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Can Another World Wide Deflationary Depression Happen Again?

If you believe in the Long Wave Theory of Nikolai Kondratiev, whose economic theories I have discussed in my last two Posts, what are the chances of another deflationary depression coming upon the world in the next few years?

We can address this issue by first noting the chart published above. It is a graph showing the meanderings of the US Dow Jones Average ever since the crash of 1929. The blue sections of the chart show the Bull market moves, while the red indicates Bear markets. As you can see quite clearly, except for the period after 1929, when the Federal Reserve was slow to respond to recessionary signals by failing to ease monetary policy, the actual period of survival for an average Bear market has been very short. This is mostly the case because the Fed actually learned its lesson after the Great Depression. Generally speaking, after the Great Depression ended in 1945, interest rates were lowered quickly, especially whenever the Fed realized that the economy in America was in some kind of real trouble, and correspondingly, the economy responded to the Fed's easing of monetary policy with a recovery that lasted far longer than the prior Bear market.

The chart above also shows how Kondratiev's Long Wave Theory looks as the Stock Market progresses through its five stages of a long wave. Until 2001, the first three waves carried the US economy, and the Stock Market, through periods of general prosperity. There were Bear markets along the way, but in general, the uptrend was in place. American business was doing pretty well, and so were Americans. The Stock Market then crested in 2001, and began its journey into the fourth wave, where two significant Bear Markets came in succession 2004-5 and 2008-9. If Kondratiev's theory is correct, we were all saved from a world wide depression in 2008 and 2009, when the Fed and Ben Bernanke, in 2008, dramatically lowered rates and began the policy of QE or Quantitative Easing. Cries of anger came from lots of policy makers in Washington, who said that the Fed's extraordinary easing was over reaching its authority and inherent powers, but Ben Bernanke ignored those cries and gave the American economy a dousing of money like it had never seen before.

Now look at what the chart indicates regarding the Fed's tremendous effort to stave off depression. The US Stock Market has risen since 2009 some 153 percent, but even so, we still see signs of deflation everywhere. First, it was the real estate market crash that began in 2007, and now we are seeing the oil market undergo its deflationary cycle. Manufacturing in the US has just entered a recession, and there's evidence that more deflation is on it way to that sector too. Only auto manufacturers seem to have been exempt from this trend, but that should not surprise anyone who knows that the auto manufacturers all went through their deflationary cycles, starting in 2006 and 2007, when the US government had to bail out GM, Chrysler and other manufacturers from bankruptcy. Only Ford escaped the fate of a bail out, and that was mostly because Ford's management reacted quickly, and downsized faster than their unlucky competitors.

So now we are at the end of the Fourth Wave, and starting the last and final leg of the Kondratiev's Long Wave theory. If the past is any indicator, this final leg of the Long Wave is going to last a while, and it is going to be characterized by more sectors of our economy undergoing deflationary cycles just like the one we are seeing in oil and energy right now. But please remember, according to Kondratiev's theory, this process, though painful for all of us who are suffering through it, is actually quite necessary for the cleansing of the overall economy. This fifth and final wave is more than likely going to end in the next seven or eight years. So we probably have more pain to go through.

Now we come to the question of whether it is possible for the world's economy to slip into a depression like the one we suffered through in 1930. The answer to this question should be fairly apparent: it all depends upon the Fed, our policy makers in Washington and on central bankers around the world. The chances of a depression are pretty much dependent upon all of these factors because what these leaders choose to do over the next few years with regard to monetary policy and tax reform is going to either help us get through this period without a depression, or their mistakes will cause our world economy to stumble, and fall into a deflationary spiral.

If the new administration in Washington next year takes the approach that Congress can help shape the American economy by providing a more competitive tax structure for our economy, along with the Fed's continued recognition that interest rates must remain low for the foreseeable future, while deflation continues to work its way through many sectors in our economy, then we have a good chance to pass through this fifth wave period without a depression event.

The recovery in real estate in America, and particularly here in Florida, should be held out as a bold example for the Fed and for our Washington policy makers. Low interest rates have helped end the deflationary cycles in both the residential and the commercial real estate markets inside the US. Now that the Fed is moving rates up a tick or two, however, we can see an immediate impact on both of these reinvigorated markets. Prices are starting to level off in some real estate markets, and both the commercial and residential markets here in Florida are starting to slow and take a pause. The reason why this pause is beginning here prior to some of the other markets in the US is because of the strong dollar. The strong dollar is a by product of the Fed's tightening policy. As rates have steadied here in the US, but are still falling in Europe and the Far East, a stronger value has been added to our dollar as compared to other currencies around the world. This strong value to our dollar is now causing buyers from other countries to slow their purchases of our American real estate. Why? This is the case because it costs our international friends much more in their own currencies to purchase our dollars, and this currency premium, is making our current real estate prices look pretty darn expensive!

Florida also has another reason to lead this slowing of sales trend. Florida's economy is one that particularly depends upon a weak dollar to stay in good health. When the dollar becomes strong, our two top economic engines, tourism and agriculture, are hurt by that same strong dollar. As fewer dollars flow into the State because fewer visitors are coming here to visit, and fewer international buyers are buying our more expensive agricultural products, fewer buyers are also available to our real estate market to purchase whatever inventory is available for sale. The good news for Florida right now is that inventories of properties for sale are generally fairly low almost everywhere across the State, so I expect this pause to last a while, and then I expect the real estate market to begin strengthening, as inventories tighten, and buyers find fewer and fewer properties available for purchase. In the end, the economies in Europe and South America should begin to get a little better over the next few years, and this should cause our dollar to ease in its value. This is when I expect another up wave to occur in Florida's real estate market.

In my next Post, I will examine what I think can be done to help our economy in this, the fifth and final wave of the Long Wave which started this period of the world economy in 1945.

John K Brackett, Ph.D.

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Chart provided by Yahoo Finance, and used for educational purposes only.