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Why The Wall Street Bubble Must Burst

Why The Wall Street Bubble Must Burst? Why the Wall Street Bubble Must Burst? In 1938, and in the teeth of the longest and fiercest depression that the United States had ever known, capital spending hit an all time high. That’s right! In 1938 the men who owned America began to pour millions of Dollars into new plant and equipment as if there was no tomorrow. We don’t think much about it today, because it has been a long time since the United States has experienced a real bone jolting economic slowdown. The fact is, however, that the very best time for the industrialist to invest in new technologies is in the middle of a depression. This is because it is at such times that labor, raw materials, and new equipment can be purchased at rock bottom prices. Henry Ford may have jumped the gun a bit.

He shut down his River Rouge plant for two years starting in 1932 so that it could be completely rebuilt. Being a bit of a genius, Ford used his time and money to redesign the plant to create one of the most powerful little engines ever built: the Ford V8. This engine was so good that it was modified only slightly to equip certain aircraft for use in World War II. It also powered a series of red hot Ford cars all the way through the 1950s. At the same time that Ford was rebuilding his River Rouge plant, Joseph Alois Schumpeter, an Austrian economist who had migrated to Harvard University, was hard at work on a book that would explain the paradox suggested above, namely the timing of business cycles and technological change.

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In this all but forgotten work one of our most famous economists spelled out the secrets of the business cycle, that is the same old pattern of boom and bust that may be coming back to haunt us now. Many, if not most, American college students know Schumpeter’s name because of his work in defense of free enterprise called Capitalism, Socialism, and Democracy. This was not, however, the book that Schumpeter was working on as America slogged through the mean and hungry 1930s. The book published by Schumpeter in 1939 is called Business Cycles: A Theoretical, Historical, and Statistical Analysis of the Capitalist Process. Not only is Schumpeter’s definitive two volume study of the business cycle not on college reading lists today, but, indeed, it continues to languish in its first edition.

The embarrassing truth is that Schumpeter’s real masterpiece remains almost unread. The present writer checked out this forgotten work from one of our leading university research libraries to discover that Schumpeter’s book had been borrowed only a total of fourteen times in the nearly four decades from June 1961 to the present! There are probably two reasons for this. In the first place, Schumpeter’s magnum opus on the business cycle came out on the eve of the Second World War. As the dark clouds of war began to cast their shadow over Europe, Asia, and eventually the United States, economists (and everyone else) clearly had more pressing concerns. Not only that, but it was also clear to Americans that the US Army would soon take care of the problems of excess supply being experienced in the labor market.

It was also quite obvious to everyone that the factories were about to start humming again, this time to produce for war. After the conflict, of course, and all the way through the 1970s, it was widely believed that the business cycle had been repealed by means of the clever economic manipulations suggested by the British Lord John Maynard Keynes. College kids in the halcyon 1960s were taught by their professors that the economy was not one of scarcity, but, rather, of endless abundance. The Great Society had arrived. Keynesian economics was in its glory days.

This new body of thought and practice was one of the British Empire’s last and most influential exports. If Keneysianism had, indeed, hung the business cycle by the neck until dead, then the only decent thing to do was to bury the corpse. Schumpeter’s text, unfortunately, was placed alongside the remains of business cycle it its tomb. Some things, however, will not simply and decently die. They come back to haunt you.

Do you remember platform shoes? They should have expired peacefully in about 1973, but just take a look at your teen age daughter! Some fifty years later, there are those who, like the present writer, appear to suspect that the business cycle, too, is back. The highly respected Investors’ Business Daily recently devoted a full-length front page article to the following shocking idea: Ominous Parallels To Late 1920s? Then As Now: Roaring Stocks, Deflation, Stingy Feds. If what the IBD is worried about turns out to be true, the American economy could be in for hard times again! If this happens, our somewhat lazy academic economists might find it worthwhile to check Schumpeter’s book out of the library a little more often. What they will find there is briefly explained in the following . If Schumpeter’s historical and economic analysis is correct, we are sliding down the long back side of what is called a Kondratieff wave and picking up speed as we head towards the trough.

What will be required to start marching up the other side and back into prosperity, according to Schumpeter, is a period of creative destruction. During this unpleasant period the fictitious values of the boom (like an overpriced stock market ) are destroyed. It is at such times that capitalists finally go to work and invest in new technologies to power us out of the depression that almost always occurs. In previous economic crises, such as the period of the late 1920s that the Investor’s Business Daily has so convincingly evoked for us, the process of creative destruction was initiated by bizarre public and official behaviors. This included stock manias, economic panics, bank runs, Fed jawboning, and stock market crashes.

Does any of this sound familiar? Schumpeter inherited the idea that there is a long a-periodic economic cycle governing all of this from an unfortunate Russian called Kondratieff. We’ll call him K for short. K’s article on what he called long waves came out in 1926. Not much later K perished in one of Stalin’s brutal purges, probably for having above average intelligence. Schumpeter speaks of Kondratieff’s long wave very approvingly and discusses it together with two observed business cycles of shorter duration called the Juglar and the Kitchin cycles after the statisticians who described them. Schumpeter believed that there were ..

six Juglars to a Kondratieff and three Kitchins to a Juglar- not as an average but in every individual case (pp.173-174). Having lived through nine years of economic crisis by the time his book was published, Schumpeter believed that the Great Depression happened because the end points of all three of these fluctuations occurred at the same time (p. 173). Juglar and Kitchin cycles have been pretty much forgotten today. The Kondratieff long wave, however, still excites interest among cycle buffs, perhaps because it fits in so nicely with what we know about economic history.

All three of the patterns pointed out by Schumpeter, on the other hand, have one very important element in common. The Kitchin, the Juglar, and the Kondratieff are all based on the timing of technological change (or what the economic historians call innovation) as it occurs within the free market system. The Kondratieff is easier to see because it fits in with the most obvious moments in the development of the industrialism in its dynamic relationship with free enterprise. The first Kondratieff, Schumpeter says, was the Industrial Revolution itself which lasted from about the 1780s through 1842. The era that followed (1842-1897) was, according to Schumpeter, the age of steam and steel.

The third Kondratieff was based on electricity, chemistry, and motors, and was ongoing when Schumpeter was working on his masterpiece (p.170). These periods of growth and expansion saw ever increasing productive and financial power in the industrializing countries and were punctuated by episodes of economic crisis in every case. If the IBD has called it correctly, we might be entering such an era of economic crisis once again. The key to the picture is the long- term behavior of prices in general and commodity prices in particular. The short form of the argument is as follows: when prices go into long periods of decline, look out! The logic of the long wave idea is not complex.

Long wave theorists believe that innovation in the world of production and management happens not as a series of single events, but as a related set of changes all simultaneously affecting one another. Those of us who have lived through the computer revolution can see the logic of this in our own lives. Take computers (or as the stand up comic guy might say Please take computers!). No sooner did you get a simple PC for a little word …


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