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What is the Best Medicine for a Suffering World Economy?

In my last few Linkedin Posts, I have described how Nikolai Kondratiev, a Russian economist, who died in 1938, studied commodity markets in Europe from the Seventeenth Century to the early Twentieth Century. Based upon his extensive research, Kondratiev developed a theory of what he called economic market waves, or cycles. In order to explain these recurring patterns of price changes and crop production rates in any given set of commodity markets over a three hundred year period, Kondratiev developed a thesis that all commodity markets contain within their ongoing market transactions a repetitive pattern of price and production correlations. Kondratiev further refined his research by delineating a set of characteristic patterns within any given market. Kondratiev believed that each market contained five repeating patterns.

Each of these five "waves," as Kondratiev liked to call them, corresponded to a period of time within a market in which the price of a commodity passed through a dramatic series of price changes, and those changes could be correlated to corresponding production levels. Each of the first three patterns in Kondratiev's wave theory repeated over time, again and again, as market participants produced more of a commodity because market inventories were low and prices were rising, and therefore, as prices went through a series of moves upward, production expanded. Kondratiev argued that this pattern of a rise in market prices over a period of time basically culminated in what could be demonstrated on a chart as a period of overall price inflation, and these periods of inflation generally contained three major upward moves on a commodity's price chart.

The first three of these inflationary waves were then followed by two additional waves, wherein production finally caught up with rising market prices, and an oversupply of a commodity began to develop in the market. This phenomenon of deflationary price pressure, and a corresponding oversupply of inventories over time, also repeated itself over and over again. The first deflationary wave contained an initial sudden crash in prices, which was then followed by a series of downward turns in price as the supply of commodity inventories took over the market and drove prices down even more. In the fifth wave of this deflationary cycle, the prices of a commodity continued to fall, but the fifth wave also ultimately produced the restoration of balance between the production of a commodity with inventories coming into balance with the commodity's price.

Kondratiev applied his wave theory to other markets in the West and found that the pattern of five waves best explained market behavior in markets other than commodities. He thereby reasoned that an overarching Long Wave existed within all market economies. This Long Wave was essentially a way of describing how entire economies go through a similar five cycle pattern of time periods, or five waves, in which the overall economy forged its way through and completed an inflationary period, followed by deflation and a fall into a final fifth wave in which there was a final cleansing period of economic activity. This Long Wave period lasted fifty to seventy years.

I have made the case in previous Posts that this Long Wave Theory of Nikolai Kondratiev best explains what our world economy has been going through since 1945. I have also argued that we are now in the final, or fifth wave, of a normal fifty to seventy year Long Wave cycle. This period we are currently enduring is characterized by a series of rolling deflationary crashes and wicked price drops in our economy on a sector by sector basis, as an overwhelming set of deflationary forces make their way into each market and a reduction of market inventories slowly work their way into balance within our overall economy.

The Long Wave Theory seems to contain the best explanation of why we are struggling with the current world economy because no matter what our policy makers and leaders do, not much changes in our current economy. As everyone knows, we started this final period of current deflationary struggle in 2007 with a crash and decline of the US Stock Market, and the Federal Reserve's quick response to that crash by taking a course of drastically lower interest rates. The real estate crash that followed in the US, precipitated by the downward spiral of home and commercial property prices in almost all local real estate markets, was next to suffer, followed by the similar crashes and deflationary spirals in other markets. Crashes in manufacturing, materials, and then last year in oil and energy, have only confirmed to any objective observer that deflation continues to roll through our economy at an accelerated pace. So, now, the question is, what can our policy makers and leaders do about this very serious economic situation?

Here are a few of my answers.

First and foremost, our leaders and policy makers around the world need to find a way to accept the fact that deflation is here to stay for the next five to seven years. Only the leaders of the Federal Reserve Board in America, and now at the ECB in Europe, have appeared to realize the seriousness of this situation. Fortunately for us, these folks have taken quick and decisive action to save our world economy. As a result, these same leaders have been severely criticized for their attempts to mitigate the world's economic problems. In fact, in America, Congress has done almost nothing to create new policies which could help ease many of our economy's natural deflationary pressures. So what could Congress do now that it is currently not doing?

1) Congress could pass some new tax policies which are designed to promote the easing of deflationary pressure. One way to do this without creating a major overhaul of our current income tax system would be for Congress to restore the interest tax deduction for personal income taxes. This action would allow consumers to deduct from their annual income tax all of their consumer interest from their credit cards, all installment loan interest, and all other consumer related interest. Such a change to our Federal tax code would immediately spur consumer spending, and increase consumer demand for goods and services, thus depleting our nation's over stocked inventories of goods and services. The 1986 Tax Act took away these type of deductions in exchange for lower income tax brackets and rates, and it did so in the midst of an accelerated period of inflation in annual prices, but times have changed, and now our current Federal tax brackets are much higher than originally set in 1986, thus creating less incentive for our consumers to spend. To stimulate demand and consumer spending, we must have tax policies that encourage tax rewards for consumers.

2) Genuine government infrastructure spending needs to be immediately appropriated by Congress passing large blocks of money on to each State in order to encourage spending on the State level for immediate infrastructure projects. There is no doubt that government spending creates economic demand and jobs, and thereby such spending helps deplete inventories. Government spending also creates jobs because businesses have more work than previously completed with the workers they have on hand. Spending on the State level also helps local governments target local job markets better than overall Federal infrastructure spending. So Congress needs to let the States choose what roads they want to improve, or which bridges they want or need to schedule for replacement. Federal grants of tax money remitted back to the States best serves this purpose.

3) Consumption taxes in the US need to be reduced. Yes, this is controversial, but it needs to be done now. Sales taxes and other taxes added on to goods and services that punish consumption only discourage consumer spending. We need policy makers to make spending easier and more affordable to our consumers. This can be best accomplished by lowering sales taxes, and other taxes that discourage spending, and yes, this includes a temporary reduction of the gasoline tax.

4) While the notion of flat tax rates with no deductions for consumers is currently popular with some leaders in Washington, these plans for tax changes in America need to be postponed. Almost all of the current Republican Presidential candidates have proposed new tax reforms with a flat Federal income tax rate as a centerpiece of their tax programs. In a deflationary economy, the implementation of flat income tax rates have a both a positive and a negative effect. While a flat Federal income tax does initially create a psychological effect on some consumers, by causing many buyers to think they have more money in their pockets for spending, the reality of what actually happens next to tax payers is not so great. Local governments, such as States, counties and cities, step in and make up the difference by increasing their property taxes, sales taxes and other governmental user fees in order to assure that each jurisdiction gets what it needs to accomplish and complete their normal governmental business. And when these new taxes hit the consumer's pocket, the impact of having more money from a flat income tax quickly disappears.

5) If Congress does pass a flat income tax next year, let's hope that they also decide to keep some deductions and incentives for spenders. We need people to spend so that all over production of goods and services in our world economy is more quickly balanced with falling market prices. Consumer incentives are best expressed in a tax code by making consumption easy, and short term saving less attractive. Long term incentives for saving are fine and needed, but short term spending needs to be rewarded too. Credit also needs to be less onerous for most consumers by Congress creating better guidelines for consumer lending and tax incentives for lenders to lend according to those new guidelines.

6) Congress needs to proceed with deficit reduction, but it needs to be sequestered to infrastructure spending so that tax revenues generated by improvements in our economy permit corresponding budget cuts and deficit reductions. Only fair and equal cuts to our Federal budget will create some money for deficit reduction, but this can only be accomplished when tax revenues rise and present themselves as new revenue to be utilized for budget cuts. Congress currently has a similar policy in place regarding spending, but now it needs to expand this policy to deficit reduction.

7) If a Democrat becomes President of the United States next year, we need Congress to put off any proposed increases to the current income tax rates because those increases in the tax rates will also discourage consumer spending. And, we need more money directed towards infrastructure spending, even if it comes through the Federal Government, and not through grants to States. Regardless of how badly the rich have been assailed by Democrats for not paying their fair share of taxes in this country, those citizens with high incomes are without question the most prolific spenders in our American economy. They are also the consumers most interested in tax incentives. So the reduction of consumption taxes, and the reintroduction of tax credits for consumer interest could also generate some support by a Democratic President.

8) Congress needs to withhold any increases of excise taxes or tariffs on China, Vietnam, and Mexico, but especially on those exporting deflation to the West. Instead, Congress should consider import limits on goods from these countries. Why? Tariff increases would only cause American consumers to spend less as price increases caused by the higher Tariffs were added into the retail prices of goods and services on the market for sale to potential consumers. On the other hand, limitations on imports from China, and other countries exporting deflation, would give our leaders control over the amount of deflation entering the US. Import limits by the ton would also permit negotiations to be reopened with countries with import limitations on issues that have caused damage to our manufacturing base, as well as to other economic sectors in the US.

And what else can our leaders do to help us stay off deflation?

1) The Federal Reserve can continue an ongoing policy of easy monetary policy by keeping interest rates low. The Fed needs to recognize that only a very slow policy of normalization of rates can assist consumers around the world in their work of overcoming deflation. Announcing a coming series of rate hike increases, with no real economic data to demonstrate that the US economy is overheating, is a poor way to regulate monetary policy. If the Fed wants to get us through these next five to seven years of world wide deflation, we need leaders who stay the course with their monetary easing and stick to their principles of letting the data best dictate whatever Fed action is required.

2) Television producers and Hollywood studios need to pay attention to the growing world wide fear of a coming apocalyptic end. With this cycle of world wide deflation has also come a growing fear produced by the 9/11 Attacks, Jihadism and other Terrorist attacks. Dramatic climate changes and unusual weather events, along with a growing sense of negative psychology, has suddenly appeared in many media of our society. Apocalyptic tendencies have always had an impact on human existence during difficult times in human history, as people slowly became convinced that their lives were doomed to endure culminating human tragedy as their historical legacy. When a deflationary psychology takes over the mind set of consumers within the world economy, negative thinking seems to come along with it. Many people begin to think that some kind of horrible apocalyptic end is coming near or upon them. The terrorist attacks in the West from Jihadist groups has only added to this growing fear. Hollywood studios and Television network producers have tried to capitalize on this negativism in a dramatic way. Flesh eating zombies , numerous end of the world movies, along with movies about vampires and Jihadist shootouts to the death, have become a growing norm in many of our regular communication mediums. This overarching negative view of the world's history deeply affects all consumers, and, generally speaking, most everyone, in ways that cannot be fully understood or quantified. Though I am not one who believes that the exercise of free speech, or a free press, needs or requires government regulation, I am someone who knows apocalyptic fear when I see it, and currently, our lives are being bombarded with a fearful negativity unparalleled in our lifetimes. Our leaders need to step up and point out the good things in our lives and in our world. An attitude of gratitude would be very helpful at this point in our struggle to overcome the psychology of the coming Apocalypse presently pervading our culture.

John K Brackett, Ph.D.

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