©2008 Investment and Business News. All Rights Reserved.

©2008 Investment and Business News. All Rights Reserved.

If inflation is always a monetary phenomenon, then the credit crunch will surely lead to a crunch in the supply of money. Money is, after all, created by debt. Economic theory would suggest a credit crunch would lead to deflation, not inflation.

That is why many fear we are close to a 1930s type depression. Well, probably not. The economy has an awful lot going for it right now, and we are supposed to know what we should do to avoid a repeat of the mistakes that characterized that period.

But maybe we can learn from history. This is the scary bit. In the past, economic depression followed every 50 years. Okay, it’s nearer 70 years since the beginning of the last great depression. But these things are not pin point accurate.

The is no shortage of theories to suggest the economy follows a cycle – its turnings and rotation as inevitable as the rising and setting of the sun. If that is true, then we are due a downturn.

Maybe, though, you see this as hocus pocus. The pattern of history, no more than half coincidences, and half the laws of probability, throwing up occasional convergences, because that’s the way numbers work.

So, does that mean depression beckons? Or can we throw the theory of inevitable rise and fall in the dustbin?

Winston Churchill once said: “The further back you look, the further forward you can see.” But on this occasion he may have been slightly off. Circumstances occasionally conspire to throw up similar outcomes, but that does not mean history repeats itself.

Yet, there is a constant. One law never changes – human nature. We are the same everywhere, and every time. When the stock market in China booms beyond all reasonable fundamentals, we are told that in China it is different – that we are mistakenly applying western values to oriental practice. Yet, the Chinese stock market bubble burst all the same. Despite all the grand ideas of Confucianism breeding a way of thought that is alien to western ideology, we discovered that actually we are all the same really. The truth is Humans have the same motivations, always.

And that is the common thread of history. It is human nature. That is why Mark Twain was closer to the truth than Britain’s famous wartime Prime Minister, when he said: “History never repeats itself, but it rhymes.”

The lesson of history then is not that time is a monotonous cycle of repetition. It’s not like classical music with its structure. It is more like jazz, full of improvisation. But, clues still lurk in the manuscript of history which can throw light on the present and hints about the future. There is nothing more important than trying to understand this. Here is an attempt to throw some light on this.

So, as Jimmy Page and Robert Plant once said: “Listen very carefully, for the tune will come to you at last.”

Teenagers. Are you misfortunate enough to be a parent of teenagers? Or maybe you work with them, perhaps as a teacher, or maybe you are one, in which case all that is left to be said is cover up your eyes, for the next few sentences are not going to be pretty.

Teenagers just don’t want to learn from us. You can tell them the right thing to do. You can say, “Learn from my mistakes.” But they won’t. Alas, they learn through doing, and all you can do is pray, just like your parents did, that the learning of the lesson will not be too painful.

Yet, teenagers’ inability to learn without trial and error is not really limited to those spotty gits at all. None of us are really good at taking heed of what our parents say.

Maybe that is why we have the so called Kondratieff cycle.

This cycle was first dreamt up by a man who, funnily enough, was also called Kondratieff. Well, that wasn’t his full name, he was called Professor Nickolai Kondratieff and he was a true wise man who really did seem to hear the rhythm of history – at least of economic history. Yet his wisdom failed him in one respect. He failed to foresee the impact his ideas would have on the Soviet government that controlled his fate. Poor old Nicky, his ideas were of true insight, but he ended his days at the pleasure of Joseph Stalin before being sentenced to death in around 1938.

But his insight was to observe four key stages in an economic cycle – something he reckoned to be around 54 years long.

Stage one was spring – also described as an inflationary growth phase. So stage one in the current Kondratieff cycle would be that period from around 1950 to the late 1960s. In the previous cycle it would probably be from about 1896, which marked the end of the late Victorian depression, to the outbreak of World War I.

Stage two in the Kondratieff cycle is known as the summer stagflation phase. So that would apply to the 1970s and early 1980s.

This stage in the Kondratieff cycle often coincides with war. So in the current cycle it was the Vietnam War, in the previous cycle World War I. It has been suggested that the American Civil War and the Napoleonic War coincide with the previous summer phase in the Kondratieff cycle.

Stage three in the Kondratieff cycle is known, strangely enough, as the autumn phase. This is considered to be something of a plateau period, and often sees the combination of growth and deflation. So that is the roaring 1920s in the US, and one assumes the period during the late 1980s and 1990s, and no doubt including that era central bankers now refer to as Nice – non inflationary consistently expansionary – which has only just come to an end.

Bet you can’t guess what season applies to stage four. Give up already? Well, it’s winter. And quelle surprise, winter is not associated with a particularly pleasant economic period.

The last Kondratieff cycle ended with the Great Depression – which led into World War II. In the previous cycle the global economy fell into a phase now known as the Long Depression, between around 1873 to 1896, and the 1830s too saw a deep depression.

Now that is all very interesting and a little uncanny, when you consider the similarities with today. The noughties crash in stocks and shares, followed by house prices, had all the hallmarks of previous precursors to depressions. The 1930s and Japan’s lost decade being obvious examples. The credit crunch, too, seems likely to lead to deflation – again the hallmark of a depression.

So that is all a bit worrying.

But then consider this. We have all heard of the theories of Nostradamus, and no doubt we have all been subjected to some kind of mumbo jumbo prediction of doom. Well, social science has its own theories, but they differ from astrology because they do at least try to apply science.

Back in the 1990s, book authors William Strauss and Neil Howe published a book called The Fourth Turning.

To be honest, the book does ramble on a bit. But it does contain an interesting idea: in fact the idea is pretty core to the book’s underlying thesis.

Strauss and Howe say society goes though four stages – each stage roughly the length of a human lifetime – which they say is around 80 years. But their base idea does make sense. Consider family businesses. They start off with their innovative founder, often they are passed on to an even more innovative son, followed by a not quite so focused grandson and the next generation really are more interested in partying.

Without getting too hung up on the four-generation thing, consider Ancient Rome; Augustus and Julius Caesar himself seem to have been quite brilliant. But go down the family tree, and you find monsters like Caligula and Nero.

But Strauss and Howe try to be more specific than that. They detail four stages: survivor, creator, consumption driven and, finally, the flaccid generation. But their theory uses more colourful language and they refer to four “turnings”– a High, an Awakening, an Unravelling, and a Crisis. They then argue we are not stage four- crisis in the cycle.

The big problem with these theories though is that they are rather inclined to take a series of coincidences, and try and extrapolate a correlation that isn’t really there.

Mathematicians have claimed to prove the Bible follows a mathematical formula. Do you believe that?

But the real problem seems to be us. Have you noticed that the last the last 1o paragraphs either begin with the letter S and T, which come immediately after each other in the alphabet, the letter B, which, spookily enough, is the second letter of the alphabet, or M or W, which kind of look like each other, especially if you turn one of the letters upside down. Strange indeed.

The truth is, though, that there is no pattern. You can create any pattern you like after the event – but it is no guide to the future. So the first year Bjorn Borg wins Wimbledon he doesn’t shave for the whole fortnight, therefore he doesn’t shave again when he plays at Wimbledon. And would you believe it, he wins every year.

But of course Borg did get beaten eventually. And this is where these theories of patterns break down. Once a pattern stops working it ceases to be meaningful. This is what Nassim Nicholas Taleb was referring to in his book The Black Swan. We used to believe all swans were white, until, that is, the discovery of black swans in Australia.

The repetition of history only exists in hindsight.

And bear this in mind too. Modern history is a short affair. Just because economic depressions came about 50 years apart for a century or so, it doesn’t mean they always will. This is a terribly unscientifically short sample from which to make a conclusion. Besides, some argue, the Long Depression of the late 19th century wasn’t a depression at all, just a series of recessions.

But human nature, however, is a constant. We tend to react in the same way to similar circumstances.

So when markets rise, we tend to get over excited, and we then get carried away and jump on like lemmings.

When demand for a good is higher than supply we quickly see an opportunity. But this in turn crowds the market. It becomes a victim of its own success.

There is no inevitable cycle – the cycle is simply the product of human folly and our refusal to learn from the past.

That’s why bankers in the early noughties failed to spot the similarities with the previous banking orgy. That’s why the oil industry failed to realise that when oil was priced at $10 a barrel demand would rise to such a level that supply would be incapable of meeting demand.

This is why the truly insightful investor buys when everyone else is selling and sells when everyone else is buying.

But it is a risky strategy. Get the timing wrong and you look stupid. So fund managers often find it safer to go against their instinct and run with the herd. No one gets fired if they make the same mistake everyone else is making. But the contrarian who goes against the pack and gets it wrong is out of a job as fast as you can say Kondratieff.

©2008 Investment and Business News. All Rights Reserved.

It fell another 3 1/2 dollars a barrel yesterday. It is now $21 down from the all-time high reached in early June, or, to put it another way, it has fallen 14 per cent.

And, right on cue, yesterday also saw the first report from a respected analyst predicting sharp falls in the price of the black stuff for some time.

Ed Morse, chief economist at Lehman Brothers reckons oil is nearing a tipping point and will fall to $90 within a year.

Meanwhile, others are calling the end of speculation. Speculators, of course, have been at the receiving end of US politicians’ wrath in recent weeks, but this morning, the Telegraph reported Rob Laughlin, senior energy broker for MF Global as saying “We’ve seen the exiting of some of the speculative fund money re-entering equity markets.”

When oil does finally begin its descent into the sub $100 region, there will of course be two sides to the story. There will be the story of falling demand, and there has been plenty of evidence of that in recent weeks, and there will be the story of rising supply.

And this morning the pink ‘n’ revealed the other side of the coin. It reported on the latest findings of US scientists who reckon they have managed to show the Arctic could hold as much as $90bn worth of undiscovered oil and natural gas, equivalent to the known reserves of Russia.

It went on to talk about the race to exploit the Arctic, with the US, Russia, Canada, Denmark and Norway all hoping to get their share of the pie.

This could of course lead to all kinds of tensions – especially, one assumes, between the US and Russia. It is strange because, right now, the Arctic doesn’t really belong to anyone. If one was to be truly objective about this, then really there is no reason why it shouldn’t stay that way. Instead, the Arctic should perhaps be seen as the world’s resource. It does, after all, serve the world pretty well via its storage of water in the polar ice caps. It won’t happen, of course. But it is fun to dream, even if its just for a few seconds.

As regular readers will know, for some time now this column has been arguing that oil is too expensive, and will fall back to $70 within a couple of years. But the speed with which the current falls are occurring is surprising.

They say bubbles burst when just about everyone is talking about jumping on the bandwagon. And that has simply not happened. Mind you, the economic news has been pretty diabolical of late, so maybe we don’t need to look far for evidence that the price of oil is really hurting, and therefore inevitably leading to cutbacks. The speed with which the economic downturn is occurring has caught everyone by surprise; maybe oil can slide in price just as fast.

©2008 Investment and Business News. All Rights Reserved.

The UK is, of course, in the doctor’s surgery room, waiting to be told it too can have a sickie.

But Asia, at least, and maybe mainland Europe are supposed to be above all that now. The world has decoupled. The US is no longer the world’s hub.

If that is so, explain this. Japan saw its first fall in export orders in June for four years; now fears are growing the economy of the Rising Sun could be heading for an economic sunset – or at least a recession.

Economists had expected to hear exports had risen.

These days, the global economy is a bit like that children’s rhyme about our bones. You known the one: “The foot bone’s connected to the leg bone, the leg bone’s connected to the knee bone,” etcetera.

Well, China is connected to Japan, Japan is connected to the US, the US is connected to Europe, Europe is connected to China. Sorry about the complete failure to make that rhyme, but you get the point.

Almost 20 per cent of all Chinese exports are to the US. Just under 10 per cent of its exports are to Japan. Around 20 per cent of Japan’s exports are to the US. The list goes on. World trade is like a complex web, but the US still stands pretty much at the centre.

If Merrill Lynch’s forecast, reported here yesterday, that the US will contract by 0.5 per cent next year is right, then expect to see a big fall in US imports. This will have a big impact on the Chinese and Japanese economies.

For some time, economists have been arguing that China needs to see more economic impetus coming from its own consumers. This in turn will lead to a rise in Chinese imports. And enable the likes of the US to export their way out of trouble.

2009 will see the truth of those words, as China is left with no choice but to look towards its own citizens for the next phase of growth.

©2008 Investment and Business News. All Rights Reserved.

©2008 Investment and Business News. All Rights Reserved.

©2008 Investment and Business News. All Rights Reserved.

©2008 Investment and Business News. All Rights Reserved.

©2008 Investment and Business News. All Rights Reserved.

David Blanchflower, MPC arch dove, and famous for his more gloomy thoughts on the economy, reckons the UK is heading for recession – unless interest rates are dropped fast.

“I think we are going into recession and we are probably in one right now,” the dove told the Guardian. “We will probably have three or four quarters of negative growth, but the risks are to the downside.”

He added, “It’s not too late to stop it, but we have to act right now. Monetary policy has been far too tight for too long. We can’t just sit and do nothing as we have done for too long.”

He went on to talk about how we are likely to go down the same path as the US, but that unlike the US we will not be getting a big tax stimulus. As for inflation, he is more worried about prices falling too slowly. “The economy is now slowing so fast that we run the risk of writing a letter on the low side in the medium-term,” he said.

So if the UK could mirror the US economy, how are things Stateside?

Yesterday, Merrill Lynch produced a report so nightmarish in its projections that it should have come with an “X” certificate.

New York-based economists Sheryl King and Drew Matus who penned the report said, “Just like consumers, who are insulating their windows and making fewer trips to the malls, we are adjusting our economic forecasts to the new high-oil-price reality, not to mention the latest round of trauma in the mortgage markets.”

They went on to predict a 2.5 per cent contraction in the US economy in the final quarter of this year. Let’s run that past you again. A 2.5 per cent contraction. They are saying the economy will be 2.5 per cent smaller at the end of this year than at the end of 2007.

They also predict a similarly bad performance in the first quarter of next year, and expect the US economy to contract by 0.5 per cent in 2009.

The Merrill report was in sharp contrast to last week’s report from the IMF predicting US growth of 0.8 per cent next year. The IMF actually upped its projections for global growth this year and next, and even upped its projections for the US for 2008.

But not everyone was impressed. Writing in the Telegraph, Ambrose Evans-Pritchard, surely the most bearish reporter in broadsheet land, said, “Plainly, the IMF cannot or will not offer any useful insights.”

The IMF bases its model on what it calls mean reversion. But there seems to be a failure to realise how serious any kind of mean reversions will be. For years the US and UK have been propelled forward on debt. Debt encouraged by interest rates that were far too low. US debt has in turn provided the main impetus to global economic growth. If these two countries now just start repaying their debt, save more, and spend less, then the implication for the global economy could be very serious indeed.

Despite some comments on our blog to the contrary, it is not as simple as just cutting our cloth for a few years and living within our means. As Mr Evans-Pritchard said, “True ‘mean-reversion’ would imply debt deflation on such a scale that would, if abrupt, threaten democracy.”

This is why the current crisis is more serious than many forecasters would have you believe.

This is why the solution requires a great deal of creative thinking.

But, those who urge cuts in interest rates as the key way to bring normality miss the point. As Keynes pointed out 70 years ago, cutting rates at a time of high debt is akin to pushing on string. This crisis can not be ended simply by cutting rates so that we can borrow our way out of trouble.

Neither can it be ended simply by the US and UK buying less and selling more abroad. The big changes this would prompt in the global economy would be catastrophic.

The only solution lies in tax cuts. Big tax cuts – targeted especially at poorer earners. Not only will this make impoverished Anglo Saxon consumers feel more confident, it will, in the case of the UK, incentivise the longer-term unemployed to find work. Work that is sure to be created as Polish workers realize there is not much point in staying in the UK.

The real hope is that somehow these tax cuts will not encourage greater borrowing, instead at least some of the proceeds will be used to repay debt. In some ways then the credit crunch would be no bad thing as it would stop further borrowing.

UK government borrowing may be too high, but net debt remains modest. Government borrowing can be reduced by cutting unemployment, through providing greater incentives to the unemployed via taxation. This will reduce benefit payments. The government should accompany this with a gradual scaling down in various means tested benefits. If it wants to give more to the poor and take from the rich, it should instead up personal allowances, but, if necessary, up percentage income tax too.

The government needs to act fast too. It has grossly underestimated how serious this crisis is. It can no longer afford to remain asleep at the wheel. It can no longer react to events after they have happened.

©2008 Investment and Business News. All Rights Reserved.