Long Waves
...dea: "Ominous Parallels To Late 1920s? Then As Now: Roaring Stocks, Deflation, Stingy Feds." If what the IBD is worried about turns out to be true, the American economy could be in for hard times again! If this happens, our somewhat lazy academic economists might find it worthwhile to check Schumpeter's book out of the library a little more often. What they will find there is briefly explained in the following . If Schumpeter's historical and economic analysis is correct, we are sliding down the long back side of what is called a "Kondratieff wave" and picking up speed as we head towards the trough. What will be required to start marching up the other side and back into prosperity, according to Schumpeter, is a period of "creative destruction." During this unpleasant period the fictitious values of the boom (like an overpriced stock market ) are destroyed. It is at such times that capitalists finally go to work and invest in new technologies to power us out of the depression that almost always occurs. In previous economic crises, such as the period of the "late 1920s" that the Investor's Business Daily has so convincingly evoked for us, the process of "creative destruction" was initiated by bizarre public and official behaviors. This included stock manias, economic panics, bank runs, Fed jawboning, and stock market crashes. Does any of this sound familiar? Schumpeter inherited the idea that there is a long a-periodic economic cycle governing all of this from an unfortunate Russian called Kondratieff. We’ll call him "K" for short. K's article on what he called "long waves" came out in 1926. Not much later K perished in one of Stalin's brutal purges, probably for having above average intelligence. Schumpeter speaks of Kondratieff's "long wave" very approvingly and discusses it together with two observed business cycles of shorter duration called the "Juglar" and the "Kitchin" cycles after the statisticians who described them. Schumpeter believed that there were "…six Juglars to a Kondratieff and three Kitchins to a Juglar- not as an average but in every individual case" (pp.173-174). Having lived through nine years of economic crisis by the time his book was published, Schumpeter believed that the Great Depression happened because the end points of all three of these fluctuations occurred at the same time (p. 173). Juglar and Kitchin cycles have been pretty much forgotten today. The Kondratieff long wave, however, still excites interest among cycle buffs, perhaps because it fits in so nicely with what we know about economic history. All three of the patterns pointed out by Schumpeter, on the other hand, have one very important element in common. The Kitchin, the Juglar, and the Kondratieff are all based on the timing of technological change (or what the economic historians call "innovation") as it occurs within the free market system. The Kondratieff is easier to see because it fits in with the most obvious moments in the development of the industrialism in its dynamic relationship with free enterprise. The first Kondratieff, Schumpeter says, was the Industrial Revolution itself which lasted from about the 1780s through 1842. The era that followed (1842-1897) was, according to Schumpeter, " the age of steam and steel." The third Kondratieff was based on "electricity, chemistry, and motors", and was ongoing when Schumpeter was working on his masterpiece (p.170). These periods of growth and expansion saw ever increasing productive and financial power in the industrializing countries and were punctuated by episodes of economic crisis in every case. If the IBD has called it correctly, we might be entering such an era of economic crisis once again. The key to the picture is the long- term behavior of prices in general and commodity prices in particular. The short form of the argument is as follows: when prices go into long periods of decline, look out! The logic of the long wave idea is not complex. Long wave theorists believe that innovation in the world of production and management happens not as a series of single events, but as a related set of changes all simultaneously affecting one another. Those of us who have lived through the computer revolution can see the logic of this in our own lives. Take computers (or as the stand up comic guy might say "Please take computers!"). No sooner did you get a simple PC for a little word processing and maybe to balance your checkbook, than it was obsolete. The reason was that, not many months after you bought it, you found out you needed something called a "modem." Then you noticed that your original software was already archaic, ineffective, and slow: six months after you bought it. A few short years later, everything you see and hear off from an overheated stock market to the problems of the "E-traders" is about "telecommunications." "Telecommunications", it turns out includes the computer you now own which is ten thousand times more powerful and about half the price of the first one you bought not so very long ago! The total complex of innovations and interconnections that has taken place in cyberspace in the last two or three years has happened so fast that you may already feel like a dinosaur. This can be especially true when your pre-teen comes up to you and starts whining about something called "bandwidth." All of the eras of intense technological change mentioned by Schumpeter as the basis of K’s "long wave" were like this. The first of the Kondratieff waves, according to Schumpeter was due to industrialization itself. Schumpeter refers to the waves that followed as based on "railroadization", electrification, and "motorization"(p.167). To follow out Schumpeter's logic here we would call the era that we have been living through the era of "computerization." Of course, our era is not over yet. In fact, some people believe that the era of "computerization" has hardly begun; especially those people who are paying several hundred times earnings for those high flying Internet stocks. The question you should be asking by now is "Why does there have to be a down segment of the long wave? Why can't things just keep going up?" Schumpeter's answer to this question occupies the best part of the five hundred plus pages that make up the second volume of his major work. In a short form of words, however, Schumpeter's position can be simply explained as follows. Industry produces two kinds of goods: consumer goods and producer goods. The production of consumer goods (in other words what the economist calls "capital goods") dominates the upswing. This inevitably leads to increases in the amounts of consumer goods being produced as the new capital goods create wealth more efficiently. This is, indeed, where the problem lies, namely, with the new producer goods that created prosperity in the first place! As Schumpeter puts it: "In general, however, new products will be released as prosperity wears on, their impact being part of the mechanism that eventually turns prosperity into recession"(p.502). This is where we came in! That is, with the clarion call of the Investors' Business Daily and their concern to the effect that the period we are living through looks an awful lot like the "Roaring ‘Twenties." The period of the 1920s saw both declining prices in basic commodities and a stock mania on Wall Street . According to the IBD it also saw the endless jawboning of a certain Mr. Young who was at the What seems to happen at the top of the long wave is that the effects of innovation spread out like ripples in a pool and eventually involve almost all firms in the economy. When this takes place the profit picture for each individual firm changes. As more and more companies incorporate the new technology, profit rates are less and less exciting to each of those companies and to the people who own them. Owners of capital who are not making the kind of money that they enjoyed during the upswing decide to sit things out until better times come along. Technically, they withdraw capital from production. Consequently, the demand for raw materials normally used in production (ie, basic commodities) also declines. This demand side weakness ushers in a long period of declining prices, business failures, and, paradoxically, a stock market that becomes overheated as capital is switched from productive to speculative uses. This was, more or less, what was going on in the late 1920s. A certain Mr. Young was Chairman of The Federal Reserve Bank of the United States at the time. Compared to Mr. Young, who snarled about "stock speculators" and how he was going to hang them from the yardarm, current Fed Chairman Mr. Alan Greenspan looks like a nice guy. Like his unfortunate predecessor, however, Mr. Greenspan is also trying to jawbone the markets out of their madness or what he calls their "irrational exuberance." As far as prices are...