profile

Graham’s Newsletter

The reverse market crash of 2023

Published 3 months ago • 9 min read

You can read all previous issues of Graham's newsletter here. And don't forget to subscribe if you haven't already!


The cities were still there, the houses not yet bombed and in ruins, but the victims were millions of people. They had lost their fortunes, their savings; they were dazed and inflation-shocked and did not understand how it had happened to them and who the foe was who had defeated them.
– Pearl S Buck, about Germany in 1923

Imagine you invest a small amount in an asset, hoping for some incredible returns. In six months, your investment has grown ten times. You can’t believe your luck. But it doesn’t stop there. In another 6 months, your investment has grown by 1,000 times. Now the situation seems absurd. In the next six months, your original investment has grown 1 billion times!

This actually happened with the German stock market from July 1923 to January 1924. If you had invested just 1,000 marks in July 1923, you would have had 1 Trillion marks by the end of July 1924.

But you would have had no reason to celebrate. The money was useless. 1 US dollar was equal to 4 German marks in 1914. By November 1923, 1 US dollar was worth 1 Trillion marks.

1 Billion marks would buy you one loaf of bread or 10 eggs.
On paper, you were a trillionaire. In reality, you were broke.

That’s what a reverse market crash looks like, when the market surges irrationally while the economic system topples. It doesn’t happen that often – but it has happened enough times in enough countries to make it a serious concern, and sometimes with dangerous consequences. When decades’ worth of savings were obliterated in Germany, there was an incredible gap between the rich and the poor, overnight. The wealth inequality played a major role in setting up World War II.

But something like this could never happen in the United States of America, right? Well, that’s the possibility that people are worrying about all of a sudden, citing past examples like the Dot-com bubble and the Great Financial Crisis. A reverse market crash could help you make or lose a lot of money, depending on where you stand.


How reverse crashes happen

Reverse Market Crashes happen for roughly the same reason: Inflation and mismanagement of debt. Patrick Bet-David made a detailed video about this topic. He gives three main examples.

First, Germany after World War I. As we saw, 4 German marks equaled 1 US dollar in 1914. But after Germany lost the war, they were forced to pay tens of billions in reparations to cover civilian damages. The money printer went on overdrive, and Germany racked up so much debt that by the time they were done, a trillion marks were needed to buy 1 US dollar. Their economy was in shambles, and inflation went out of control rapidly.

One story from this time is that, in 1919 a student ordered a cup of coffee at a cafe. The price on the menu was 5,000 marks. After finishing the first cup, he ordered one more, and when the bill arrived, it was for 14,000 marks. “If you want to save money and you want two cups of coffee, you should order them both at the same time,” he was told.

A case more disastrous than Germany’s was in Zimbabwe. Zimbabwe has the dubious honor of printing $100 Trillion notes. But each note was worth just 40 cents in the US. How did this come about? Again, it was terrible economic mismanagement, political exploitation, and reckless money printing to finance military operations and food production. Their accounts were fraudulent and they underreported their money printing by $20 million every month. When this was called out, they resorted to calling inflation “illegal”. If the country you’re doing business with doesn’t even keep its books in order, how can you trust them to pay back what they owe you? This led to a loss of confidence in Zimbabwe’s currency and asset prices exploded.

The most recent story is that of Argentina. A few days ago, Argentina’s inflation rate came in at 142%. If you think that’s bad, their average inflation since 1980 comes out to 206% per year – Prices triple every year on average.

im

When there are talks about the US defaulting on its debt even once, the global economy panics. But Argentina has defaulted on its national debt almost a dozen times. The money printing is so much that in the last 10 years, the Argentine peso has lost 99 percent of its value against the dollar. As confidence in the currency falls, economic investment comes down in value (how do you plan ahead for a business if your cash reserves keep falling in value?). But because of such high devaluation, stocks are ironically seen as the place to store money – Argentina’s market is up by 1,650% since 2020.

There are more cases like this all over the world. Record-high inflation is coupled with record-high stock prices in Turkey. Inflation reaches a high of 50% in Iran, and stock prices shoot up even higher. And finally, Venezuela went the same way with high inflation occurring with a reverse stock market crash.

The real question is: Can something like this happen in the US? And what are the consequences? To answer that, we need to look at how inflation can switch from rising suddenly to going out of control.


The inflation machine

When the Federal Reserve comes under fire for not bringing inflation under control, and rate hikes affect the stock market, there’s one crucial point to understand: There are two interest rates, and the Federal Reserve directly controls only one of them.

The interest rate that the Federal Reserve sets, which most of us are familiar with, is called the nominal interest rate. This is the rate that decides how much banks can charge when they lend money, and it influences everything from how much your savings account pays, what treasury bills yield, and how expensive mortgages can get. Right now, the Fed has set interest rates at around 5.25%, and that’s what the nominal interest rate is.

However, the real interest rates in the economy are often affected by the amount of inflation in the economy. This real interest rate is the nominal amount minus inflation – and that’s a more reliable indicator of what you’re actually paying. If interest rates are 5.5% and inflation is 4%, then the real interest rate would be 1.5%. This is the net out-of-pocket cost of borrowing money. While today’s interest rates are high in a nominal sense, real rates for the last 20 years have been incredibly low.

  • In April 2001, real interest rates were only 2.2%.
  • After the 2008 Great Financial Crisis, real rates were briefly negative. You were getting paid to borrow money for several years in a row.
  • During the 2020 shutdown, real rates fell as low as -0.5% – For every $1 Million you borrowed, you “made” $5,000 per year.

Now why is this important? In the context of a “Reverse Market Crash”, Patrick argued that every other economic catastrophe was also induced by temporary “negative” interest rates – when borrowing money and investing it in stocks seemed like it would have a higher payoff in the short run. Zimbabwe, Argentina, Turkey, Iran, all experienced this effect. Since 2009, the S&P 500 has also seen a rapid run-up, increasing by 6.5x!

In all of these situations, this is the cycle that happens:

  • Money printing is abundant. Hence real rates drop.
  • When real rates drop, it’s cheaper to borrow and invest.
  • Those with spare cash invest in assets, and asset prices rise.
  • Fewer goods are produced and prices rise. Real inflation rises and the cost of living increases.
  • The government raises nominal rates to control inflation – but too little, too late.
  • Confidence in the economy drops, and the wealthy continue to invest in the stock market as a flight to safety.

Then the cycle keeps repeating, with the stock market rising and inflation rising in parallel. It ends up with a few people investing and building disproportionate wealth on paper while the economy collapses. We are seeing a bit of this in the US… Rate hikes, high inflation, and now Moodys has cut its outlook for the US economy from stable to negative.

So in terms of whether we actually have something to worry about…


Reverse crash in the US?

Even though countries like Weimar Germany, Zimbabwe, Argentina, Turkey, Iran, and Venezuela were absolutely destroyed by inflation and rapid stock market growth, let’s put that in perspective with the US.

For Germany, their market increased 600% in 3 years – but relative to the US dollar, adjusting for the currency value, their market actually declined by over 80%, completely negating any profits made on paper. All the “gains” in the market were because of the currency value diminishing. Zimbabwe was even more extreme – their index has gone from 1,000 to 553,000 now. But relative to the US dollars, their market has crashed by more than 90%.

Argentina had a similar spike – but lost 61% of its value against the dollar.

In each of those cases, stock values were high. But that wasn’t correlated with high purchasing power or wealth – even though it’s a good idea to invest in appreciating assets, it still became a net loss against the United States as a reserve currency. Each of those countries had other problems to deal with – severe and persistent corruption, war, famine, sanctions – and there wasn’t any economic resiliency built into they system to recover. But the US case is different. For a better comparison, let's look at what happened in Japan.

There was a similar run up of stocks in Japan, and though Japan’s stock market crash is infamous; Share prices increased 3x faster than corporate profits and the Nikkei went from 10,000 to almost 40,000 in less than 3 years! The crash that occurred in 1989 wiped out almost $2 Trillion from the market – and the market has never returned to those historical highs. At the same time, Japan didn’t face hyperinflation like the countries we saw because the monetary infrastructure was carefully regulated. The Dollar/Yen rate has been held stable for decades.

The United States has its own problems – We are $33 Trillion deep in national debt, parties are becoming politically divided, and inflation remains higher than the Fed would like – but:

  • Both inflation and interest rates have been much higher than in the past, and we have recovered from those scenarios.
  • GDP has been incredibly consistent for the last 50 years, and
  • The US holds the reserve currency status of the entire world.

The monetary structure of the United States is so tightly regulated, and so many countries are high-stakes players that it’s extremely unlikely that we’ll witness a reverse crash where inflation rises 200% while stock markets surge up by 10,000%. Systemically, there are so many fundamental differences that if anything happens here, we’ll have way bigger problems to deal with – and the only items of value will likely be beans and ammo.

This could happen on a much smaller scale of course. We’ve already seen inflation increase, interest rates lowered, and people either made or lost a lot of money in that window. That’s why I think the problem is more of an income gap than an investment gap. When the Federal Reserve lowered rates and there was a buying opportunity, the ones who could actually take advantage of it were the ones with assets and disposable income, to begin with. The others were left out and doubly affected when inflation reduced their purchasing power.

Having an emergency fund or a plan for hard times also gives you a buffer to take more risks with your money – and wealthier investors tend to take more risk because they already have the reserves to weather short-term fluctuations. Somebody working paycheck to paycheck can’t afford that risk and they would lose the opportunity when it’s most lucrative.

That’s why, given all of this, as far as what you can do to make sure you’re in the best position possible to come out ahead, the really boring basic philosophies still hold true: Save more than you spend, invest in a diversified portfolio long term, don’t panic sell, stay invested, and focus on what you can control, like your overhead, job skills, employability.

Wish you a happy Thanksgiving!


That's it for this week. I hope you enjoyed this article. Have a different view? Want to see more of something? Tell me your thoughts by replying to this email – I read every single comment :)

If you found this useful, consider forwarding it to just one person who'll appreciate the information.

Stay safe, stay invested and I will see you next week – Graham Stephan.

113 Cherry St #92768, Seattle, WA 98104-2205
Unsubscribe · Preferences

Graham’s Newsletter

by Graham Stephan

A 32 year old real estate agent and investor with over $120M in residential real estate sales since 2008, I've created this profile to share my successes, failures, insights, and experiences in the investing world.

Read more from Graham’s Newsletter

Welcome to Graham's Newsletter! If this is your first time here, you can check out all previous issues here. Why did a book about flies cost 24 million dollars? In 2011, a postdoc researcher logged into Amazon.com looking to buy a copy of “The Making of a Fly.” Though the book was out of print, the researcher thought the book was a tad overpriced. Amazon had listed 17 copies for sale: 15 used from $35.54, and 2 new ones: one for $1.73 million, the other for $2.19 million (plus $3.99 in...

8 days ago • 7 min read

Hello! Is this your first time here? You can read all the previous issues of Graham's Newsletter and subscribe here. The story starts with another bank that’s making headlines for the wrong reasons – New York Community Bank. Not even a year since Silicon Valley Bank, Signature Bank, and First Republic Bank failed, every major headline is talking about the newest “Banking Crisis”. And while the issue last year was with banks not being flexible enough to handle sudden interest rate hikes, the...

14 days ago • 7 min read

Hello! Is this your first time here? You can read all the previous issues of Graham's Newsletter and subscribe here. Codie Sanchez is one of my favorite people to listen to on the topic of money and business. She's been through an amazing career graph – from investment banking at Goldman Sachs, to striking out on her own as an entrepreneur who buys and sells small businesses. I recently caught up with her to pick her brain on building a great career. There’s no roadmap to being an...

19 days ago • 5 min read
Share this post