So my last post was about stocks, what they are, the basics. Now, if you guys really want to learn something, and why we always hear about a "stock market crash" and the problems it can cause, then pay attention. This one is gonna be long.

A "stock market", is used sometimes by some people as an indicator of how well the economy is doing (it's not the perfect reflection, but its a measuring stick). When a stock market is going really well, people are happy, the prices of stocks are going up (because they're more valuable to investors who buy them) businesses are making money, people are getting paid and we all have a good time.

And then when the prices of a whole lot of stocks go down at once, it's called a crash. People lose their jobs, and businesses close or lose money. Their eyeballs melt in their sockets, they're disemboweled, etc. It's not fun.

WHY DOES THIS HAPPEN??? We need someone to come in and fix things, right? We need the politicians or the president or the Federal Reserve (a central bank, i'll get to that later), to come in and fix things, to give people their jobs back, and get the economy back on track, right?

Wrong.

Remember back in part 3 when I explained what a stock was. It's a small portion of ownership in a company, that you get paid a small percentage based on how well the company does. Well, that's not the only way stocks make people money.

Buying stock that a company is selling is called the "primary market." But you can also buy stock from somebody who has already bought the stock themselves. This is called the "secondary market".

Let's go back to our bottled lemonade company example. I bought 1 share of stock from the company for $1, and the company will give me 1% of the profit, the amount of money I receive from this stock is tied to how well the company is doing.

Since this lemonade company is doing really really well, and they're making more and more money, that stock that I have is making me money also. It's looking kind of attractive, like that girl or guy at school that suddenly got so hot over the summer vacation, but, alas, he or she already has a boyfriend/girlfriend.

Year 1, the lemonade company sells 10 bottles. At $2 profit per bottle, the company itself made $20. 1% of 20$ is $0.20. 20 cents is all mine. Since I paid $1 for the right to make that 1%, i just recovered 1/5th of my initial investment (minus opportunity cost, but that's another lesson entirely)

Year 2, the lemonade company sells 50 bottles. Again (holding everything else constant for the sake of the example), the $2 profit per bottle is 100$. 1% of 100 is 1, so in year 2, I get $1.

I paid 1$ for the stock before year 1. In two years, I made $1.20. This lemonade company is doing really really well, and growing really fast. Other people want some stock now, too. They want what I have. They want my suddenly hotter boyfriend/girlfriend.

So I might find someone who says, hey, PBF, i'll buy your share in the lemonade company for $10. Wow. $10. That's 10 times more than I spent on the stock in the first place. They are willing to pay that much, because the other person thinks the lemonade company is going to keep growing. And they're probably right.

Seizing the opportunity to make some quick money, i sell the other person my stock (my ownership in the lemonade company) to them on the secondary market for $10.

Let's run through that again. I spent $1 before year 1. I made $0.20 the first year, and $1 the second year, and now, I made $10 for selling the stock to someone else.

I spent $1, and got back $11.20. I'm a very rich man now, especially if I bought a lot of stocks in the company at the beginning. Think about it.

This is how stock prices rise and fall over periods of time, changing many times, going up and down sometimes within the span of a few hours. If the lemonade company started not performing as well, it looks less attractive, and not worth as much for the next person who buys it.

Now what happens when an economy is doing well? People are making money, and they buy other things with that money. The lives of people all over the place are improving because they can buy more things. When the economy isn't doing as well, people don't get paid as much, and they buy less stuff, choosing to hold onto the money they have instead of spend it on things they don't want or need.

This is where a Central Bank comes in. If an economy isn't going well, it's the central banks "job" to give it a "push". In the United States, the central bank is called the Federal Reserve (the Fed). How does the Fed give the economy a "push?"

Well, the main way they do this is by buying stocks and bonds in the financial markets. The Fed, recently, has been buying US Treasury Bonds (money the government borrows) on the secondary market from investors who bought them first.

Now, pretend there is a bank. A big bank. We'll call this bank, "The Bank of Saffron City" This bank buys the loans that the Government is selling (the Treasury Bonds). The government will pay the bank back at a certain period of time. Then, the Saffron Bank meets the Federal Reserve.

The Federal Reserve notices how the economy is going pretty slow right now. Remember, it's the Fed's "job" to make the economy run smoother. How will the Fed do this? It will buy the Treasury Bond from Saffron Bank, for more than Saffron Bank bought the Treasury Bond from the Government.

Now Saffron Bank has more money. They made quick and easy money by buying the Treasury Bond from the government, and selling it for more money to the Fed. What will Saffron Bank do with this extra money?

Why, they go to a stock exchange. Saffron Bank will then invest in our Bottled Lemonade Company, by buying it from stock owners like me who own shares of the Lemonade company, helping it grow. The employees who work for the lemonade company, because its growing so fast, make more money, and in turn, they spend the money wherever they want. The economy is now running more smoothly, people are making money, and everything is happy, and unicorns poop rainbows in the sky and everyone looks up with their tongues open and wait for the skittles to fall. It's just peachy.

Saffron Bank is now also making money from the lemonade company stock, and they want more money (who doesn't?). Repeating this process, Saffron buys MORE Treasury Bonds, sells them to the Fed (who still wants them to make the economy run better), and uses the profit to buy more stocks, not just in the lemonade company, but all kinds of companies. There's money to be had all over the place!

Everything is perfect, right?

So Saffron Bank buys even MORE treasury bonds, and sells them to the Fed, who is still buying them! They can't get enough! It's like a drug. Where is this Fed getting all this money to make the economy run better??

The answer: they create it out of thin air.

The economy is running better and better at this point. Saffron Bank gets free money, and they invest in all kinds of businesses like the lemonade company. They even help invest in brand new companies that people are creating.

This is where Billybob comes in. Billybob sees everywhere he looks that the economy is rocking and rolling. People are making money everywhere he looks. He has a brilliant idea: Billybob is going to open a restaurant that only serves cereal.

Wow. So profound. Much vision.

Billybob needs some money to start his cereal restaurant, so he goes to Saffron Bank. Saffron Bank just can't stop making money due to their profits from stocks in other businesses, loans they make to other people, and free money they get from the Fed. Saffron Bank thinks the idea is a little fishy. Who would go to a restaurant to eat cereal? But who cares? they're making so much money, so they invest in it, lets say by giving Billybob a loan for $50 to start the business.

Billybob starts his cereal restaurant, and now he wants to offer the same stock deal to other investors as the lemonade company. $1 gets you 1% of the company. Billybob sells 75 shares, making 75$, and keeping 25 shares for himself (as the owner).

Billybob then pays back the loan to Saffron Bank with the 75$ he made from selling away some ownership in the company. Without selling a single bowl of Fruit Loops, Billybob made 20$ (+75 dollars by selling stock, minus 50 for the business loan to Saffron Bank, minus 5 as interest to Saffron Bank for letting Billybob borrow) which he then divides out and pays to his stockholders.

Saffron Bank notices that the loan that started the business was paid back. So Saffron Bank buys stock in BillyBob's cereal from the people who bought it from Billybob himself. They just keep making money. Money from: the lemonade company, loaning money to borrowers, and money for selling Treasury Bonds to the Fed.

The Fed, meanwhile, keeps buying these Treasury Bonds, noticing how many more people are making money. The economy is so awesome right now! The Fed keeps on buying with brand new money that they are allowed to create out of thin air.

Saffron Bank, meanwhile, is making more loans to other businesses. Sure, some may fail, but in the end, they just make more money because its so easy to sell the Treasury Bonds to the Fed.

The stock market turns into a casino, where Banks like Saffron buy stock from others, and then others buy the stock again from the banks. The price of the stock keeps going up and up and up. The money from the Fed keeps coming in because there's economic growth everywhere! Anyone who wants a loan, gets a loan! Stocks, from the successful lemonade company and Billybob's Cereal alike, change hands multiple times a day. the price of the stock changes a few times, sometimes it goes down a little, but because of the easy money, more money gets spent in the casino, over time making prices go up up up! And people everywhere make money.

Then a month passes. People realize that it's silly to go to Billybob's restaurant just to eat expensive Raisin Bran. They stop going. Billybob loses money. His family doesn't eat (anything more than the leftover cereal that no one buys).

The people who bought stock in Billybob lose money.

Billybob isn't the only guy in this world who started a new business. In the real world, hundreds, thousands, of people start businesses because of the easy money they can get. When these people can't pay back their investors, the investors need to get back the money they spent.

The investors, holders of stock like you or me or Saffron Bank, try to sell, sell, sell the stocks. However, everyone realizes now that Billybob doesn't make any money. They don't want the stock. In order to entice people to buy, the stock of Billybob goes down, down, down.

And remember, it's not just Billybob. Think of all those other people that started a company because the money was easy to get. Businesses all over the place lay off employees, or close, because they don't make any money in the end.

So, do we still think our politicians and governments should come in and save these peoples' businesses and jobs? The answer is no.

Those businesses were artificially created when the Fed prints money out of thin air. the money makes its way into the stock market casino, where prices reflect businesses. When the market goes SQUISH, this is the sign that the business really shouldn't be in business in the first place, it should be allowed to fail.

In short, when the economy is doing bad, there's a reason. People don't want things at a certain price because they'll lose money. When the Federal Reserve, and Central Banks give the economy a "push" with free magic money, the ride only lasts for a little while. Then, when the crash happens, people wonder why and their eyeballs melt and blah blah blah.

The "crash" isn't a problem, its the economy trying to fix itself, to set itself straight after the injection of easy money.

The rapid rise in prices is called a "bubble", and naturally, the "bubble pops." So why do we want the government or the fed to come in and "save the day" by replacing one bubble, with another that will just pop sooner or later?

I hope you stayed with me this long and learned something.