The Kondratiev Cycle Revisited: Part One, Current Position in Cycle
In a previous article I presented a new way to look at prices called reduced prices. Reduced prices are a normal price index, such as the PPI, divided by a theoretical price obtained from a simple monetary model:
Model Price = A + B·S, where S = (money supply + cumulative federal deficit)/GDP
Here A and B are parameters obtained by doing a linear regression of the actual price versus S over a moving 100 year period centered on the year of interest. For more details see my previous article. Figure 1 shows a plot of reduced prices from 1860 to the present. Three Kondratiev peaks are evident, in 1864, 1918 and 1981. In between the peaks are two "Kondratiev troughs" in prices, one in 1897 and the other in 1946. The spacing of these peaks and troughs average 55 years in agreement with the 50-60 year length usually ascribed to the K-cycle.
The period of rising prices, between the Kondratiev trough and the Kondratiev peak is the Kondratiev upwave, or just upwave. Conversely, we call the decline from the peak to the trough the downwave. If we examine each downwave closely we see that after each Kondratiev peak there is a sharp drop and then a leveling-off in prices, producing what is sometimes called the (price) plateau. The plateau ends with a second precipitous drop, or what is sometimes called the fall from plateau. This second drop bottoms in what has been called the vortex by the economist Brian Berry. Figure 1 shows plateaus ending in 1872 and 1929, with a third possibly ending now. The vortices following the fall from plateau occurred in 1878 and 1932. Following the vortex, there is a temporary rise in prices to an intermediary peak, before prices fall still further to the Kondratiev trough. Following Berry, I call the price peak reached at this time the "deflationary growth peak" or DG-peak. DG-peaks occurred in 1881 and 1937.
In my spring 2001 article, I suggested that if the interpretation given by historical reduced prices is correct, the stock market peak in 2000 should be equivalent cycle-wise to that of 1929, and that we were getting ready to "fall off the plateau" in terms of reduced prices. I wrote this "interpretation suggests that reduced prices should peak soon, very possibly this year." At that time I presented data up to the end of 1999 and as of that date the trend in reduced price was upwards. As Figure 1 shows, the trend in reduced price began to fall early in 2001 and as of last December (as late as I have data as of this writing) reduced price has fallen to the lowest level of the post-1981 downwave. Figure 1 suggests that we almost "fell off the plateau" in 1998 but the Fed was able to push the economy back up for a couple of years by deftly-timed rate cuts. This time, after a year of rate cuts, reduced price has continued to fall. It seems less and less likely that Chairman Greenspan will succeed a second time at holding Kondratiev winter at bay.
Also shown in Figure 1 is a new measure for the K-cycle, the ex ante real interest rate. The ex ante real rate is a measure of investors' collective beliefs about the future value of money. It cannot be measured directly, but it can be inferred from measurable data using complex mathematical models which are beyond my understanding. One such model, based on a regime switching framework1 and implemented following Garcia and Perron's three-state interest rate model2, has been recently proposed by Kolari and Viale3. This model shows investor beliefs about future real interest rates shifting between high-level (4-6%) and low-level (negative) regimes. Figure 1 shows a plot of the quarterly ex ante real rate obtained from Mr. Viale, which has been smoothed using a running nine quarter moving average. The key feature of interest is the rise from a trough, that is close to K-peaks in reduced prices, to a broad plateau that falls to another trough around the vortex in reduced prices. This trough is followed by another, even deeper trough, which denotes the K-trough. Another feature is a peak between troughs corresponding to the K-trough and K-peak. This peak closely corresponds to the upwave secular bull market peak that denoted the transition from Kondratiev spring to Kondratiev summer.
Table 1 summarizes the Kondratiev cycle signposts using three criteria, stocks, reduced price and the ex-ante real rate. It presents my basic case for asserting that our current position in the K-cycle is in the early stages of the "fall from plateau".
|Signpost||Stocks||Reduced Price||Ex-ante Rate|
1. Hamilton, James D., (1989), "A New Approach to the Economic Analysis of NonStationary Time Series and the Business Cycle", Econometrica, 57(2) 357-384.
2. Garcia, René, and Pierre Perron (1995), "An Analysis of the Real Interest Rate Under Regime Shifts", Scientific Series, No. 95s-5, CIRANO Centre Interuniversitaire de Recherché en Analyse des Organisations.
3. Kolari, James W and Ariel M. Viale, "Gibson or Fisher Paradox? Back to the Future Expectations and Escape Dynamics of a Very Plausible Robust Agent", 2001, unpublished manuscript.