How the Kondratieff Cycle Might Play Out

Nelson Hultberg

December 5, 2002

There is a very important point that many deflation advocates seem to be ignoring: Unlike Kondratieff winters of past eras, a modern Kondratieff winter does not necessarily have to follow in like fashion. I believe Ian Gordon and Robert Prechter are right about a winter coming, i.e., massive recessionary forces descending upon America and the world. We are confronting the end phase of the 60-70 year cycle that is now in its fourth repeat over the past 240 years. The fact that it must play out is, in my opinion, inevitable. But HOW it plays out is, by no means, set in stone. This is because we can now intervene with monetary and political policies that can alter the nature of the winter phase of the cycle. We can change its form.

(If by chance the reader is not familiar with the Kondratieff Cycle, see Jay Taylor’s interview with Gordon, July 12, 2002 —

Our Awareness of the Cycle Will Alter It

During the previous three cycles, no one was aware that the cycle existed, nor were they aware of the four seasons of the cycle (except for Kondratieff himself and his close followers at the end of the third cycle). Nor was there in the first two cycles any central banking power with the capability to print massive amounts of money, i.e., monetize bonds and deficits in a large scale way. Thus, we sort of drifted along with the force of the cycle as it played itself out in a deflationary form.

In the third cycle that went through its winter season between 1929 and 1945, we had a central bank but not the clear awareness of the cycle and a sophisticated grasp of the role that money creation plays in its inflationary seasons. Now, however, we not only are aware of the cycle and the role money creation plays in it, but we have a central bank that is deathly afraid of deflation and willing to do anything to avoid it. So this winter season does not have to just play itself out in the form of “inevitable deflation” as the other three cycles did.

The Fed has the power to alter what form the cycle’s winter season takes, because they can print money massively and turn a “deflationary” winter into a “stagflationary” winter. And this they might well do. What they cannot do, however, is AVOID the winter, i.e., the massive adjustment process needed to right the excesses of the previous inflationary seasons of the cycle. We must go through the adjustment process before the economy can become healthy again. This we will do either through deflation or stagflation. These are the two choices as I see it.

This, of course, is the old rock-and-a-hard-spot dilemma for the Fed. Greenspan and his board members will have to pick one of the two scenarios. The only way they can avoid deflation is to monetize massively, which will drive billions of foreign dollars out of our stock and bond markets and destroy the dollar’s value in the forex markets. This will bring on a plunge of both our bond and stock markets, and create a recession with rapidly rising prices (stagflation), which is what we had in the 1970’s. The only question is WHEN does the Fed decide to accept stagflation as the lesser of the two evils? Have they already decided? Or will they wait until we are knee deep into deflation before they throw in the towel and accept a stagflation scenario?

Can Fed Monetization Save Us?

Another question must be asked, however: Is the Fed prepared to monetize at a high enough level to create the “mega-purchasing power” needed to avert a deflationary credit contraction? The Fed can monetize the purchase of massive amounts of bonds, and it can monetize $100 billion plus annual deficits on the part of Congress, which would inject large amounts of money (without debt) into the economy through its open market operations, and through welfare handouts, farm subsidies, pork barrel bills, wartime spending, etc., which would create substantial purchasing power for consumers and businesses. But would it be enough to counteract the massive credit contraction that a Kondratieff winter brings on?

The problem is that trillions of dollars in credit and its corresponding debt have been created by the Fed over the years at a 10-1 ratio through the pyramiding process (or “multiplier effect”) of fractional reserve banking. Now with businesses and consumers slowing their borrowing to a snails pace, the Fed can no longer effectively use the “multiplier effect” to create purchasing power for the economy. It can only resort to simple injections of fiat money that do not work their way into the pyramiding process. In other words, its monetization policies create purchasing power for the economy at a far lower ratio than 10-1 pyramiding does, probably at a 2-1 or 3-1 ratio only. This means that the Fed will find it difficult to create purchasing power at a fast enough rate to counteract the credit contraction taking place amidst all the liabilities that were created at a 10-1 ratio, and which will liquidate at a more rapid pace once deflation sets in. So the big question becomes, can the Fed monetize massively enough through simple fiat money injections devoid of the “multiplier effect” to counteract the power of a Kondratieff winter?

Jay Taylor, editor of Taylor’s Gold & Technology Stocks, thinks it is doubtful. As he explains, because the dollar is the world’s reserve currency, if the Fed were to print up massive amounts of fiat money, “the U.S. dollar would immediately be trashed as huge foreign investors in the U.S. would [abandon] the currency. At that point, not only inflation, but hyper-inflation would be the likely outcome. Argentina can do that. The U.S. cannot.” (, November 5, 2002)

Thus, in Taylor’s opinion, unless the dollar somehow ceases to be regarded as the world’s reserve currency, the Fed will have to fight deflation primarily through credit and debt creation. Massive amounts of fiat money injections are not really an option. This would make deflation an inevitable outcome.

Other Fed Dilemmas

But perhaps the Fed will attempt moderate monetization in an effort to avoid a collapse of the dollar (i.e., try and devalue the dollar slowly in pace with other currencies) thereby avoiding a huge exit of foreign money from the U.S. Surely Greenspan has worked out agreements with the central banks of Japan, China, and Europe, etc. to coordinate rates of monetization between their respective countries so as to avoid one of them adopting a more rapidly depreciating currency, which would create destablizing capital flight. After all, it is certainly in Japan’s, China’s and Europe’s interest that the U.S. economy and dollar do not collapse dramatically. Their economies are tied irreparably to feeding the ravenous American consumer behemoth through their exports.

The question then becomes, would this kind of coordinated moderate monetization be enough to avert the power of a Kondratieff credit contraction? Ultimately I think not, because the consumers of America are still human, and humans have limits to how much DEBT they can tolerate. Ultimately this will be the undoing of the central banks of the world. They have only fiat money and debt to offer, and it is these two poisons that we are drowning in today.

Another important question: Greenspan’s term as Fed chairman ends in July of 2004. What affect will this have on what the Fed ends up doing? Will Greenspan wish to put us into a certain stagflation scenario in the waning months of his term? Or will he try and keep the economy above water with just small amounts of monetization for another 18 months so as to hopefully avoid a collapse of the dollar, thus dropping the whole mess onto the doorstep of his successor?

But if the Fed does opt for stagflation over deflation, then they surely realize they must induce it via heavy monetization early on before deflationary forces solidify. This means perhaps in the upcoming year. Will they opt for such a scenario and chance setting off a collapse of the dollar? Or will they con themselves into believing they can win the battle against both deflation and stagflation, and that they don’t have to make such a choice?

None of these questions are possible to answer with certainty. But I think we can say with reasonable certainty that there are only two choices — deflation or stagflation. The Fed is not going to be able to restore a healthy, goldilocks economy where there is great growth and a resurgent bull market in equities. We are far too DEBT SATURATED for that. The only way a goldilocks scenario can be restored is to go through the great “winter of readjustment” in the cycle so as to liquidate all the debt that has accrued during our past two-decade credit binge. This will take 5 years at least (maybe 7-8), and it will not end pleasantly.

In fact, if stagflation develops, such a scenario might have to be followed by a gargantuan crash of the the economy anyway. In other words, it is not clear whether a prolonged period of stagflation would purge enough of the debt in order to restore the economy’s capacity for borrowing and growth. Recessions and depressions are equivalent to the withdrawl symptons of a drug addict from the preceding inflation which is the high. (Paper dollare are the drug, the Federal Reserve is the needle, and politicians and bankers are the pushers.) The recessionary period is a very necessary healing-restructuring process whereby the economy cleans up all the malinvestment that resulted from the previous Kondratieff seasons of inflation. So if a period of stagflation is not enough of a debt purge to heal the economy, then there might have to be a final plunge to effect the cure. The force of the winter comes from the economy’s need to be healed and cleaned up. This is what gives it its inevitability.

Think for a moment about the alleged quote by Greenspan when he was younger that “he would love to be the Fed chairman during the Kondratieff winter and prove that it could be overcome.” Well, he now has his chance. But in order to overcome the winter, will he not have to opt for massive monetization and a stagflationary scenario that dwarfs that which we experienced in the 1970’s? If so, has he really “overcome” the Kondratieff winter? Hardly; this would be the classic pyrrhic victory, or simply picking the lesser of two horrendous evils. If he did indeed make the above statement in his youth, however, it proves he was well aware of and accepted the existence of the Kondratieff Cycle. Schumpeter at Harvard was well aware of the cycle, as were several other high profile economists by the time the 50’s rolled around. And since Greenspan certainly read Schumpeter, he has to be aware of the Kondratieff Cycle’s existence, and quite possibly accepts its validity.

Anyway, things are never set in stone. Life does not unfold neatly. History repeats, but never exactly. The task at hand for those in the precious metals community is to grasp the “messiness” of history and gear for the long haul. This bear market probably has a long way to go. It could very well be a slow, excruciating grind downward with a final, frenzied collapse 10 years from now. It’s earlier than we think.