An Interview With a Long Wave Master: Part II
David Knox Barker is one of the leading authorities on the economic long wave, otherwise known as the Kondratieff Wave (a.k.a. "K Wave"). Barker has had an impressive career both as a financial market writer and long wave analyst, as well as being an entrepreneur in the field of emerging nanotechnology. Back in the late 1980s and '90s, Barker was known for his insightful and accurate views on the U.S. economy and financial markets via his "K Wave Report" newsletter.
Barker first emerged on the financial market scene in June 1987 with the publication of his first book, Jubilee on Wall Street: An Optimistic Look at the Coming Financial Crash. The second edition was published in 1995 under the title, The K Wave. The third edition of Jubilee on Wall Street was published in late 2009 and is, in my estimation, an instant classic that should be read by anyone interested in the outcome of the global financial crisis.
Barker recently discussed the book with me and shared his thoughts on what he sees ahead for the United States and the emerging markets. What follows is the second installment of the transcript of that interview.
Q: You touched on this in your book, but let's talk for a minute about some of the technologies that could help put the U.S. on the economic path to long-term recovery.
Barker: I'm a believer in alternative energy as one of the technologies that will lead us into the next [long wave] advance. Fuel cell technology and electric cars will be a part of that. If you look at the sciences like nanobiotechnology and environmental technology and nanotechnology and other areas of technological innovation. Then we have innovations in transportation and space travel. The U.S. is a major leader in space exploration. By the time we get into the late spring and summer seasons of the next long wave I think space tourism will be a significant industry. To take one instance of new technologies coming online, there's a company here locally [in North Carolina] that has acquired the patents for a new ballast that reduces the electrical costs of street lights by 30 to 70 percent depending on how you set up the system. You could actually have something similar to this attached to the whole grid. It's very exciting technology.
Q: What are some other examples of radical new technologies that could propel the next long wave advance?
Barker: I actually know of a local real estate company that has developed a building system that could have a potentially shocking impact on the housing industry. Right now to build certain high-end houses you need $200 + per square foot. [This company] has built a system using inert materials, a green system that's hugely efficient and the structural integrity of it is phenomenal. You're cost of building falls closer to $50 per square foot under this system and it's a home that's virtually indestructible. It would be ideal for building houses in tornado alley or on the seacoast where homes are vulnerable to hurricanes. Then you just look at it and ask, "What's the implication on the whole housing market where people are paying X amount of dollars per square foot?" After the 30 percent deflation in the housing market we're still north of $100 per square foot. Well this is what happens during a long wave winter season. New inventions and technologies come out that can have a huge impact on multiple industries. On the housing industry this development will have significant implications for building a house that's [environmentally sound], it's efficient and it will last generation after generation. It's a deflationary technology on the old technology, which is typical of some of these innovations made during the long wave winter.
Q: What are your views on real estate between now and when the long wave bottoms?
Barker: I still think we have another leg down [in the housing market]. I mean if you look at the shadow inventory and the supply that's available on the market now, especially if we enter this debt crisis phase I'm talking about, I see another leg down. Depending on the market it could be anywhere from 10 percent to 40 percent. And then you have new technologies coming, as we discussed, that will naturally drive down prices because they reduce the cost of building. But I believe the real estate crisis will bottom by 2012. I don't consider myself a real estate expert, but it's just looking at the natural tendency toward deflation of this next leg down in the long wave winter season.
Q: You also talk about Digital Gold Currency (DGC) in your book. Please expand on this.
Barker: All of a sudden for the first time in 20 years the central banks aren't sellers of gold. I think we're in a window here where gold is effectively the world's second reserve currency. It's not acknowledged publicly and people aren't aware of it but I believe gold is the second reserve currency behind the dollar. Depending on what government policy does will depend on whether gold becomes more dominant. I think fiat currencies are here to stay but what most people have not yet recognized - James Turk has recognized it; he's the founder of GoldMoney.com - is that during the next long wave advance gold will become even more important. [Turk] has created a new currency based on gold. If you combine the data system of the Internet with gold and with secure vault storage in Switzerland or London, Digital Gold Currency has the potential to become huge. Right now you can open an account with DGC at any given time and you can move in and out into other currencies into your gold account. It's coming.
Q: Tell us more about how Digital Gold Currency can be used in the global economy.
Barker: Imagine yourself as a Wal-Mart or an IBM and you operate in hundreds of countries and you have to hedge your currencies in all these countries. With James Turk's company, businesses can open an account in Digital Gold Currency and operate in a way that prevents their having to do a lot of the hedging and eliminate a lot of the expenses they incur in their hedging activities. That's one reason why I'm optimistic about the drivers of the next long wave advance.
Object oriented programming is another thing I'd like to mention that's going to be a dominant force in the next advance. What you see is that these are the technologies that selected by industry during the long wave winter and begin to be capitalized but they don't get fully implemented until the advance. For instance, the object oriented paradigm, which was converted to the object oriented computer programming approach, is making the world more efficient. But it's also doing a few other things. The world really is a loosely coupled object model and object oriented programming, or OEP, is realizing that and allows companies to deploy in a more efficient manner. I think OEP is going to be a major driver in the next advance of the long wave. There's also a connection between OEP and digital gold currency because under the hood of the systems running major corporations and banking institutions is an object oriented paradigm, a view of the world, which allows everyone to operate more efficiently and what it allows is for your computer systems to more intelligently reflect the real world. The way this will play into Digital Gold Currency (DGC) is that it will be a driver to make DGC a logical option for people. I think there will be a combination of private digital gold currency banks as well as sovereign players. I think you'll see certain countries buying into Digital Gold Currency and effectively establishing sovereign DGC systems.
Q: In the book you also talk about the Great Republic. Let's discuss this concept.
Barker: Necessity is the mother of invention and it's my hope that during this crisis we will make some changes. If you look at the austerity in Ireland and the austerity being forced on Greece, and I think the austerity that will be forced on the United States as we enter this debt crisis. I get the term Great Republic from Adam Smith's book, Wealth of Nations, when he talked about the great mercantile republic. I've simply dropped mercantile and left the word republic. The dominant feature of this idea is that as a nation we can't consume more than we produce. I believe there is a great deal more political change coming that most people realize. The Tea Party movement is just the cutting edge of the political changes that are coming.
One of the hallmarks of the Great Republic would be a massive change to the current tax structure. I would advocate that we shift to a flat sales tax system as opposed to an income tax based system. It would be a much more fair tax system. It also needs to come with a movement to reduce government spending as a percentage of GDP. I think there will be much more need for change in this coming crisis than people realize and I'm optimistic that we'll make the change in the right direction. I realize this optimism may seem misplaced relative to what we see happening today. Nonetheless I make a case for it and I present a12 points of the Great Republic in the new edition of the book.
Q: The book chapter with the most frightening implications was the one entitled, "A Redistributive World Empire." Please tell us more about it and what are the chances that the U.S. enters into this type of political system in the years ahead?
Barker: I picked up that term from, Redistributive World Empire, from Immanuel Wallerstein. There's an interesting group called World Systems Analysis that studies the advance of civilizations, cultures, etc. Wallerstein has said that in the past he has said that any world economy has ultimately evolved into a redistributive world empire. Rome is the classic example of this type of empire, where the bread and circuses were required to pacify the masses and the Roman Senate was completely corrupt and of course the Caesars became corrupt and ultimately Rome collapsed. What's interesting is that Wallerstein's work has always seen that progression from a world economy to what he calls a redistributive world empire. This time around, however, he's proposing that each long wave is a kind of birth pang of global socialism. Incidentally, Wallerstein has very left-leaning socialist inclinations. He believes that instead of going toward a redistributive world empire we're going to go toward global socialism. Of course if you look at what has happened in the last year and the way we responded to the global financial crisis, you have to say, "Oh my goodness, Wallerstein may be right after all." But if you look closer, what really has transpired is what looks more like a Redistributive World Empire where the middle class is taxed really for the interest of an elite class of political and business managers. I guess another term of Redistributive World Empire would be crony state capitalism. And state capitalism isn't the same as international free market capitalism.
So basically in the book I present three scenarios. Scenario one is what Wallerstein says, namely that each long wave leads to a bigger crisis of capitalism with the birth of global socialism. I don't think that's where we're headed. Then I examine the observation that in the past a crisis in the world economy always produced a redistributive world empire. You'd have to say that's the most likely outcome where we're headed based on the evidence. My proposal is the Great Republic, and I truly believe there is a great chance to go in the direction of true international free market capitalism as a result of the crisis that we're sailing into. I think as you look around and see the austerity in Ireland and see the Germans preaching austerity to the Greeks, it's important to realize that austerity is not a redistributive world empire. I actually believe that a sovereign debt collapse would be the ultimate mother of invention leading to the necessity of a Great Republic. There's definitely the potential for such a collapse to produce change towards the Great Republic.
Q: Many observers would dispute this assertion based on the weight of evidence. How would you respond?
Barker: It's easy to look around at what has happened since the credit crisis and say, "This looks like a Redistributive World Empire." But it's also interesting to look at a recent quote from Ron Paul, who was responding to the accusation that Obama is a socialist. Ron Paul said, "Obama isn't a socialist, he's a corporatist." The corporatist world view is the same view as the Redistributive World Empire, namely that there's an elite class of business and government taken care of no matter what happens while the middle class is taxed to make sure that the elite class survives. I think that the Redistributive World Empire that embodies this concept is currently going through a shock of its own and it's not going to work. I think the only direction we have to take is not toward socialism but toward international free market capitalism. It's part of my optimistic outlook following the global financial crash. I mean, who would have ever thought you would see the German Chancellor quoting Ayn Rand in saying that the Greeks must learn that they cannot consume more than they produce. That to me is the light coming on in the minds of politicians, causing them to realize that the Redistributive World Empire won't work. We need to actually reduce the power of government and austerity is the path we must take.
Q: In the book you talk about the relationship between the Federal Reserve and the U.S. government. Specifically, you state that government spending is primarily to blame for the financial crisis, not the Federal Reserve. Could you expound on that for us?
Barker: If you look at what happened in Congress with Fannie Mae and Freddie Mac and the political demand on the Fed to stimulate economic growth, the core issue here is that the Fed has two mandates: price stability and leading the country toward full employment or economic growth. The European central bank only has the mandate of price stability. By giving the U.S. Fed the mandate of economic growth and price stability you create an oxymoron, a contradiction. I wouldn't say the Fed isn't to blame for any of this crisis but I do believe that more of the blame should go to government policies than on Fed policies. Where I think the Fed messed up was with the reserve requirement. We should have a much higher reserve requirement to significantly reduce the leverage in the system.
A significant part of this problem was the $7 trillion in mortgages that Fannie and Freddie dumped onto the market place. And then the mortgage originators weren't regulated, the ones who created these zero money down "liar loans," these 120 percent of principal loans. It was total insanity but it wasn't a free market phenomenon because if an investor didn't think they were government insured mortgages then no one would have touched them, they were toxic. There would not have been the securitization of these mortgages by Wall Street. To get back to the Fed, the Founding Fathers knew what they were doing when they wanted to have limited governmental power. Obviously people question whether the Constitutions allows for the creation of the Federal Reserve. I believe it probably does but it doesn't allow for a Fed that has the kind of leverage used in the system and tied into government policy. The problem is that primarily bad government policy and bad Fed policy combined created [the credit crisis].
A lot of the critics of the Fed will show you what a dollar was worth when the Fed was created and show you the decrease of the value of the dollar. But if you actually draw that chart in a dollar that was kept in a 3-month or 6-month T-bill account, you have actually done quite well. But again, the problem here is the over-leverage of the system.
Q: What can be realistically done to balance the power of the Federal Reserve?
Barker: I sincerely believe that Digital Gold Currency (DGC) will balance the Fed; it's coming. The Internet has met gold and secure vaults in Switzerland, London or New York and we're going to have international currency. It's interesting that for the first time in 20 years central banks are no longer selling gold, they're holding it. I think what we're effectively seeing is the development of the world's second reserve currency. You're going to see DGC combined with the Internet to see some very interesting dynamics in the currency market. I can actually see Fort Knox being turned into a Digital Gold Currency bank before this crisis is over with independence from the Federal Reserve and run by the U.S. Treasury.
So if you had a central bank that had only a price stability mandate and actually maintained higher reserve requirements and didn't juice the system, and if you also had a competing Digital Gold Currency system, it would make for a very interesting world and I think it's where we're headed.
Q: You also discuss some of the technical details of your system of market analysis for the benefit of investors who want to capitalize on changes in the long wave. Please tell us more about the system that you call Long Wave Dynamics, or Theory 144 Analytics.
Barker: What I call Long Wave Dynamics (LWD) is looking at the whole economic force of the long wave and which deals with market fundamentals. Theory 144 Analytics, which is an integral part of LWD, turns the long wave into a tool for technical market analysis. The long wave is an economic phenomenon and there are technical aspects to it and it fluctuates between 48 and 64 years and you'll recognize that's a Fibonacci ratio of a 56-year cycle.
Theory 144 Analytics essentially is based on the work of the market analyst PQ Wall. A lot of people misunderstood the writings of PQ Wall, who passed away last year. He was a friend of mine and I spent a great deal of time discussing cycles with him and I learned a great deal from him. I think PQ's greatest contribution to technical analysis is that the long wave divided by 144 is a miniature long wave and is what a trader would recognize as a 20-week cycle. In the 1995 edition of the book I rechristened that cycle as the Wall Cycle. The way you get to the 20-week cycle from the long wave from the divisibility of 144 is what PQ called the Principle of Threeness and Fourness. He first divides the long wave by four to come up with the four long wave seasons. You divide it by four again and you come up with 16 regular business cycles in every long wave. That's extremely important and is another area where PQ must be credited. Many people realize that the famous Harvard economist Schumpeter created a cycle model that had 18 regular cycles in the long wave. I sincerely believe that one of PQ's greatest contributions is when he corrected Schumpeter when he realized there were only 16 regular business cycles in a long wave.
Q: How does your concept of the smaller cycles fit into this theory?
Barker: What I began doing in the mid 1990s was experimenting with PQ's model of cycles and trying to determine ideal lengths of cycles. Anyone who is a technical analyst or a trader knows about these cycles but you also know they're never consistent exactly. But if you take my notion of ideal cycles and take a 20-week cycle, what I'm suggesting is that the ideal 20-week cycle is 141.9 days. That also means that the ideal business cycle would be 42 months, then you keep dividing it by three and that's how you get to 141.9 days. If you take that 141.9 days and look at the Fibonacci ratios on either side of that, for instance, if it's 38.2 percent short or long, or 50 percent long or short, then you begin to see that these cycles will consistently hit these ratios to their ideals. You'll find that very consistently it hits these dates [based on Fibonacci ratios] in time. You can obviously use Fibonacci in terms of price as well. So when you combine Fibnoacci in time and Fibonacci in price you have a new theory of technical analysis. Theory 144 Analytics is really Wall Theory juiced up with Fibonacci and stochastics in order to understand what's going on in the cycles.
If you're a true investor - and as an investor I defer to Benjamin Graham - the reason you buy any stock is based on cash flow that you'll generate in the future. So you can use the business cycles within the long wave season for looking at entry and exit points for investments. Traders, on the other hand, look at the Wall Cycle, the 20-week cycle, and the quarter Wall Cycle, which is a 35-day cycle, to evaluate stocks. A trader has a different view than an investor and a lot of people think that they are investors when really their actually a speculator. And you need to make sure you know what you are. It's important to realize that you're either a long-term investor and your purchasing investments because they generate cash flow in the future and you're going to buy those cash flows at a discount. Or you're a trader and you're betting on the short-term movement and you're simply timing the market irrespective of cash flow considerations. The Theory 144 approach allows us to serve both of those targets for investors and traders.
Q: What can you tell us about the psychological aspects of the long wave?
Barker: Human psychology drives the cycles and there are trends in psychology. For instance, if you look at the 1970s to early '80s and the force that brought Ronald Reagan into office, it was a seasonal change in the long wave. It was a shift from the Roosevelt era of the 1930s of "The government should go out and save me from the economic forces" to "Let the free market take care of itself." Then with Obama we saw a shift back to the idea that the government needs to step in and control the markets. A lot of the psychology you see is manifested in political trends. In the 1930s we gave the New Deal a chance. I talked in about that in the 1995 edition of my book, that fact that we'd probably see a global version of the New Deal proposed during the present crisis. And sure enough that's exactly what was proposed [during the credit crisis of 2008]. The fact that people are even talking about a global New Deal is a sign that the psychology has radically changed. The socialists are excited because they think we're headed in that direction, but I think they're in for a major disappointment. I think we're heading for a shift [in psychology] to a degree larger than the previous shift in political psychology. I sincerely believe the Tea Party movement is an early manifestation of this emerging shift, which I believe will be toward the Great Republic.
Q: Thank you, David, for taking the time to share with us your views on the long wave.
Barker: It was my pleasure.
Note: David K. Barker's book, "Jubilee on Wall Street" is available from Amazon.com by clicking on the following link: https://longwavedynamics.com/?page_id=16