Black Holes and Revelations: Kondratiev Waves, Infinite QE and Economic Spaghettification

Romain/ décembre 4, 2020/ Finance/ 2 comments

Many people do worry about the impact of quantitative easing and infinite bailouts policies. But many of them believe that authorities do not really have the choice.

“Is there any alternative?” That is the right question.

As already explained in a previous post (see The Western Minority Report), central bankers and governments of developed countries base their decisions on a the very old Keynesian model, that can be summarized by the following equation: Y = C + I + G + (X – M), where Y is the GDP, C is consumption spending, is investment spending, G is government spending, and (X – M) is the trade surplus/deficit.

Once again, it is not complicated to understand that increasing public spending mathematically leads to an increase of the GDP. As the national income grows with Y, consumption spending may continue to rise afterwards (all things being equal), and so on. This theoretical virtuous circle is known as “the Keynesian multiplier”.

John Maynard Keynes heavily criticized the lack of supportive economic intervention during the 1930’s, also known as the Great Depression, and his macroeconomic theory was highly influenced by that period.

Supercycles and Complex Dynamics

However, I already explained that the Keynesian framework is uncomplete as it relies on several unrealistic assumptions, like the fact that economic agents are said to be rational, and also the fact that the economy is supposed to reach an equilibrium which does not make any sense for living systems.

Moreover, Keynesian analysts tend to underestimate complex dynamics such as long-term cycles and nonlinearity. For instance, Kondratiev waves, which are not accepted by many academic economists.

Even if it is complicated to understand such long cycles, as they involve many structural factors such as demographics, technology, and debt, they seem to match with past long-term dynamics of Western economies.

From that perspective, the 1945-2020 period could be regarded as an entire supercycle for countries like the US, France, or the UK. While there was a natural positive base effect at the beginning, after one decade of economic de pression and almost six years of global war, the wave was also catalyzed a few years later by industrial changes, booming population, and the rise of mass consumption.

The 1970’s can be seen at the peak of the organic demand growth, with inflations tensions and the beginning of a slow but structural economic decline that governments have continuously tried to offset issuing more debt.

A massive speculation wave started during the 1990’s, fueled by easy money and lower perspective in terms of income growth. The dotcom bubble, the subprime frenzy, and all the recent speculation manias are symptoms of the same disease: the end of a Kondratiev wave. The only different case is Japan, which had already gone through the whole pseculative boom and burst process at the end of the 1980’s before entering three decades of zero growth.

An economy is a living and non-equilibrium system, driven by complex interactions between agents. As narratives emerge, imbalances appear and make the system more vulnerable to shocks. As long those imbalances remain, the economic potential of a region gets weaker and weaker.  In other words, the system must be cleaned up in order to lay the ground for a new source of organic demand.

Economic Spaghettification

The end of the Kondratiev Wave could be seen a powerful black hole attracting the whole economic system of a region. While the collapse came fast after the 1929’s market crash, recent post-Keynesian policies have only managed to generate a smooth transition towards depression.

Said differently, they cannot destroy the black hole but they can slow down the fall, leading to the economic spaghettification of Western countries (i.e. a GDP growth rate asymptotically tending towards zero).

The problem with that strategy is that it does not only postpone the final impact of the depression, but also the beginning of a new structural recovery. One could argue that priority has been given to older generations rather than younger people.

Of course, low interest rates and quantitative easing could be used to enforce economic reforms, let zombie firms fails, support the households during the transition, and invest in new innovative fields. For instance, this is what China has tried to do since 2015. Germany also did a huge economic effort at the end of the 1990’s, but many of their neighbors have never followed that path (e.g. France).

It seems more complicated for democratic regimes. Indeed, no politician is willing to let companies go bankrupt and let unemployment rise, as it would threaten his/her chance of reelection. But saving inefficient agents is a just a way to postpone the day of reckoning, as a few years later governments will be forced to save them again, and so on.

Imagine a village with a residential area which is structurally vulnerable to floods. What is the most intelligent thing to do? Build new houses in a safer area, or rebuild the exact same area after each natural disaster?

So Far So Good

Believe or not, but countries like the US, France, and the UK, have chosen the second option for their economy. Probably because some people still benefit from the current situation, especially politicians and/or those who own assets like stocks or property.

But there is no free lunch in economics. As there will be no durable recovery without serious reforms, our economies may not be able to escape depression.

The main problem is the fact that other countries like China are building critical advantages in the global competition. Please read my older post on reverse black swans.

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