As I demonstrated in my last article, the principle of supply and demand  functions in all world markets as a fundamental driving force for price and value. So, for example, when demand for some available product or resource rises, while the nbsp;supply of that product or resource remains constant, a rise in price follows. Similarly, when supply of a product or resource rises in quantity, while demand remains constant, prices for that product tend to fall. We also learned last time that the inverted relationship between supply and demand is definitively linked  and driven by the fundamental physical needs of human beings. These needs are necessary for ongoing human existence. Scarcity is a word we use in our language to describe the recognition through competition with others that the number of available resources out there in the world is less than the total and ongoing need. When we say that something is scarce, we mean that we recognize that the availablitiy of that resource is rare and difficult to find. But there is something more we need to understand about scarcity. And this is probably more important for our analysis of world markets than the principle of supply and demand itself. When human beings begin to recognize that they must complete with each other for something they must have, FEAR BEGINS TO TAKE OVER AND DRIVE THEIR COMPETITIVE BEHAVIORS.

Fear is a powerful force in world markets precisely because it drives participants in the market place to take actions that they would not normally take. And why do these folks suddenly decide to do things that they normally were in the past unwilling to do? It's because they have suddenly realized that they might not get what they need. There is another aspect to fear that you should understand. When participants compete in a marketplace for what they need, and they become fearful that they will not be able to get what they need, THEIR FEARS BEGIN TO DISTORT HOW THEY SEE WHAT IS ACTUALLY HAPPENING IN THE MARKETPLACE. Fear makes people see gobblins and ghosts where there really aren't any. Fear makes market participants think that the sky is falling and that it is the end of the world, when, in fact, nothing of the sort is actually happening. Fear creates distortions for how market participants see and interpret the actions of others. And this fear makes their distorted perceptions seem very real to them . So, they begin to tell others what they see. As they tell others, market participants listen, and they begin to feel nervous too. The effects can sometimes be like a literal wildfire, spreading through a parched forest.  This phenomenon of how fear distorts reality and creates an inaccurate assessment of reality is called, "market psychology." Sometimes, you'll hear analysts speak of "market sentiment."

But there is another side to this coin, and that is the issue of abundance. Abundance is a term we use in our language to describe a condition where there exists in the market place more resources available to consumers than is actually needed for their consumption. As I mentioned in my last article, abundance is a term deeply connected to the notion of what we call in our language, "enough." When a person has enough of a resource, they are no longer under the power of fear. Enough means that they are satisfied and hence their demand for the resource in question lessens. If, however, they continue to add the needed resource to their stockpile, then they can begin to speak of their condition as being one of abundance, at least with regard to that accumulated and stockpiled resource. Ironically, abundance, like scarcity, can engender a negative emotion in human beings. That emotion is greed. But the funny thing is that abundance can only engender greed in a person, if and only if, they somehow begin changing their own long standing and established definitions of what "enough" means.

For example, let's say that for the last ten years you have owned one and only one TV in your home. You bought this beauty  in the late 1990's. It's a thirty two inch color TV with a nice remote control,  and it has worked beautifully ever since you purchased it for three hundred and fifty dollars. When you watch baseball and football on your TV, you really enjoy the clear, crisp color and the stereo sound. One day, a good friend calls you and says, "Hey,  Man, why don't you come over and watch the Yankees play the Red Soxes on my new wide screen TV. It has high definition and surround sound." So you go over to your friend's house and watch the game. To your shock, you realize that you have been living in the TV stone age. Your friend's picture is so clear you can see the whiskers on A Rod's chin. And the sound is so crisp and animated, you can hear some of the players talking to each other in the batter's box. You go home and think to yourself. Wow, I have to get myself one of those TV's! 

Without realizing it, what has happened to you is this. The experience of a new discovery has caused you to change your ongoing and established definition of what is "enough" for you, especially when it comes to TVs. Before your experience at your friend's home, your thirty two incher was just fine. But now, after seeing what is possible out there, you realize that you WANT a new TV. Now wanting is not the same as needing. The fact is, you don't really NEED a new TV. But you do want one, and you realize that you are going to have to pay for it. When you ask your friend how much his set up cost him,  you are dazed by his answer. He paid almost four thousand dollars for everything.  Wow! Now comes the conflict. Do I spring for this thing or not. If I do spring for it, I will have to put it all on my credit card, and this means debt. All kinds of emotions rise inside of you. Fear of debt, but also a strong desire to have the same TV as your friend, battle inside of you for days. Finally, you order the new TV and charge it  to your credit card.

By going through with this action, you have definitively changed your established standard of what was enough for you. Previously, one TV was enough. Now two TV's are enough. Previously, you were living in a state of abundance, at least when it comes to the issue of TVs. But that abundance got disrupted by an experience that caused you to change your standard of what enough meant to you. Now you have lots of debt and your standard is higher. What was the driving force behind your decision to change your long held standard of what was enough for you? Greed. Somehow, greed changed your perception of your own self and your own reality. This was a distortion because in reality, you didn't really need a new TV. But somehow you convinced yourself that you did. This was in fact a false perception, and just as unreal as though you were afraid and creating some gobblin to believe in. Well, at least you now have new TV to watch.

These two aspects of market theory are rarely, if ever, discussed in economic commentary.  In most cases today, when you hear anyone in the business press discuss these concepts, they typically speak of "animal spirits." Another typical set of praises that commentators use are, "negative market sentiment" or ." an increase in market volitility." Others say things like, "market psychology is strongly positive." Well, when you hear these kind of descriptions of what market participants are seeing out there in the market, keep in mind that market sentiment is simply another way of speaking about the perceptions of the participants in the market place. And if greed or fear are behind those perceptions, most of what those folks see is going to be wrong.

In terms of the "the world's economy," market sentiment is important. Whenever in history world stock markets have enjoyed huge gains, market sentiment has usually been quite negative. And yes, you guessed it, whenever world markets have suffered huge losses in the past, market sentiment has for the most part been quite positive. If you know this fact, you can really avoid some big investment mistakes. When the "experts" in the market are telling everyone around them that things are just wonderful, a small group of important traders in the market listen carefully. These folks are really smart people, and they have lots of money to invest. They are really good and experienced investors who know what they are doing. Many of them help insure their success by literally trading on the floor of the world's exchanges. Anyway, when these so called, "market makers" hear the positive spin from their fellow investors, their faces turn to a smile, and they immediately go to their trading desks and start selling the market short. We will discuss how this is done in another article, because a lot of investors simply do not understand how shorting the market works. But for now, let's just conclude this article by stating that when these smart market makers begin selling the market short, they are taking a contrarian position against the majority of investors who seem to think that everything is just rosy and wonderful. By taking this position opposite the majority of investors, the market makers lead the market down. Other smart investors, who have tons of money to invest, will often try to piggy back on the market makers and try to mimic every single trade the market makers make for themselves. This piggy back phenomenon causes volume on the exchange to move briskly upward and to accelerate until still other investors join the party. Suddenly, the market makers are leading a large pack down, and they are all making huge amounts of money while you, and all the other folks out there who are still long, are losing your shirts. Why? Because you believed the market sentiment,  which stated that everything was just rosy.

If you understand how scarcity and abundance drive distortions in market sentiment, you can avoid huge losses and make money in the world economy when others are losing their shirt.

John K. Brackett, Ph.D.

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