Wednesday, March 16, 2016

The Long Wave and the Failure of Central Banks

Most people and, I suspect that in this group we can include most central bankers, would agree that the post-Great Recession recovery has been far from normal.  Despite central banks doing this to their balance sheets to rescue the global economy from a near depression:

...the economy seems nearly completely resistant to whatever "monetary medicine" the ECB, Federal Reserve, Bank of England and Bank of Japan force-feed their respective economies.  Something is different this time and there may be a reason why even the most imaginative central bank intervention will not be successful.

Back in 1926, Soviet Professor Nikolai Kondratieff published a report entitled "Long Waves in Economic Life".  Here are the opening paragraphs:

"The idea that the dynamics of economic life in the capitalistic social order is not of a simple and linear but rather a complete and cyclical character is nowadays generally recognized.  Science, however, has fallen far short of clarifying the nature and the types of these cyclical, wave-like movements.

When in economics we speak of cycles, we generally mean seven to eleven year business cycles.  But these seven to eleven year movements are obviously not the only type of economic cycles.  The dynamics of economic life is in reality more complicated.  In addition to the above-mentioned cycles, which we shall agree to call "intermediate", the existence of still shorter waves of about three and one-half years' length has recently been shown to be probable.

But that is not all.  There is, indeed, reason to assume the existence of long waves of an average length of about 50 years in the capitalistic economy, a fact which still further complicates the problem of economic dynamics."

Professor Kondratieff went on to use long-term economic data from England and France since the data from these two nations was most complete back to the end of the eighteenth century.  From this data, he was able to track wholesale price levels, interest rates, wages, foreign trade, the production and consumption of coal, pig iron and lead (the major commodities used in manufacturing during the 19th century).

Here are some of his graphs (pardon the quality of the screen captures):

1.) Index reflecting commodity prices:

Professor Kondratieff noted that, between the 1780s and the 1920s, price cycles exhibited three waves ranging in duration between 47 and 60 years.

2.) Quotations of Interest-bearing securities:

The existence of great cycles in the movement of interest rates is quite apparent; these cycles also agree with the corresponding periods in the changes of wholesale commodity prices as noted above.

3.) Wages in England:

4.) Coal production and consumption:

In all series, the turning points of the long waves (or great cycles) correspond quite closely and result in the following summary observations:

1.) First long wave - rise lasted from the end of the 1780s until 1810 to 1817 and the decline lasted to 1844 to 1851.

2.) Second long wave - rise lasted from 1844 to 1851 until 1870 to 1875 and the decline lasted to 1890 to 1896.

3.) Third long wave - rise lasted from 1890 to 1896 until 1914 to 1920 and Professor Kondratieff estimated that the decline probably began in the years between 1914 and 1920.  As we know, this decline reached its ultimate nadir during the Great Depression.

In general, the length of the long waves fluctuated between 48 and 60 years between the late 1780s and early 1920s.

As you may have noticed, each Kondratieff Cycle has four distinct phases as follows:

1.) Spring - Inflationary Growth Phase where economic growth begins from a depressed economic base and expands continuously.  The interactions of the participants within the economy causes wealth (i.e. savings) as well as the production of capital equipment to increase.  The expansion of both production and wealth causes prices to rise and the increased volume of goods causes the velocity of money to rise.  This part of the cycle is generally 25 years in length.

2.) Summer - Stagflation or Recessionary Phase where economic growth reaches its limits largely because there is a shortage of human and material resources.  Inefficiencies in the economy beging to build and recessions often occur, lasting for 3 to 5 years.  Limits to economic growth become apparent and the economy is trapped into a consolidation mode for the next 20 to 25 years.

3.) Autumn - Deflationary or Plateau Phase where the economic growth is flat and prosperity is mild.  Because of the accumulation of wealth over the past 30 to 40 years, the economy becomes consumption-oriented.  This phase generally lasts from 7 to 10 years and is characterized by selective growth in certain industries and development of new social and technological ideas.  The inflated prices and strong desire for consumption produces a rapid increase in debt and consumption expands beyond practical limits, resulting in a severe and protracted recession at the end of the phase.

4.) Winter - Depression Phase where the excesses of the plateau phase results in a collapsing of prices.  The economy undergoes a period of sharp retrenchment which includes recessionary periods and a 15 year period of deflation.

Professor Kondratieff regarded economic depressions as a cleansing period that allowed the economy to cleanse itself of the excesses accumulated during the previous cycle before it transitioned into a new "spring" cycle of expansion.

Now that we have that background on the long wave theory, let's look at a more up-to-date long wave graphic from Long Wave Group:

While some economists feel that the Kondratieff Cycle is no longer applicable in the post-World War II economy given the monetary policy tools that are part of central banking in today's world, in fact, such does not appear to be the case.  If anything, the globalization of the world's economy and central bank intervention in the free market which has continuously added to the global debt load may have magnified both the autumn phase (debt accumulation) and winter phase (deflation).  All you have to do is look at the unprecedented growth in sovereign debt to see that it is going to be much harder to reverse the "winter" phase than it has been in the past.  The preceding chart shows that the global economy is likely to have some additional downside before the "winter" phase is complete with the bottom of the trough being out as far as 2020 if the beginning of the most recent spring started after the end of World War II and the beginning of the winter cycle started around the year 2000.  If the latest winter phase actually started during the Great Recession of 2008 - 2009, the economy could have another 15 or so years of retrenchment.

Kondratieff Cycles are a descriptive way of looking at the generational economic cycles that give us insight into the current global economic cycle.  From our collective individual economic experiences since the end of the Great Recession and the seeming inability of the world's central banks to prod the economy back to life, it appears that the global economy will continue to languish if Nikolai Kondratieff's theory is correct.


  1. Excellent post. Linked to it in my blog (Money Daily).

    Love the chart.

    1. No problem. Please feel free to link any of my postings that you find of interest.