Grasping at Straws: The Life of a Market Cycle Guru

Techniques of soothsaying or prophesying have changed over the centuries, but the basic tactics and strategy have remained the same. In the more frankly mystical atmosphere of the Middle Ages, it became common for gurus to arise and predict the Second Coming and the end of the world, with seemingly stunning precision.

If the guru was shrewd enough, he made the date of the final days near enough to whip up excitement, but not so near that it would actually arrive and he would be caught out. Thus, the most famous of all these forecasters of doom, Joachim of Fiore, who lived in the late 12th century, predicted with absolute assurance that the day would come about fifty years afterward. That was close enough to develop a mighty movement of followers, but far enough away not to prove an embarrassment.

…when anyone spends a lot of time predicting…once in a while some of these forecasts are bound to be proved right, just by chance.

But suppose that the predicted day arrives and nothing happens? There have been various classical techniques to deal with that problem. The most obvious but the shakiest is to say, oops, I miscalculated, but now I have corrected my calculations and the precise day of the end of the world is eleven years and five months hence. Straightforward, but a bit desperate, and it is risky for the guru ever to admit error, for then his all-important aura of absolute self-confidence and infallibility will have begun to slip.

Far better to use a fudge factor, which maintains one’s air of omniscience and adds profundity to boot. “No, you see,” the guru will reply loftily to his critics, “I was absolutely right; the end of the world has begun, we have now entered the period of the last days.” If the guru is lucky enough, that period can last another century or so. And who is there to say him nay? The idea is to reinterpret for the faithful what had previously seemed to be clear and unmistakable language; a “day” has simply become an eon or two.

In the modern era, when all things “scientific” are in vogue, the same sort of activity goes on, but now it comes cloaked in the wondrous trappings of the high-tech. The predictions of our new breed of soothsayers and crystal-ball-gazers – the managers of the high-speed computers and the charts and the econometric models – are just about as accurate as Joachim of Fiore.

But the fudge tactics have become more elaborate. In the same way, astrologers fudge their predictions. If you are a Pisces, they will proclaim that you are a mystic, who loves water. If you say, “You’re right,” they will smile triumphantly upon this confirmation of their analysis. But if you say, “Wrong. I’m a skeptic who hates water,” they’ll say, “Ahh, that’s because your Jupiter is rising, and you’re fighting your stars,” or some such twaddle. The key point is that, with any guru worth his salt, there is no way ever to prove him wrong. He will always come up with the fudge factor. And, it should be clear to the wise that a prediction that somehow can never be proved wrong is worth far less than the paper it is printed on.

Furthermore, when anyone spends a lot of time predicting, on whatever grounds, once in a while some of these forecasts are bound to be proved right, just by chance. And so, in the world of economic as well as astrological forecasting, the soothsayers trumpet any successes they may have (“I predicted . . . !”) while quietly burying their mistakes.

Business cycles began a mere two centuries ago. Despite the fevered hopes of some enthusiasts who claim to have observed business cycles going back to Methuselah, before the late eighteenth century there was no such phenomenon. Of course, there were centuries in which business improved and the economy progressed and there were other centuries (the Dark Ages, the 14th and 15th centuries) when it went into a long secular decline. But, within shorter time periods, business pegged along in a rough straight line year after year. Business was either good, bad or indifferent, but it tended to remain that way steadily for many decades.

Once in a while, it is true, something drastic happened. The king, as was the custom of monarchs, might need a lot of money quickly and therefore confiscated all the gold or silver he could lay his hands on. The result was a dramatic economic and financial collapse. Or a war would take place, and business might boom; or trade would be cut off in a war, and business collapse.

The point is that there was nothing cyclical or wave-like about these events; and there was nothing esoteric or difficult to understand. It was clear to every observer what the problem was; the cause was exogenous, i.e., it came from outside the economic system and was imposed upon it. Almost always, that outside and disturbing force was government, and government intervention, in one form or another, was the clear cause of the sudden boom or more likely the sudden collapse. There was no need to conjure up any obscure “business cycle theory”; the cause was obvious.

Then, around the middle or latter part of the eighteenth century, something happened. A new phenomenon struck the world, occurring first in Britain, the most economically advanced country, and spreading to other advanced countries as they entered the market nexus of trade and finance. This phenomenon was a regular, continuing, wave-like movement of business activity.

Instead of business proceeding on a straight line, it experienced a regular pattern of euphoric boom, sudden crisis or panic, bust or contraction, and gradual recovery, succeeded without pause by another boom. In contrast to earlier years, observers of business could find no clear-cut exogenous cause for these waves. They concluded that business is marked by a continuing, perpetual cycle, and that the cause, whatever it may be, comes from somewhere deep within the market economy.

One of the worst things about the “business cycle” is its name. For somehow the name “cycle” caught on, with its implication that the wave-like movement of business is strictly periodic, like the cycles of astronomy or biology. An enormous amount of error would have been avoided if economists had simply used the term “business fluctuations.” For man is all too prone to leap to the belief that economic fluctuations are strictly periodic and can therefore be predicted with pinpoint accuracy. The fact is, however, that these waves are in no sense periodic; they last for few years, and the “‘few” can stretch or contract from one wave to the next.

At that point, those who had made their reputations as forecasters of the cycle had two options: they could have simply given up the idea of periodicity. But that would have detracted from their aura of omniscience. And so, many of them introduced the first big fudge factor: the idea that cycles, despite appearances, are still strictly periodic, except that there are several mystical cycles all occurring simultaneously beneath the data, and that if you manipulated the data long enough, you could find these simultaneous, parallel, strictly periodic cycles, all going on at the same time. The apparently non-periodic data are only the random result of the interactions of the strictly periodic cycles.

This doctrine is mystic for two basic reasons. In the first place, very much like the “epicycles” of the Ptolemaic astronomers who fought against the Copernican Revolution, there is no way ever to prove the cycles wrong. If the cycles don’t fit the facts, you can always conjure up one or two more “cycles” so as to make a perfect fit. Note that the fit has to keep changing in order to adapt to the new data that are always coming in. More epicycles get folded into the data.

Secondly, as we noted above, the market is a seamless web. All facets of the market are interconnected through the price system, and the profit-and-loss motive. Booms and busts spread throughout the system; that is precisely why they are important. It is absurd to think that one part of the economy can peg along on a nine-year cycle, another on a three-year cycle, and still another on a 25-year cycle, with each of these cycles barreling along on a hermetically sealed track, not influencing and modifying each other. In fact, there can only be one real cycle going on in the economy at anyone time.

We have seen already that there can be only one business cycle at a time – the real, or evident one, the one that actually shows up in all the data – and that this cycle is emphatically not periodic. One of the mystical “cycles” that has been getting a lot of play from time to time is the flimsiest “cycle” of them all: the Kondratieff long cycle.

The Kondratieff is supposed to be a strictly, or at least roughly, periodic cycle of about 54 years, which allegedly underlies and dominates the genuine cycles for which we have actual data. Even though, as we shall see, this cycle is strictly a figment of its fevered adherents’ imagination, there does seem to be some sort of cycle in the periods when the “Kondratieff” captures the interest of financial and economic analysts.

Kondratieff Waves, 1800-1980

The “Kondratieff” first made its appearance in the mid-1920s, the creature of the Soviet economist Nikolai D. Kondratieff. Even though it was translated into German at the time, it made no particular stir until the mid-1930s, when the German translation was, in abridged form, itself translated into English. The “long wave” had a brief vogue in the late 1930s, only to disappear until the 1970s, and since then it has had another and even bigger run.

It seems clear that the times of fashion for the Kondratieff are a function of the economic climate of the day. Orthodox, mainstream economics had no explanation for the Great Depression of the 1930s, and so the Kondratieff was offered as one “explanation” for this phenomenon.

After World War II, Keynesian economics was in the saddle, and claimed to be able to fine-tune the economy and eliminate inflation and recession alike. The simultaneous inflation-and-recession of 1973-75 inaugurated an era of many such “stagflations,” which put an end to Keynesian dominance. Economists and financial analysts were led to look to some other explanation of this unwelcome phenomenon. And, lo and behold!, the old, forgotten “Kondratieff” was trotted out.

Power will tend to be used, and the power to create money out of thin air is no exception to the rule.

Kondratieff postulated a “long wave” of business that began somewhere in the late 1780s – it is all very murky since there are almost no statistical data for that period – and continues periodically roughly every 54 years. In short, Kondratieff long “depressions” were really booms in everything that counted except the fact that prices fell, and we have seen that falling prices are perfectly compatible with economic growth and prosperity. And Kondratieff long “booms” were really short booms fueled by devastating wars.

So, if “the Kondratieff cycle” is a myth and a chimera, why are there business cycles at all?

In short, government intervention cripples the market economy, and recession or depression is the painful but necessary adjustment by which the market reasserts itself, and liquidates the distortions committed by the government’s inflationary boom. After each depression, the government generates inflation once again, because it is the government’s natural tendency to inflate. Why?

Quite simply, whoever is granted a monopoly of printing money (e.g., the Fed, the Bank of England) will use that monopoly and print – to finance government deficits, or to subsidize favored economic groups. Power will tend to be used, and the power to create money out of thin air is no exception to the rule.

The cause of the boom-bust cycle is not some mystical periodic Force to which man must bend his will; the fault, dear Brutus, is not in our stars but in ourselves, that we are underlings.

Regards,

Murray N. Rothbard
for The Daily Reckoning

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