Saturday, October 31, 2009

Kondratieff Winter - is over? Or just starting?

Back in 1920s, Nikolai Kondratieff who was a Soviet economist explained an observed cycle that repeated approximately 50 to 60 years. According to his theory, capitalist economies are prone to boom and bust cycles. Kondratieff waves have four seasons in each cycle: Spring, Summer, Autumn, and Winter.

According to this labeling, Austrian school would say the Spring starts when excesses of the economy has been cleaned by a previous crash. Hope and innovation brings a new cycle of investment and expansion. During the Spring phase, people start feeling better and they borrow. In Western economies, due to fractional reserve banking, when we borrow banks create money. They do not lend existing money. This new money creates a boom that keeps borrowing and expansion going. Herd behaviour of the people makes them borrow, invest and spend together.

This brings prosperity, which is summer. Money is easy to earn, people are optimistic. These are the good times. We feel rich. Expansion continues. Albeit more selectively. Prices are inflated by the optimism and the borrowing that inflates the money supply.

Autumn comes and borrowing slows down. We have the capacity to produce goods and services that we consume. But expansion is not there.

Then the winter arrives. It is pay back time. The debt that has been accumulated for decades needs to be paid back. This makes it hard for some parts of the economy to survive. During the boom times, almost all prosper. But when the money supply deflates, it becomes harder and harder to earn.

Robert Prechter, who is now famous for predicting the 80s boom, 87 crash weeks in advance, the 2007 top and 2009 March bottom days before, has just released the second edition of his book Conquer the Crash which was originally published in 2002.

Prechter explains why we should prepare for the stock market crash, and why deflationary crash will continue. That perspective puts us roughly at the early stages of the Kondratieff winter.

In this blog, I hope to discuss the current macro economic environment, social mood and the stock market. Again according to Prechter, social mood directs the stock market, and it is an early indicator of where the economy is going.