Surfing the Kondratieff Economic Long Wave

As the world collectively suffers the hangover of economic excesses propagated by excessive debt, greed and deregulation, many wonder if all or any of this could have been avoided.  Fans of Nikolai Kondratieff will tell you that this era of falling prices, deleveraging of excessive debt and increased unemployment was both predictable and unavoidable.  We are suffering through the Winter, or final season of an economic long wave that lasts from forty to sixty years, and that we can expect that it will last for years to come.

Kondratieff was an early Soviet-era economist who studied inflation rates, economic growth and commodity prices from the early 20th century back to 1789 and was able to distinguish a long wave of economic activity that could be divided into four phases he called seasons.  The cycle begins with Spring, which is characterized by rising wealth and prices, which corresponds with the post-WWII boom from 1949 to 1966 in the current cycle.  In the second phase, Summer, economic growth cannot sustain the desire for further increases in consumption and political and economic crises erupt –such as the period from 1966 to 1982, which included the Vietnam War and the oil crisis of 1973, which brought on stagflation (low growth and high inflation).  The Autumn season is characterized by a desire to maintain consumption, but when faced with dwindling resources, great increases in debt result in an effort to sustain the system – witness the explosion in financial debt during the period of 1982-2000.   Finally, the debt is unsustainable and an era of falling prices and deleveraging results, until costs become affordable enough to launch a new cycle and expansion begins again.  We are currently living in the Winter of the year 2000 onwards, which could last until 2014 if we end up with an exceptionally long wave this time around.  The theory deserves greater explanation than what is contained here – the internet offers many sites that provide detailed explanations of the cycles since the late 18th century, a favorite would be www.kwaves.com.

Kondratieff’s lessons for our political leaders

If the Winter of the wave is unavoidable, then at least something positive should emerge from all the economic pain and suffering to be inflicted on the world’s economies.  Joseph Schumpeter, the conservative Austrian economist, studied Kondratieff’s work and coined the term “creative destruction”, which affirms that during times of economic turmoil, assets must be liberated from inefficient investments or means of production in order to be re-deployed in more promising sectors or firms so that they can create new wealth.  Kondratieff was executed by Stalin before he could comment on Schumpeter’s work, but he would certainly have agreed; if the Winter of the cycle does not liberate both human, financial and resource capital to be redeployed for more promising endeavors then the resulting inefficiencies will only prolong the Winter period and/or weaken the Spring of the next cycle.

Our politicians are missing the opportunity to make serious structural changes during this difficult period and instead are perpetuating the old market models and industries with trillions in new debt, a mortgage on future generations.  In Quebec, Premier Charest has yet to dust of his 2003 mantle of re-making the Quebec economy and is embarking instead on minor initiatives to sustain traditional industries like home construction with a subsidy for renovation projects.  In Canada, political pressures on the minority Conservative government have resulted in a planned $60-billion stimulus package to appease the opposition parties.  As a conservative-minded economist, one can only imagine how difficult it was for Prime Minister Harper to turn his back on his small-government principles to propose this package in the House.

In the United States, trillions will be spent to support the cul-de-sac of attempting to maintain an over-heated consumer-driven economy that was perpetuated by a heaving mountain of sub-par mortgage debt.  These trillions in new government-issued debt are unlikely to find ready buyers around the world, eventually leading to one arm of the US government lending to the other, which is less-polite circles we call printing money.  One can recall the pictures from Weimar Germany with a shopper pushing a wheelbarrow of paper bills on his way to buy a loaf of bread; the potential for massive US inflation and the debasement of the US currency is real and possibly imminent.  The really bad part about this policy is that the US economy is still 25% of the world’s economic output, and the existing US federal debt is increasingly held outside its borders.  The internationalization of US-dollar obligations means that any debasement of the US-currency also destroys wealth worldwide, wealth that is needed to begin a new wave cycle of economic expansion.

Where are the managers of tomorrow?

One of the greatest disappointments emerging from the recent crisis is the lack of change-over in human capital at the head of our largest corporations.  From the US auto manufacturers to the banks and even our home-grown Nortel, all the management that was in place for the onset of the crisis is still firmly in charge.  Shareholders (or creditors, in the case of Nortel) seem powerless or unwilling to unseat the current range of management and seek out new talent from within or outside to provide these institutions with a new vision of management.  Since the days of Kondratieff’s analysis, human capital has emerged as an important asset class, just as important as the raw materials prices he tracked for over two centuries of history.  The concept of creative destruction applies to human capital as well – the old must move on so that the new can take hold and create new management models for future value creation. 

So far, all we have heard from the current management crop as they appeared before Congress is that no one could have seen it coming and there was nothing that they could have done differently to mitigate the severity of the impact on their own industries.  Stale auto product offerings and dangerous mortgage lending practices had been discussed for years, but yet, no one is to blame.  Only in select Japanese companies have we seen executives stand up and resign for the poor performance of their corporations.  We have not has a single “mea culpa” from a US auto or banking executive, though there have been many comments by laid-off middle managers that they could have seen this coming.  Readers should view the interview on 60 Minutes with Paul Bishop, a former mortgage broker with California-based World Savings, detailing how his warnings were ignored.  The interview is available from the 60 Minutes website on CBS news.

Doomed to ride the Winter wave a while longer

The bailouts, handouts and support for outmoded business models will not save those that are past their best-before date.   GM is set to present the US Congress with a stark report this week; either billions more in bailout money or bankruptcy.  Commentators who reviewed GM’s problems correctly predicted that this would be the case, but the initial insufficient rescue package was handed out in any case.  The industrialized world will not emerge from this crisis via a line-up of piecemeal packages to special interests and outmoded industries – we will only emerge when we embrace the crisis and use it to tackle the old statist models of economic management that created the inefficiencies we struggle with to this day.  If we fail to find a new class of politician and business leader who are up to the task, then Kondratieff’s Winter wave will be longer and colder than first imagined – and we will only have ourselves to blame.