In my last Post, I described the true story of Nikolai Kondratiev. Kondratiev was a Russian and Soviet chief who studied historical agricultural data from Europe over a three hundred year period, and from that data, he developed the theory that all agricultural markets in Europe were constantly subject to repeatable, inevitable price and production patterns. Kondratiev called these data patterns waves. His historical research showed an amazing correlation between the rise and fall of market prices and the production of a commodity in any given market. Kondratiev found that each commodity market he studied contained within itself a repetitive five wave structure, culminating in a final two wave period of collapse of prices. Kondratiev's research also showed that there was great evidence for what he called, "A Long Wave." This so called Long Wave was an overarching, all encompassing pattern of behavior in which all sub markets could be found to be repeating their five waves of regular action on a constant basis. Kondratiev also determined that over a three hundred year period, a Long Wave was subject to repetitions in the historical data at a rate of approximately 5 times. In other words, the tracking of all commodity markets in Europe was subject to a repeating Long Wave period of repeating price fluctuations, lasting approximately every 50 to 70 years.
Sadly, Kondratiev's work fell into disfavor with Stalin, so that he was arrested, imprisoned by the Stalin government, and eventually shot in 1938 for his determined faithfulness to his theories. While in prison, Kondratiev was asked repeatedly by government officials to renounce his belief in agricultural cycles and particularly in his Long Wave Theory. In every case, he refused, and as a result, suffered a tragic death. So what makes his academic research so important and what makes Kondratiev, himself, such a compelling figure in economic history? First and foremost, this amazing man is important because he was willing to defend and die for his research work on economics.
Now, in this Post, we want to ask the question, how does Kondratiev's thinking apply to our present day economic situation?
First, we must say that no one theory ever serves to address every single bit of data or set of facts discovered in any given historical situation. Historians have always looked for the BEST explanation for historical facts. They have never stated that there is only one answer or interpretation for any given historical event or set of historical data, so I have to begin by stating that even Kondratiev's Long Wave Theory may not perfectly fit into all of the historical facts currently available to any economic and historical observer, but, in my opinion, Kondratiev's Theory is currently the BEST explanation to explain our current economic situation . So we are going to look at it, and see how it can help us understand the current world economy, and the present economy of the United States.
Second, Kondratiev's Long Wave Theory basically states that every 50 to 70 years, any given economy, regardless of location or formation, will inevitably pass through a series of predictable and repeating stages. The most marked and drastic of these stages is a depression like event in which all prices begin to fall without warning. As I mentioned in my last Post, Kondratiev identified five major waves in any given market cycle. To simplify this idea, we can say that according to Kondratiev's research, in any given economic market, there are always five trends that characterize all economic price and production activity. The first three of these trends begins at the end of a depression, or very bad market event in which the market falls without warning.
The first wave begins after a depression period ends. This is a new period in which most all prices of goods or services begin to consolidate and stabilize within the market. The second wave begins when the market starts an uptrend in price and production. The third wave accelerates the prior trend of wave number two. It should be noted that counter trends, or corrections downward in price and production can always occur in any of these first three up waves, but the general trend during this period of the cycle is an upward surge in prices and a growing increase in product production.
At some point at the end of wave three, the market begins to accelerate upward with even greater price increases so much so that production can not keep up with demand. This leads to rising inflation and the beginning of the fourth wave: when prices of a good, service or product rise so fast that excesses begin to become apparent. When this phenomenon of excess begins, there is a at some point or another a sudden turn in the market downward in prices as the "smart money" or "market makers" begins to realize that an over supply of goods is on its way into a market where prices are way too high to support demand. This factor leads to the beginning of a leg down in prices. In some cases, over supply during this wave can lead to a crash in prices. The final and fifth wave is a period of continued deflation in prices, while supplies of a good or service begin to abate and then deplete inventories within the product's market.
In Kondratiev's Long Wave Theory, these same five periods or cycles can exist and last much longer, some cycles lasting 10 to 15 years, depending upon the commodity or good involved. So, for Kondratiev, while many kinds of items for sale in any given market can be going through their own market cycles, overall, the general economy, which is also a combination of thousands of sub markets, is going through its own economic five wave long cycle.
Now, taking Kondratiev's theories into account, and looking at world history, we can see some interesting correlations with Kondratiev's Long Wave Theory. The last major world depression began in 1930, and ended in 1945 with the close of World War Two. During that fifteen year period, America, and pretty much the rest of the world too, went through systematic series of crashes in prices, with deflation smashing each market in succession. The action of the Federal Reserve during that 15 year period added to the deflation problem. At first, the Fed failed to react to the onset of deflation by failing to ease its monetary policy, thereby keeping monetary policy too tight until 1932. This compounded the fall in prices in almost all markets, and caused further debilitation of the entire American, and indirectly, world economic structure. Then, in 1932, the Fed finally began to ease and continued to do so until 1937. In that year, the Fed decided that the economy was heating up too much, so it returned to a tighter monetary policy with the result being another recession, and a deep fall in prices in 1938 and 1939. Only America entering World War Two in 1941 caused industrial production to return to a rise in output, and the Fed to ease further because of a need for a war time economic monetary approach. By 1945, prosperity began returning to America, and with the rebuilding of Europe, under the Marshall Plan, the European economy also began to get its feet on the ground too.
From 1945 onward, the first wave of a new Long Wave began. Innovation, technology advances, and productivity lead to great economic booms in the late 1950's, 60's and 70's. America and Europe lead the way in finding new markets to produce new goods and services that everyone wanted. Generally speaking, the Fed's monetary policy during this period tended to stay on the side of easing. Thus, market prices were continually strong, and inflation slowly became a problem, especially beginning in the late 1960's and early 1970's.
With the rise of OPEC, prices for oil were cartel controlled, and costs of production in the West began to rise even more because of a rise in energy costs. With this phenomenon, continuing over a long period of time and into the 1990's, the Federal Reserve responded by ordering a cycle of rate increases that led to a major recession in the 1980-1982. Changes in tax reform under President Ronald Reagan, and an emphasis on "supply side" economics, also created a boom for the American and world economic into the early 1990's. But it was the "go go" years of the late 1990's, characterized by high job growth, middle class expansion of income, and rising manufacturing production, in the context of continued high demand for new technology, that led to the first signs of deflation. Japan, China, and other nations around the world, suddenly became our competitors by producing products for our growing technologically based economy. They also began to demonstrate that they could produce many of our most basic manufactured products at much lower costs. This cost factor caused many American and European producers of technological and manufactured goods to move their production operations overseas and particularly to the Far East. The results of this free trade policy was the unforeseen and unwanted continuation of deflation of prices for all technology and manufactured products worldwide.
The Nine Eleven attacks on the World Trade Center in New York by embedded foreign Jihadists in 2001 was the final blow to an already tired and depleted world economy. The recession of 2001, and the recovery that followed, never seemed to restore the American economy to its former health of the 1990's. A rolling set of deflationary cycles began to move through the American and European economies, resulting in more and more companies going out of business, or being forced to move their operations to the Far East. American and European producers became convinced that it was only by moving their operations to China, Vietnam or Thailand that a manufacturer of goods could suddenly compete with any other competitor in the world. American manufacturing fell to a new and historic low.
Since the Great Recession of 2007, both the American and European economies have been under a constant and ever growing attack from growing deflationary forces, all originating from the Far East. And the timing of this deflation is no accident as the Great Recession has occurred about 62 years after this Long Wave's starting period of 1945. As noted above, according to Kondratiev's theories, we should have expected a depression like event at some point from 2005 to 2015. If Kondratiev's Long Wave Theory still applies to our current world economies, this deflationary cycle will continue for another seven or eight years. We have only been protected to some degree during this period by the Federal Reserve's and the ECB's correct, but unpopular policy of extraordinary easing. Without Quantitative Easing, our economies in America and in the EU would most likely be in an even poorer condition than they are today. The Fed's recent increase of a quarter point to the Fed Fund's Rate, and the Stock Market's corresponding downward plunge in January of 2016, should help confirm for any observer that the Stock Market is currently very dependent upon Fed policy. In other words, the Stock Market is filled with buyers and sellers who are worried that our economy could slip once again into a deflationary depression like the one beginning in 1930.
Will a depression come upon us in the next few years, or at any time in the near future? My next Post will address this important question.
John K Brackett, Ph.D.
All Rights Reserved