While many believe (or at least, would like us to believe) that the global economy is in a painfully slow recovery with better times ahead, some economists are warning that the “Great Recession” of 2008-09 is just the first taste of a greater crisis to come. I tend to be cautious or skeptical of extreme views, but I’m happy to share my opinion!
I attended the Financial Intelligence Conference, at which a number of speakers outlined their views of where the US and global economies are heading, and what that means to us personally. It was thought-provoking stuff. While my economic background is limited, I have seen enough in my lifetime to realise that experts have widely diverging opinions and that experience and training do not guarantee that one’s conclusions are correct. So I feel justified in giving my two cents’ worth!
The Kondratieff Wave
Larry Jeddeloh (founder of TIS Group, an investment strategy consultancy) pointed to evidence which suggests that we are beginning the ‘winter’ phase (a deflationary period) of the Kondratieff Wave. Kondratieff waves are naturally occurring long economic cycles that have been observed since 1800. Each cycle lasts between 40 and 60 years.
Source: Longwave Group
It makes sense to me because these cycles are driven by human nature, not economic policy.
Here’s my simple explanation: if credit is extended, human nature means that we will tend to take on debt to fuel a lifestyle above our means. If people are willing to take on too much debt, then lenders will be keen to supply this demand rather than miss out on business. Governments won’t put sufficient safeguards in place because that would stifle the economy in the short-term, and short-term is how they need to think if they want to be re-elected. This all leads to a growing economy which keeps everyone happy. Happy at least until the whole system collapses under the weight of the debt.
Facts of Life
Although Kondratieff waves are not completely supported by mainstream economics, there are other indicators to suggest that hard times are ahead. Confidence is everything, and the US Federal Reserve is maintaining confidence by injecting massive amounts of liquidity into the market. But each shot is less effective than the last, and there will come a time when unlimited printing of money no longer props up the market. Without confidence, the artificially inflated markets will collapse.
Demographics are also hard to argue against. Sixty year olds simply spend differently to 40 year olds – people drastically reduce their discretionary spending as they age, because they are thinking more about the future and are saving for retirement. In most developed countries, the baby boomers have passed their peak spending years, and there are fewer young adults coming through to drive growth in consumer spending. Jonathan Last, writing in the Wall Street Journal, says that the root cause of America’s decline is its declining fertility rate. Joel Kotkin says the same in Forbes about Europe. Demographics points to a slowing economy, even after taking into account increased health spending.
So if the evidence points to a decline, why don’t most economists and politicians see it? I can offer a few reasons:
- Western culture is based on a Greek mind-set, which operates in linear terms. We naturally think of continual improvement, rather than of life being cyclical which is characteristic of Hebrew and Eastern thinking. So the experts expect that we can control our economies, and that aided by the theories of economists like Keynes and Friedman we have been able to take control of the economic cycle for our benefit. If this is our mind-set, even if we see a repeating pattern in history, we don’t think it will happen to us.
- Economists focus more on mathematics than psychology. But it seems to me that markets depend more on human behaviour than on economic theory. I think we need to learn from psychologists and sociologists and theologians about how people behave.
- I don’t think that the world’s major economies have populations with the necessary moral character to deal with the economic problems that they face. Politicians will not get re-elected if they sacrifice short-term results in order to solve long-term problems. And people are reluctant to sacrifice their life style (e.g. government entitlements) for the good of future generations. But I haven’t noticed moral character being mentioned in economic theory. Jean Monnet observed that “people only accept change in necessity and see necessity only crisis.”
Some Points to Ponder
Overall, I think there is sufficient evidence to suggest that we are facing an economic ‘winter’ of deflation and debt elimination (through default) which will last until the debt issues have been resolved.
If that is the case, here are some points to keep in mind.
- Secular (i.e. long time frame) bear markets are a series of cyclical ups and downs. There were five major stock market rallies during the Great Depression before the bottom was finally reached, and then regular collapses for the next 17 years before a sustained rally began.
- People survived the Great Depression. It was hard, but life carried on. In fact, many made their fortunes during this time.
- The purpose of a depression is to get rid of debt. And here’s a fundamental principle – those with debt will have their assets taken away, while those with cash will buy these assets dirt cheap. There will be a massive transfer of wealth from the cash poor/asset rich to the cash rich/asset poor.
Weighing the Risk
To summarise: I believe there is enough evidence of continuing economic turmoil to take the warnings seriously. We can never know for sure what will happen, but I often think in terms of evaluating the consequences (Decision theory) – what will happen if I’m wrong?
In this case, choosing to prepare for another Great Depression would mean sacrificing potential investment return for a few years. If I’m wrong and the economy stays good, I lose potential returns but I don’t lose capital. However, choosing to dismiss the possibility of a major downturn and being wrong will mean a loss of virtually all assets invested in markets in addition to bankruptcy where debt is held.
The risk of not taking this seriously is too great.
I will be writing a follow-up post on how this information can be applied in a personal or business setting. If the Kondratieff Wave is real, can we ever overcome it? How can we as individuals profit during an economic winter? What can businesses do to thrive during decades of depression? Subscribe to this blog or come back soon to find out!