THE LONG WAVE THEORY
Are we surfing toward a boom or bust, according to the Kondratieff clock?
Top economic pundits have differing views.
By Andrew Nikiforuk
Wednesday, April 06, 2005

WHAT TIME IS IT?
Whenever Calgary investor Keith Conrad gets a little worried by the chaos of current events, the affable 66-year-old grandfather checks his Kondratieff clock. Now a Kondratieff clock is an unusual timepiece because its namesake never lived in Switzerland or tinkered with clocks. But the dogged Soviet economist did author a paper in 1926 that suggested that capitalism was a dynamic force that naturally renewed itself by expanding and crashing in 50- to 60-year cycles. The dismal Marxist, who drew upon the earlier work of other business-cycle pundits, called his analysis the Long Wave Cycle.

Many modern investors, such as Conrad, typically imagine Kondratieff’s Long Wave as a 12-hour economic clock for simplicity’s sake. An expansionary up wave usually occupies the time before early morning and noon (the peak). After 12, a subtle or dramatic financial downturn takes hold that doesn’t bottom out till around 6 a.m. Conrad, who grew up in that humongous down wave known as the Great Depression, sometimes refers to Kondratieff’s cycle as an early-warning economic tsunami system. Right now Conrad is smiling. He says Kondratieff’s clock points to about a quarter to 12. “I think we still have about 10 years of expansive economic growth left.”

Ian Gordon, a Vancouver stockbroker and editor of The Long Wave Analyst, also keeps his eye on the Kondratieff clock. But unlike Conrad, Gordon is not smiling. His clock points to about 15 minutes after 12, which means an economic tsunami is rising somewhere out there in the great global marketplace. “I don’t think there is any doubt we’ve peaked,” says Gordon. In fact, Gordon predicts a devastating economic crash could be in the works, as well as mighty political changes. “It’s the end of the U.S. hegemony as the world’s financial and political leader and the end of the dollar as reserve currency.”

So how can two investors using the same economic clock come up with completely different times? Well, it all depends on how you read Kondratieff, and as any Kondratieff watcher will tell you, the economist’s Long Wave is just a big-picture take on things. “It doesn’t tell you which stocks to buy or sell, and it doesn’t mean you are always right,” explains Conrad. Consequently, Kondratieff’s work lends itself to different interpretations and, fundamentally, two different takes on where our economy is headed.

Let’s begin with a few details about this Kondratieff fellow. Nikolai Kondratieff was born in 1892 in St. Petersburg and majored in history and farm statistics. He survived the revolution to become head of the Conjecture Institute, where Soviet number crunchers studied capitalist crises. During the 1920s,Kondratieff did a lot of number crunching on his own and studied the price of wheat, the consumption of coal and the weekly wages of cotton workers in Europe and the United States. His data covered a 140-year period beginning in the 1780s. He discovered that capitalist economies peaked and crashed in three regular waves that lasted on average 54 years. During each wave, the economy expanded, ultimately overshot itself and then corrected its excesses with a major recession or depression only to start all over again.

Wars, technological innovations and agricultural depressions all played roles in defining these recurring cycles. By examining peaks and lows in the 17th and 18th centuries, Kondratieff pretty well predicted the Great Depression as early as 1924. He also astounded his peers by asserting that capitalism had the capacity to regenerate itself.

Kondratieff’s revelations, however, didn’t win him any friends in the Soviet Union, nor did his opposition to collectivism. Fellow Marxists called his work “wrong and reactionary” and argued that capitalism was surely an economic deadbeat. Kondratieff said the facts suggested otherwise. The Long Wave had its own rhythm and self-correcting manner, he added. By 1928, Kondratieff had made so many political waves that he lost his job. In 1930, he became an unwilling performer in one of Stalin’s great show trials. The author of the “vulgar bourgeois theory of crises and economic cycles” spent the rest of his life in solitary confinement in a Siberian Gulag, where he died in 1938.

Ever since then, economists and social scientists have quibbled, revised, debunked or amended Kondratieff’s cycle. The famous Harvard economist Joseph Schumpeter, for example, championed the Russian’s work but with an added twist. Schumpeter believed that a cluster of innovative technologies primarily drove the beginning of each wave by creating their own industrial revolutions. Once introduced, these technologies diffused, saturated and then overwhelmed the market place only to be succeeded by another wave of innovation.

In other words, the cotton gin and newspapers drove the first wave (1783 to 1842), and steam and steel drove the second. The third wave began in 1897, propelled by the innovations of electricity and motor cars. Sherry Cooper, chief economist at BMO Nesbitt Burns and author of Riding the Wave, believes that jets and televisions started the fourth wave in 1950, while the microchip and the Internet may have launched the fifth wave in the 1990s.

Other observers have added more intriguing ideas to the Long Wave, like kids decorating a Christmas tree. American sociologists, for example, surmised that different parts of the cycle had an impact on people’s mood and psychology or vice versa. During a rising wave, people tend to be expansive, exuberant and then even greedy and hedonistic. During a crashing wave, the public mood becomes more cautious, dependent and security conscious. As each wave rises and falls, the values of political movements shift.

Expansionary up-wave times tend to be liberal and progressive, while peak times tend to have a definite imperialistic flavour. (Even analyses of the British monarch’s Speech from the Throne show distinct 50-year political cycles.) And the decline, as one would expect, welcomes very conservative parties and quasi-religious movements, such as Nazism in Germany in the 1930s.

Now, the whole idea of Long Wave cycles has fallen in and out favour numerous times. In the 1950s and 1960s, economists particularly lambasted the Kondratieff theory as pure voodoo, superstition or worse. Conrad can remember attending a bank-credit conference in 1966 where several Montreal economists berated the notion of cycles. They just didn’t like the idea, as one put it, that man was “bound to a large, slow-turning wheel, unable to avoid having his head dunked in the mire at regular intervals.”

In recent years, however, a growing number of economists and historians have found some good empirical evidence for the Long Wave. Jay Forrestor, a researcher at MIT’s Sloan School of Management, built a computer model for the economy based on the policies followed by banks, industries, markets and government in the 1970s. And surprise, it showed short-term cycles, stagflation and, you guessed it, a long wave—a major rise and fall in economic activity that peaked every 50 years.

Let’s now return to our original investors and their divergent readings of the Kondratieff clock or economic seasons. (Kondratieff followers invariably pepper their assessments with nomenclature that invokes surging waves, ticking clocks or changing seasons.) Gordon, you’ll recall, is a doomsayer “bear” and believes that it is past “high noon” and that the economy has entered a Kondratieff winter. In contrast, Conrad suspects that it is still mid-morning and that the economy is still riding the wave of a Kondratieff summer.

Now both men, who don’t know each other, share some thoughts about Kondratieff. Each regards the Long Wave Cycle as essentially a lifetime generational cycle. Or, as Conrad puts it, “people make the same mistakes over and over again and you have the corrections that come from that.” Both men are also true history lovers and understand that the forces driving economic corrections are universal and there is no country not subject to its law. In other words, both men believe Hegel’s pointed observation that “what experience and history teach is ... that people and governments never have learned anything from history or acted on principles deduced from it.”

Yet Conrad and Gordon read the current wave very differently. Conrad essentially believes that the last Kondratieff wave bottomed out in the recession of the 1980s and that a new fifth wave began in the early 1990s with the infamous tech boom, which met an equally infamous correction in 2000. Conrad accepts that the stock market has played itself out but reckons that commodities will do well for another 10 years at least. Generally speaking, he believes that the current expansionary phase of this long wave promises a long and strong prosperity, much like the 1960s and 1970s. That doesn’t mean there won’t be modest or short corrections or political upheavals. But he doesn’t see any tsunami-like trouble ahead for a long time.

Conrad’s optimistic assessment is supported by a number of mainstream economists. Sherry Cooper, for example, “can’t help being excited” about the current up wave and describes the stock bust of 2000 as just a speculative excess. Martin Barnes, editor of the Bank Credit Analyst, recently concluded that “there is no reason to believe that the long wave upturn that took hold around the mid-1990s has ended.” But he suspects that the aging baby boom generation (all 75 million of them) could make their own wave when they try to cash out around the middle of the next decade.

Gordon, the contrarian, takes a different perspective. He believes that the fourth wave began in 1949 and is still rolling toward a dramatic conclusion. Gordon thinks we are smack dab in a Kondratieff winter. People don’t know they are in a downswing, explains Gordon, “because they are spending like no tomorrow.” He ultimately believes that unprecedented debt levels will crush the economy and everything else. When ordinary folks realize that they can no longer make money on real estate or the stock market, there will be a terrible reckoning. “We will see the destruction of the middle class in the next depression,” he predicts. He also believes that the American empire is being challenged on a number of financial and political fronts and is rapidly loosing its legitimacy. In other words, we are now locked in a perfect Kondratieff winter of despair and concern, accompanied by massive economic shifts but conveniently disguised by easy credit.

Gordon, who has been producing his newsletter for seven years, doesn’t make any apologies for his analysis. He thinks people like Cooper are “absolutely wrong because debt is a killer.” He adds that both Germany and Japan are deep in Kondratieff winters. His investment advice is simple: get out of debt, avoid real estate, stockpile some cash and make a few gold investments. “The bull stock market is over.”

Ultimately, time will settle this Kondratieff argument. “In 20 years, we will find out who is right,” admits Barnes, who has long regarded the Long Wave as a process and a loosey-goosey one at that. “That’s the beauty of the Long Wave,” he adds. “We’ll be pushing up daisies then.” Gordon, however, suspects the real direction and predictable outcome of the Long Wave will declare itself much sooner than that.