The Coming Second Great Depression
In this essay, I examine the theory of long term economic cycles, and pose the question as to whether a series of catastrophic banking and financial failures such as those occurring in the 1930s could once again happen, plunging the world into a second Great Depression.
Changes that take place over periods measured in human lifetimes (such as long wave economic cycles) may go largely un-noticed by most people. Most people are preoccupied with the short term, businesses have to be run with an eye to the annual tax year, and the weekly or monthly sales budget, and people often live from one pay packet or monthly salary payment to the next.
The Kondratieff Wave is named after N. D. Kondratieff, who conjectured that there were supremely long economic waves whose complete cycles can only be observed in a historical perspective, and had not hitherto been considered by economists who studied trade cycles on the order of three, five, or fifteen years.
"The upswing in the first long wave embraces the period from 1789 to 1814, i.e. 25 years; its decline begins in 1814 and ends in 1849, a period of 35 years. The cycle is therefore completed in 60 years. The rise in the second wave begins in 1849 and ends in 1873, lasting 24 years. The decline of the second wave begins in 1873 and ends in 1896, a period of 23 years. The length of the second wave is 47 years. The upward movement of the third wave begins in 1896 and ends in 1920, its duration 24 years. The decline of the wave, according to all data, begins in 1920."
- N. D. Kondratieff, "Die langen Wellen der Konjunktur", Archiv fur Sozialwissenschaft und Sozialpolitik, 1926.
It is important to note that following a commodity market price peak and crash in 1920, there was a two-year recession that preceded the "Roaring Twenties". Thus, the stock market mania of the late 1920s was a phenomenon of the completion of the long wave cycle.
The rise and decline phases of the Kondratieff cycle have been divided into four "seasons".
Kondratieff Spring
During this period of steady growth, unemployment falls, wages and productivity rise. Commodity and asset prices show a steady but benign inflation.
Kondratieff Spring starts from a low level of consumer confidence, which was broken down by the previous cycle (In 1949, this would have been the Great Depression, followed by World War II). Consumer confidence recovers but is still at moderate levels. People want new products and there is a general mood favouring accumulation. Products are based more on the refinement of existing technology (innovation) rather than completely original ideas (invention). For example, horseless carriage and radio with their roots in the 19th century led to the production of radio sets whose numbers, between 1919 to 1930, grew from very few to around 14 million, while the number of car registrations tripled to around 23 million.
Debt begins to grow, but the amount of GDP generated per unit of debt is larger than later in the cycle, and there is a good rate of return on investment in business. Eventually, the debt built up reaches its maximum level, which reduces growth.
Kondratieff Summer (Primary Recession)
The burgeoning K-spring economy of revitalised consumer confidence leads to runaway inflation in the K-summer, which ends with an inflationary blow off, recession, and stock market weakness, an example being the 1920 period:
"The speed at which the 1920-21 depression struck was quite extraordinary. In May 1920 commodity prices were 248 per cent of their 1913 level. By August 1921 they had plunged to 141, a drop of 100 points. However, production continued to expand until it reached a peak in July and then sharply contracted with the Federal Reserve's index of production showing the physical volume of production falling from 85 in July 1920 to 65 in July 1921. (As usual, the capital goods industries took the blunt of the downturn). Despite the savagery of the downturn, the economy began to recover in August 1921..."
- Brookes News, "The US recession: how long and how deep?" by Gerard Jackson
Debt has grown to its maximum level, curtailing growth and ending the upwave. The recession affects the "old economy" businesses generating "mixed signals" about the state of the economy and a debate about "old economy" versus "new economy".
The imbalances of K-summer have been associated with wars known as "peak wars". For example, World War I and the Vietnam war. Their strains on the economy contribute to the breakdown of the benign K-spring environment; output decreases, unemployment increases, and inflation takes off. The primary recession is not long (2 or 3 years), but it has a longer term effect on the population's mood, which supports the stability of the following "Plateau Period".
Kondratieff Autumn (Plateau Period, Start of Downwave)
The Kondratieff Autumn is characterized by a strongly growing popular participation, and ultimately mania, in investment speculation, until it reaches its maximum sustainable level, followed by a spectacular collapse, such as the 1929 crash.
The business activity in K-autumn attracts investment, but many of these are not prudent high-return-on-investment businesses as was typical of K-spring, but instead are speculative ventures with hopes for future profit that never actually materialise. This bad investment generates bad debts but the bubbling investment activity hides the weakness in the afflicted sections of the economy, and people are fooled into believing that the good times will last for ever. As the old economy is not generating the growth any more, the bubble money generated by speculation tends to create a "consumer economy", and much of this consumption is wasteful. Along with the speculative ventures come new technological and social ideas that will contribute the basis for the innovations in the next K-spring.
When the investment mania becomes exhausted, insufficient new investment is coming in to maintain the illusion of growth, and the bubble collapses, at a time of maximum debt, leading to a severe depression.
Debt has grown exponentially to this point, and has reached such a level that even small problems, such as an incremental increase in unemployment, interest rates, commodity inflation, or a falling back of external investment funding creates a situation in which debt interest can no longer be repaid.
Kondratieff Winter (Secondary Recession) - The Final Phase of Mania
K-winter is the season during which excessive debt is purged from the economy. This creates some difficulties in the banking system, because they have clocked up excessive credit, a significant proportion of which will never be repaid. Of course, the same argument applies to entities outside the traditional banking system who may have supplied credit on favourable terms in the "good times".
Kondratieff winter also ensures that the financial excesses of the K-spring and K-autumn that resulted in asset overvaluation are corrected. Accumulated wealth is destroyed as financial assets collapse.
Bankruptcies and unemployment grow in a domino chain reaction and asset prices collapse. Not suprisingly, as anyone can see from the effects of the financial collapse in Argentina, the fabric of society itself threatens to break down. The net effect is the set of conditions that in the 1930s cycle were termed the "Great Depression". A spell of deflation is to be expected, as wealth has been destroyed, easy money is no longer being created, and people are no longer confident to spend money. Prices fall to encourage spending, but people put off purchases because they know that things may be cheaper in the future.
As consumer confidence drops rapidly, confidence in the banking system and the economy fails and there is a run away from things with intangible value, such as speculative stock market and "new economy" concept companies, towards tangible assets such as durable goods, established industries without debt loading, gold and silver, and commodities.
There may be currency crises with interest rates spiking up as credit contracts or foreigners disinvest in the currencies associated with the worst excesses of the cycle.
The K-winter is also associated with the "trough wars" which is liable to break out in relation to the social and political stresses caused by the depression. World War II is an example of a "trough war"- and the geopolitical realignments that it caused set the stage for the world's international relations in the next cycle.
Growth and Decay Cycles in the Kondratieff Cycle
Let's consider each season of the Kondratieff cycle as a process of growth, but limited by the finite supply of some quantity, such as the supply of new investors. This sort of growth can be modelled by an exponential curve known as the logistic growth curve. The recessionary parts of the cycle are modelled by the same curve, but this time it is shaped like a decay curve, where a percentage of the economy is sliced off every year until the decay process is exhausted and levels out.
The up cycle is the combination of the spring and summer growth functions. The down cycle is the combination of the autumn and winter functions. And the overall cycle is the combination of the up and down cycles, or the four season functions.
There will undoubtedly be extraneous influences and shorter term growth and decay phenomena which result in finer ripples in the market indices.
Growth may occur in commodities markets or stock markets, and if one suffers a collapse, the effect on the other market may be attenuated (as in the commodities crash of 1920-1921). Subsequent cycle behaviour may then be manifested by increased participation in the market that did not suffer primarily in the previous run-up.
One growth cycle may be associated with the dominant "old economy", while a separate one is associated with the "new economy". Thus there may be differences in market behaviour according to which curve predominates. There may be a break in the slope of the market as "new economy" investments suck in funding, creating new debt while people begin to believe that the "old economy" is dead and it's a "new paradigm". With the "old economy" stagnated while the "new economy" powers ahead, it is possible to see conflicting reports about the health of the economy. It's a two-speed economy; some parts of the economy are generating bad news while other parts of the economy are generating good news (This might even explain difficulties in applying the "hemline indicator"; because in the autumn period, some hemlines follow the "old economy" and others follow the "new economy").
The Growing Debt Load
As indicated in the above summary of the Kondratieff cycle, the level of debt grows throughout the cycle and eventually results in the Kondratieff winter and a repudiation of the debt to allow the next cycle to begin.
The following chart shows how the debt load has increased over the current cycle. As usual, the American data will serve as proxy for most "Western" economies. Note that just looking at state debts does not show the full debt load increase. A particularly strong rise in debt load has occurred in domestic financial sector debt, followed by household debt and business debt.
Those sectors that have been most strongly leveraged by debt will be the most to suffer when the K-winter cycle unwinds the debt.
A new cycle K-spring can only start when taking on debts to fund business expansion is viewed with disdain, and when valuations of stock markets (as indicated by such traditional measures as the P/E ratio, which is conveniently ignored at the end of the cycle) are near the bottom of the long-term valuation range. The last K-wave spring and autumn took these valuations up to historic highs, and they must be counterbalanced in the long-term cycle by a period of historic lows, according to the law of averages.
Life Expectancy
The key to the existence of the long K-wave, it seems to me, is that it is linked to the human life-cycle.
All the world's a stage,The men and women who play upon the stage of commerce and trading base their actions on what they have learned; at first in college, and then in the experience of their working lives. But those lives are of a finite duration, and their actions must be more strongly influenced by the events that happened in their own direct experience. On the other hand, the experience of previous generations may seem distant, or no longer relevant to the present day. In this way the mistakes of previous generations are destined to be repeated.
And all the men and women merely players:
They have their exits and their entrances;
And one man in his time plays many parts,
His acts being seven ages.
Shakespeare - As You Like It (Act II, Scene vii)
"The market going up made a lot of people look like geniuses," said John Kuddes, a Merrill Lynch director for Kansas and Missouri. "Some people who never experienced a bear market didn't realize stock can also drop."
- From The Kansas City Star, 08/11/01
This is a clue to the effect that human generations have on investment behaviour. Each generation has its own perspective, and generations that have no direct experience of a serious bear market may well be more inclined to have an appetite for risk.
"According to an Investment Company Institute survey of a couple of years ago, just about a third of fund investors have owned mutual fund shares for five years or less. These investors, who likely have never experienced a bear market, may have expectations built on short-term memories and may be particularly vulnerable to disillusionment in the face of a market decline of any significant length..."
- From "Remembering the Past: Mutual Funds and the Lessons of the Wonder Years", by Barry P. Barbash, Director, Division of Investment Management, U.S. Securities and Exchange Commission, at the 1997 ICI Securities Law Procedures Conference, Washington, D.C., December 4, 1997.
Here is a chart showing how life expectancy has increased in the last century.
The Life Expectancy Adjusted Kondratieff Wave
The following two charts show, in terms of the Dow Jones Industrial Average, how the Kondratieff cycle has operated in the last whole cycle, and in the present cycle.
These charts show, in addition to the long-term Dow, the ratio of the Dow index to the price of gold in dollars. This is a key to isolating the Kondratieff cycle. We will compare the Dow index with the Dow/Gold ratio to identify salient points about the 1896-1949 cycle compared with the present one.
The first chart shows the Kondratieff cycle from 1896 to 1949.
Note how the Dow/Gold ratio tracks the Dow up until 1933. This corresponds to the period in which gold was fixed at $20.67. Between 1931 and 1934, in attempts to break the Great Depression, most countries decided to abandon the gold standard.
In 1933, President Roosevelt issued an Executive Order prohibiting the private ownership of Gold Coin, Gold Bullion, and Gold Certificates.
The Federal Reserve also made currency backed by gold and silver illegal for domestic use and devalued the dollar against gold.
The second chart shows the (incomplete) Kondratieff cycle from 1950 to 2001.
Note that in 1971, Nixon suspended the free exchange of U.S. gold for foreign-held dollars, devalued the dollar to 1/38 and in 1973 to 1/42.22 of an ounce of gold (Since then, currencies have been free-floating). This chain of events took place not long after Kondratieff summer starting in 1966, when inflation accelerates. Unlike the previous cycle, the price of gold is now free to tell us something about the inflation in the cycle. Hence, the Dow/Gold ratio shows the benign inflation in K-Spring, which is good for stock investments, followed by the runaway inflation of K-Summer, which decimated the real value of stocks but led to a bull market in gold culminating in gold at $850/oz in 1980.
The value of real tangible materials is not what you pay for them in dollars or pounds, but this is only a transient valuation or rather a means of exchange of value. After a spell of inflation, many more dollars are required to obtain the exact same thing. Therefore, to understand the value of real tangible materials over a long time frame, it is more reasonable to measure their value in terms of another real tangible material, and in a financial context, gold does this job. So if the dollar loses exchange value through inflation, we can say that the dollar has fallen in terms of gold.
If we measure the value of the Dow in terms of the number of Dow units required to purchase the unit of gold, this gives us an indicator for the relative values of intangible financial assets (i.e. shares, paper money, investment funds, debt-linked ownership such as housing, etc.) compared with tangible material assets (i.e. gold, silver, steel, basic bulk foods etc.).
So far we have not considered the duration of the current Kondratieff cycle. But consideration of the Dow charts strongly suggests that the peak in 1929 corresponds to the peak in 2000. In fact, several major indices peaked in 2000:
- The DJ Industrial Average topped out on January 14, 2000, at 11,722.98.
- The Russell 2000 topped out on March 9, 2000, at 606.05.
- The Nasdaq Composite topped out on March 10, 2000, at 5048.62.
- The Amex Index topped out on March 23, 2000, at 1036.40.
- The S&P 500 topped out on March 24, 2000, at 1527.46.
- The Morgan Stanley Cyclical Index topped out at 619.09 on May 10, 1999.
- The Wilshire 5000 topped out at 14,751.64 on March 24, 2000.
We now have a clear reference point at which to compare the two cycles. If we align 1896 with 1950 as the start of each cycle, and align 1929 with 2000 as the reference point (the stocks peak and crash characteristic of K-autumn) then we get a K-wave duration of 80.3 years.
In the chart displayed at the following URL, you can clearly see the K-autumn peaks of 1929
and 2000 which touch the top of the long-term inflation-adjusted DJIA:
Fred's Intelligent Bear Site: Dow Jones Industrial Average, Inflation Adjusted
The peak in 1966 does NOT touch the top of the trend lines.
It is also interesting to note how, with this alignment, the primary recession peak of 1920 appears to align with the 1987 stock market crash.
The average duration of the last three K-cycles is 53 years. Look at the life expectancy chart before 1949, see how it passes through the 53 year level, and then look where the chart is heading after 2001. The line for females reaches 80 years. Also bear in mind the statistical spread of the K-wave cycles, which is quite large.
Apart from the increase in life expectancy, there is a tendency for the length of generations to increase. Aware of the long life expectancy, brought about by the medical advances of the 20th century, and mindful of the cost of establishing a place to live, people have been starting families later, have been slower to establish their own homes, and there is a movement to allow the repayment of mortgage debt over longer terms in order to keep people coming into the property markets.
It is surely not surprising that this would have the capability to influence mass economic behaviour on a similar time scale, and that the corresponding Kondratieff cycle could conceivably be lengthened relative to previous cycles in which life expectancy was shorter and it was normal for there to be one breadwinner in a family and for people to have more children and start families earlier.
It is also well known that liquidity-supporting policies championed by Alan Greenspan have been pursued, resulting in long periods of very low real interest rates, which allow people to extend their debts without financial hardship, and support the real estate bubble, where refinancing and equity release allows consumers to continue consuming based on the appreciation of the value of their houses, while retail price inflation has been kept at bay by imports of goods from cheap-labour countries such as China. Such factors are likely to extend the duration of the Kondratieff Wave further. Unfortunately, there may be a price to pay in that the K-winter and debt repudiation process will take longer than before.
The table below illustrates the 1896-1950 cycle with a timeline of significant financial events.
Timeline of the 1896-1950 cycle
| Year | Event | |
| 1896 | Start of cycle; William McKinley elected president. Charles Dow publishes first separate Dow Industrial(containing 12 stocks) and Railroad Averages, on May 26. | |
| 1897 | Japan adopts gold standard | |
| 1898 | Spanish-American War | |
| 1899 | "Flowers" stocks panic and "Black Week" in London | |
| 1900 | William McKinley elected president; panic in iron trade | |
| 1901 | Corn drought panic | |
| 1902 | ||
| 1903 | Rich man's panic1903-1904; Orville and Wilbur Wright's first flight | |
| 1904 | Theodore Roosevelt elected president; Lawson panic | |
| 1905 | ||
| 1906 | Construction of Panama Canal starts | |
| 1907 | Worldwide credit crisis (panic of 1907), starting in the trust companies of New York; Copper scam panic | |
| 1908 | William H. Taft elected president; Aldrich-Vreeland Act provides for emergency currency issues during crises and establishes National Monetary Commission. | |
| 1909 | First Ford Model T produced | |
| 1910 | Coal bubble bursts; President Taft's "dollar diplomacy" in Nicaragua | |
| 1911 | Steel antitrust panic | |
| 1912 | Woodrow Wilson elected president | |
| 1913 |
Underwood-Simmons Tariff Act makes the first reduction in duties since the Civil War;
16th Amendment allows income based taxes; President Woodrow Wilson signs the Federal Reserve Act on December 23, 1913, which was drafted as House Resolution 7837 by Representative Carter Glass, incoming chairman of the House Banking Committee, establishing the Federal Reserve System of banks. |
|
| 1914 | Clayton Anti-Trust Act; WW1 starts; October 22: U.S. Congress passes the Revenue Act, which imposes the first income tax on incomes over $3,000 to offset loss of tariff income caused by the Underwood-Simmons Act of 1913. | |
| 1915 | Einstein's general theory of relativity | |
| 1916 | Woodrow Wilson re-elected; DJIA increased from 12 to 20 stocks | |
| 1917 | America enters World War I; Russian Revolution | |
| 1918 | WW1 ends | |
| 1919 | Post-WW1 bull market ends | |
| 1920 | US economic expansion peaks in January; commodities crash; 1920-1921 recession- durable goods production falls by nearly 50%; Warren G. Harding elected President; Economic depression starts in Japan; 1920-1929: Farmland values fall 30-40 % | |
| 1921 | US economic contraction ends in July. | |
| 1922 | (1922-1923): German hyper-inflation | |
| 1923 | Harding dies amid corruption scandals; New York Fed acts through large purchases of government securities to stem a recession, signalling the beginning of Fed open market operations as a monetary policy tool to control credit in the banking system. | |
| 1924 | Calvin Coolidge elected president | |
| 1925 | Top US tax rate lowered to 25% | |
| 1926 | General Strike in Britain Minor US recession Oct 1926-Nov 1927; Revenue Act of 1926 cuts taxes of those earning $1M or more by two-thirds. | |
| 1927 | Car output slumps and Dow earnings slump; Dow A/D ratio tops out in mid-1927; Banking crisis starts in Japan | |
| 1928 | Herbert Hoover elected; stock trading volume accelerates; RCA's stock price leaps from 85 to 420; DJIA increased from 20 to 30 stocks. Bond prices start to decline and money rates start to increase. | |
| 1929 | US economic expansion peaks in August; The Dow peaks at 381 in early September, followed by Wall St. Crash on October 24 ("Black Thursday") | |
| 1930 | Great Depression starts; banking panic (Thousands of US banks fail over 1930-1933); Smoot-Hawley Tariff passed | |
| 1931 | Banking panic in Austria as Credit Anstalt Bank fails, banking crisis in Germany and UK. Fed raises rates twice. Britain and Japan abandon gold standard. New York Bank of the United States collapses on December 11th. | |
| 1932 | Franklin Delano Roosevelt elected; GNP falls 13.2 %; recovery starts in Japan. US Revenue Act of 1932 raises top tax rates from 25% to 63%. | |
| 1933 |
US Banking Crisis; Emergency Banking Act,
National Industrial Recovery and other New Deal Acts, US off gold
standard; Hitler becomes German Chancellor;
Glass-Steagall Act prohibited banks from both accepting deposits and underwriting securities,
(to prevent a disaster in underwriting destroying a bank's deposit accounts),
creates the Federal Deposit Insurance Corporation,
and requires use of government securities as collateral for Federal Reserve notes.
Franklin D. Roosevelt issues Executive Order 6102 "Forbidding the Hoarding of Gold Coin,
Gold Bullion and Gold Certificates".
|
|
| 1934 | FCC, SEC created; US GNP rises again; Gold Reserve Act establishes Exchange Stabilization Fund and allows the U. S. Treasury to seize gold held by Federal Reserve banks. An FDR executive decree raises the official price of gold from $20.67/oz to $35/oz. The US Silver Purchase Act requires the government to buy large quantities of silver, to increase the Treasury's silver holdings to 1/3 the value of gold, causing its price to rise on world markets. | |
| 1935 | New Deal: National Labor Relations Act, Social Security Act; Banking Act of 1935 creates the Federal Open Market Committee (FOMC) | |
| 1936 | Roosevelt re-elected | |
| 1937 | Recession | |
| 1938 | GNP falls 4.5% | |
| 1939 | Germany annexes Czechoslovakia and invades Poland | |
| 1940 | Roosevelt re-elected | |
| 1941 | Lend-Lease; Pearl Harbor attack | |
| 1942 | U.S. enters World War II | |
| 1943 | ||
| 1944 | Roosevelt re-elected; high inflation starts in France; hyper-inflation in Hungary. | |
| 1945 | WWII ends, UN established; US National debt 123% of GDP; high inflation in Germany. | |
| 1946 | Strikes and shortages | |
| 1947 | Marshall Plan. IMF and IBRD start up. | |
| 1948 | Harry S. Truman elected President | |
| 1949 | End of Cycle. Britain devalues the pound from $4.30 to $2.80 | |
| 1950 |
The Disruption of the Coming K-Winter
What if the next Kondratieff Winter phase causes the Dow/Gold ratio to correct to a long-term average? What would then happen to the DJIA or the price of gold? Fitting a linear regression line to the data between 1896 and 2001 gives a line with a slope of 0.1511 increase per year in the ratio. This puts the long-term average ratio at about 17 in 2002. The last period for which the ratio was below the regression line was 1973 to 1995, when the average ratio was 5.54 over the period.
"Looking at the chart, the long term trend of the ratio is up at a rate of 1.25% per year. This should be expected as the process of mining gold becomes more efficient and cheaper due to advances in machinery, energy, exploration technology, chemicals, etc. In fact, the advances in mining probably match the efficiency gains seen in the economy in general."Long Term Dow/Gold Ratio [Fred's Intelligent Bear Site]
We can now predict what the Dow and the price of gold would be, assuming they both change by the same proportion (i.e. Dow falls to a certain fraction of its bubble value, and gold rises by the same proportion).
If the ratio falls to the value that it had in the last low period, then the Dow will be 3934 and gold will be $710. Even if we only assume a fall to the trend line, the result is a Dow of 6889 or a gold price of $405. Of course, for the long term trend to hold, the ratio by the law of averages must correct for its time above the trend by a corresponding time below the trend.
We can also look at what might happen if either Gold or the Dow stays roughly the same, but either the Dow falls or gold rises to revert to the trend.
If we assume that gold stays at about the level of the 2001 close, i.e. $278.7, this predicts a Dow that will fall to 1544. If we assume that the Dow stays at about the level of the 2001 close at 10021.5, this predicts a gold price of $1808. Even if we only assume a fall to the trend line, the result is a Dow of 4734 or a gold price of $590.
The bottom channel line of the long-term inflation-adjusted DJIA suggests a potential Dow fall to around 2-3000:Dow Jones Industrial Average Inflation Adjusted [Fred's Intelligent Bear Site]
So, whatever happens, when the Dow/Gold ratio crosses over its long term trend, and the Kondratieff cycle gives us a clue as to when that might happen, there must surely be major consequences in the markets.
The Next Great Depression
Eighteen months of interest rate cuts by the US Federal Reserve up to 2003 resulted in a stock market that was generally down 20%.
This is exceptional. What normally happens is that the Fed eases, and then 18 months afterwards, stocks are normally up.
The astute have already noticed that the only precedent for this kind of market behaviour was in the Great Depression of the 1930s.
The underlying reason according to Kondratieff cycle analysis, is that the market has absorbed as much debt as can be sustained in the cycle, and the supply of new investors in the autumn phase of the mania is now at saturation levels. The amount of new GDP generated by each new dollar of debt is very much smaller than it was at the start of the cycle. The earnings of businesses are not being boosted sufficiently to make any difference, and the P/E ratio of the S&P 500 based on trailing earnings is in the forties. The consumer economy is driving on low interest rate fuel. When the time comes for interest rates to rise, consumers will cut back on the gas and since we are late in the Kondratieff cycle, there is nothing much else holding the economy up. And there are precious few savings to fall back on.
"...Middle Britain is mortgaged to the hilt, spurred by the lowest interest rates in 38 years. In 1997, when Labour came to power, the savings ratio (the proportion of income households save) was more than 10% in Britain; today it is barely 5% and falling..."
- Labour's nightmare is coming home to roost [The Scotsman, 17th June 2002]
"The chairman of the UK's Financial Services Authority, Sir Howard Davies, said in an interview with the BBC on June 18th that he was concerned at the high borrowing levels for housing in some parts of the UK, with some people taking out mortgages on very high multiples of income, and little or no deposit..."
Warning on 'risky' home loans BBC News Online: Business, Tuesday, 18 June, 2002
"The late 1990s were an abnormal period in world finance. By any statistical measure of stock market prices, the price earnings ratios, of the US deficit, the late Clinton years were a far bigger boom than that of the late 1920s. No doubt the global economy is now much stronger than it was then, but the scale of the Clinton distortion is a measure of the likely scale of the correction that has to follow. Neither stock markets, nor the prospect for earnings, nor house prices in the US or UK, nor the US deficit suggest to me that the global correction has been completed"
Golden days are behind us as the dollar declines, by William Rees-Mogg [Times Online, June 17, 2002]
Looking for the Big Picture
It was once said that "There needs a long time to know the world's pulse". There comes into view a very interesting set of patterns, if we step back and look at the long heartbeat of history.In 1697, the forgery of Bank of England notes was made a capital offence. Between 1797 and 1821 some 600 miscreants were convicted, of which half were hanged.
Also in 1797, four French ships attempted an invasion numbering 1200 on the Welsh coast, near Fishguard. Although speedily rounded up, the attempted invasion sparked a loss of confidence in paper currency and a rush to withdraw gold coin. The Bank of England's bullion reserve had fallen dangerously low due to "continual governmental demands for advances" [Remind you of anything?]. The Prime Minister and Chancellor of the Exchequer, William Pitt the Younger, made an Order of the Privy Council preventing the payment of gold for bank notes, until 1821.
The Retail Price Index, based on a datum of 100 in 1694, increased by no more than 50 percent or so up to 1797, where it took a leap up to about 250-ish during the Napoleonic Wars. After Napoleon's defeat, it drifted slowly back to around 150 but World War 1 sent it back up to nearly 300. The Armistice led to a fall back again and the index bottomed out around 200 during the Great Depression. This (1931) was about the time that Sterling was taken off the Gold Standard. Although World War 2 did not cause the index to exceed its Great War level, since then the RPI has zoomed up through 300, 400, 500 and 600, trampling the previous quarter-millennium's index underfoot. Viewed on this scale, the difference in price stability between a gold standard and its absence stand out with crystal clarity.
There are three roughly equal century-sized periods between 1695 and 1995 in which the RPI alternately trends up, then trends down, then trends up again. Will the next century usher in a century-long down trend in prices?
The present deflationary scenario for commodities and gold is well known. Can we see anything further in the long term if we imagine price inflation deflating well into the future? Well- for those interested in chart patterns, take a look at the Consumer Price Inflation chart. Could there be the makings of a head and shoulders chart pattern with the right shoulder at 2059-2076?
- Left Shoulder: 1914-1931
- Left side of head: 1931-?
This will mean a change in the way of life for many. Business Week once said:
"After four decades of almost uninterrupted wage and price increases, the idea that a broad range of prices and incomes could see a decline seems as outmoded as paper collars and running boards"
Picture this scenario spread over the next century and the efforts that people will have to make to adjust to it. Such a future will be a paradigm shift indeed!
Further Reading
30 July 2000 Tenorio Research Letter © 2000 by Tenorio Research & TradingCycles by Wally Bently, April 5, 2002
Kondratieff Student Sees Stock Market Plunge and $2,000 Gold, Jay Taylor, Gold Resource & Environmental Stocks, 19 July 1999
The Currency of Last Resort - Money? & Kondratieff Cycle Timing
Growth Cycles and Market Crashes, September 5, 1999, Michele Boldrin (University of Minnesota)and David K. Levine (Department of Economics, UCLA)
Bi-Logistic Growth, Perrin Meyer, Technological Forecasting and Social Change 47:89-102 (1994)
