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Introduction in Kondratieff cycles

research 9 January 2017 575   

The world doesn’t stand still. The technologies and money has changed, old calculation methods become obsolete. The powerful empires get ruin and go into oblivion, some countries eventually become new world leaders. In order to prove existence of big cycles it is necessary to track at least four of them, in such a way, price statistics for two hundred years have to be analysed. It is also important that data have to be collected in comparable market conditions. Do we have such a statistics and can we trust that data?

In fact, price history for GOLD and currency rates start only from 70s of XX century. OIL and S&P 500 rates available from 1861 and 1871 years respectively, but their can’t be consider as indicative, because in those times OIL didn’t have a value for economy, and S&P 500 index didn’t reflect the dynamics of the market capitalization. In such a way, the only data that deserve our attention is statistics of consumer price index. (Figure 1)

Introduction in Kondratieff cycles
Figure 1 – the dynamics of consumer price index (CPI) in the US.
Red line – change year to year, blue – average change in 11 years.

As you can see from chart, there are only six inflation shocks in the US history, and all of them related with well-known historical events - The American Revolutionary War (1775-1783), War of 1812 between the United States of America and the United Kingdom (1812-1815), American Civil War (1861-1865), First and Second World Wars and of course oil crisis of 70s last century. In general, to contest the theory of cycles, the generation of wars can be considered as accidental, although the logic of historical process suggest that it is not so.

Every fan of Civilization - which is going to be performed in all American high schools - well known that military ambitions tend to appear in the state at the moment, when it has free production capacity. Such a state has insufficient technological reserves or unused resources for future development. In such a way, if economic cycles really exist, they generate military conflicts, but not vice versa.

Introduction in Kondratieff cycles
Figure 2 – the dynamics of the retail price index (RPI) in UK.
Red line – change year to year, blue – average change in 11 years

Figure 2 demonstrate the rate of retail price index in the UK since 1600. As you can see, the cyclicity, appeared only at the beginning of the XIX century, after the industrial revolution and recover of world economy from the Malthusian trap. In the future, inflation cycles in Britain in phase and period matched with the US, although the peak of the middle of XIX century against the background of geopolitical tranquillity not so pronounced.

In addition to CPI, the calculations can be performed based on GDP deflator. On the first sight, this indicator probably more suitable, due to independence from volatile import prices and possibility to take into account goods and services that produced in just one historical period. However, there is no fundamental difference in the nature of cycles, even in Britain, which rather strongly depends on imports (Figure 3). It can be used any of these two values.

Introduction in Kondratieff cycles
Figure 3 – the dynamics of the GDP deflator in the UK.
Red line – change year to year, blue – average change in 11 years.

The US inflation cycles modelling

It can be noticed that the average long-term inflation rate steadily increased – that’s the consequences of monetary stimulus, which is increasingly used by the governments around the world. For instance, for the period from 1774 till 1920th years the average growth rates of the CPI in the US were only 0.6%, while for the remaining 80 years of the XX century, they reached almost 3%. At the same time since the Great Depression, there was not a single case that the average inflation rate fell below 2% in 10 years.

On the basis of formation from Figure 1, it can be assumed that before a certain time in the last quarter of the XIX century the average long-term inflation rate was zero, after that they began to grow linearly, approximately with constant speed. In such a way, the cyclical component of the CPI relative to its long-term average (CC value) is equal to:

Introduction in Kondratieff cycles
where E – average value CC, k – index of observation year,
t – start year of long-term inflation, p – speed of grow of average inflation.

Optimal values (t = 1886 and p = 0.00042) can be found from the condition of minimum dispersion:
Introduction in Kondratieff cycles
n – number of observation years

Inflation cycles demonstrate Figure 4, and long-term average of the CPI - Figure 5.

Introduction in Kondratieff cycles
Figure 4 – inflation cycles in the US (based on index CPI).
Red line – change year to year, blue – average change in 11 years.

Figure 4 demonstrate only four inflation peaks. The top of 40's is an intermediate, as well as the peak in 1778 that appeared on the background of the struggle for the independence of the United States. In such a way, all events of the middle XX century, include the Great Depression, the Second World War and the oil crisis of the 70s, are the part of a huge cycle. Generally, the history of the US has only three completed cycle, with an average duration of 56 years.

It should be noted that the final function is very sensitive to the initial parameters and if the date of peaks, can be surely get, up to one year, then the CC value can be inaccurate. First, initially designed scheme greatly lowers the CC in recent years. Secondly it is in principle not capable to reflect long-term changes, which has begun recently. As it will be shown later, such a beautiful cycles on the chart, no more than just a coincidence.

Introduction in Kondratieff cycles
Figure 5 - CPI index in the US and its long-term average.

Inflation cycles in the Great Britain

Price dynamics in the UK is slightly different from the US, which is dictated by the logic of the historical process. Starting from the date of independence, the United States developed steadily, progressively established as a world leader. On another side Britain, has reached the peak of its power at the turn of the XX century, and later loss of the status of military and economic power, and currently classified as normal in developed countries, with narrow niche in global division of labor.

The whole XIX century American prices gradually caught up with the British, so that the United Kingdom has developed in the condition of long-term deflation. Inflation processes in the UK have started almost simultaneously with the US, but later, after the Second World War, inflation received an additional acceleration of the devaluation of the pound. In such a way the entire price dynamics become more complex, more over it is heavily dependent on exchange rate fluctuations.

In order to avoid adjusting a results, it is necessary to accept unsightly look of chart, but do not take into account any additional factors, which by the standards of the global cycles have appeared not so long ago. It is more correct to use every time the same universal formula, especially since it has, been written in a general form, allows the index to be accelerate not only horizontal, but also from the inclined section. Such a CC value (based on the GDP deflator) will be equal to:

Introduction in Kondratieff cycles
where GD – value of GDP deflator;
e – start year of observation (e=1820);
q – speed of deflation in XIX century.

Inflation cycles demonstrate - Figure 6, and the long-term average - Figure 7.
Introduction in Kondratieff cycles
Figure 6 - inflation cycles in the UK (based on GDP deflator).
Red line - the annual value of the SS, blue - an average of 11 years.

The final function, as expected, is very unstable, so the optimal parameters (q = 0.004, t = 1876 and p = 0.0006) were established based on visual perception of cycles without calculating the dispersion. After sorting out of parameters, it can be seen how much they affect the result, which makes the value of CC is almost useless for predicting inflation in the future. Fortunately, at least cycles date calculated accurately and this is the most important thing!

Actually CC value allows us to understand only one thing - the top of the 40-ies of the XX century, in any case is an intermediate, as well as in the United States. In such a way Second World War, the most devastating in modern history of the United Kingdom, did not led to the emergence of superior inflation peak. This fact confirm the non-random nature of economic cycles and their supremacy over the war and other historical events.

Introduction in Kondratieff cycles
Figure 7 - the GDP deflator in the UK and its long-term average

Inflation cycles in Australia and other countries.

For Australia can be applied the GDP deflator and the US formulas with parameters t = 1890, p = 0.00066. Inflation cycles demonstrate Figure 8, the average value of the deflator in Figure 9.
Introduction in Kondratieff cycles
Figure 8 - inflation cycles in Australia (based on GDP deflator).
Red line - the annual value of ICPI, blue – the average of 11 years.

Introduction in Kondratieff cycles
Figure 9 - the GDP deflator in Australia and its long-term average.

The data for Australia available only from 1828, but it's enough to make a conclusion about the synchronization of inflation processes in all developed countries, irrespective of whether a country with dominant role of the primary sector or post-industrial. The dates of price peaks in Australia accurately matched with the UK and the US, although the inflation process due to the absence of large-scale shocks flow more smoothly and consistently.

I should be noted that synchronization is only a qualitative regularity, but not quantitatively, it is enough historical examples when in developed countries there was hyperinflation. In addition, it is not necessary to look for a global trends in those countries that do not yet participate in global division of labor, or only incorporated into it, such as China in the past 30 years. As demonstrate Figure 10, the peak of inflation in China happened 10 years later than in the rest of the world.

Introduction in Kondratieff cycles
Figure 10 - CPI indexes in some countries (the average change over 11 years).
Red Line – China, Blue - Japan, green - The United States.

The key dates and brief description of the cycles

The stock market do not accurately follow the CPI index. On the contrary, in the XX century, the history of inflation in the US each peak (prime or intermediate) coincided with some key bottom on the S & P500, if it is consider in constant dollars (Figure 11). The total number of bottom were a few more, so not all of them are formed on the background of high inflation – that’s what confused the researchers, who were looked at charts big cycles.

Introduction in Kondratieff cycles
Figure 11 - S&P index is adjusted for inflation (CPI).

Stock quotes, without doubt, is the best indicator of what is going on, so that the dates of cycles should be linked specifically to them. Cycles traditionally assume for bottom, according to the principles of Hirst. In XX century, use data of the S&P500 index in the XIX, if it is absence, it should be focused on the end of known historical events. If so, then the final dates of big Kondratieff cycles in the United States similar to the following:

0 cycle - before 1815
1 cycle from 1815 to 1865 (50 years)
2 cycle from 1865 to 1921 (56 years)
3 cycle from 1921 to 1982 (61 year)
4 cycle from 1982 till present.

Similar as CPI index, market quotes also have a cyclical component that resembles conventional sinusoid (Figure 12). Periodically it is occurred short duration corrections, but it is never change the direction of the global trend. The only exception to this rule is the Great Depression, which is resulted in breach of the logic of the whole 3rd cycle and, in fact, to its fracture into two separate sinusoids (Figure 13).

Introduction in Kondratieff cycles
Figure 12 - a normal cycle with one peak.

Introduction in Kondratieff cycles
Figure 13 - disintegrated cycle with two peaks.

It can be suggest that the Great Depression not the usual cyclic crisis. On the contrary, it happened there, where it could be continue of the global growth wave, and now can only guess at what are the reasons for this turn of events. In fact, it can be state that in the 20s the US economy used full potential of growth just for eight years, and then fell into a tailspin, as the plane, which was climb too quickly.

The consequences of the crisis were traditional - the enslavement of the production relations, and new world war. It is noticeable that- despite the almost total destruction across the world, the old cycle has not ended, but inflation was much lower than in the result of the First World War. The new cycle has started only in the 80s, when the old economic model completely exhausted itself, and cleared the hyperinflation economy from all remnants of the Keynesian era.

The current state of the cycle.

As mentioned, the completed cycles has an average duration of 56 years. The last of them severely delayed and perhaps took some time in the present. The global ascending wave for the S&P500 almost the most powerful in the history, but it has fit into 18 years (from 1982 till 2000th years), while emerging markets continued to grow, at least eight more years. In total the current cycle should complete in the period from 2028 till 2032nd years.

Move back to the rate of inflation, because it is coincide with the market, rather than cyclical component of the CPI. In this perspective, each non crashed cycle can be divided into three parts (Figure 14). First period is fall of inflation, coinciding with the growth markets, second, the so-called non-inflation plateau, which starts after the top of the economic cycle, or alternatively, just before it, and strong, but short inflation shock at the bottom.

Introduction in Kondratieff cycles
Figure 14 - a schematic representation of an inflation cycle.
1 - active deflation zone, 2 - non-inflation plateau, 3 - inflation shock.

Figure 14 demonstrate non-inflationary plateau as a period of stagnation and lack of aggressive price fluctuations, although the actual rate of inflation on whole period of this phase is unstable, moreover, progressively increasing and creating the preconditions for the future acceleration. In addition, the term non-inflation plateau created to describe the processes in the XIX century, when the average long-term inflation rate was zero. In present time it is, much more.

In the current cycle, the approach to plateau did not accompanied by classic deflationary collapse, due to timely monetary stimulus and high share of services in the index, which prices always lag and smoothing out the dynamics of the CPI. As it can be seen from Figure 15, direction of the trend in services not changed yet, on another side - durable goods that better reflect to technological development and growth of labor productivity demonstrate another dynamic.

Introduction in Kondratieff cycles
Figure 15 - special components the CPI index (average change in 11 years).
Red Line - services (services), blue - products (commodities), green - durable goods (durables)

It can be stated that it is enough reasons to put the start of plateau in 2004th year. In such a way, should be underline that already passed half of the period of stagnation. That’s the time when inflation in the United States should come close to its long-term average, to the level of 5% per annum. In the future, inflation pressure around the world will only increase.

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