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July 05, 2005

Data and Markets Unanimously Support the Current Depression Phase of the Longwave
by Jas Jain

Regrettably, most Americans, who take interest in the economy and investments, and most economists are ignorant of the economic Longwave, also known as the Kondratieff Wave, but Greenspan is not one of them. Greenspan is supposed to have said that he would love to be the Fed Chairman during the coming Kondratieff winter, or the Deflationary Depression phase of the Longwave, a wish that did come true. Aren't we Americans lucky?

What Is the Longwave Depression?

A long interval, or period, during which the growth rate of the economy is 2-3% per year lower than the preceding growth period, i.e., the economic activity is significantly depressed for a long period. The last Longwave Depression, obviously, was the Great Depression, which lasted for approximately 20 years; though, the worst of the GD was before the US entered the WW II. Just imagine a 2-3% a year fall in the growth rate for 10-12 years and that gives you some idea as to how it feels despite the fact that overall the economy keeps growing over that period. THE US GDP GREW AT AN ANNUAL RATE OF 2.83% A YEAR BETWEEN 1930 AND 1941! I don't have the exact number, but the GDP growth rate during the preceding growth period, 1920Q2-1929Q2, approximately, was in excess of 5% a year; and could well have been close to 6% a year.

The worst of the Deflationary Depression phase takes place when the Private Debt begins to liquidate, by force if not by volition. The most damaging interval for the economy takes place when the Consumption Debt (yes, home mortgage debt is Consumption Debt) starts declining because it directly affects the demand side, which in turn affects the employment and creates the snowball effect. It is not being recognized now, but in a low, or negative, inflationary environment paying down debt, for those who are close to the limit of debt that they can handle, is a very painful process. Unfortunately, it will be forced upon households that are way above their heads in debt.

Various Phases of the Longwave and the Summary of the Current Longwave

One of the tests of a scientific theory is its ability to predict the future outcomes. The first two columns in the table below are the pre-known, or predictable, aspects of the Longwave. What is not predictable beforehand are the turning points and nor are the turning points very precisely identifiable. Therefore, one cannot precisely time investments, for example, in stocks versus the highest quality bonds, but one knows what lies ahead, i.e., what investments will do well, long-term, during the various phases.

From the first three rows of the above table it should be clear that the Longwave theory has passed the test of a scientific theory with flying colors. There is some time lag between the investment performance and the economic performance indicated by the Longwave, with the former being the leading indicator by 6 to 18 months (between the bond market and the stock market, the former has the longer lead time).

As the table indicates, the growth rate of the economy during the current phase of the Longwave is only 2.53%, 30 basis point below the growth rate during the worst 12 years of the Great Depression. Also, in terms of the employment and real wage growth for workers, the current recovery is the worst ever recorded in the US. The best explanation is that this be because we are in the Deflationary Depression phase of the Longwave, or in the Kondratieff winter.

However, the best support for the Deflationary Depression phase comes from the financial markets. ONLY DURING THE DEFLATIONARY DEPRESSION PHASE THE HIGHEST QUALITY BONDS, E.G., TREASURIES, OUT-PERFROM STOCKS FOR A LONG PERIOD OF TIME. For the past 8 years, the long-term US Treasury bonds have out-performed the major stock indexes. The 2017 US Treasury STRIP that I purchased in 1997Q3 is up 110%, handily out-performing the S&P 500 in total return. Please note that 8 years ago the US stocks were not in the bubble phase; stocks were over-valued but bonds were not undervalued either.

If we limit ourselves to a shorter time frame, the markets are screaming Deflationary Depression. Four years ago, on July 3, 2001, the economy was in a recession and the S&P 500 closed at 1234.45. On the last trading day before the July 4, 2005 holiday, the economy has been in a recovery for 44 months and the S&P 500 closed at 1194.44. During the same four years, the long-term US Treasuries have gone up in price nicely and have yielded 2.5 times! This, stocks doing worse during a recovery compared with the recession and bonds doing better, never happens except during a Deflationary Depression phase. Only a gullible fool listens to economists over the markets.

The most important conclusion to be drawn from the market performance is that the markets look ahead; hence, the Deflationary Depression is more likely to be in the future than in the past.

How Come We Don't See the Signs of Outright Deflation and Depression Yet?

Good question, but there is a very simple explanation. In any given phase, the defining characteristic of that phase does not have to be at the beginning. In the Inflationary Recession phase, for example, the worst is more likely to be at the end from the nature of that phase. Since the Deflationary Depression of the previous Longwave lasted lot longer than the preceding growth phase, it is probable that the current Deflationary Depression could last anywhere from 15 years to 35 years. We are only in the first 5 years of the Deflationary Depression phase and we have lot of time for outright deflation and outright depression to take place that no one would be able to deny. What is the hurry? And for those of us whose investments are positioned for Deflationary Depression, the best is yet to come. Sorry, but economic forces are too powerful for Greenspan, or any other span, to be able to avert. We must position ourselves as best as we can from the knowledge of history. The only thing a political hack like Greenspan can do is to postpone the inevitable and make matters worse. And that he has already done before his departure.

To buttress the above point, if you recall your history of recessions and recoveries you will notice that there were some sharp contractions during the two growth phases and good recoveries during the recession phase. Counter trends are normal and always take place during any of the four phases of the Longwave. And they sure fool lots of people.

The worst period during any phase only lasts for 12 to 36 months, even though the phase could be 20 years long, as was the case during the Great Depression. The WW II led recovery during the Great Depression was the best ever recorded in the US, but the economy fell into depression after the war economy was withdrawn. One reason that we have not had the worst yet is that this phase is likely to be lot longer due to greater distortions in the economy that lead to the Deflationary Depression in the first place. It is the cleansing phase for the economy. Doesn't it feel good when one gets rid of all the garbage and junk accumulated over a long period of time? The junk in the case of the US economy has a name that start with d and ends in t. The worst will come when the Private Debt starts to shhhhrrrrrink. Wouldn't it feel good for 5'7" Amerique Conman, the symbol of the US economy, to go from 390 lb. to 110 lb. and lose all that flab?

When the Chief Economist for the Wall Street firm with the big bad bull symbol says, "Play It Safe!," it pays to heed the advice.

Your econ-crank,

Jas Jain, Ph.D.
the Prophet of Doom and Gloom

Copyright © 2004-2007 Jas Jain

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