given at the Babe-Bolyai University, School of Business Administration,
Sf. Gheorghe, Romania, on May 2, 2001.
The long-wave inflation/deflation cycle discovered by Kondratieff is
generated by huge speculative money-flows to and fro between the commodity
market and the bond market. The oscillation pattern of these flows reflects
changes in the propensity to hoard. The problem of the long-wave cycle is
thus reduced to the question: what is causing the fluctuations in the
propensity to hoard, and how can it be contained?
propensity to save
Let's start with the
uncontroversial proposition that the greater the propensity to save, the
lower is the rate of interest and vice versa. The mechanism whereby the flow
of savings regulates the rate of interest under a gold standard is very
transparent. Savers who feel that the rate of interest is too low will
exchange their bank notes and deposits for gold coins. In this way, savers
have direct control over the level of bank reserves, and they can confront
the banks with the choice of either raising the rate of interest, or calling
in some of their credit outstanding. The mechanism that regulates the rate
of interest is the savers' privilege to hoard gold, and any effort to
tamper with it is bound to cause distortion in the economy.
present monetary arrangements have removed the gold coin as a regulator of
bank reserves, in order to disenfranchise the savers who no longer have a
say in setting the rate of interest. The banks are now free to pursue a
credit policy motivated by political rather than economic considerations.
Worse still, the government has assumed power over monetary policy in
contemptuous disregard of the wishes of the savers. It goes without saying
that such a monetary regime is unconstitutional and flies in the face of the
principles of representative government of limited power.
our purposes it is even more important to note that the abridgement of the
savers' rights and privileges predated their total disenfranchisement by
several hundred years. The banks have always had a bag of tricks on hand to
dissuade their depositors from taking the gold coin - which was the
depositors' legal right to do. When the banks were at the end of their
rope, they could always count on the government to suspend the gold standard
in order to save the banks' face - and skin - in making the banks'
bad liabilities legal tender. The banks were rewarded, rather than
penalized, for their wrong credit policies. No wonder that more credit abuse
was heaped upon credit abuse throughout the centuries.
The legal right of the
savers to demand gold coins in exchange for bank notes and deposits whenever
they get worried about the state of banks or the spending habits of the
government, is eminently just and equitable. It is the little man's
protection against the powerful without which, as history has made it
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. Originally creditors were free
to press for the liquidation of firms that had failed to perform on their
promises. Now banks were made exempt - they got blanket protection against
the wrath of their creditors. Of course, there is no justification in
jurisprudence for extending special privileges to banks, the spurious
argument that bank failures cause too much economic and social pain
notwithstanding. All should stand equal before the law. But the banks got
still more protection from the government when they overstated the value of
their assets and understated that of their liabilities. Other firms doing
this kind of window-dressing, if caught, are found guilty of fraud and
punished accordingly. Bank examiners look the other way when they discover
fraudulent accounting practices. They do this with the full knowledge, if
not at the outright request, of the government.
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: 'you scratch my back and I scratch yours'.
The banks had ample opportunity to return the favor to the government when
they were expected to buy up treasury paper which the market was no longer
willing to take at the yields offered, and to deliver other similar
would be naive in the extreme to assume that savers meekly acquiesced in
this act of double-dealing and coercion manifested by the sabotaging and,
ultimately, the destroying of the gold standard. Instead of (or in addition
to) hoarding gold coins, savers started hoarding marketable commodities. The
list of these is endless. There are the traditional ones such as salt,
sugar, spices, spirits, tobacco, tea, coffee - not to mention drugs such
as cocain and heroin. The suggestion cannot be easily dismissed either that
the escalation in illegal drug trade during the twentieth century was in
direct consequence of the destruction of the gold standard. (Consider the
fact that as long as governments
tolerated the gold standard, there was little problem of illegal drug
trafficking.) In more recent times semifinished products such as crude oil
and raw lumber have joined the list of hoardable commodities.
would be an impossible task to estimate, however tentatively, the size of
existing stores of goods held not for impending consumption but, rather, in
protest against the low level of the rate of interest, or against reckless
government spending and against the banks' plundering of the savings of
individuals. This is where statistics must plead impotence. The only way to
grasp the hoarding instincts and habits of the people is through theoretical
divorce of the act of hoarding from that of saving was in response to the
conspiracy between the banks and the government. The propensity to hoard has
been gaining ground as an independent economic force at the expense of the
propensity to save, in direct consequence of the practice of governments to
protect the banks against their creditors, and of the banks sheltering
illiquid government debt in their balance sheets.
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 it is confined to boorish
and uninformed people whose action can safely be ignored. However,
economists can dismiss the problem of hoarding in the modern economy only at
their own peril. The means of hoarding are just as ingenious as its objects
are varied. Examples are not confined to housewives buying more sugar to
fill up their pantry, or to small-time smugglers holding contraband
merchandise in mountain caves. They also include sophisticated inventory
management techniques by multinational firms such as inventory-padding, the
deliberate use of leads and lags in warehousing by producers, distributors,
and industrial users, the slowing down of input or output at either end of
the production line. In recent times cutbacks in production quotas of
marketable goods (e.g., crude oil) were utilized for the same purpose with
dramatic effect. The Japanese import far more raw lumber from Canada than
they need for current consumption. Having treated the excess with an
impregnating solution, they sink it to the bottom of their mountain lakes.
The same applies to their import of coal. Hoarding energy-carriers is not
confined to energy-poor countries. The U.S. government is filling up disused
salt mines with crude oil. The supertanker construction boom of the 1970's
is another point proving the enormous increase in the propensity to hoard.
The supertankers were built as floating warehouses, not as efficient
carriers of crude oil. Futures and options trading has opened up new avenues
for the general public for participation in the hoarding-game.
There is a phenomenon for
which economists have failed to offer a satisfactory explanation. This is
the apparent linkage binding the long-term movement of the price level and
that of the rate of interest together. Apart from inevitable leads and lags,
the two appear to be linked: they always move together in the same direction
whether up or down. A host of excellent economic thinkers such as
Knut Wicksell, Wilhelm Ropke, Gottfried Haberler, and many others
who considered it, found the phenomenon '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". G. F.
Warren and F. Pearson in their 1935 book Gold and Prices 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 notice the rise in the price
level and demand compensation from the debtors in the form of higher
1947 this reasoning was rejected by Gilbert E. Jackson. In his paper The
Rate of Interest he pointed out that linkage works in both direction:
sometimes the price level leads and the rate of interest lags, at other
times the other way around. Jackson summarized his comparison of British
wholesale prices and the yield on British consols for a period of over 150
years from 1782 to 1947 in the form of a chart (included at the end). 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. His chart shows the inflationary spiral as a
rising, and the deflationary spiral as a falling trend of the two curves.
Inflationary and deflationary spirals alternate. Sometimes prices lead, and
sometimes they lag behind the rate of interest. Neither Jackson, nor anyone
else who studied the phenomenon could offer a full theoretical explanation
for the linkage. The most they could say was that it appeared to be an
Our own explanation for the
linkage is as follows. Frustrated savers sell their bonds and put the
proceeds in commodities. Thus a rising price level can be characterized by
huge speculative money-flows from the bond market to the commodity market.
As bonds are sold, their prices fall, that is, the rate of interest rises,
together with the price level. But as soon as prices start to fall in
earnest, the money-flow reverses itself and moves from the commodity market
to the bond market. As bonds are bought, their prices rise, that is,
interest rates fall, again emulating the movement of prices.
linkage is therefore explained by the fluctuation in the propensity to
hoard. When the latter is rising, the price level and the rate of interest
are rising with it, and conversely. Although Fullarton recognized already in
1844 that gold hoarding is just a protest of the savers against the banks'
loose credit policy and against the government's budget deficits, Keynes
almost a hundred years later looked at gold hoarding as a
psycho-pathological aberration. He invoked the authority of Ricardo, who
also failed to recognize its economic significance. But 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.
economics is still at the retarded level of Keynes when it comes to
assessing the merits and demerits of the gold standard. It refuses to
recognize the protest-aspect of gold hoarding, and it is forgetful about the
axiom that saving must precede spending, and that without saving there is no
economic development. Gold is the leash on which the frugal must keep the
prodigal. It was this leash that the banks and the governments wanted 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 without the leash of the gold standard has only a short history of
hardly 30 years. It is not a glorious history.
could say that since taxation and treasury departments were invented, a
great tug-of-war has been going on between the frugal and the prodigal. The
latter is the consortium of the banks and the government. The former is the
saving public, which includes not just the creditors, but the little man as
well, who is forced to keep his savings in the form of cash, that is, paper
money open to plunder by the consortium. It would be a great error indeed to
take it for granted that the tug-of-war will eventually end with the defeat
of the frugal, only because the prodigal has succeeded in knocking the
weapon of the gold coin out of his hand. Enter the propensity to hoard, the
newest and extremely efficient weapon which, however, is not free of some
very dangerous side-effects. A jump in the propensity to hoard can siphon
off a tremendous amount of money from the bond market, which would make the
rate of interest jump, too. The last time it did that was in the years
1973-1980. It shook the world as it heralded the beginning of the
deflationary spiral in the long-wave cycle.
The increase 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
high interest-rate structure can no longer be maintained in the light of the
high level of inventories. The inflationary spiral is ending and gives way
to the deflationary. The painful process of inventory liquidation starts,
and the money-flow from the bond market to the commodity market makes an
'about-face'. Liquidation is another prolonged affair that may cause the
failure of many a firm and may bring on a depression.
so-called contra-cyclical policy of Keynes, that has been dogmatically
applied by central banks since the 1930's, not only fails to help but,
actually, makes things worse. Following the Keynesian script the central
bank is trying to contain the weakening of prices through open market
purchases of bonds. As a direct result of this bond prices rise, that is,
the rate of interest falls. The linkage will then make sure that prices will
fall, too (or at least stay weak). We see that during the deflationary
spiral the central bank is unable to stem the tide of money flowing from the
commodity market to the bond market. As a matter of fact, its
contra-cyclical moves can only pour oil on the fire. But exactly the same is
true of the inflationary spiral, when the main worry of the central bank is
the high rate of interest. To bring it down, once more, the central bank
resorts to open market purchases of bonds. In doing so it puts new money
into circulation that quickly finds its way to the commodity market and bids
up prices there even more. Linkage will see to it that the rate of interest
is up, too. The contra-cyclical policy fails again.
deflationary phase the central bank combats weakening prices, causing the
rate of interest to fall - which leads to more weakness in prices. In the
inflationary phase it combats the high rate of interest, causing prices to
rise - which leads to a still higher interest rate. The contra-cyclical
policy of Keynes backfires in either case, because Keynes was ignorant of
the linkage. For example, during the 1947-1980 inflationary spiral, the rate
of interest rose five-fold, and the price level rose ten-fold
in the United States, in spite of the vigorous contra-cyclical intervention
of the Federal Reserve banks.
have seen, the long-wave economic cycle is caused by the enormous
speculative money-flows back-and-forth between the bond and commodity
markets, which are further reinforced by mindless contra-cyclical
intervention. The speculative money-flows are generated by the fluctuation
in the propensity to hoard. It is futile trying to correct these
money-flows; one should direct them into channels where they can do no harm.
Keynes was so obsessed with the thought of gold hoarding that he missed the
problem of hoarding goods altogether, which was potentially infinitely more
dangerous. Keynes was the high prophet of the anti-gold agitation. He
preached that if the gold coin were kept away from man's greedy palms (sic),
then there would be no hoarding, no economic contraction, no deflation. His
was a colossal mistake, the kind that only a doctrinaire can make. After the
destruction of the gold standard by the government, hoarding did not cease:
it only changed forms. The benign tumor turned into malignant. The
withdrawal of gold coins from the monetary bloodstream by government
coercion not only failed to stop the deflation, but it set off a huge
suction pump in the bond market siphoning off money from every other corner
of the economy. In particular, it created a devastating liquidation and
depression from which only a world war could pull out the economy. We
can't help but notice that gold is the philosophers' stone: in its
possession the propensity to hoard can be directed into its proper channels,
but without it the world economy becomes a plaything in the hands of
commodity, bond and foreign exchange speculators.
Since 1981 the world
appears to be in the grips of a deflationary spiral which has not run its
course yet. Some liquidation has taken place, but the worse seems still to
come. The politicians and economists are congratulating each other for
having succeeded "squeezing inflationary expectations out of the
system". They squeezed nothing of the sort. Inflationary and deflationary
spirals are caused not by expectations, but by actual money-flows to and fro
between the bond and the commodity markets. The international monetary
system is still the same rudderless ship it was in 1971, and it is still
exposed to the same monetary storms. The only difference is that the
direction of the gale has changed.
dangerous deflationary spiral threatening the world's prosperity is most
obvious in Asia. In Japan the stock market collapsed, followed by the real
estate market. The banks are at the brink of the abyss. The sun appears to
be setting on the economy of the Land of the Rising Sun. The devastation
caused by deflation in Japan in the 1990's was of the same order of
magnitude as that caused in America in the 1930's. Both deflations could be
characterized by an irresistible money flow to the bond market, drying up
the resources in all other departments. In Japan, the rate of interest fell
to almost 0 percent. In 1995 the Japanese government reacted in the same way
as the U.S. did in 1933: it devalued the yen by 50%. The yen's
devaluation, however, was just as futile as the devaluation of the dollar
had been. The latter triggered competitive devaluation of the world's
currencies in the 30's. The yen's devaluation could very well have the
same effect. This is suggested not only by the death-throes of the ruble and
a number of other Asiatic currencies, but also by the infantile diseases of
moment, the American economy may appear healthy and robust. But as one
observer has aptly put it, the Japanese deflation-tumor could very well
metastasize across the Pacific. All is not well in America. The stock market
boom has not been justified by corresponding increases in profitability and
productivity - any more than it was in the 'roaring twenties'. If the
stock market crashes, the already irresistible speculative money-flow to the
bond market could be reinforced - just as it happened after the 1929
crash. Falling interest rates could cause over-indebted firms to scramble.
That could trigger a credit collapse. Already, the long-term rate of
interest has been pushed down from 16 to 6 percent. The danger is that it
will keep falling to 3 percent or lower, due to the speculative orgy in the
bond market. Like a gigantic vacuum cleaner, the bond market could siphon
off resources from the real economy. It is not generally realized that a
depression, far from depressing the bond market, creates boom-conditions for
the bond speculator who makes a killing while everybody else suffers.
suggestion that the present deflationary phase may have another ten years to
run is not a prognostication. There are too many imponderables. For one,
governments know only one nostrum to cure economic ills: devaluation, and if
it does not help, more devaluation. Central bankers may lose their cool in
the deflationary inferno, and open the spigots to flood the world with
worthless paper currency. The race of the world's paper currencies towards
the brink is still on.
The idea of a long-wave
cycle in the capitalist economy was put forward in 1922 by the Soviet
economist N. D. Kondratieff (1892-1930). He had been anticipated by J. van
Geldren in 1913 and, even earlier, by H. Clarke in 1847 and Jevons in 1878,
and also by others. Independently of Kondratieff, De Wolf proposed a theory
involving a long-wave cycle in 1924. Kondratieff's is only one of four
cycles generally recognized by economists:
short-wave cycle of 3-5 years duration, discovered in 1930.
of 7-11 years duration, discovered in 1862.
medium-wave cycle of 15-25 years duration, discovered in 1923.
long-wave cycle of 45-60 years duration, discovered in 1922.
The Kitchin cycle is
otherwise known as the inventory cycle. The Juglar business cycle is the
best known and was discovered first. (3) is the building cycle. Kuznets
noticed that residential and industrial buildings have an average useful
life of 21-23 years, and his cycle is about the fluctuations caused by the
amortization and replacement of ageing buildings. The cycles were named
after their discoverers by J. Schumpeter with the exception of (3) which he
doesn't recognize. As a consolation, Kuznets got the Nobel prize for his
discovery. It is interesting to note that all three students of cycles whose
names begin with a K were Russian.
economists insist that the cycles operate independently of one another. This
is the view of Forrester, for example. Others, like Schumpeter, believe that
the cycles are interdependent. It was noted that the average duration of
each type of cycle is approximately double of that of the immediately
preceding shorter cycle. In the 1930's the historians F. Braudel, F. Simiand,
and E. Larousse looked at changes in the 'secular trend' that
was taking place every 100 years, so that Kondratieff's cycle might also
be followed by one of twice the duration.
involved the analysis of 21 statistical series. These were economic
indicators such as price indexes, the rate of interest, wage rates, rents;
the volume of production, consumption, employment, exports, imports, etc.,
as well as their standard deviations. In studying volumes Kondratieff worked
with per capita data. He used the method of least squares to calculate the
deviation from the trend. He employed 9-year moving averages in order to
filter out noise caused by the shorter cycles. He took his data base from
the French, British, German and the U.S. economy.
6 of the 21 series could Kondratieff not confirm the presence of a long-wave
cycle (the price level and the rate of interest were not among them). His
ultimate conclusion was that there was enough empirical evidence to support
the hypothesis of a long-wave economic cycle in the capitalist countries
that he studied, with an average duration of 54 years. He allowed a 25
percent deviation from this average. In particulat, Kondratieff identified
The rising phase of the first wave from 1780-90 to 1810-1817,
falling phase from 1810-1817 to 1844-1851.
The rising phase of the second wave from 1844-1851 to 1870-1875,
falling phase from 1870-1875 to 1890-1896.
The rising phase of the third wave from 1890-1896 to 1914-1920,
falling phase started 1914-1920.
Kondratieff was exiled to
Siberia by bolshevik officials who flatly rejected his conclusions,
maintaining that there can only be one falling phase of the
capitalist economy, which must be followed by socialist revolution and the
dictatorship of the proletariat. Kondratieff 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 1947-1948, and also that
The rising phase of the fourth wave started 1947-1948 and ended
falling phase started 1973-1980.
The current fourth wave is also confirmed by an extrapolation of G. E.
Jackson's results. We may assume that Jackson was unaware of
Kondratieff's work. Therefore it is remarkable that the two economists
working independently came to almost identical conclusions. Moreover,
Jackson's results suggest that there is no need to study 21 series since
two of them, the price level and the rate of interest, already determine the
outcome. These two, together with the linkage, suffice to provide the
theoretical foundations for the long-wave economic cycle. If this is so,
then we may conclude that the long-wave cycle of the world economy is caused
by huge speculative money-flows to and fro between the bond market and the
commodity market. These money-flows are in turn governed by the fluctuations
in the propensity to save, the tide of which creates the inflationary, and
the ebb the deflationary, spiral.
most worrisome aspect of Kondratieff's long-wave economic cycle is its
global nature. There is no place in the world to hide from the deadly
consequences of the deflationary spiral. Far from being confined to the
economy, its effects extend to demography, politics, education, crime,
fashions, literature and the arts.
existence of the long-wave cycle forces us to give up the earlier,
optimistic models of uniform growth of the capitalist 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, Bela
Hamvas (Secret Minutes, 1962, see: Works of B. Hamvas, vol. 17, Medio,
Budapest, p 104-106, in Hungarian.)
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 - as long as the fair
weather lasts. But let drought strike or flood engulf the land, 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 sight of a mutation. The fair-weather system of unlimited
government is forever unable to cope with catastrophes. (N.B. This was written 25 years before Chernobyl.)
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 one state to another. 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
admitted that dull times called for dull theories, they believed that
critical times called for theories altogether alien and different from those
dull theories. In critical times you must think deeper, you must be wiser,
and more imaginative.
are in the habit of slighting and disparaging the accomplishments of older
philosophers. We seem to be incapable to benefit 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 in waters
teeming with dangerous reefs under the surface... We are in deep trouble...
Que sera, sera...
is to be done?
need not conclude our excursion on such a pessimistic note. We are able to
temper the deleterious effects of the long-wave economic cycle, even though
we are unable to eliminate it. If we cannot legislate away the propensity to
hoard, we may confine it to its proper channels. The role of gold in the
world is to provide just this. As it were, God created gold in order to
render the propensity to hoard harmless. Gold hoarding has no effect on
essential consumption, only on jewelry consumption. Under the regime of the
gold standard there was no bond speculation, still less foreign exchange
speculation. This is the only road to stabilization: to put speculation into
its proper place, and to confine speculators to fields where they could do
no harm, but they could do some good: to commodity markets where the supply
of goods is controlled by nature, not by governments or central banks.
significance of the 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 consonant with the state of the economy. The stabilization of
the rate of interest and foreign exchange will then impart as much stability
to the price level (and to all other important economic indicators) as can
be humanly achieved. By letting the saver withdraw the gold coin (that is,
bank reserves) when the rate of interest falls to a level he considers
unacceptable, the irresistible speculative money-flows to and fro between
the commodity and the bond markets - the engine of the inflationary and deflationary spirals
- would be shut down at the 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.
alternative to a gold standard is too horrible to contemplate: unemployment
more devastating than that of the 1930's, earthquake shaking the foundations
of the international monetary system, construction of unscalable protective
tariff walls, world war in which governments are hoping to find an escape
route from economic chaos.
Antal E. Fekete
Professor Emeritus, Memorial University of Newfoundland, Canada; recipient of
the 1996 International Currency Prize awarded by Bank Lips, Zurich,
Switzerland, for his essay Whither Gold? This talk is based on a
Chapter from the author's projected 3-volume treatise Credit.