F.U.C.T. (Face Up to the Cold Truth)

The field of economics, like medicine, has its own distinct schools of thought. Within these perspectives one need not search long to find references to 'wave' theories, which describe natural cycles of feast and famine as they relate to the world of commerce, and indeed, our lives in general. Although different cycle theories suggest disparate time frames and divergent parameters, these (and other) cycle-based theories complement -- rather than rip on -- one another. This is truly fascinating stuff, and not difficult to understand with a little patience.

Blog follower Astatula Map makes a compelling case that we are entering a new era defined by one of these cycles, specifically: the era of the "Kondratieff Winter." Once again, I yield the floor to my well-learned audience...

Kondratieff wave theory (see http://en.wikipedia.org/wiki/Kondratiev_wave for an adequate short explanation) posits a sort of economic "super cycle" lasting between 50 and 75 years. Some have tried to tag it with an exact number of years (e.g., 54), but I wouldn't get too hung up on exact timing. While some would dismiss the theory as being in the same class as biorhythms, astrology, or other superstitions, I believe it has a logical basis in psychology and the human life span (e.g., we become peculiarly vulnerable to repeating past mistakes when the generation that last committed them and learned from them dies off). The last Kondratieff Winter was in the 1930's, so it is to that era that we must look in order to help us see where we are headed now.
In both today's environment and in the Great Depression, the phenomenon was preceded by an enormous credit bubble that persisted for approximately 15 to 20 years until a "tipping point" was reached. At the dawn of the last depression, the tipping point was the stock market crash of 1929 (there is anecdotal evidence that suggests this stock market crash was due to the break-up in the Senate of the coalition that had been opposing the Smoot-Hawley tariff legislation). For us the tipping point was the "subprime mortgage crisis" of 2007, an event that was regarded as a notable problem at the time, but one that could be safely contained. It turned out that both events merely preceded the initial domino falls of their respective eras as each event led to a widening and accelerating credit collapse. In each case, when enough financial institutions had gotten in trouble, a collapse in monetary velocity (the rate at which money changes hands) ensued due to deleveraging, spiking risk premiums, and the resulting hoarding of money, both by individuals and institutions. This state persisted for several years in the 1930's. We can expect it to persist for several years from now as well, notwithstanding frantic efforts of governments to contain and counteract it. It should be emphasized again that in each case the tipping could not have happened without primary exhaustion of a decades-long secular trend of growing affinity for credit, risk, speculation, and basic greed. These conditions will take years to unwind, just as was the case in the 1930's. Due to the secular rather than cyclical nature of this counter-trend, the unwinding should be relentless and unstoppable, reinforced by multiple positive feedback loops along the way.

Take housing prices for instance. It has been widely reported in the news media that the price of houses must stabilize in order for us to see any improvement in our current economic condition. If one looks at housing price trends over the past century -- http://jluscher.googlepages.com/Housing_Boom.png/Housing_Boom-full.jpg -- one notices that home prices, in real terms, must fall by between 40% and 50% to return to 'normal' levels. The best case scenario is that after two years of home price declines, we may be close to half way there. The worst case scenario takes into the account the fact that the pendulum never stops in the middle. It is possible that before this is all concluded homes may be nearly universally despised as an investment vehicle, and home prices may end up at historically low levels in real terms. Deflation of the general price level could also magnify the nominal home price declines. Obviously this means that there is no end in sight to the foreclosures, hence no bounce in view for the toxic mortgage assets on the books. In fact, many apparently still "good" mortgage assets will become toxic soon. Few people will want to buy or build new homes in the current environment, and many of those who do will not be able to obtain financing. This means thousands of subdivisions stopped dead in their tracks, which in turn means thousands of strip malls and other retail outlets stopped dead in their tracks. This will torpedo the construction industry and the commercial real estate market. The nations regional banks that primarily specialize in commercial lending, as opposed to residential mortgage lending, will be affected next. All of this means soaring unemployment, which means more bankruptcies and foreclosures, more home price declines, etc.

Now as then, the government is impulsively flailing about trying to counteract the K-Winter. They may actually have stopped the K-Winter from beginning in 2002 - 2003 through Alan Greenspan's 1% interest rate policy and the start of the war in Iraq, but if in fact they delayed it they have only made it worse. The history of government actions meant to counteract a K-Winter fail to inspire us with confidence. In the last K-Winter, the government took two specific actions (the Smoot Hawley Tariff Act and a massive Federal income tax increase) that contributed significantly to the severity of the downturn. Current actions being taken are rife with potential for unintended harmful consequences. At the very best, they may lead merely to cancer rather than a car crash, as one observer has noted.

In addition to obvious economic woes, we could see vast national security problems as a result of the destabilizing effects of this crisis at home and around the world. Ominously, K-Winters identified in the past have often concluded with major wars.

When we do eventually come out on the other side of this, the massive amount of monetary printing currently taking place will probably lead to high inflation. It so happens that high inflation is one of the characteristics of the Kondratieff Spring. But for now, credit destruction is far outpacing monetary creation, and is likely to continue doing so for some time to come.

Just as the last boom sowed the seeds for its own destruction, so also the coming depression will sow seeds of renewal, if history is any guide. Many new businesses and product lines had their humble beginnings in the Great Depression. IBM is one example. Many people will by sheer necessity rediscover the virtues of saving and frugality. Many millions of families are already contemplating these and other changes in our lives, which could ultimately prepare the way for a resumption of healthy economic growth based on a sounder foundation of prudence and discretion (not forever, but at least for many years).
-Astatula Map

Any new cycle-holics may also reference:
the Kitchin inventory cycle (3–5 years) —after Joseph Kitchin,
the Juglar fixed investment cycle (7–11 years) —after Clement Juglar,
the Kuznets infrastructural investment cycle (15–25 years) —after Nobel Laureate Simon Kuznets,
the Forrester cycle (200 years) -after Jay Wright Forrester, and
the Toffler civilization cycle (1000-2000 years) -after Alvin Toffler.