Nikolai Dmyitriyevich Kondratieff (1892 - 1938)
Who Was Kondratieff?
To introduce the Kondratieff Theory, we must go back over seventy years and
examine a remarkable story in economic history, encompassed within the life of one still
little known man. I am certain that, in time, Kondratieff will rank with the giants of
discovery as Einstein and Newton. Like these men, his insights have begun to alter
radically and permanently our perceptions of economic history.
The Kondratieff wave cycle goes through four distinct phases of beneficial inflation (spring),
stagflation (summer), beneficial deflation (autumn), and deflation (winter). Since, the last
Kontratyev cycle ended around 1949, we have seen beneficial inflation 1949-1966,
stagflation 1966-1982, beneficial deflation 1982-2000 and according to Kondratieff,
we are now in the (winter) deflation cycle which should lead to depression.
Professor Nickolai Kondratieff
( pronounced "Kon-DRA-tee-eff")
Shortly after the Russian Revolution of 1917, he helped develop the first Soviet
Five-Year Plan
, for which he
analyzed factors that would stimulate Soviet economic growth.
In 1926, Kondratieff published his findings in a report entitled,
"Long Waves in Economic Life". Based upon Kondratieff's conclusions, his report
was viewed as a criticism of Joseph Stalin's stated intentions for the total
collectivization of agriculture. Soon after, he was dismissed from his post as director
of the Institute for the
Study of Business Activity in 1928.
He was arrested in 1930 and sentenced to the Russian Gulag (prison); his sentence was
reviewed in 1938, and he received the death penalty, which it is speculated was carried out
that same year.
Kondratieff's
major premise was that capitalist economies displayed long wave cycles of boom and bust
ranging between 50-60 years in duration. Kondratieff's study covered the period
1789 to 1926 and was centered on prices and interest rates.
Kondratieff's theories documented in the 1920's were validated with the
depression less than 10 years later.
Today, we are faced with another
Kondratieff Winter (depression) when the majority of the world anticipates economic
expansion. Each individual needs to weigh the risk of depression in light of
Kondratieff's work.
Accumulation and Consumption
U. S. wholesale prices dating back to 1800 show several periods of accumulation
followed by periods of over consumption. Because these periods are statistically difficult
to measure our outline follows historical events, pinpointing major changes in trend.
During periods of relatively cheap prices, assets accumulate. As prices increase, the
consumption of assets are necessary to maintain a standard of living. When new production
fails to keep up with consumption, due to relatively high prices, the economy begins to
decline to another period of cheap prices, and a new growth cycle begins.
Four Phases of One Cycle
A Kondratieff cycle consists of four distinct phases, or distinguishable,
dramatic mood changes, the tone of which determines the actions of individuals involved in
the economy. The awareness of these characteristics allows for the anticipation of the
change in the economy and the psychological mood that will prevail.
SPRING - Inflationary Growth Phase
A common premise among business cycle economists supposes inflation as an
inevitable part of growth. Government becomes a passive participant in the inflation
cycle. Growth begins from a depressed economic base and expands in an ever-increasing
spiral. The interaction of the participants within the economy causes wealth, as
represented by savings, and the production of capital equipment to be accumulated for the
future. The expansion of production and affluence causes prices to rise, and the increased
volume of goods requires a higher velocity of money, thus creating a higher price
structure.
Historically, the growth phase requires 25 years to complete. During this time,
unemployment falls, wages and productivity rise and prices remain relatively stable. The
mood of the growth phase is one of accumulation and the desire for new product
manufacture.
Accompanying growth is a shift in social demands. As wealth is
accumulated and new innovation introduced great upheavals and displacements take
place. The process of social unrest builds with growth culminating in
massive shifts in the way work is defined and the role of the participants in
society.
SUMMER - Stagflation (Recession)
Eventually, the continuation of exponential growth reaches its limits. Excess
capital produces a shortage of key resources and the economy enters a period where
growth creates a shortage of resources. An economy will only support expansion to the limits of its
resources, both human and material.
The mood of affluence also brings a change in attitude
towards work. As an economy gets closer to its limits inefficiencies build up
The imbalances of this period have been historically exaggerated
by what can be labeled a "peak war". Examples such as War of
1812, the Civil War, World War I and Vietnam, came at the end of a very
affluent period. These Wars produce strains on the economy increasing the
impact of inflation. A dramatic drop in output, rapid rise in unemployment and unusually severe
recession characterize this period. Although this primary
recession is short lived lasting only three to five years, it is key in altering
perceptions and the structure of the economy. No longer does excess create
an abundance. The "Limits to Growth" now define a maximum level
of economic activity that traps the economy into consolidation and tight bounds
for the next 20-25 years. With the change comes a conservative shift in
the popular
mood reinforcing the limits..
AUTUMN - Deflationary Growth (Plateau Period)
The primary recession occurs out of an imbalance forced upon the economy by real
limitations. The rapid rise in prices and changes in production correct this imbalance --
at least temporarily. The change in price structure, along with the mood of a population
used to consumption accompanied by the vast accumulation of wealth from the past 30 years,
causes the economy to enter a period of relatively flat growth and mild
prosperity. Due to structural
changes and the limits of the existing paradigm the economy becomes consumption oriented.
Excesses of an unpopular war, along with fiscal liberalism, cause popular
reaction toward stability or normalcy. A mood of isolationism permeates . The
plateau period generally lasts seven to ten years and is characterized by selective
industry growth, development of new ideas ( both technological and social ) and a strong
feelings of affluence, terminating in a feeling of euphoria. The inflated price structure
from the primary recession, along with the desire for consumption, produces a rapid
increase in debt. Eventually, wealth consumption expands beyond all practical limits, and
economy slips into a severe and protracted depression.
WINTER - Depression
Excesses of the plateau period effect a collapse of the price structure. This
exhaustion of accumulated wealth forces the economy into a period of sharp retrenchment.
Generally, the secondary depression entails a three year collapse, followed by a 15 year
deflationary work out period. The deflation can best be seen in interest
rates and wages that have shown a historic alignment with the timing of the Long
Wave - peaking with and bottoming at the extremes.
Kondratieff viewed depressions as cleansing periods that
allowed the economy to readjust from the previous excesses and begin a base for future
growth. The characteristic of fulfilling the the expectations of the
previous period of growth is realized within the Secondary Depression or Down
Grade. This is a period of incremental innovation where technologies of
the past period of growth are refined, made cheaper and more widely
distributed. Incremental innovation consolidates industries.
As increment innovation narrows profits and increases
The Down Grade sees one final period of recession before transitioning
to a new period of growth. The final recession is mild with very low
inflation and appears far more severe than it will be remembered for later in
the Growth Cycle.
Within the Down Grade is a consolidation of social values or
goals. Ideas and concepts introduced in the preceding period of growth
while radical sounding at the time become integrated into the fabric of
society. Often these social changes are supported by shifts in
technology. The period of incremental innovation provides the framework
for social integration.
It is important to realize the Long Wave as global.
While global issues are of prime importance today with increased air travel and
communication, the Long Wave defines a time table for geo political
events. The Growth Period is one of political stability. Staring a
the peak old alliances become challenged. Through the process of the Down
Grade old alliances fail and new alliances are formed. The final stages of
the Down Grade is a period of coalescing or "quickening" of the
alliances that will govern the next period of growth.
Current Economic Cycles
With four distinct phases in the K-wave a number of analysts have compared them to the
seasons. Spring (inflationary growth, expansion), summer (stagflation, recession), autumn
(deflationary growth, plateau) and winter (depression).
Our chart below summarizes the generally accepted phases since 1784 in the United
States. We have noted the significant wars that accompanied the recession (price peak)
and depression (trough) phase. We have also noted the tag name for the Autumn periods
that were characterized by massive debt growth and speculative bubbles.
Many have argued as to whether the Kondratieff wave is valid for the post WW2 economy
given the fiscal and monetary tools of a modern economy. Others have argued that trough
of the K-wave has already passed. Their count is from the stock market trough of the
Great Depression in 1932. Add the average 54-year K-wave period and we are in the spring
expansion of the new K-wave.
But what the Kondratieff wave is about is a study of long cycles of debt buildup and
repudiation. It is not exclusively about price inflation and deflation periods. Deflation
is caused in part by the debt collapse. It is also a generational thing as the next cycle
of debt buildup and collapse is renewed every 2-3 generations as the previous generation
that went through comparable periods dies off. The old adage that "this time it is
different" means the circumstances are different, yes, but they fail to recognize that
the previous period was the same in terms of excesses and therefore the end result is
the same.
Most analysts take the last K-wave to have made its final trough in 1949 when interest
rates and prices bottomed. The effects of the Great Depression were softened by WW2 and
it was in the 1950's that the world firmly started to shake off the long two decades of
depression and war. The K-wave has followed quite true to form with the solid growth and
low inflation of the 1950's and 1960's followed by the commodity/price inflation and
recession driven 1970's. Commodity prices peaked in 1980.
Following the steep secondary recession of the early 1980's the markets embarked into
the Autumn K-wave plateau. We had stock market and real estate bubbles, a collapse in
commodity prices, a collapse in interest rates and low inflation. But we also had a huge
build up in debt that allowed us to buy our way out of the recessions of the early 1980's
and early 1990's. Each succeeding recession required higher levels of debt to purchase an
additional dollar of GDP.
Now the debt has become unsustainable and the ability to buy our way out of further
problems is severely compromised. One only needs to look at the decade long nightmare of
Japan to see that zero interest rates and all the stimulation in the world has failed to
bring it out of its slump. We are witnessing merely the beginning of the debt implosion
that inevitably follows the excesses.
The collapse of the tech market and NASDAQ, Enron, Aldelphia, K-Mart, Global Crossing,
WorldCom, Arthur Anderson and numerous others are the corporate face of the scandals and
the debt collapse. On the country side we have the implosion of Argentina and possibly
Brazil, which would imperil all of Latin America. African countries never seem to be out
of bankruptcy. As the job losses mount the consumer driven economy will fall into a deep
funk and the consumer will go through their own debt implosion.
As occurred at the end of previous Autumn plateau K-wave's (1920-1929) the winter that
followed revealed numerous financial scandals. This one has been no different. Enron and
WorldCom are big and visible but are they merely the tip of the iceberg? The Autumn
plateau K-wave brings on excesses in both the stock market and the boardroom. Even the
early part of the Autumn plateau K-wave had its share of scandals and debt implosions with
the insider trading scandals of the 1980's followed by the debt implosion and scandals
of the Savings & Loans. If the 1990's were a decade of loss of faith in government for
its excesses of debt buildup then the first decade of the millennium will see the same
occur with capitalism and the corporation.
One of the more intriguing characteristics of a K-wave winter is the buildup of
sinister forces that are religious in nature. The 1930's saw the rise of Nazism that led
to WW2. But in an earlier generation K-wave winter in the latter quarter of the 19th
century we saw the rise of the Klu Klux Klan as a backlash to the South losing the Civil
War.
Today it is the so-called war on terrorism led allegedly by Muslim fundamentalist
fanatics. There is a titanic religious war being played out. The Arab/Palestinian/Israeli
conflict has the attention and imagination of conservative evangelistical religions in
the United States. It is their belief that the current conflict was ordained in the Bible
and will ultimately lead to the apocalypse. The President of the United States George W.
Bush owes his election to these same conservative religious groups (as was Ronald Reagan
before him). Many of his key aides are cut from the same cloth. Thus the many references
to God and evil empires that dot Dubya's speeches.
The religious right firmly backs only Israel in the conflict. They view Israel as
integral to their fermentations of the coming apocalypse (Time Magazine - The Bible
and the Apocalypse, July 1, 2002 Vol. 160). On the other side conservative fundamental
groups, some of whom see glory in suicide bombings, are swaying the Muslim world.
We have entered the downside of the current K-wave. This wave could last anywhere from
nine to twenty years as we saw in earlier winter K-waves. The K-wave is the rise and fall
of a generation and covers both the social and economic life of the period. The ancient
Mayans knew of the inevitability of the cycle and took steps to mitigate its effects
(although ironically in the end it did not save them). Our challenge will be to see that
we come through so that once again we can rebuild.
The current winter K-wave is still young. We have noted in the past that following a
speculative bubble things have a tendency to return to where they started or stated
another way the gains of the previous period are wiped out. Already some stocks such as
Nortel Networks have fallen 98%. Other big names are just disappearing period. We highly
suspect that the NASDAQ will ultimately lose at least 90% of its value from the top. That
means a fall to at least 500 over the next decade. We have already fallen about 75%.
For the Dow Jones Industrials, in theory at least that could translate into a fall back
to 1000. While that may be only for some super bears vivid imagination we believe that at
a minimum the Dow Jones Industrials will ultimately fall at least 50%-60% or down to
around 5000. The highs of January 2000 are but a dream for years to come.
The current 4-year stock cycle is coming to an end. Some thought it ended last
September 21, 2001. It may still be in play and could bottom in early July 2002 although
we suspect it will, following a summer rally, bottom later in the fall of 2002. That
should set up a decent run in 2003, which should allow for graceful exits for those still
caught in the malaise of the first big drop. That would set the next cycle bottom for
around 2005/2006, which could be the ultimate low for the markets. Time of course will
tell.
The Winter of the K-wave is a dangerous period. But it will be eased for those holding
gold or gold stocks. That new bull market is still in its infancy and may yet face a
significant shakeout to make its final bottom. But we would all be wise to hold at least
a little gold. The winter of the K-wave is upon us.
THE KONDRATIEFF WAVE. Peaks and troughs are associated with major political or cultural events.
Summary
Probably Kondratieff's greatest contribution to the science of
investment is not his observation the world economy operates in long
cycles. Cycles would suggest a repetitive nature to events. While
the underlying economic conditions will repeat over time due just to the
physical nature of our world, our reactions will always be tempered by knowledge
and experience. The history of man has been one long climb higher.
Kondratieff recognized progress as the irreversible trend.
Imposed upon our progressive nature are the physical limits of
life. It is the interaction of these physical limits with our dreams and
aspirations that creates the constant push pull of the economy known as the Long
Wave.
|
TOP OF PAGE