Summary for the busy executive
Here we offer a
new theory explaining the causes of Kondratiev's long-wave economic cycle in
terms of gold and the hoarding of commodities. Our description of the cycle
itself is also novel and very different from the conventional. We shall be
talking about a huge oscillating money-flow to-and-fro between the bond
market and the commodity market. When the money-tide begins to flow at the
commodity market and ebb at the bond market, we have the inflationary phase
of rising prices and interest rates. When the tide is reversed and it begins
to flow at the bond and ebb at the commodity market, we have the deflationary
phase of falling prices and interest rates. In one word, Kondratiev's
long-wave cycle is the manifestation of the fluctuation in the propensity to
hoard. The key question is this: what causes this fluctuation? Is it a
natural phenomenon outside of man's control or, perhaps, it is induced by
wrong-headed government policy?
Economic cycles
Economists
recognize four major cycles, or regular fluctuations, in the economy as
follows:
(1) Kitchin's
short-wave cycle of average duration 3-5 years, discovered in
1930;
(2) Juglar's
cycle of average duration 7-11 years, discovered in 1862;
(3) Kuznets'
medium-wave cycle of average duration 15-25 years,
discovered in 1923;
(4)
Kondratiev's long-wave cycle of average duration 45-60 years,
discovered in 1922.
J. Schumpeter,
who was born in Austria and came to the United States where he also served as
President of the American Economic Society in the 1950's, was an outstanding
student of economic cycles. He believed that the various cycles are
inter-dependent, in contrast with the view of others such as Forrester, who
believed that the cycles act independently of one another. Schumpeter baptized
three of the four cycles by naming them after their discoverers. The
exception was Kuznets' cycle which he did not recognize.
At any rate,
Kuznets got a "consolation prize" for being passed over by
Schumpeter, namely the Nobel Prize for economics. Moreover, he is the only
Nobel-laureate among the four name-giving economists. Kuznets noticed that
residential and industrial buildings have an average useful life of 21-23
years. His medium-wave cycle is about fluctuations caused by the
amortization-cycle and the problem of replacing ageing buildings. It is
interesting to note that all the students of cycles among the four whose name
begins with a K were Russian.
Kondratiev's long-wave cycle
The long-wave
cycle in the capitalist economy was discovered by the Soviet economist N. D.
Kondratieff (1892-1930) in 1922. He had been anticipated by J. van Geldren in
1913 and, even earlier, by Jevons in 1878 and H. Clarke in 1847, among
others. Independently of Kondratiev, De Wolfe proposed a theory involving the
idea of a long-wave cycle in 1924.
As we have
noted above, some important students of cycles believed that they were
inter-dependent. In particular, they noted that the average length of each of
the four cycles is slightly longer than double the length of the immediately
preceding shorter cycle. In the 1930's historians F. Braudel, F. Simiand,
ands E. Larousse looked at changes in the "secular trend" that was
taking place roughly every 100 years. This suggests that Kondratiev's cycle
might also be followed by a centennial cycle of approximately twice the
duration.
Kondratiev's
methodology involved the analysis of 21 statistical series, that is, 21
economic indicators such as the price index, the rate of interest, wage
rates, rents; volume of production, consumption, exports, imports,
employment, etc., as well as their standard deviations. In studying volumes
Kondratiev used per capita data. He calculated deviation from the trend
through the method of least squares. In order to filter out noise caused by the
shorter cycles he employed nine-year moving averages. He took his data-base
from the French, British, German, and the U.S. economy.
Only in 6 of
the 21 series could Kondratiev not confirm the presence of a long wave-cycle.
Significantly, in the case of the price level and the rate of interest the
evidence was strong. Kondratiev's ultimate conclusion was that he obtained
sufficient empirical basis to support the hypothesis of the existence of a
long-wave economic cycle in the capitalist economies he studied, with an
average duration of 54 years. He allowed a 25 percent deviation from this
average. In particular, Kondratiev identified three historic waves:
(i)
First wave: rising phase from 1780-90 to 1810-17;
falling phase from 1810-17 to 1844-51
(ii)
Second wave: rising phase from 1844-51 to 1870-75; falling phase from
1870-75 to 1890-96.
(iii)
Third wave: rising phase from 1890-96 to 1914-20;
falling phase started 1914-20.
Kondratieff was
exiled to Siberia by Bolshevik officials who flatly rejected his conclusions.
To the faithful there could only be one falling phase of the capitalist
economy, followed by the socialist revolution and the dictatorship of the
proletariat. And, following that, there was to be only one rising phase,
leading to eternal bliss under communism.
Kondratiev died
in the Gulag in 1930 at the age of 38. His work was later updated by other
economists using his original methodology. They found that the falling phase
of the third wave ended 1947-48, and that there is a
(iv)
Fourth wave: rising phase from 1947-48 to 1973-80; falling phase
started 1973-80.
Jackson's linkage
In 1947 the
British-born Canadian economist Gilbert E. Jackson studied the behavior of
just two economic indicators, that of the price level and the rate of
interest. He found that the two are linked. Sometimes the price level leads
and the rate of interest lags; at other times, the other way around. In his
own words just like two hounds on a leash holding them together, while one
can get a little bit ahead, they cannot come apart, the leash obliging them
to follow the same path, uphill or down. Jackson's calculations yielded the
same long-wave cycle established by Kondratiev. He called this phenomenon
"the linkage".
Jackson was
probably unaware of Kondratiev's work. Therefore it is quite remarkable that
two economists working independently came to virtually identical conclusions.
Yet Jackson's contribution is all the more significant as he focused on just
two economic indicators instead of twenty-one, to get the same conclusion.
Jackson's methodology used British data, namely wholesale prices in Britain
and the yield on British consols for a period of over 150 years from 1782 to
1947. In order to iron out short-term fluctuations in the data-base due to
the business cycle and other factors, Jackson replaced the raw figures by
eleven-year moving averages. He then charted both indicators in the same
coordinate system showing two curves with the rising trend of both curves
indicating an inflationary spiral, and their falling trend the deflationary
spiral, alternating with one another. We reproduce Jackson's original chart
at the end of the paper. As the chart clearly shows, sometimes prices lead,
and sometimes they lag the rate of interest. Neither Jackson, nor anyone else
who studied the phenomenon of linkage, could offer a full theoretical
explanation. The most they could say was that it appeared to be an
"accidental coincidence".
Jackson's results
were published in 1947 in a paper The Rate of Interest that was barely
noticed by the profession at the time. By now it is largely forgotten in
spite of the renewed great interest in Kondratiev's long-wave cycle to which
Jackson's linkage is closely related. Nobody ever bothered to update
Jackson's chart using his original methodology.
Since prices
and interest rates are by far the two most closely watched and studied
economic indicators, the possibility of a connection between the two has
attracted a great deal speculation among economists. A host of excellent
thinkers such as Knut Wicksell, Wilhelm Röpke, Gottfried Haberler, to
mention only three who have studied it, found the phenomenon of linkage
"puzzling". Irving Fisher went as far as saying that "it seems
impossible to interpret [the linkage] as representing an independent
relationship with any rational basis". In their 1932 book Gold and
Prices G. F. Warren and F. Pearson claimed that they have found the
causal relationship explaining linkage. They asserted that rising (falling)
prices are the cause, and high (low) interest rates are the effect. They
argued that creditors note the rise in the price level and demand
compensation from debtors for the loss of purchasing power in the form of higher
interest. Conversely, when the price level falls and the purchasing power of
the currency rises, competition of creditors forces reduction in lending
rates.
Jackson
rejected this line of reasoning. He pointed out that linkage works both ways.
While sometimes the price level leads and the rate of interest lags giving
impetus to lenders to change the lending rate, at other times the rate of
interest leads and the price level lags. Do Warren and Pearson suggest that
lenders are clairvoyants who can divine what direction prices will take in
future years?
The propensity to hoard
Mainstream
economics bypasses the problem of hoarding altogether. It suggests that in
the modern economy with a well-developed capital market hoarding is either
non-existent, or if it is practiced at all, then the practice is confined to
boorish and uninformed people whose action can be safely ignored as
unimportant. However, economists can dismiss the phenomenon of hoarding and
its consequences only at their own peril.
There may be
more to hoarding than boorishness. It is well-known that informed producers
regularly use sophisticated inventory-management techniques involving the
speeding up or the slowing down of input and output at either end of their
production line. The means of hoarding are just as ingenious as its objects
are varied. The practice is certainly not confined to housewives buying more
sugar to fill up their pantry, nor to small-time smugglers holding contraband
merchandise in mountain-caves. They also include big multi-national firms
using the most up-to-date techniques such as inventory-padding or the
deliberate use of leads and lags in warehousing. In recent times cutbacks in
production quotas of highly marketable goods such as crude oil have been
utilized for the same purpose with dramatic effect. The Japanese are known to
import far more lumber and coal from Canada than they need for current
consumption. Having treated the excess with an impregnating solution, they
sink the lumber and coal to the bottom of their mountain lakes. Nor is
hoarding of fuel confined to energy-poor countries. The U.S. government is
filling up disused salt mines with crude oil. They call it "strategic
stockpile", but in the vernacular it is called hoarding, even if the
word has a pejorative or boorish connotation. The supertanker construction
boom in the 1970's was not an exercise in efficient transportation. Its
purpose was to build floating warehouses. The supertankers filled to the brim
with crude set sail without the captain having the slightest idea of its
final destination. If the highest bid for the crude in the tanker was not
high enough, no problem. The supertanker just had to keep cruising a little
longer. Futures and options trading opened up new avenues for the general
public to participate in the hoarding game. These examples illustrate the
phenomenal increase in the propensity to hoard in the period preceding 1980,
which was manifested not only in rising prices but rising interest rates as
well. Since 1980 the world has been experiencing a fall in the propensity to
hoard, and even "dishoarding" previously hoarded goods. The process
of reducing stockpiles at falling prices, which have been built up in
expectation of higher prices, is a painful one.
It would be an
impossible task to estimate, however tentatively, the size of existing
stockpiles of goods held not for impending consumption but, rather, for some
other reason, notably in protest against low interest rates, reckless
government spending, and the banks' plundering the savings of individuals.
This is where the statistician must plead ignorance. The only way to grasp
the hoarding instincts and habits of people is through theoretical
understanding.
The divorce of
hoarding from saving took place in response to the conspiracy of the banks,
aided and abetted by the government, in order to defraud and dispossess the
saving public. Over long periods of time the propensity to hoard has been
gaining ground as an independent economic force at the expense of the
propensity to save (i.e., save money) in response to deteriorating bank
practices, in particular, the banks' sheltering of illiquid government debt
in their balance sheet, and the government's protecting the banks against
depositors withdrawing the gold coin.
By now the U.S.
has reached the point that the savings rate is negative. It is wrong to blame
the American people for this unfortunate state of affairs. The blame should
be assigned to American politicians and officials who have corrupted the monetary
system to such an extent that people refuse to put their savings into
instruments the banks have to offer. No one knows what the savings rate would
be if the value of marketable goods hoarded by Americans could be calculated.
Gold as the monetary metal
What makes gold
the monetary metal par excellence is that it is the most hoardable
commodity. This means that the opportunity cost of hoarding gold is lower
than that of hoarding any other commodity. Gold is held in the balance sheet
even if the promise of return to capital is nil. No other commodity is held
in the balance sheet unless there is some promise of return to capital. This
property puts gold outside of the power of governments. The pronouncements of
the government about the "demonetization of gold" is empty gesture.
More anti-gold propaganda will only increase the propensity to hoard gold.
Consider the
proposition that the greater is the propensity to save, the lower will the
rate of interest be. This proposition in itself is not controversial. The
mechanism whereby the flow of savings regulates the rate of interest under a
gold standard is quite transparent. Savers who feel that the rate of interest
is too low will exchange their bank notes and deposits for gold coins. In
this manner savers retain direct control over the level of bank reserves as
they confront the bank with the choice of either raising the lending rate or
contracting bank credit. Thus the mechanism that regulates the rate of
interest is the savers' privilege to hoard gold. Any effort to tamper with
this mechanism is certain to introduce distortions in the economy.
Governments in
their wisdom have removed the gold coin as a regulator of bank reserves. They
did this in order to disenfranchise savers who no longer have a say in
setting the rate of interest. The government and the banks usurp this
privilege. The government wants to project an image of itself as a
"do-gooder" in keeping the rate of interest low, purportedly in
order to benefit the general public. The banks, in their turn, want to pursue
a credit policy motivated by political rather than economic considerations.
No cost-and-benefit analysis has ever been carried out, and the costs have
been conveniently ignored. To be sure, there are costs connected with pushing
gold out of the monetary system.
As the
government has assumed power over monetary policy in contemptuous disregard
of the expressed wishes of the savers (to say nothing of the provisions of
the Constitution), it aggrandizes power. Since by its very nature the power
to issue money is unlimited, the new monetary regime flies in the face of the
principle of representative government of limited and enumerated powers.
But for our
purposes more important than the destruction of the gold standard is the
abridgement of the savers' rights and privileges that has predated their
total disenfranchisement by several hundred years. The banks have always kept
a bag of tricks on hand (other than raising the rate of interest) to dissuade
their depositors from taking the gold coin. When they reached the end of the
rope, they could always count on the government "to go off gold" in
order to save the banks' face - and skin - in declaring the banks' bad liabilities
legal tender. Thus the banks were rewarded, rather than punished, for their
wrong-headed credit policies. No wonder that more credit abuses were heaped
upon credit abuse for the centuries.
Double standard of justice
The legal right
of savers to demand gold coins in exchange for their bank notes and deposits
whenever they get worried about the condition of banks or about the
profligate spending habits of the government is eminently just and equitable.
It is the little man's protection against the powerful and mighty without
which, as history has made abundantly clear, the former would get plundered
by the latter for all his worth.
This protection
has been compromised by a double standard that was surreptitiously introduced
in contract law. Creditors were free to press for the liquidation of firms
that have failed to perform on their contractual promises. Originally there
were no exceptions. Later, however, the banks got exempted from this
provision of contract law. They were made immune against the wrath of their
creditors, including depositors. A bank that refuses to pay gold on its sight
liabilities could no longer be sued for breach of contract.
There is no
defensible justification in jurisprudence for extending special privileges to
banks, or for protecting them against the consequences of their own folly. A
law setting up double standard of justice is bad by definition. The argument
that bank failures cause too much economic and social pain is spurious. All
should stand equal before the law. Compromising this principle lets the bad
effects of bank policy accumulate and will ultimately cause far more harm and
economic or social distress than the immediate punishment of the bank that
has gone astray.
Later the banks
got still more protection from the government in the form of compromised
standards of inspection. When they overstate the value of their assets and
understate that of their liabilities, bank examiners look the other way.
"See no evil, speak no evil". Banks can get away with fraudulent
accounting practices that would trigger harsh punitive action if practiced by
other firms. Bank examiners exonerate guilty banks upon the tacit approval,
if not at the outright request of the government.
Economists are
not famous for their curiosity about this peculiar tolerance for fraud that
governments the world over have displayed for centuries. Yet the explanation
is rather simple: "If you scratch my back, then I shall scratch
yours." The banks have ample opportunity to return the favor of the
government when they are expected to buy up treasury paper which the market
is no longer willing to take at the yields offered, and to deliver similar
sweetheart deals.
It would be
naive in the extreme to assume that the savers meekly acquiesced in such acts
of double-dealings and coercion. They could not prevent the government and
the banks from sabotaging and ultimately destroying the gold standard. But
they could do something about it. Instead of (or in addition to) hoarding
gold, savers thereafter started hoarding other marketable commodities. The
list of marketable goods is endless. There are the conventional ones such as
salt, sugar, spices, spirits, tobacco, tea, coffee. To this, one has to add
the non-conventional ones, energy carriers such as crude oil, and narcotics
such as heroin and cocain. (Note that as long as governments tolerated the
gold standard there was little problem with drug trafficking. The suggestion
cannot be easily dismissed that the escalation in illegal drug trade in the
twentieth century was in direct response to the destruction of the gold
standard.)
Causes of the Kondratiev cycle
We can now
present our own explanation for the linkage and, simultaneously, our own
description of the genesis of Kondratiev's long-wave cycle. Frustrated savers
sell their bonds and put the proceeds in marketable commodities. Thus rising
commodity prices and falling bond prices are linked and they reinforce one
another. The linkage is best described as a huge speculative money-flow. The
money-tide begins to flow at the commodity market while ebbing at the bond
market. This epitomizes the inflationary phase of Kondratiev's long-wave
cycle.
But falling
bond prices are tantamount to rising rates of interest. Thus a rising price
level and a rising interest-rate structure, if they do not march in lockstep,
at least they are closely linked. The money-flow from the bond to the
commodity market, while it can go on for decades, will not last indefinitely.
Holders of commodities will find that it is not possible to finance ever
increasing inventories at ever increasing rates of interest. At one point
they will panic and sell. Not all can get through the exit doors at the same
time, however. Some will get trapped. Inventory reduction is a long-drawn-out
and painful affair.
This means that
the speculative money-flow has reversed itself. Now the money-tide begins to
flow at the bond market while ebbing at the commodity market. Prices of
commodities fall while bond prices rise. Again, rising bond prices are
tantamount to falling interest rates. The falling price level and the falling
interest-rate structure are linked and they reinforce one another. This
reversed money-tide epitomizes the deflationary phase of the Kondratiev cycle.
Note the role
of speculation in all this. Speculators are prominent in both the
inflationary phase in which they go long in the commodity and short in the
bond market, as well as in the deflationary phase in which their long and
short legs are switched around. Just about the only way to make money in a
depression is to speculate in the bond market on the long side. The bull
market in bonds in a deflation is completely ignored by mainstream
economists. Yet this is the key to the understanding of the reversal of the
money-tide. Speculators do arbitrage between the bond and commodity markets.
When they think that the saturation point has been reached, they reverse
their position. They replace their existing straddles with the opposite ones.
That is, they enter their long leg in the commodity and short leg in the bond
market. This then heralds the end of the deflationary and the beginning of
the inflationary phase.
The linkage and
Kondratiev's long-wave cycle are explained in terms of fluctuations in the propensity
to hoard. Since hoarding gold, the natural conduit, is obstructed by the
banks and the government, the propensity to hoard manifests itself as the
hoarding of other marketable goods. Already in 1844 Fullarton recognized that
gold hoarding is just a protest-vote of the savers against low interest
rates, the banks' loose credit policy, and profligate government spending.
Nevertheless, almost a hundred years later John Maynard Keynes looked at gold
hoarding as a psycho-pathological aberration. He invoked the authority of
David Ricardo. But Ricardo had also missed the economic significance of gold
hoarding, and he proposed the gold bullion standard to combat it.
To explain gold
hoarding with psycho-pathology is nothing but scientific obscurantism. Keynes
had a hidden agenda. He wanted to forge a weapon against the gold standard
out of the fact of gold hoarding. The British economist was a bully. He was
determined to sell the idea that the gold standard was unworkable, first to
F.D. Roosevelt, and then to the rest of the world. In this he did succeed.
Mainstream
economics is still at the retarded level of Keynes when it comes to assessing
the gold standard. It refuses to recognize the protest-aspect of gold
hoarding, it is forgetful about the axiom that saving must precede spending,
and it ignores the fact that without saving there is no economic development.
Gold is the leash on which the frugal must keep the prodigal. It is this
leash that the banks and the government have always wanted, and eventually
managed, to escape from when they first sabotaged and then junked the gold
standard. Although the sabotage started several hundred years ago, the world
economy being run entirely without the leash of the gold standard has only a
brief history of barely 30 years. It is not a glorious history.
In the great
tug-of-war between the frugal and the prodigal the former appears to be the
perennial loser. This is explained by the fact that the playing field is not
level but tilts against the frugal, that is, the saving public. This includes
not just creditors but, above all, the little man who is forced to keep his
meager savings in the form of cash, i.e., paper money open to plunder by the
prodigal which is the consortium of the banks and the government. In spite of
this bias we cannot take it for granted that the tug-of-war will end with the
ultimate defeat of the frugal, just because the prodigal has succeeded in
knocking the weapon of the gold coin out of his hand. The frugal has
something else up in his sleeves. It is the propensity to hoard, an extremely
efficient weapon which, however, is not free from some very dangerous
side-effects.
A
jump in the propensity to hoard can siphon off enormous amounts of money from
the bond market. This will make the rate of interest jump, too. The last time
it did that was in the years 1971-81. Those ten years that shook the world
heralded the deflationary spiral in Kondratiev's long-wave cycle, the spiral
that is still continuing.
Contra-cyclical
policy
As
already noted, the rise in the propensity to hoard has its limits. The
hoarding of goods reaches its saturation point when it dawns on people that a
high price structure and a high interest-rate strructure cannot be maintained
in the presence of high inventories. Declining marginal utility kicks in,
ending the inflationary and ushering in the deflationary spiral. The long and
painful process of inventory liquidation begins. The money-flow from the bond
to the commodity market makes an "about face". The deflationary
spiral may turn into a depression in which innocent firms start falling like
dominoes.
Keynes'
contra-cyclical policy should properly be called "counter-productive
policy". It has been dogmatically applied by central banks since the
1930's only to make things worse. Following the Keynesian script, during the
deflationary spiral the central bank is trying to contain weakening prices
through open market purchases of bonds. Bond prices rise, in other words, the
rate of interest falls. Bond speculators take the clue and they buy the
bonds, too. Linkage causes the price level to fall (or at least stay weak).
The central bank is unable to stem the deflationary tide of money flowing
from the commodity to the bond market. In fact contra-cyclical monetary
policy just pours oil on the fire.
Exactly
the same is true of the inflationary spiral. The main worry now is the high
rate of interest. To bring it down the central bank resorts to open market
purchases of bonds. In doing so it puts new money into circulation which it
hopes will flow to the bond market. Instead, it quickly finds its way to the
commodity market and bids up prices there. Linkage does the rest. Higher
prices bring about higher interest rates. Contra-cyclical policy fails in
this case as well.
In
the deflationary spiral the central bank combats weakening prices. This
causes the rate of interest to fall, which leads to still lower prices. In
the inflationary phase the central bank combats high interest rates. This
causes prices to rise, which leads to still higher interest rates, all
because of the linkage. The contra-cyclical policy of Keynes backfires in
either case. For example, during the 1947-80 inflationary spiral the rate of
interest rose five-fold and the price level ten-fold in the United States, in
spite of vigorous contra-cyclical intervention by the Federal Reserve banks.
Dr. Keynes prescribed medication that made the condition of the patient
worse. He was ignorant of the linkage.
To
recapitulate, the long-wave economic cycle is caused by a huge speculative
money-flow back-and-forth between the bond and commodity markets. The flow is
further aggravated by mindless contra-cyclical intervention. The oscillating
money-flow is induced by fluctuations in the propensity to hoard. It is
futile trying to correct these money flows. At best one can re-direct them
into channels where they can do no harm. Keynes was so obsessed with gold
hoarding that he missed the hoarding of other marketable goods, a problem
potentially far more menacing. Keynes was the high priest of anti-gold
agitation. He preached that if "the gold coin was kept away from man's
greedy palms" then there would be no gold hoarding, no economic
contraction, no deflation, no unemployment. His was a colossal mistake, the
kind that only a doctrinaire could make.
After
the destruction of the gold standard by the government hoarding did not
cease. It only changed form. The benign tumor turned malignant. Not only did
the withdrawal of gold coins from the monetary bloodstream through government
coercion fail to stop deflation: it set off a huge suction pump in the bond
market siphoning money off from every nook and cranny of the economy. In
particular, it created a devastating liquidation and depression from which
only a world war could pull the economy.
We
can't help but notice that gold is the philosopher's stone. In its possession
the propensity to hoard is directed into its proper channels. Without it the
world economy becomes a plaything in the hands of bond and foreign exchange
speculators.
Competitive
devaluations
Since
1981 the world appears to be in the grips of a deflationary spiral, right on
schedule as predicted by the Kondratiev cycle. This spiral hasn't run its
course yet. Some liquidation has taken place, but the worst seems still to
come. The politicians and economists congratulate each other for "having
squeezed inflationary expectations out of the system". Whatever they
have squeezed, the inflationary and deflationary spirals are not caused by
expectations, but by actual money-flows between the commodity and bond
markets. The international monetary system is still the same rudderless ship
it has been since 1971, and it is still exposed to the same monetary storms.
The only difference is that the direction of the gale has changed.
The
dangerous deflationary spiral threatening the world's prosperity started in
Japan where the stock market collapsed followed by the real estate market.
The sun has set on the Land of the Rising Sun. The next sunrise is probably a
long way off. The devastation caused by deflation in the Japanese economy is
of the same order of magnitude as that in the American during the previous
cycle in the 1930's. Both deflations can be characterized as an irresistible
money-flow from the commodity to the bond market, drying up resources in all
departments outside of the bond market. In Japan, the rate of interest fell
practically to zero. Ten years ago the Japanese government reacted in the
same way as the American in 1933. It devalued the yen by fifty percent. This
measure has been just as futile as the devaluation of the dollar was seventy
years ago. It triggered competitive devaluations of the world's currencies in
the 1930's. The yen-devaluation has the same effect. It was the cause of the
collapse of the ruble and other Asiatic currencies. Right now it is the turn
of the U.S. dollar to devalue. It remains to be seen whether the euro will
also succumb to the temptation.
The
Japanese deflation-tumor could very well metastasize across the Pacific.
There is a carry-trade between the Japanese and American bond markets.
Overpriced Japanese bonds are sold and the proceeds are put in the relatively
underpriced American bonds. Note that this carry-trade is not hindered but
rather helped by the devaluation of the dollar. At any rate, the outcome is a
further fall in the rate of interest in the U.S. The deflationary spiral is
alive and kicking.
The
stock market boom in the 1990's was not justified by increases in
productivity and profitability any more than it was in the "roaring
twenties". If the stock market crashes, the already irresistible
money-flow to the bond market would be reinforced, just as after the 1929
crash. Falling interest rates would cause over-indebted firms to scramble in an
effort to get out of debt. Credit-collapse may ensue. Already, the long-term
rate of interest has been pushed down from 16 to 6 percent. The danger is
that it may keep falling to 3 percent or lower, due to the speculative orgy
in the bond market. Like a gigantic vacuum cleaner, the bond market siphons
off resources from the real economy, just as it did in the 1930's. As noted
already, it is not generally realized that a depression, creates
boom-conditions for the bond speculator who makes a killing while everyone else
is bleeding to death.
Mutations
and catastrophes
Kondratiev's
long-wave cycle forces us to give up the earlier, optimistic models of
uniform growth of the capitalistic economy, at least until the world is ready
to return to the principles of classical liberalism and limited government,
including its harbinger the gold standard. The following is a paraphrase of
the thoughts of the Hungarian philosopher Béla Hamvas (Secret
Minutes, 1962, see: The Works of B. Hamvas, vol.17, Budapest: Medio, p
104-106, in Hungarian).
"Our
government, without the limitations imposed upon it by the principles of
classical liberalism, makes for a fair-weather system. Under such a
paternalistic, omnipotent and omniscient government modern civilization may
appear to work productively and humanely enough, that is, as long as the fair
weather lasts.
"But
let drought strike, or let flood engulf the land. Then our democratic
unlimited government will at once show its feet of clay. No sooner does
social disturbance, civil strife, or distrust raise its face than will
centralized government lose its grip and get entangled in one crisis after
another, all of its own making. The government that was omnipotent in fair
weather would be helpless in foul. The government that was omniscient during
the smooth evolutionary phase would plead ignorance at the first sign of a
mutation. The fair-weather system of unlimited government is forever unable
to cope with catastrophes.
"Older
schools of evolution did not assume continuous progress. They were not given
to thinking in terms of growth curves rising uniformly forever. They made
allowance for mutations, they admitted the possibility of setbacks, abrupt
reversals and tumbles. Older philosophers assumed that nature abhorred
uninterrupted continuity, as much as she abhorred vacuum. They knew that in
nature there was no continuous transition from the lower state to the higher.
We should do well to remember the teachings and emulate the humility of those
older philosophers. They were wise men, immeasurably wise. Certainly far
wiser than ourselves. Their thinking had one great advantage: they were not
afraid to warn of the day when the weather would turn from fair to foul. They
dared to think mutations. They dared to think catastrophes. While they were
aware that dull times called for dull theories, they believed that critical
times called for theories altogether alien to and different from those dull
theories. In critical times you must think deeper, you must be wiser and more
imaginative.
"We
are in the habit of slighting and disparaging the accomplishments of older
philosophers. We seem incapable of benefiting from their wisdom. They
bequeathed a theory of limited government to us, a theory we have passionately
rejected in favor of dull theories suitable for dull times... Yet the days of
fair weather are numbered... We have lost our compass and the sea is growing
stormy... Our boat of government omnipotence is now in waters teeming with
dangerous reefs under the surface... We are in deep trouble... Que sera,
sera...."
What is to
be done?
We
need not conclude our review on such a pessimistic note. We are able to
temper the deleterious effects of Kondratiev's long-wave cycle, even though
we are unable to eliminate it. If we cannot legislate the propensity to hoard
out of existence, we may at least confine it to its proper channels and
secure it with a safety-valve. The role of gold in the world is to provide
just such a safety-valve. God created gold in order to render the propensity
to hoard harmless. Gold hoarding has no effect on essential consumption, its
only effect is on jewelry consumption. Under a gold standard there is no
bond, still less foreign exchange speculation. The only road to stabilization
is to put speculation into its proper place, confining speculators to fields
where they can do no harm, but they may do some good: to the market of
agricultural commodities with supply controlled by nature, not by man. The
greatest blunder that Keynes committed was that he failed to foresee the
forces that his policies would unleash. In particular, he was oblivious to
speculation unleashed in markets where supply is not controlled by nature but
by man (read: governments and central banks), such as the bond and foreign
exchange markets.
The
significance of a gold standard is not to be seen in its ability to stabilize
prices, which is neither possible nor desirable. It is, rather, seen in its
ability to stabilize the rate of interest at the lowest level that is still
compatible with the requirements of the saver. The stabilization of the rate
of interest and foreign exchange will then impart as much stability to the
price level as is consonant with a dynamic economy. By letting the saver
withdraw the gold coin (read: bank reserves) when the rate of interest falls
to a level he considers unacceptable, the irresistible speculative money-flow
to-and-fro between the commodity and bond markets - the engine of
inflationary and deflationary spirals - would be shut down at source. Benign
bond/gold arbitrage would replace the malignant bond/commodity speculation.
Since the former is self-limiting while the latter is self-aggravating,
economic stability would be enhanced.
The
alternative to a gold standard is too horrible to contemplate. Unemployment
more devastating than that of the 1930's, an earthquake shaking the
international monetary system to its foundations, the construction of
protective tariff walls and, in the end, a world war in which governments
hope to find an escape route from economic chaos.
Antal E. Fekete
San Francisco School
of Economics
aefekete@hotmail.com
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