Book Review: "SuperCycles" by Arun Motianey

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.


It is common knowledge among market historians and even many traders that there tends to be alternating twenty-year cycles of rallies in commodities and stocks. These long-term rallies and the sell offs that follow them are referred to as secular bull and bear markets respectively. In his new book, “SuperCycles”, Arun Motianey produces an economic theory that ties together these alternating cycles putting them into an even longer-term context and places central bank monetary policy as the originator of the phenomenon.

While superficially, Motianey’s supercycles appear similar to Russian economist Nikolai Kondratiev’s long waves, they differ in important aspects. They agree that the length of the supercycle can range from forty to sixty years and that it is global in scope. Kondratiev’s long cycles were an empirical observation though, not a theoretical explanation and they included socio-political as well as economic behavior. Motianey, on the other hand, creates a model to explain why the cycles take place. Their cycles also have different beginning and end points. Kondratiev began his first cycle in 1790 and his second long wave lasted between 1850 and 1896. Motianey begins his first supercycle in 1873, in the middle of Kondratiev’s second cycle. The key for Motianey is the point where the major world economies increasingly adopted the gold standard.

Motianey’s supercycles begin with the arrival of a new monetary regime that promises price stability. The breakdown of that regime ultimately ends the supercycle many decades later. His first supercycle begins with the gold standard years in 1873 and ends in 1930 when many countries were forced to leave the gold standard because of the Great Depression. The second one is Keynesian based and it terminated  in 1979 when U.S. Fed chair Paul Volcker stopped the inflation that began with the breakdown of Bretton Woods in 1971 by imposing high interest rates. Motianey defines the current supercycle as the era of enlightened fiat money – a term that seems inherently oxymoronic. It should end somewhere around 2020 to 2030. The breakdown of our current monetary regime seems to have begun with the Credit Crisis.

In the Motianey model of supercycles, central banks and their mistakes are driving force of the deflationary and inflationary periods that seem to repeat over and over again. Instead of producing their stated goal of price stability, they wind up going too far in one direction or the other and exaggerate the price movements that would have taken place without their intervention. Motianey’s supercycles begin with a period of deflation, as occurred in the late 1800s and the 1930s, or disinflation, which characterized the 1980s. Inflation appears toward the end. Inflation in the 1910s because of World War I and in the 1970s because of the breakdown of the dollar were the two major inflationary episodes in the previous two supercycles. We are now about to head into the inflationary years in the current cycle.

Motianey does nevertheless examine three possible outcomes in his book for the next decade or so. He thinks deflation is highly unlikely as this would indicate a premature ending to the third supercycle and it would make it the only one without an inflationary episode. Motianey considers two ways governments might handle inflation – with indexation and without. While Motianey thinks indexing could be a good idea, history indicates it rarely if ever works out as I pointed out when I interviewed him at the February meeting of the New York Investing meetup (http://investing.meetup.com/21). Brazil implemented a completely comprehensive indexation system starting in the 1960s and this only served to entrench inflation and many years later eventually led to hyperinflation. The U.S. already has minor indexation in Social Security cost of living increases and of tax brackets. An expansion of indexation is actually quite likely to take place; it is not a good idea however.

Motianey is an engaging writer and “Supercycles” should be considered a must read for economic junkies. His ideas are fresh and innovative and he attempts to avoid the dogma that frequently leads those in the profession astray. I highly recommend it for those who want to gain greater perspective on the Credit Crisis and where we might be heading in its aftermath.

Disclosure: McGraw-Hill provided a copy of the book for review purposes.

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Daryl Montgomery
Organizer,New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Dance of the Declining Dollar Continues

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

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The trade-weighted dollar fell below 75.00 yesterday, only seven trading days after it decisively broke 76.00. It is up above 75.00 this morning and should have a short rally at some point soon because it is too far below its 50-day moving average. Any recovery will only be temporary however. Selling pressure seems to never be far away. The short-term rallies have the signature of some form of government intervention. They are sharp, sudden and tend to take place after some support level has been broken and when trading in the U.S begins. Once the intervention money runs out however the dollar just continues its downward drift.

Manipulating a major currency is an expensive undertaking and requires a lot of resources. The size of currency markets is huge compared to the bond market, which in turn is huge compared to the stock market. Direct intervention requires using foreign exchange reserves. The U.S. has almost none of these. Late July figures from the Treasury website indicate that the U.S. has only a net $7 billion in reserves (foreign currency holdings minus short positions). This would be appropriate for a small developing economy, not a superpower. In contrast, China has approximately $2000 billion in foreign reserves. All the big holders of foreign reserves hold large amounts of U.S. dollars. Their intervention in the currency markets would require they buy even more dollars with their other more desirable reserves in euros, yen, pounds or other currencies. This would not be a good deal for them.

Significant intervention to hold up the dollar will be occurring probably next year. There has been a history of such interventions in the post World War II era. Their effect is only short-lived unless the underlying condition that caused the currency weakness in the first place is corrected. In the current case, the U.S. needs to raise interest rates to attract dollar investments. The actual condition of the U.S economy (not the phony PR about the recovery) makes this impossible for the next many months. It is possible though that an extreme drop in the dollar may force the Fed's hand next spring.

Whether the dollar just continues its slow agonizing fall, which has become a fixture since the U.S. left the gold standard in 1971, or whether there are some serious short term declines (this happened through devaluations in the 1970s) remains to be seen. This fall may be the first time one of these sharp, sudden drops takes place.

NEXT: In for a Penny, In for a Pound

Daryl Montgomery
Organizer,New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

The Myth About the U.S. Dollar and the Trade Deficit

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

One of the most widespread pieces of misinformation that is believed in and broadcast by the financial community is that as the U.S. dollar falls, the trade deficit will improve and by implication even disappear. It is almost impossible to view financial TV or read the press without seeing this incorrect piece of information being cited with great certainty and authority by the 'experts'. While this idea was indeed true when the U.S. was on the gold standard, it is not true in a monetary regime where where the dollar floats instead of having a fixed value.

It is only necessary to look at two charts to see that the generally accepted relationship between the U.S. dollar and the trade deficit is false. Those charts are the value of the trade-weight dollar (the value of the U.S. dollar based on the currencies of its major trading partners) and the trade deficit itself. It becomes immediately obvious when examining these charts the declining dollar has had less and less positive impact on the trade deficit over time and seems to have actually made the trade deficit worse since 2000. New York Investing meetup thought this issue was so important that we made one of our first videos about it (please see: "The U.S. Dollar Relationship to Inflation and the Economy" at: http://www.youtube.com/watch?v=3amH-T1B9pQ).

The U.S. went off the gold standard in 1971. There has been a continual trade deficit since 1977 and the amount of the deficit has gotten bigger and bigger over time. Classical economics would infer from this that the value of the dollar has been steadily rising. Instead the value of the dollar has been in a long-term downtrend since 1984. The trade-weighted dollar in fact lost around half its value between 1984 and 1992 and while the trade deficit decreased at the end of this period, at no point did it disappear. The dollar has been in a sharp decline since 2002 and the trade deficit, in total contradiction to classical economic theory, has skyrocketed during that time.

A hint as to how the U.S. trade deficit has managed to grow while the dollar was in sharp decline appeared in the report on the January 2008 trade deficit. Even though the U.S. dollar had been almost in free fall for the preceding several months because of Federal Reserve easy money policy, the trade deficit once again defied classical economic thought and increased instead of decreasing. An explanation in the report mentioned that the price of oil had gone up so much (and the U.S. is a major oil importer and has imported an increasing amount of oil since the early 1970s), that it had more than wiped out any benefits from the falling dollar elsewhere. Since the falling dollar itself makes the price of oil go up, a possible destructive feedback mechanism could be at work. In this scenario a falling dollar causes oil prices to rise and overwhelm the benefits elsewhere of the falling dollar, so the trade deficit goes up. In turn, the rising trade deficit damages the U.S. dollar (since the U.S. has to borrow money from foreigners to fund the trade deficit) and the dollar goes down further. The cycle then repeats itself over and over again.

Next: Housing Market Collapses, but the Statistics Hold Up

Daryl Montgomery
Organizer, New York Investing meetup

For more about us, please go to our web site: http://investing.meetup.com/21