The Cycles of Economic Life

By TAN Kee Wee

(MediaCorp 938LIVE’s Money Talks, Thursday, 30 October 2008, 7.50 am and 7.20 pm)

Poor Alan Greenspan, the former Chairman of the US Federal Reserve. When he retired in January 2006, many people saw him as the greatest central banker ever.

In his last appearance as Fed Chairman before the US Congress in November 2005, a senator praised him, saying: “You have guided monetary policy through stock market crashes, wars, terrorist attacks and natural disasters. You have made a great contribution to the prosperity of the US and the nation is in your debt”.

Last week, three years after he was lionized like this, Greenspan must have wondered whether he was in a nightmare. In an appearance before a Congressional committee, Greenspan was questioned very harshly by the lawmakers.

Instead of treating him like a demi-god, which they used to when their stockholdings had higher values, the lawmakers interrupted Greenspan’s answers. They sarcastically quoted his own words from years ago, and forced him to admit that his policies had worsened the current financial crisis.

In the face of the lawmakers’ attacks, Greenspan conceded that he made the mistake of believing that free markets could regulate themselves without government oversight.

Greenspan said that he was in a “state of shocked disbelief” because his 40 years of experience made him believe that free markets worked exceptionally well.

Forty years is a life cycle for any man. But for an economic historian, 40 years is short. In 1925, Russian economist Nikolai Kondratieff (1892-1938) published a book outlining grand economic cycles that range from 40 to 60 years.

These Kondratieff cycles alternate between periods of high growth and periods of low growth. During high-growth periods, prices rise and interest rates are low. During low-growth periods, prices fall and interest rates are high.

Of course, not everyone believes in such economic cycles. They say that looking for such cycles in a mass of statistics is no different from looking for objects in the formation of the clouds above us. Even among believers, there is no agreement on the starting and the ending dates of these economic cycles.

Despite the disagreement, the more popular version of Kondratieff Cycles used nowadays are the ones proposed by the three economists – Schumpeter, Freeman, and Perez. According to their model, there have been five Kondratief Cycles since the Industrial Revolution in 1771.

This means that we are now at the mid-point of the Fifth Kondratieff Cycle which began in 1971. Unfortunately, the mid-points of Kondratieff Cycles tend to be the low-growth years. If we go back to the middle of the Fourth Kondratieff Cycle, it would bring us roughly back to the Great Depression of the 1930s.

So the bad news is, according to Kondratieff Cycles, the global economy will now have to go through a low-growth period before the sun shines again. How bad the low-growth period will be normally depends on how good the high-growth period was. Since our recent high-growth period was very good, perhaps we must expect the forthcoming low-growth period to be very bad.

If Alan Greenspan could have lived through a few Kondratieff Cycles, he would not have rejected his belief in the free markets last week. This is because the booms and the busts will happen no matter what government policies, with their checks and balances, are introduced.

How is that possible, you ask? Well, I suppose it’s just like car accidents. Despite the many safety features installed in modern cars, the proportion of drivers killed has not really come down.

And that’s because car manufacturers have put in more powerful engines, and drivers are taking even bigger risks on the roads, thinking that the safety features installed in their cars would save them.

In the end, car drivers will continue to kill themselves, just as speculators will continue to destroy the markets somewhere in the economic cycle.

Talking about grand economic cycles, this is the final program of Money Talks for this current cycle. Thank you for tuning in. We should be back next year.