All Articel 2

Economic history shows us that there have been some well-defined patterns in inflation and interest rates over the last 150 years. (1) Indeed, David Hackett Fischer [1996] extends this study back to 1224. Perhaps the most well-known treatment of long-waves was the work of Nicolai Kondratieff [1925], who suggested that there was a long-wave of about 50 years duration. His work was never fully developed because Joseph Stalin felt that it conflicted with Marxist doctrine and Kondratieff was sent to Siberia in 1930 and was executed in 1938. However, the idea was taken up by Joseph Schumpeter [1954] and by William Fellner [1956]. They divided the long-wave into two phases--an upgrade and a downgrade--and observed that business downturns were more severe and recoveries weaker in downgrades. Professor Fellner felt that the concept was useful even though he believed that long-waves could not be extrapolated into the future with any precision.
In the spirit of that idea, my earlier paper [Synnott 1995] focused on the third phase of an idealized 56 year wave, from 1988 to 2002, as suggested by Figure 1. Using the historical experience of a previous "third phase," from 1876 to 1890, as a guide, 1 made some observations about likely financial and economic developments in future years. The next section of this paper reviews those projections in the light of what actually happened.
1. Review of Developments Since 1994
If the center line of Figure 1 is taken as the longrun average rate of inflation, the "third-phase" represents a period not only of slowing inflation but of low inflation or actual deflation. (This was particularly acute in Japan.) One might expect in this environment that corporate profitability would be under intense pressure. This was certainly true of the 1876-90 period, when virtually the entire American railroad industry became bankrupt and was reorganized by J.P. Morgan. Another severely affected industry was cotton textiles, as new technologies and high costs in New England led to a shift of the industry to the South.
Of course, declining agricultural prices and wholesale prices generally put great pressure on farmers and small businesses, leading to continuing political struggles in the latter part of the 19th century. Table 1 lists some characteristics of the Third Phase periods (1876-90, 1932-46 and 1988-2002) drawing heavily on the 1876 -90 experience as well as what we knew, in 1994 about our current period.
Table 1. Characteristics of the Third Phase
Downward pressure on prices
Many commodity prices below the cost of production
Corporate mergers, restructuring and bankruptcies
Commercial real estate--declining rents and values
Intense Credit Pressures
Rising and high debt burdens
Bank loan losses
Political Tensions
Zero-Sum Thinking
Pressures for income redistribution
Depression of spirit
Protectionism
Emergence of new engines of growth
New products and industries
Major infrastructure projects spurred by low long-term interest rates
What happened?
As anticipated in my 1995 paper, the Third Phase (1988-2002) proved exceptionally difficult. The savings and loan crisis in 1989, the Mexican peso crisis in 1995. the Asian financial crisis in 1997-98, the Long-Term Capital Management problem in 1998 (Lowenstein 2000), and the dot.com boom and bust in 1998-2002 roiled world financial markets and led the Federal Reserve (and the Bank of Japan) to pursue aggressively easy monetary policies. In the United States this monetary reflation led to a surge in house prices, a boom in housing construction, and a huge bad-credit expansion.
The conclusions of my 1995 paper (pages 15-16) mainly came true--particularly that U.S. economic growth was "likely to lag behind other centers--especially those in Southeast Asia." This period also saw "increased political turmoil in the industrialized world as restive electorates strive to find political solutions to high unemployment."
However, despite significant monetary stimulus, overall inflation in the United States and other industrialized countries remained low, and interest rates were much lower than expected.
What did not happen?
First, the federal government did not shift spending toward long-term investment. Rather the U.S. involvement in two costly and protracted wars has resulted in a crowding-out of productivity-enhancing investments in infrastructure. Second, the U.S. economy, following the collapse of the housing boom and the crisis in the financial system, has yet to get onto a sustainable growth path.
2. Lessons from the History of 1890-1904 (Phase 4)
One should have paid more attention to this period when thinking about the Fourth Phase of the Long Wave. The end of the 19th century saw the emergence of three new industrial powers: the United States, Germany, and Japan, boosting world economic growth but setting the stage for conflict with the old industrial powers--Britain and France. Today, we in the United States are seeing the emergence of China and India as major economies. Have we learned enough to avoid repeating the mistakes of the past?
In the United States, low prices for farmers and pressure on wages pitted debtors against creditors and led to political conflict over whether to stay on the Gold Standard. (William Jennings Bryan was the several-times Democratic candidate for President and is remembered for his "Cross of Gold" speech.) During the "Gay Nineties" there were three recessions and one serious financial crisis (in 1893). The crisis was resolved only by a huge goldloan to the U.S. government by the House of Morgan. While the public debate was largely about whether the U.S. dollar should be backed by gold or by silver, the real question was whether the United States would devalue with respect to the British pound, which was then defined in terms of gold. If we had devalued, European investors who had bought great quantities of bonds to finance American railroads and municipal improvements would have lost heavily. J.P. Morgan as the conduit for foreign capital would probably have had a very hard time attracting foreign investment to finance American industrialization.
Still, difficult as this period was in many ways, important new industries emerged--electric power, automobiles, chemicals, modern steel-making, for examples--and the individual railroad companies were combined into a modern efficient system. This in turn enabled the expansion of the cotton textile industry in the southern United States and the growth of a national market for goods.
Then the discovery of gold in Alaska and new mining techniques in South Africa led to a world-wide monetary reflation. Figure 2 shows that commodity prices rose and the overall wholesale price index was on a gently rising trend by the late 1890s and early 1900s.
Figure 3 shows a moving average rate of change in the Producer Price Index (formerly the wholesale price index) from 1862 to 2006. World War II, of course, caused a price surge that was out of synchronization with the other long-wave peaks.
Note that since 2002, wholesale price inflation has been on a gently rising trend. This, as will be seen later, is importantly related to a significant use in the prices of crude oil and a number of