Guest Analyst
June 22, 2001

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Antal E. Fekete*

Talk given at the BabeÕ-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?

The Propensity to Save

Let's start with the uncontroversial proposition that the greater the propensity to save, the lower is the rate of interest. 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.

Our 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.

But for 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 punished, for their wrong credit policies. No wonder that more credit abuse was heaped upon credit abuse throughout the centuries.

Double Standard

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.

Economists 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 sweetheart deals.

It 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 destroying 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.

It 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 understanding.

The 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.

Mainstream 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 in 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 Röpke, 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 1932 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 interest.

In 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 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 'accidental coincidence'.

The Great Tug-o-War

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.

The linkage is therefore explained by the fluctuation in the propensity to hoard. When it 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.

Mainstream 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.

One 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.

Contra-cyclical Policy

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.

The 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.

In the 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.

As we 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 that 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, 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 which the world economy becomes a plaything in the hands of commodity, bond and foreign exchange speculators.

Competitive Devaluations

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.

The 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 edge of the brink. 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 in 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 the euro.

At the 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 - 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.

The 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.

Economic Cycles

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:

(1) Kitchin's short-wave cycle of 3-5 years duration, discovered in 1930
(2) Juglar's cycle of 7-11 years duration, discovered in 1862
(3) Kuznets' medium-wave cycle of 15-25 years duration, discovered in 1923
(4) Kondratieff's 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.

Some 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.

Kondratieff's Long-Wave Cycle

Kondretieff's methodology 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.

Only in 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 three waves:

(i) The rising phase of the first wave from 1780-90 to 1810-1817; The falling phase from 1810-1817 to 1844-1851
(ii) The rising phase of the second wave from 1844-1851 to 1870-1875; The falling phase from 1870-1875 to 1890-1896
(iii) The rising phase of the third wave from 1890-1896 to 1914-1920; The 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

(iv) The rising phase of the fourth wave started 1947-1948 and ended 1973-1980, the 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.

The 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.

Mutations and Catastrophes

The 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, Béla Hamvas (Secret Minutes, 1962, see: Works of B. Hamvas, vol. 17, Medio, Budapest, p 104-106, in Hungarian.)

The 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 is 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.

Older 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 were aware 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.

We 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...

What is to Be Done?

We 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.

The 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.

The 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.

Jackson's Linkage


The record of wholesale prices is taken from Jevons, The Statists, and the British government. The record of long term interest rates shown is the yields of British Consols and is taken from Warren and Pearson, Gold and Prices, (New York, 1935) and The Economist. The figures are shown in eleven-year moving averages, so as to bring out their essential characters.

* Professor Emeritus, Memorial University of Newfoundland, Canada; recipient of the 1996 International Currency Prize awarded by Bank Lips, Zürich, Switzerland, for his essay Whither Gold? This talk is based on a Chapter from the author's projected 3-volume treatise Credit. Mr. Fekete was former advisor to Congressman W. E. Dannemeyer of California on the gold standard bills he introduced to Congress, 1984-1990