June 15, 2012 – Nikolai Kondratieff (1892-1938) was a Russian economist who theorized that capitalist economies are subject to a repeating 54-year cycle, though I have seen his work interpreted to fit economic periods lasting anywhere from 40 to 60 years. Each “Kondratieff wave” is divided into four periods that are given the name of the four seasons. A wave begins with an economic boom and ends in a financial bust lasting several years. This period of poor economic conditions is called the Kondratieff Winter.
A Kondratieff Winter is marked by depression and deflation, like occurred during the Great Depression of the 1930s. Followers of this theory generally contend that the world is presently in another Kondratieff Winter.
I am not a proponent of the Kondratieff theory because I do not believe that events are preordained, or that they fit precise cycles. Nevertheless, I am an adherent of Austrian Economics, and thus recognize that economic booms that are artificially induced by cheap credit do occur, and that these booms result in an inevitable bust. So in that sense, if one wishes to call the world’s present circumstances a Kondratieff Winter, I would agree.
Like the 1930s, we are in a period of depression, and if you use the correct money to measure prices, there is deflation. Today’s deflation though is generally not recognized because people only look at prices using national currencies, and not gold.
The dollar price of assets like houses, crude oil and the stock market is falling, but that is not deflation. That is simply an overvalued asset being marked down in price to a more realistic level. Asset prices fall during a bust because the excessive credit extended during the boom is wrung out of the system. This process describes wealth destruction, which is not the same thing as deflation. Deflation, and for that matter, inflation are monetary events.
House, crude oil and stock prices are falling even while the currency being used to measure these prices is inflating. The dollar is inflating even by the US government’s own CPI, which many – including me – contend actually understates the true rate of inflation. This inflation means that the dollar is losing purchasing power. In contrast, in the 1930s the purchasing power of the dollar rose, which is what happens in a deflation. Its purchasing power rose back then because the dollar was tied to gold, first at $20.67 per ounce, and after Roosevelt devalued the dollar, at $35 per ounce.
Today the dollar is fiat currency. It is no longer backed by gold or tied to gold at a fixed rate of exchange, but instead is informally linked to gold by a floating rate of exchange, normally called the gold “price”. Even though gold rarely circulates as currency these days, gold is money. Consequently, gold is useful in economic calculation, i.e., measuring prices to determine whether there is inflation or deflation.
For example, consider the price of a popular commodity such as tea, which rose 49.6% from $2.28 per kilogram in January 2000, near the peak of the economic boom, to $3.41 last month. When measuring in terms of goldgrams, the price of tea fell over this period from 0.251gg per kilogram to only 0.066gg. To put it another way, 0.251gg bought 3.8-times more tea last month than it did in 2000. That huge increase in the purchasing power of gold is deflation, just like occurred in the 1930s. A similar price comparison for dozens of other goods and services would yield the same result. The prices of goods and services when measured using gold are falling, or in other words, the purchasing power of gold-money is increasing because of deflation.
Unfortunately, nearly everyone today calculates prices only in terms of dollars or their national currency. As a consequence, they say “the price of gold is rising”. What they need to realize though is that the purchasing power of gold is rising. In a deflation, money buys more, and that is what gold is doing, though this way of viewing purchasing power and prices is generally ignored. In contrast to the 1930s, in today’s world of fiat currencies deflation is only apparent when measuring prices with gold.
Given the prevailing poor economic conditions and gold deflation, we are in what might be called a Kondratieff Winter, but to be more accurate, I prefer to call our present circumstances a “Fiat Currency Bubble”. It has been ballooning for 40 years, during which time people lost sight of gold’s essential nature and put undue reliance upon currency backed by nothing.
Given that all bubbles are unsustainable, this bubble too will pop. When it does, the preponderance of people who now ignore gold or dismiss out of hand its monetary attributes will once again come to understand that these attributes and characteristics that made gold to be accepted as money for 5,000 years have not disappeared, been destroyed or become less useful. They remain, but sadly, have been ignored or forgotten, allowing the Fiat Currency Bubble to emerge.
When the Fiat Currency Bubble finally pops, the gold price will soar and fiat currencies will collapse, just like all fiat currencies have done throughout monetary history. At that time I expect gold will return to its rightful and traditional role as international money at the center of global commerce. My recommendation therefore is to continue accumulating physical gold, and if so inclined, silver too, in order to protect your wealth in preparation for this watershed event. Even though gold’s purchasing power has been rising for more than a decade, its appreciation has much further to go.
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