Global Markets Collapse Again as 1930s-Style Debt Crisis Emerges

Most people do not wish to be alarmist, nor do they wish us to be alarmist. Yet, sometimes the reality of a situation sounds alarmist. Such may be the case now with the global economy, especially given this weekend's tense waiting game over the situation with the international banking system and Russia's probable default on a debt payment Monday.

To be more specific, many market analysts sometimes do, in fact, sound alarmist at times. To scream "1930s-stlye depression" every time the global economy moves from an expansion phase of the business cycle into a declining phase (typically, in turn, leading to recession) would not be desirable. However, once every 60 years, 1930s style depressions typically do occur, and this time the global economy is, unfortunately, experiencing the kind of economic collapse that occurs only every five or six decades or so. It is, in fact, a full-blown depression in some parts of the globe and spreading at an alarming rate to other parts.

What, then, distinguishes a 1930s-style downturn from a more normal, or even severe, downturn leading to a period of recession? Almost always, the difference lies in the status of debt service of a particular country and the state of the global monetary system as it relates to the foreign exchange market. In a nutshell, human complacency typically builds to an extreme state every five to six decades, leading to poor decision-making with respect to credit expansion and speculation on both the part of governments and the private sector. The resulting financial debacle due to the collapsing debt pyramid that goes along with that complacency typically leads to a global depression, not a recession.

This, I have repeatedly written about for the past 11 years, is what the Kondratieff Long Wave Cycle is all about. Many mistake this cycle, based on the findings of Russian economist Nikolai Kondratieff, to be one that is used to predict where a market or an economy is going. To the contrary, though, it is a cycle that he discovered occurs regularly due to the excesses of debt that develop during the easy money days of the decades-long economic expansion. The Kondratieff cycle, then, is actually a cycle of debt repudiation, and that is exactly what is beginning to occur in parts of the globe.

Indeed, the world awaits Russia's decision Monday, only a week after it effectively devalued its currency, the ruble, and declared a debt moratorium. Russia, in fact, is in such bad shape (some report them on the verge of anarchy) that even if they were to make Monday's debt payment, it would wipe out remaining reserves and render them technically bankrupt.

Human nature, therefore, is to become too overconfident during the decades of expansion that characterizes the "upwave" of the Kondratieff cycle. Many even feel "it is different this time" at the top of each revolution of this cycle, unfortunately just at the wrong time when the whole debt pyramid is about to implode. Reflected in this type of thinking is perhaps the urge to be chic, to buy, as we heard had occurred in Hong Kong in the days leading up to their 1997 debacle, a second Mercedes Benz. Word last October was that some in Hong Kong were having to sell their second Mercedes to meet margin calls emanating from the stock market crash.

This is certainly not to single out Hong Kong as a bastion of hedonism since this kind of behavior still occurs everywhere and will continue to occur until humanity learns to be more prudent and less impetuous with their finances. Moreover, Hong Kong and Asia's financial debacle last year and this year provided the alert investor an opportunity to realize that, no, this time it is not different, that financial collapses and depressions do, in fact, happen in the modern day global economy. Presently, Americans, in fact, are being put to the same test, albeit not to the same private or banking sector excess as had occurred in parts of the Pacific Rim. American investors, however, still appear very stubborn about holding onto stock holdings no matter what, even sending more money to their mutual funds or brokerage firms during this year's steep market correction.

In conclusion, this generation of investors is on assignment: to learn what no prior generation has yet learned; to go where no generation has gone before. The assignment is to learn to be prudent; to not be "irrationally exuberant," as we and the U.S. Fed Chairman have discussed so many times in the past. It is to learn to balance portfolios as the marketplace changes, and it is to learn that being a conservative investor is not defined by holding onto stock and taking no action but, instead, to reallocate portfolios and keep them balanced (i.e., between stocks, bonds, cash, gold, etc.) at all times. Perhaps an optimistic view is in order to sum up this outlook: every time the 4-year cycle drags stocks lower, it creates a significant buying opportunity.

The reality of the situation, not to sound alarmist, is that bear markets involve very deep declines and the typical investor will usually sell out just at the wrong time, ala 1987.

"There is nothing permanent except change." -- Heraclitus