsing in 2008 – so he knows a thing or two about crises!) 

And here, at the London School of Economics, he outlines the really big debt issues facing the world and what we ‘might’ do about them.

His brilliant book is ‘Between debt and the devil’

You’ll see Robert Peston on hand here also – to challenge Turner’s radical ideas.

Okay – so this might all be sounding a bit scary

And I’m really sorry if it is – but these are the financial realities of the world at the moment.

We have way too much debt globally. 

It’s not going away and something will have to give.

As for stockmarkets and house prices, well . . . where they go from here, in the short term, no one knows. It all depends on the various factors that drive demand and supply. And we can debate all those another time.

But what we can say for sure is this

The prices of houses (and other assets) have been lifted into the stratosphere bytoo much moisture credit availability – and interest rates at 400 year lows.

Big storms in market prices do NOT (as some advisers will tell you) only come along once in a generation.

They sometimes cluster together – within a few years of each other.

And that’s about it.

Of course, this thunderstorm / economy analogy is not perfect – none of them are.

But as an example of an unstable system – created by positive feedback loops – it’s a pretty good model.

The thunderstorm is similar to a credit extended economic system.

The main difference is that in the economic world we have ‘authorities’ who could interfere to prevent the build up of too much moisture credit.

But sadly they chose NOT to do that – and have gone on to encourage even more credit build up  – after the storm has started building.

And whilst we can’t be sure whether the actions of our central banks have helped matters or made them worse . . .

I think most ‘informed’ opinion would say that we’re not in a good place right now.

So, take care out there and check the forecasts.

Of course, they’re never exactly right . . .

. . . but they might help you decide when to take your waterproof.

All the best for now

And thanks for dropping in …

Paul

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