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Long Waves, Short Memories

The wave-form is beautiful. The sound of the ocean beating against the sand is evidence that order exists in nature.

When you consider the physics of a wave-form, it becomes even more beautiful. It is matter displaying the tendency to invert: the energy that makes the wave rise is the same energy that makes it fall.

When you consider the mathematical properties of the wave-form, it becomes more fascinating still. Fifteen hundred years ago, an Indian mathematician discovered that if you plot every possible ratio between two sides of a triangle it produces a wave-like pattern. Medieval scholars called it a ‘sine’. Today we call the smooth, repetitive waves found in nature sine waves. An electrical current moves in the form of a sine wave; so does sound; so does light.

And there are waves within waves. To a surfer, waves seem to come in sets, growing in size, so that the sixth or seventh is the big one that you want to catch. In fact, this is just the result of a longer, flatter wave moving ‘through’ the short ones.

This relationship – of long waves to short ones – is a source of order in acoustics. For musicians the harmonics created by short waves within longer waves are what gives each instrument its particular sound; music is in tune when long and short waves are in strict mathematical proportion.

Waves are ubiquitous in nature. In fact, at the subatomic level, the wavelike movement of a particle is the only way we can know it exists. But waves also exist within big, complex and unnatural systems – such as markets. For those who analyse stock markets, the wave-form has become like a religious icon: they use tools to filter out the ‘noise’ of daily fluctuations to produce a predictive curve. ‘Peaks’ and ‘troughs’ have become everyday economic terms.

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But in economics the wave-form can be dangerous. It can imply order and regularity where there is none. A sound wave simply decays to silence; but waves generated from random data become distorted and disrupted after a time. And the economy is a world of complex, random events, not simple waves.

It was the wave-chart experts of the last boom who failed to predict the slump. In surfing terms, they were looking at waves instead of sets; sets instead of tides; tides instead of the tsunami that was about to hit them. We think of a tsunami as a big wave: a wall of water. In fact a tsunami is a long wave: it swells and it keeps on coming.

For the man who discovered their existence in economics, long waves proved fatal.

DEATH BY FIRING SQUAD

The prisoner shuffles; he can’t walk. He is partially blind, has chronic heart disease and clinical depression. ‘There is no way that I can force myself to think systematically,’ he writes. ‘To think scientifically at all without actively working on materials and books, and with headaches, is very difficult.’¹

Nikolai Kondratieff had spent eight years as a political prisoner in Suzdal, east of Moscow, reading only the books and newspapers permitted by Stalin’s secret police. He had shivered in winter and sweltered in summer but his ordeal would soon be over. On 17 September 1938, the day his original sentence expired, Kondratieff was tried a second time, convicted of anti-Soviet activity and executed in his cell, by firing squad.

Thus perished one of the giants of twentieth-century economics. In his time, Kondratieff ranked alongside globally influential thinkers such as Keynes, Schumpeter, Hayek and Gini. His ‘crimes’ were fabricated. An underground ‘Peasant Labour Party’, of which he was supposed to be leader, did not exist.

Kondratieff’s real crime, in the eyes of his persecutors, was to think the unthinkable about capitalism: that instead of collapsing under crisis, capitalism generally adapts and mutates. In two pioneering works of datamining he showed that, beyond short-term business cycles, there is evidence of a longer, fifty-year pattern whose turning points coincide with major structural changes within capitalism and major conflicts. Thus, these moments of extreme crisis and survival were not evidence of chaos but of order. Kondratieff was the first person to show the existence of long waves in economic history.

Though it was later popularized as a ‘wave-theory’, Kondratieff’s most valuable insight was to understand why the global economy goes through sudden change, why capitalism hits structural crisis, and how it morphs and mutates in response. He showed us why business ecosystems that have lasted for decades can suddenly implode. He used the term ‘long cycle rather than ‘wave’ because cycles in scientific thought create a sublanguage that is highly useful: we speak of phases, states and their sudden alternation.

Kondratieff studied industrial capitalism. Though others claim to have found long waves in prices going back to the Middle Ages, his data series begins with the industrial revolution in the 1770s.

In Kondratieff’s theory, each long cycle has an upswing lasting about twenty-five years, fuelled by the deployment of new technologies and high capital investment; then a downswing of about the same length, usually ending with a depression. In the ‘up’ phase, recessions are rare; in the ‘down’ phase they are frequent. In the up phase, capital flows to productive industries; in the down phase it gets trapped in the finance system.

There’s more, but that’s the basic theory. In this chapter I will argue that it is essentially right, but that the present crisis represents a disruption of the pattern – and that signals this is something bigger than the end of a fiftyyear cycle.

The man himself was supremely cautious about the implications of his theory. He never claimed he could predict events – though he did predict the

Depression of the 1930s, ten years before it happened. He arranged for his findings to be published alongside a brutal critique and peer-review.²

But Stalin’s police had, in a way, understood more about Kondratieff’s theory than he did himself. They understood that – if pursued to its conclusion – it would bring Marxism face to face with a dangerous proposition: that there is no ‘final’ crisis of capitalism. There can be chaos, panic and revolution but, on the basis of Kondratieff’s evidence, capitalism’s tendency is not to collapse, but rather, to mutate. Huge swathes of capital can be destroyed, business models can be scrapped, empires can be liquidated in global wars, but the system survives – albeit in a different form.

To the orthodox Marxism of the 1920s, Kondratieff’s explanation of what caused these transformations was equally dangerous. The events that seem to cause the big turning points – wars, revolutions, discovery of new gold deposits and new colonies – were, he said, mere effects generated by the demands of the economy itself. Humanity, even as it tries to shape economic history, is relatively powerless over the long term.

For a time in the 1930s, long-wave theory became influential in the West. The Austrian economist Joseph Schumpeter produced his own theory of business cycles, popularizing the term ‘Kondratieff Wave’. But once capitalism stabilized after 1945, long-wave theory seemed redundant. Economists believed state intervention could flatten out even the minor ups and downs of capitalism. As for a fifty-year cycle, the guru of Keynesian economics, Paul Samuelson, dismissed it as ‘science fiction’.³

And when the New Left tried to revive Marxism as a critical social science in the 1960s, they had little time for Kondratieff and his waves; they were looking for a theory of capitalist breakdown, not survival.

Only a few diehards, mainly investors, remained obsessed with Kondratieff. In the 1980s, Wall Street analysts turned his careful provisional findings into a bunch of crude, predictive mumbo-jumbo. In place of his complex data, they drew simple lines, showing a wave with a stylized shape: a surge, a plateau, a crisis and a collapse. They called it the ‘K-Wave’.

If Kondratieff was right, these investors said, the economic recovery that began in the late 1940s was the start of a fifty-year cycle, which meant that sometime around the end of the 1990s there should be a depression. They built complex investment strategies to hedge against the catastrophe. And then they waited …

WHAT KONDRATIEFF REALLY SAID

In 2008, what the investors were waiting for finally happened – though, for reasons we’ll come to, ten years later than expected.

Now, people in the mainstream are once again interested in long cycles. As it dawned on them that the Lehman crisis was systemic, analysts began to look for patterns produced by the interplay of tech innovation and growth. In 2010, economists at Standard Chartered announced that we were in the middle of a global ‘supercycle’.⁴ Carlota Perez, an Anglo-Venezuelan economist and follower of Schumpeter, harnessed wave-theory to promise a new ‘golden age’ for capitalism if it could only shrug off financial panic and return to the state-funded innovation process that produced the post-war boom.⁵

But to use Kondratieff’s insight properly we have to understand what he really said. His original research, in the 1920s, was based on data for five advanced economies between 1790 and 1920. He did not track GDP directly but interest rates, wages, commodity prices, coal and iron production and foreign trade. Using the most advanced statistical techniques of his time – and two assistants whose job-title was ‘computer’ – he established a trend line out of the raw data. He divided the data against population size and smoothed it out using a nine-year ‘moving average’ to filter out random fluctuations and shorter cycles.

The result was a collection of charts that look like shallow sine waves. They show the first long cycle, beginning with the emergence of the factory system in Britain in the 1780s and ending around 1849. Then, a much clearer second wave starts in 1849, coinciding with the global deployment of railways, steam ships and the telegraph, before entering its downswing phase, with the so-called ‘Long Depression’ after 1873, and ending sometime in the 1890s.

By the early 1920s, Kondratieff believed there was a third cycle under way. It had reached its peak and begun its downswing, probably sometime between 1914 and 1920. But this downswing was nowhere near finished. As a result, he predicted, the political crisis that consumed Europe between 1917 and 1921 would not lead to immediate economic collapse. A shaky recovery was possible, Kondratieff argued, before a depression yet to come. This was completely borne out by events.

Unlike today’s Wall Street analysts, Kondratieff was not ultimately interested in the shapes of the waves themselves. He saw the sine waves he’d plotted on to graph paper as evidence of something deeper happening in reality: a succession of alternating ‘phases’ which, for our purposes, are the most useful tools to understand the fifty-year cycles.⁶

Let’s consider in more depth these phases as Kondratieff describes them. The first, up, phase typically begins with a frenetic decade of expansion, accompanied by wars and revolutions, in which new technologies that were invented in the previous downturn are suddenly standardized and rolled out. Next, a slowdown begins, caused by the reduction of capital investment, the rise of savings and the hoarding of capital by banks and industry; it is made worse by the destructive impact of wars and the growth of non-productive military expenditure. However, this slowdown is still part of the up phase: recessions remain short and shallow, while growth periods are frequent and strong.

Finally, a down phase starts, in which commodity prices and interest rates on capital both fall. There is more capital accumulated than can be invested in productive industries, so it tends to get stored inside the finance sector, depressing interest rates because the ample supply of credit depresses the price of borrowing. Recessions get worse and become more frequent. Wages and prices collapse, and finally a depression sets in.

In all this, there is no claim as to the exact timing of events, and no claim that the waves are regular. Kondratieff emphasized that each long wave takes place ‘under new concrete-historical conditions, at a new level in the development of the productive forces, and hence is by no means a simple repetition of the preceding cycle’.⁷ It is, in short, more new than déjà vu.

Now comes Kondratieff’s most controversial point. He noticed that the start of each fifty-year cycle was accompanied by trigger events. I will quote him in full, despite the old-fashioned language, because the parallels with the present are striking:

During roughly the first two decades before the beginning of the rising wave of a long cycle, we observe an invigoration of technical inventions. Before and during the beginning of the rising wave, we observe the broad application of these inventions to industrial practice, due to the reorganisation of production relations. The beginning of the long cycles usually coincides with an expansion of the orbit of world economic relationships. Finally the beginnings of the last two successive cycles were preceded by major changes in the extraction of precious metals and in monetary circulation.⁸

If we put that into modern English we get the following. The start of a long cycle sees:

the rollout of new technologies

the rise of new business models

new countries dragged into the global market

a rise in the quantity and availability of money.

The relevance of this list to us is clear: it describes very well what happened to the global economy between the mid-1990s and the Lehman crash. But Kondratieff was convinced such phenomena were not causes, but only triggers. ‘We are no way inclined to think that this provides any form of explanation for the causes of long cycles,’ he insisted.⁹

Kondratieff was determined to find the cause of long cycles in the economy, not in technology or global politics. And he was right. But in the search for it he relied on theories that had been advanced by Karl Marx to explain the shorter, ten-year business cycles of the nineteenth century: namely, the exhaustion of capital investment and the need for reinvestment.

If, he argued, the ‘regular’ crises that come along every decade are the result of the need to replace tools and machines, then fifty-year crises are probably caused by ‘the wear and tear, replacement and increase in those basic capital goods requiring a long period of time and tremendous

investment for their production’.¹⁰ He had in mind, for example, the canal boom of the late eighteenth century and the railway boom of the 1840s.

In Kondratieff’s theory, a long wave takes off because large amounts of cheap capital have been accumulated, centralized and mobilized in the financial system, usually accompanied by a rise in the supply of money, which is needed to fund the investment boom. Grandiose investments are begun – canals and factories in the late eighteenth century, railways and urban infrastructures in the mid-nineteenth century. New technology is deployed and new business models created – leading to a struggle for new markets – which stimulates the intensification of wars as rivalries over colonial settlements increase. New social groups associated with the rising industries and technologies clash with the old elites, producing social unrest.

Some of the details are obviously specific to each particular cycle, but what’s important in Kondratieff’s thesis is the argument about cause and effect. Takeoff is caused by capital accumulating faster than it is invested during the previous depression phase. One effect of this is the search for an expanded supply of money; another is the increased availability of new, cheaper technologies. Once a new growth spurt begins, the effect is a spate of wars and revolutions.

Kondratieff’s insistence on economic causes and political/technological effects would come under attack from three directions. First, from Marxists, who insisted that the major turning points in capitalism could only be caused by external shocks. Secondly, from Schumpeter, his contemporary, who argued that long waves are driven by technology, not the rhythms of capital investment. A third set of critics said that in any case Kondratieff’s data was at fault and that evidence of waves was overstated.

But Kondratieff was right – and his arguments about causation brilliantly describe what has happened to the economy since 1945. If we can fill in the gaps in Kondratieff’s theory we come close to understanding not only how capitalism adapts and morphs in response to crisis, but why this capacity to adapt might reach its limits. I will argue in Part II that we are living through a significant and likely permanent disruption of the patterns industrial capitalism has exhibited for 200 years.

First, though, the critics have to be answered.

THE IMAGINARY CURVE

In 1922, the publication of Kondratieff’s first outline of long cycles sparked an immediate controversy. Leon Trotsky, at the time one of the top three leaders of Russian communism, wrote that, if fifty-year cycles existed, ‘their character and duration are determined not by the internal interplay of capitalist forces but by those external conditions through whose channel capitalist development flows’.¹¹

In the early twentieth century, revolutionary Marxists had become obsessed with the idea that human action – the ‘subjective will’ – was more important than economics. They felt trapped by economics, which had become the property of moderate socialists who believed revolution was impossible. Kondratieff, Trotsky insisted, had got things the wrong way around:

The acquisition by capitalism of new countries and continents, the discovery of new natural resources, and, in the wake of these, such major facts of ‘superstructural’ order as wars and revolutions, determine the character and the replacement of ascending, stagnating or declining epochs of capitalist development.¹²

It may seem strange to those who know Marxism only as a form of economic determinism, but Trotsky was here insisting that political conflict between nations and classes was more important than economic forces. Instead of the long waves, Trotsky argued that Soviet economics should concentrate on explaining the ‘entire curve of capitalist development’, from birth to takeoff to decline: that is, its whole history. Long waves were interesting, but to those who desired the end of capitalism, the most vital pattern of all was capitalism’s complete lifecycle, which must surely be finite.

Marxists had by now evolved their own explanation of the big mutation in business structures after 1890 – which they dubbed ‘imperialism’ and which, they presumed, was the final or ‘highest’ stage capitalism could

reach. So, confronted with Kondratieff’s data, Trotsky too drew a curve – a curve entirely the product of his imagination. It showed the takeoff and decline of an imagined capitalist country over ninety years. The purpose of the chart, Trotsky explained, was to show what a full and painstaking computation of the data might produce. According to him, once you understood the trend-line of a capitalist economy you could understand whether a fifty-year cycle – if it existed at all – was part of the overall upswing, downswing or the end. Trotsky made no apology for the imaginary nature of his curve. The data was not yet good enough to draw a real one, he said, though with work it might be done.

Trotsky’s 1922 attack was used then, and has been used since, to refute the idea of long cycles. But it does not. It simply says they are (a) not likely to be regular, caused as they are by external shocks; and (b) need to be fitted into a bigger, single wave-form that is the rise and decline of capitalism itself. Put another way, Trotsky was calling for a better and more historic definition of the ‘trend’ against which the fifty-year cycles were computed.

This in itself was logical. With all trends, statisticians look for what they call a ‘trend break’: a clear point where the curve stops rising, flattens out and prepares for a fall. The search for a trend break within capitalism was to obsess left-wing economists throughout the twentieth century – and ultimately elude them.

Meanwhile Kondratieff had been busy.

A COLD ROOM IN MOSCOW

In January 1926, Kondratieff published his definitive work, Long Cycles of the Conjuncture. On 6 February, the cream of Soviet economics gathered at Kondratieff’s think tank, the Institute for Conjuncture, above Tverskaya Street in Moscow, to rip it to shreds.

The verbatim record of the meeting contains none of the fear and irrationality that Stalin’s purges would soon inject into Soviet academic life. The participants speak freely and harshly. They pursue the same three lines of attack that have dominated criticism of Kondratieff ever since: that his