This month’s digest will focus on how the super cycles affect the economy and your investments. Based upon this knowledge, you can modify your investment approach to protect and grow your wealth.
Protection is most important, as it takes time and effort to rebound back from major losses. And these super cycles will result in major, and potentially catastrophic, losses for most investors who do not know they are coming. That is where you will have the advantage, and a key reason why you subscribe to this service.
Here is a quick summary of what will be discussed this month.
Major Economic Cycle Theories
Researchers have been investigating various theories around economic cycles for over a century. Perhaps the most well known and influential research came from Russian economist Nikolai Kondratiev (also written Kondratieff). He was the first person credited with bringing the theory of economic waves to the attention of international economists and scholars. Many other scholars have studied his theories and expanded on them. Several have provided their own modifications. But the basis of all modern economic cycle theory originates from Kondratiev.
Kondratiev (1892 – 1938) was an agricultural economist who analyzed business cycles. His theory was that economic patterns could be explained, after examining data, through a social lens. Often, his theories are disputed by economists who believe economics is more akin to a physical science, like chemistry or biology. These economists argue that the economy of a state or nation can be determined merely through examination of data. This belief is what has led many economists and politicians to believe in the state-planned economy often popular in communist and socialist regimes.
Even most Western governments have employed state-controlled economic planning in the form of economic policies and central bank fiat currencies. The US Federal Reserve, for example, controls the supply of money and lending rates to the major banks in an attempt to regulate the US economy. They believe that by understanding the data of past economic events, they can control the future of the economy, to an extent.
It is interesting to note; however, that even these economists and central bankers believe in the business cycle because their very existence was brought about to control it on behalf of the politicians who disliked the bust phases of the cycle. It is this attempt to control the business cycle that led to the rise of Keynesianism, after the late economist John Maynard Keynes (1883 – 1946).
What is interesting to note is that no matter which side of the argument an economist is on, whether it be economics primarily as a social or physical data science, both sides agree that the economy works in cycles. And it is the basis of this belief that all major economic policy in today’s world is built. Therefore, you should know this if you want to protect and grow your wealth for your family.
In an attempt to keep this discussion in true digest form, I am going to summarize the differences between economists. However, there have been many, many books written on the subject over the years. In fact, my book Drop Shadow is an example of my treatise on economics and finance, written for the regular everyday person who is not a studied economist. When you look at the finance section of a major book store, you will find numerous authors discussing these same things from different perspectives.
What is common among all economists is the belief that understanding economic cycles is important. Even though they approach it from different perspectives (sociological versus scientific), their aim is always to understand the cycle so they can manage the risk. One of the consistent themes of this site is to address market and investment risk, and hence why I think understanding economic cycles is vitally important.
While economists don’t always agree on the treatment for cycles, they do agree they are of the upmost importance. And they even agree that the cycles contain several major phases, though they are discussed in different terms. What I will focus on is the sociological aspects of the cycles, and will not attempt to predict specific financial outcomes using data here. The main reason is because the data is examined in much detail elsewhere on this site already, such as in the Investor Education Center. You can find more using the data in that series.
Kondratiev believed that economic cycles came in three long waves, each lasting up to 50-60 years. Each wave had an upswing and downswing, and there was an identified turning point in the middle.
Kondratiev himself based cycles on the study of capital investment dynamics. Subsequent researchers have focused instead on technological innovations within society. This is why you will often see phases of US development broken down into terms like ‘Industrial Revolution’ and the ‘Internet Generation’. Journalists are referring to the technology-focused aspects of Kondratiev wave theory.
Kondratiev himself made a key observation about technological innovation during these waves.
during the recession of the long waves, an especially large number of important discoveries and inventions in the technique of production and communication are made, which, however, are usually applied on a large scale only at the beginning of the next long upswing.
K-waves have become especially critical to an understanding of economic growth, wars, and systemic leadership… But they also appear to be important to other processes such as domestic political change, culture, and generational change. This list may not exhaust the significance of Kondratieff waves but it should help establish an argument for the importance of long waves to the world’s set of social processes”
Later, however, quite a few scientists presented new evidence supporting the presence of long waves in the dynamics of the world economic indicators. For example, Mandel (1975: 141; 1980: 3) demonstrated that, in a full accordance with Kondratieff’s theory, during Phases A of K-cycles the annual compound growth rates in world trade were on average significantly higher than within adjacent Phases B during the period between 1820 and 1967. Similar results were arrived at by David M. Gordon (1978: 24) with respect to the world per capita production for 1865–1938 on the basis of the world production data from Dupriez (1947, 2: 567), by Thomas Kuczynski (1982: 28) with respect to the world industrial dynamics (for 1830–1980) and for the average growth rates of the world economy (1978:86) for 1850–1977; similar results were obtained by Joshua Goldstein (1988: 211–217).
The table above shows that these super cycles tend to wane after 120-130 years. For example, the last one lasted from 1790 to 1920. If we use the same time frame, we are 110 years from the end of the last Kondratiev cycle. This means we are currently in the downswing of the third major wave of the cycle. We are NOT in a growth phase, even though people believe the stock market bull can last forever. Economic research says this is a false belief!
Let’s look at the next set of cycles and see what they are telling us.
Kitchin cycles are believed to be shown in inventory fluctuations. Meaning, as inventory amounts change over time, trends in these cycles predict economic events. Essentially, the market gets flooded with commodities as inventories are built up on expectation of continued growth. It is during this phase that demand declines, prices drop, and output slows.
Businessmen don’t know right away that supplies are building, it takes time for the information to get to them. Here is a time chart (from Trading Economics) of US business inventory data, which clearly indicate periods of recession about every 5-10 years.
Here is a similar chart from the Fed, that shows the relationship of inventories to recessions. Pay attention to the fact that inventory reductions tend to happen DURING recessions, and not before. Meaning, when we see inventories start to pile up, we know the recession is coming soon. But when the inventories turn down, we are already IN the recession.
So can we predict, using the Kitchin Cycle, when the next recession is coming before the inventory crash happens? Well, we can at least look at the manufacturing index, aka PMI, to see when orders are steadily falling. This is an indicator that inventories are at a peak. This chart is also from Trading Economics.
Further, we see that commodities prices overall have fallen from all-time highs in 2008. This tells us that commodity demand has never recovered from the financial recession. Meaning, we are reaching lower highs in the commodity space since 2008, a clear indicator commodity growth is going down in manufacturing. And this is occurring at a time when many commodities are becoming relatively more scarce to find, and more expensive to produce! Image from Trading Economics.
So it appears as though we may be ending the current Kitchin cycle as well. That is two cycles, what about the next one?
The most recognized cycle for post-industrial economies (e.g. those less dependent on manufacturing) are the Juglar cycles, named after French economist Clement Juglar. Juglar first observed these cycles in 1862.
The Juglar cycle describes fixed investment in capital of 7 to 11 years. Juglar cycles differ from Kitchin cycles because they measure changes in capital investment patterns, and not just changes in the level of employment of the capital into the economy. In other words, think of Juglar cycles as a measure of capital acceleration versus volume. The follow chart shows the slowing down of capital investment in the economy.
As you can see in the chart above we are not only at a cyclical peak in capital spending. We are at an all time peak. Also note this is a logarithmic chart, which adjusts for percentage changes. We are therefore not just charting overall capital spending increases, but the rate at which it has increased.
You can see the previous dips in spending on the chart which indicate we are probably near the next cyclic fall in capital expenditure, though the data is not conclusive when exactly this will happen. Many headlines in 2019, however, seem to point to reductions in capital spend are starting to form in major industrial sectors and companies.
What we see from the headlines is previous growth sectors, including transportation, energy, and green autos are seeing some pretty healthy CAPEX cuts. This bears watching in Q2 of 2019 to see if the rest of the economic sectors follow suit.
What I have shown you is that the major economic cycle theories are all pointing to a downturn in the economy. These include two short term cycles, Kitchin and Juglar, as well as a longer term one in Kondriatev. I believe the simultaneous maturation of these economic cycles is also pointing to a political and cultural cycle change. This one will change the methods in which we invest our money and time. It will change the ways in which we vote politically, and interact culturally within our country. We are not just looking at an economic depression. We are staring square in the face at the end of US hegemony in the world; or in other words, the end of the US society as we currently know it.
In 1977, Sir John Glubb published a paper called The Fate of Empires and Search for Survival. Sir Glubb was an officer in the British Royal Engineers. He spent spent time in Switzerland as his father traveled on tours of duty. Sir Glubb followed in his father’s footsteps, and joined the Royal Military Academy in 1914. He served in WWI in France and Belgium, and was awarded the Military Cross after being wounded on three occasions.
He volunteered for service in Iraq and was eventually awarded an administrative post under the Iraq government. Eventually he also commanded the Jordan Arab Legion, which was effectively the army of the country of Jordan. After his service was over, he published 17 novels and lectured widely in Britain, the US, and throughout Europe. It was his travels, and exposures to different cultures and systems, that eventually led him to form his theories on the rise and fall of great nations.
In this paper, Sir Glubb examined 11 major empires across the world, dating from the Assyrians in 859 B.C. to the modern Britain empire through 1950. His research shows an unmistakable set of similarities among the empires, despite their geographic differences and age of occurrence. I will examine our current US empire using the criteria that Sir Glubb developed from this studies.
There is a popular real-time strategy (RTS) video game from Microsoft called Age of Empires that was first published in 1997. Back in my younger days, I remember playing many different strategy games because this was my favorite genre. One thing you immediately pick up from this type of game is that there have been many great empires over history, but they have all faded into the background over time. They all had a rise to prominence, but they all suffer the same fate over time. And what is left over of their civilizations is much different than what began.
The following table is from Sir Glubb’s paper, listing the major nation states that he studied and formulated his conclusions on why great nations rise and fall.
Note that Glubb separated the Roman period in two to account for changes in government from a Republic to an Empire. In his reasoning, Rome rose and fell twice, mainly because the empire had grown so big and covered so much of the world that it faced two separate and distinct ages of maturity.
Originally, the Republic was much like the early American Republic, with the peoples having freedom politically and economically. However, as the Roman influence spread, different factions vied for control splitting the nation state into two main ideologies. One wanted to remain free, the other wanted to expand influence around the world using war and economic suppression.
In the case of each of the distinct 11 ages of empires, the countries last from between 240 to 260 years. The observant reader of this article will note that this is approximately twice the length of the Kondratiev economic wave theory. Meaning, the average empire can go through two major rounds of economic boom and bust cycles before collapsing upon itself. I will note for the reader here that the US is approximately 243 years old since the Declaration of Independence was put forth by the colonies in protest of the British rule in the west. The significance of this date is thus explained.
Sir Glubb defined several stages of development that characterized all of the 11 great nations he studied. All of them begin with an outburst stage, defined as a group emerging from a homeland looking for new ground to call their own. And during this stage, the nation’s spirit and energy provide the courage to attack the wealthy nations that once ruled or controlled the people of the new state. This pretty much perfectly describes the American Declaration of Independence, and the Revolutionary War that would accompany it.
The Age of Commerce in each nation state was characterized by a strong sea power and a buildup of manufacturing capabilities. Sea power was needed to protect the newfound trading lanes needed to ship goods to other nation states across the world. The US Constitution specifically calls for a strong Navy in Article 1, Section 8.
The Congress shall have Power To…
To provide and maintain a Navy;
To make Rules for the Government and Regulation of the land and naval Forces;
After the Navy and manufacturing abilities are built, each nation state then finds itself growing more wealthy. The power of money is met with a growing lust for military power and the expansion of society beyond the current boarders.
The Age of Conquests starts innocently as an extension of trade route protections for goods being shipped overseas. Eventually, merchants grow extremely wealthy, and commanding a large assortment of naval vessels, turn their attention to growing their influence in the lands in which they trade with. Thus, the merchant ships eventually become warships serving the desires of the expansionary government.
In the US, this led to the formation of the Merchant Marine force. During times of peace, this group represents trading vessels. But in times of war, the merchant vessels are used to augment the Navy.
The first wartime role of an identifiable United States Merchant Marine took place on June 12, 1775, in and around Machias, Massachusetts. A group of citizens, hearing the news from Concord and Lexington, captured the British schooner HMS Margaretta. The citizens, in need of critical supplies, were given an ultimatum: either load the ships with lumber to build British barracks in Boston, or go hungry. They chose to fight.
As the empire’s influence grows over time, the wealth starts to flow out of the empire easily. And within the empire, the best roads, hotels, communications systems, and art are produced. These highlight the pinnacle of the new society at the same time they also predict its imminent demise.
From a cultural standpoint, each of the 11 nations studied by Sir Glubb emphasized the role of men as the protectors. Men were expected to overcome any challenges and to build the nation into a great force. Because new empires require strength and grit to overcome obstacles, boys are taught to fish, hunt, and fight. Eventually; however, the affluence corrupts the original view of the founders and the first few generations of the now settled empire. New ideas emerge, quite different from the old ones. And it is thus that the empire starts to change for good.
From an economic standpoint, the middle of the empire occurs during the end of the first Kondriatev cycle. At this point, the nation has gone through three K-waves, or intermediate economic cycles. The financial elite believe they have control over the economic fortunes of the empire, and spread their theories far and wide. And the people, living in relative luxury, believe their theories to be immutable. It is in this era of national hubris that the seeds of collapse grow and blossom.
A commonality between Sir Glubb’s theory on the rise and fall of nations, and Kondratiev’s wave theory established so many years before him, is the idea that intellectual advancement marks the final turn for empires.
Remember how Kondratiev noticed that the biggest technological advancements happen on the downside of economic cycles. Sir Glubb also noticed, when studying the cultural and political aspects of the world’s greatest empires, that the turn from manufacturing and development to intellectualism marked the downside of the empirical rule.
In the Age of Intellectualism, the following developments occur:
Does any of this sound familiar to you? Is there a single item above that US people are not dealing with at this very moment? I do not see one point that has not come center stage in American politics and culture since the 1960’s. In fact, many of these are being trumpeted as the new American identity. When in reality, they are hallmarks for death of the formerly great American empire, much as they were all of the great empires before it.
It takes on average 10 human generations before the rise and fall of a great empire is played out. This is basically equivalent to two full Kondratiev economic cycles. Therefore, we can say that economic and cultural aspects of great societies are closely related. And this means one cannot predict the ‘State of the Union’ unless they understand both aspects of mature societies. This is why I am teaching you both aspects in this month’s digest.
For those who believe we can manage the economy through policies directed at specific data points, I would point out this has never worked. Keynesianism is a relic of past economic progress, and it is not a new idea. The reality is that economic theory is not linear; rather it follows each empire’s development closely. That is why when one studies history, they often see similar theories across time. They simply emerge, fall away, and re-emerge as new nation states rise into prominence.
Therefore, dear reader, you cannot take the existing economic theory as confirmation that your future is assured. In fact, you should take the current hubris of financial and economic commentators as the death knell for our current system. As it always was, will it always be.
Each society falls for different reasons, though interrelated with the endless lust for expansion of the current empire. Some societies fell from within, some were attacked from outside, and some died from loss of vital colonies supporting the economic growth. In reality, each empire suffered from some combination of factors, with some more prominent than others dependent on how the empire was financed and built.
In the end, the ‘diversity’ championed by each culture weakened the once strong bonds that binded the society together. The ‘Outburst’ stage that begins each empire’s reign results from the common struggles of a largely homogeneous people. The subsequent march into diversity, and the attempt to solve problems across the world’s different people’s, begins the unraveling of the cohesiveness of the nation’s society.
Further, it is selfishness and the loss of duty to one another that ensures the nation can no longer endure hardships. When the third major economic super cycle (K-wave) hits, the society has been weakened such that it just begin to fall apart. People are worried more about their wealth and their own needs that they no longer band together to weather the tough times. All of the ties that held the complex society together have been cut, and thus the nation collapses.
It is clear throughout history that the idea of a nation state has divided the world into smaller and smaller pieces. This map from the Visual Capitalist show the development of many smaller societies from the original 8 super-cultures that dominated the world.
What is occurring now is the attempted merger of the complex web of societies into super states. As the age of America’s dominance wanes, emerging powers such as China and Russia are beginning to take center stage. Older Western nations cling to international agreements and artifices, such as NATO and the UN. Political tension are rising, not only within the fading American empire, but around the world. Countries sense the end of American dominance, and are vying for the title of next emerging super power.
The question is how long does America have left before the proverbial end. And what will that end look like? As you can see from the country chart above, civilizations don’t just cease to exist. They may fade in power, but the peoples of the former great nations continue on. While the US will not always be the most dominant force in the world, the people of the 50 states will soldier on.
The main political question is what alliances with the US have, and will the current form of government persevere. Will the country once again turn to true republicanism and free markets, or will it be merged into some sort of regional democratic socialist state. Whatever happens, the next stage in the American empire will be filled with significant changes. Those who are counting on things to be the same will be severely disappointed.
Maybe beyond that, those not properly prepared may not survive the coming changes. Periods of empiric decline marked by final economic and cultural collapse tend to bring period of great chaos, violence, and suffering. That is why this site was started – to protect not only your financial wealth, but your personal well-being along that of your family. Those that do not understand, or worse yet don’t heed, these changes will be the ones to suffer the most.
And what is most important is how we will emerge from these great changes. Those who understand the founding of our society, and the light of freedom that it brought to this world, will champion the case for liberty during the chaos. If these freedom fighters win, then we may once again have the benefits of a just system that provides equal opportunities for all. If not enough fight for the core values this country was founded on, then we may experience a much darker period of history more akin to the early settlers that had to fight daily to survive. Time will tell what comes next.