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Julian Snyder
from his 1983 Introduction to The Long Wave Cycle, by Nikolai Kondratieff
Nikolai Kondratieff was an economist in the Soviet Union in the 1920s. In 1925, he released a study entitled "The Long Wave Cycle." The study, later put into book form, found strong empirical evidence of a long-term business cycle that spanned 48-60 years.
Kondratieff came to this conclusion after analyzing the level of wages, interest rates, foreign trade, coal and iron production, and commodities in the Western, capitalist countries from the 1780s to the 1920s. He found that each long wave cycle had two distinct phases, a 25-year upswing, followed by a 25-year downswing.
In the upswing, Kondratieff found that major economic change, in the form of inventions and revolution, facilitate a burst of growth, which accompanies inflation. Once the upswing peaks, it reverses and enters a downswing, where economic growth slows (or contracts outright) and accompanies deflation. From his book, Kondratieff found the presence of two cycles, and half of a third:
Cycle 1 1789-1814 Upswing
1814-1849 Downswing
Cycle 2 1849-1873 Upswing
1873-1896 Downswing
Cycle 3 1896-1920 Upswing
With the presence of hindsight, we now know that Kondratieff's third cycle completed itself in the downswing from 1920-1945. After 1929, the deflationary trends became obvious, and led to the Great Depression.
The following graph is taken from Gary Shilling's new book, published this summer (1998), entitled Deflation:
The chart shows the completion of Kondratieff's third cycle, which ended in 1945-1950. The current cycle, the Fourth, (numbered Fourth only because Kondratieff began counting with the Industrial Revolution), had its upswing in the aftermath of World War II and peaked in the mid to late 1970s. The entire period was one of inflation, which itself peaked, arguably, in 1979-1980. The period since has been in the downswing, with falling interest rates, commodity prices and overall disinflation. However, as Shilling points out in his book, much of the 1990s have been spent in a deflationary environment.
Note the phases of each Kondratieff cycle. In the first, the upswing, inventions and commercial innovation spurs the growth of the economy and a resurgence of consumer demand. The expansion leads to spreading affluence, and eventually, rising prices. Upswings also have their frictions. Kondratieff found that in his periods of upswing, social upheavals and wars were more numerous.
Eventually, the upswing reaches the peak. Inflation crests and shortages develop. Capital investment is diverted to consumption. Historically, these peaks tend to coincide with a war: The Napoleonic Wars in Cycle 1, The American Civil War and Franco-Prussian War in Cycle 2, World War I in Cycle 3, and the Vietnam War in Cycle 4. A recession hits the economy soon after the peak.
A plateau period develops after this recession. This is a period of relative stability and prosperity. Nathan Mager, in his 1987 book, The Kondratieff Waves, wrote of them:
"This period of seven to 10 years appears to be one of relative stability. Emotions restrained during the preceding war emerge in a form of public ebullience, a loosening of moral constraints, and an increase in gambling and speculation. Historically, these periods have been noted as "The Era of Good Feeling" (1815-1823), "The Gilded Age" (1867-1872), and "The Roaring Twenties" (1922-1929). During this period, accumulated demand becomes satisfied, there is an increase in new household formations, birthrates increase, and consumer spending and speculation lead to accumulation of increasing debt."
A decline inevitably develops, usually precipitated by a financial panic. This has been the case in all three previous downswings: the panics of 1837, 1873 and 1929. During these declines, deflation is the norm. Economic activity slows considerably, and the debt accumulated in the previous years is written off or placed into default. An economic depression sets in. Kondratieff noted that agriculture during this decline becomes an especially difficult task, as lower and lower commodity prices pinch farmers (as they did in the late 1800s, the 1930s, and, to a degree, the 1980s-1990s, as witnessed by the presence of large government subsidies and the Farm-Aid concerts.) Excess capacity becomes widespread in the economy, and capital investment drops off dramatically. As the decline bottoms out, inventions and innovations become more numerous, laying the groundwork for the next upswing. Perhaps the advent of the Internet and biotechnology are sneak previews of our next big upswing.
Mager wrote of the long wave cycle in the perspective of other famous economists in our time:
"Kondratieff's approach had some elements of (John Maynard) Keynes in that both appreciated that the essence of expansion of the economy was the stimulation of spending, and that spending was a key to expansion. Kondratieff found the motivation in innovation; Keynes in government spending. (Milton) Friedman found it in easy money."
So what are we to take from this? What does this mean for our stock market and our economy? If history is any judge, and Kondratieff's long cycle is any guide, the stock market and the economy are in for some tough times. If a bear market occurs now, at this stage of our Fourth Cycle, it will most likely resemble the bear markets of the three previous downswings: 1837-1844, 1873-1877 and 1929-1932. Unfortunately, these three bear markets were the worst in our (American) history, and all accompanied depressions. Similarly, a bear market now will accompany a depression. Of course, if you are reading this from a PC in Asia, you know the bear market/depression has already begun.
The present-day bull market, with us since 1982, is a long plateau period. As Snyder described plateau periods, they may result from massive government spending (as in the 1980s) and massive monetary easing (as in the 1990s). Some observers, most notably Jim Grant, have been arguing this case for years (and still retained his readership!). Re-read our interview with Bill Fleckenstein. Bill's arguments point precisely in this direction
This does not mean the end of the world. It is not a call for doom and gloom. The fact that we have lived through three similar downswings speaks volumes about our capability to endure and progress out of them. Tragically, when Kondratieff came to this very conclusion—that capitalism would endure—he was professionally discredited among his colleagues in the Soviet Union. Mager wrote of Kondratieff's fate:
"Fellow economists in the USSR were unrelenting in their attacks. Criticism was generally based on political grounds—especially on Kondratieff's findings that the cycle, in a capitalist system, was self-correcting. This was seen as a direct contradiction of the Marxian precept that continuing declines in capitalist economy would bring about the annihilation of the system. Undoubtedly much of the venom in these attacks was motivated by personal considerations. In a bureaucratic milieu, one-upmanship is essential to advancement."
Kondratieff was eventually stripped of his job, and moved to a camp in Siberia. Nothing more was ever known of him.
Fortunately for us, Kondratieff's theories survived, thanks largely to the work of Joseph Schumpeter, an economic historian and Harvard professor in the early twentieth century. In his 1939 classic, Business Cycles, Schumpeter credited Kondratieff with the "discovery" of long wave, 50-year business cycles. He viewed it as a long-term reflection of his own theory that capitalism was one of constant "creative destruction."
So, to paint a picture of previous downswings, and to give us some idea of what to expect in our present downswing, we again turn to Snyder's introduction to a translation of Kondratieff's book in 1983:
"The deepening depression (of the 1930s) shattered the assumptions of a relatively risk-free world that had dominated the mood of the 1920s. People became more cautious. Hedonistic behavior subsided and there was less tolerance of deviant social behavior. The younger generation became more respectful of their parents and less scornful of old traditional values. The music slowed down. Marriage and the family became more highly prized as social institutions and the divorce rate fell. People stayed home and spent more time with their families. Games such as Monopoly and contract bridge became immensely popular.
"Although the frivolousness and open sensuality of the 1920s disappeared, the U.S. did not turn back to the old conventions that had existed at the turn of the century. Much of the outlandish, frenzied behavior was no longer accepted, but many of the new freedoms won by the flappers of the younger generation remained…
"As a depression lengthens, disillusionment deepens. Another depression, that of 1937, followed on the heels of the 1929-33 downswing and dashed the hopes for an early recovery and return to prosperity. The change in mood became even more striking. The attempt to avoid pain dominated the social mood. People grew more accommodating and cooperative and intensified their focus on security—valuing success and work, seeking safe, unadventurous jobs, and saving for the future. There was a resurgence of religious fundamentalism among the working class and the work ethic became stronger.
"During Kondratieff downswings, a sense of community and camaraderie takes hold. Unlike prosperous times, the enemy is clear— it is the depression. No other problem seems so vital or pressing. As a result, people realize that they need one another's help and agree that material betterment should be the goal of society.
"These conservative, more traditional values and lifestyles remain through the beginning of the next upswing. People are not expecting as much and thus are more easily satisfied. Consequently, as the economy improves people don't want to rock the boat, so a great deal of social stability and tranquility develops."
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