Editors' pick: Originally published August 17.
Nature functions in cycles. Each 24-hour period divides into smaller cycles of morning, afternoon, evening and night. The year divides into seasonal cycles. Similarly, one's life can divides into cycles.
Likewise, economic experts have noticed that the world also follows different cycles. An important pioneer in this field was the Russian social economist, Nikolai Kondratiev, also called Nikolai Kondratieff. He was a relatively unknown genius.
Who Was Kondratiev?
Geniuses have been known to defend their principles and beliefs, even at the cost of losing their lives. They may die but their legacy lives on, as was the case for Kondratiev. He was an economist who died defending his beliefs.
Kondratiev was the founding director of the Institute of Conjuncture, a famous research institution, which was located in Moscow. He devised a five-year plan for the development of agriculture in Russia from 1923-1925.
He published his book, "The Major Economic Cycles," in 1925. In this work, he laid out policies contrasting to those of Stalin's. But Kondratiev was right. As a result, Stalin had him arrested in 1930 and sentenced him to prison. In 1938, Soviet authorities executed him.
It was the tragic loss of a genius at only age 42 years. In 1939, the Austrian-born economist Joseph Schumpeter named waves describing cycles Kondratiev Waves. They are also known as K-Waves.
What Are Kondratiev Waves?
The Kondratieff Wave describes alternating long-term, high growth and low-growth economic periods.
Kondratiev developed his theory based on European agricultural commodities and copper prices. He noticed periods of evolution and self-correction in the economic activity of the capitalist nations and felt it was important to document.
These waves are long cycles, lasting 50-60 years and consisting of various phases that are repetitive in nature. They are divided into four primary cycles:
Spring-Inflationary growth phase: The first wave starts after a depressed economic state. With growth comes inflation. This phase sees stable prices, stable interest rates and a rising stock market, which is led by strong corporate profits and technological innovations. This phase generally lasts 25 years.
Summer-Stagflation (Recession): This phase witnesses wars such as the War of 1812, the Civil War, the World Wars and the Vietnam War. War leads to a shortage of resources, which leads to rising prices, rising interest rates and higher debt. Because of these factors, companies' profits decline.
Autumn-Deflationary Growth (Plateau period): After the end of a war, people want economic stability. The economy sees growth in selective sectors. This period also witnesses social and technological innovations. Prices fall and interest rates are low, which leads to higher debt and consumption. At the same time, companies' profits rise, resulting in a strong stock market. All these excesses end with a major speculative bubble.
Winter-Depression: This is a period of correcting the excesses of the past and preparing the foundation for future growth. Prices fall, profits decline and stock markets correct to the downside. However, this period also refines the technologies of the past with innovation, making it cheaper and more available for the masses.
Accuracy Of The Cycle Over The Last 200 Years
The K-Waves have stood up over time. They have correctly identified various periods of important economic activity within the past 200 years. The chart below outlines its accuracy.
Very few cycles in history are as accurate as the Kondratiev waves.
Criticism of the Kondratiev Waves
No principle in the world is left unchallenged. Similarly, there are a few critics of the K-Waves who consider it useful only for the pre-WWII era. They believe that current monetary tools, which are at the disposal of the monetary agencies, can alter the performance of these waves. There is also a difference of opinion regarding the timing of the start of the waves.
The Wave Is Being Pushed Ahead, but the Mood Confirms a Kondratiev Winter
A closer study reveals that the cycles are being pushed forward temporarily. Any intervention in the natural cycle unleashes nature's wrath, and the current phase of economic excess will also end in a similar correction. The K-Wave winter cycle that started in 2000 was aligned with the dot-com bubble.
The current stock market rise stems from easy monetary policy of the global, central banks. Barring a small period of time from 2005-2007 when the mood of the public was optimistic, the winter has seen people in a depressed social mood. The stock market rally from 2009-2015 will be perceived as the most hated rally and the one most laden with fear.
Every dip of a few hundred points in the stock market starts with a comparison to the Great Recession of 2007-2009. The mood exudes fear and disbelief that the efforts of the central banks have not been successful and are unable to thwart the winter, as predicted by the K-Waves. The winter is here and is reflected in the depressed social mood.
How To Weather Out Brutal Winter
In the last phase of the winter cycle, from 2016-2020, which is likely to test us, the stock market top is in place. Global economic activity has peaked, terrorism further threatens our lives, geopolitical risks have risen, the current levels of debt across the developed world are unmanageable, and a legitimate threat of a currency war occurring will all end with the "The Great Reset." Gold will be likely to perform better during this winter cycle. Get in love with the yellow metal; it's the blanket which will help you withstand the winter.
Cycles give us an insight into the future so we can ace it and prosper. Without excessive intervention, nature is forgiving while correcting its excesses. But if one meddles with nature, it can be merciless during the correction. The current economic condition will end with yet another reset in the financial markets. Prices will not rise forever, and a correction will take hold eventually. Until then, we follow and trade accordingly. There will be steps to follow when it unfolds.
This article is commentary by an independent contributor. Chris Vermeulen is full-time trader and research analyst for TheGoldAndOilGuy Newsletter.