|Forecasting America's Destiny ... and the World's|
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These pages contain the complete manuscript of the new book
Generational Dynamics: Forecasting America's Destiny,
written by John J. Xenakis.
This text is fully copyrighted. You may copy or print out this
material for your own use, but not for distribution to others.
Comments are invited. Send them to mailto:firstname.lastname@example.org.
Once I built a railroad, made it run, made it race against time. Once I built a railroad, now it's done. Brother can you spare a dime? Once I built a tower way up to the sun, with bricks and mortar and lime. Once I built a tower, now it's done. Brother can you spare a dime? Once in khaki suits, gee we looked swell, Full of that Yankee Doodley Dum Half a million boots went slogging through hell, I was the kid with the drum Oh say don't you remember, you called me Al, It was Al all the time, Say don't you remember, I'm your pal, Brother, can you spare a dime? -- 1930s Song, written by Edgar "Yip" Harburg
It shouldn't be surprising that a crisis period also goes along with some sort of financial crisis: after all, any society going through a major war is bound to suffer economic dislocation.
What is a surprise is that it seems to be that the prototypical case is like the Great Depression of the 1930s -- a general business collapse resulting from the end of a credit bubble like the one in the 1920s.
Most surprising of all is that the evidence indicates that the Nasdaq crash in Spring 2000 is like the October, 1929, stock market crash, and was the beginning of a new 1930s-style Great Depression, to last throughout the decade of the 2000s.
Since I first made this prediction in spring 2002, the amount of skepticism I've heard was universal. Later, as this is being written early in 2003, there are many analysts concerned about America entering a new depression, but the analysts overwhelmingly believe that the Federal Reserve can prevent such a result by rapidly expanding the money supply. Unfortunately, the evidence I'm presenting here and in Chapter 11 shows that the prediction of a new Great Depression will not be affected by anything the Fed will do.
I'm presenting two different kinds of evidence. This chapter contains generational evidence, and Chapter 11 contains analytical evidence.
Irrational Exuberance in the 1990s
Let's begin by using the Generational Dynamics methodology to explain why a new financial crisis is occurring about 80 years after the last one.
Ask any financial counselor who worked during the 60s, 70s, 80s or 90s, and he'll agree with the following: Anyone who grew up or lived through the Great Depression is "risk aversive." People who lived through the Depression were extremely cautious about spending money or making risky investments.
They had good reason to feel that way. Kids who grew up in the 1930s saw homelessness and starvation all around them. My own mother often told me how her father's business had gone bankrupt, and how she talked her way into a job to keep her family from starving -- the job paid $8.00 per week!
Money had been flowing freely in the "roaring 20s." Everyone was rich, and everyone spent money freely. In the 30s, surrounded by starvation and homelessness, people were bitter not only at the government and businessmen, but also at themselves: they would be living comfortably if they had only saved the smallest amount of the money they had throwing around so freely a few years earlier.
So they learned to save money, never knowing when the next depression would come. My mother lived in fear of another depression in the years I was growing, and when I started going to college, any bad financial news she heard on television would prompt her to ask me if this was a new depression.
People like my mother were so cautious that they were often mocked by younger people (perhaps including myself) and caricatured.
And yet, people in my mother's generation also worked in financial institutions, and carried the same caution and risk aversion in making institutional investments.
Those people, more than anyone, understood the significance of this graph. The heavy black line shows the ups and downs of the Dow Jones Industrial Average from 1896 to 1940. Something crazy happened, starting around 1922. People started borrowing money from one another and using it to leverage stock purchases, and then used those stock purchases as collateral to get more loans, and purchase more stocks.
The graph above shows how the value of stocks skyrocketed throughout the 1920s. The stock market bubble burst in 1929 when the interlocking credit structure collapsed. Over the next 4 years, stocks lost about 80% of their peak value.
The people who lived through those times advanced in their jobs over the years. By the 1980s, they were the senior people in banks, investment houses and other financial institutions. They brought an atmosphere of caution to the entire financial industry.
But in the 1990s, things started to change. Then, people who had grown up in the 1930s began to retire or die. Their senior positions in financial institutions were taken over by younger people with no personal memory of the depression, and no self-blame for not having saved a few bucks during the 20s.
Now look at the graph above to see what happened: a bubble very similar to the one that occurred in the 1920s.
Alan Greenspan, head of the Federal Reserve, recognized the situation very early. In 1995, Greenspan tried to warn the financial community by coining the phrase "irrational exuberance" to describe the new stock market bubble that was growing dangerously. No wonder he recognized the danger: Greenspan was born in 1926, and well remembered the last time it happened!
If we compare the 1990s in this graph to the 1920s in the preceding graph, we can see that if history repeats itself, then the DJIA will fall to about 3,000.
The above argument uses Generational Dynamics concepts to explain why there was a big stock market bubble in the 1990s, and why it's leading to a major stock market fall in the 2000s decade.
In order to make this understandable, this section attempts to provide an ordinary explanation in words why this is happening.
Take another look at the DJIA graph above. This graph shows very dramatically how huge the bubble was in the last half of the 1990s. Starting in 1995, stock values took off like a rocket. The bubble in the last half of the 1990s decade was so huge by historical standards that it'll take an enormous additional drop in stock prices to compensate for it.
First, it's worth pointing out that the DJIA surge between 1982 and 1994 was quite justified, based on what was happening in the American workplace. Personal computers started becoming popular in the early 1980s, and they enormously improved the productivity of the workforce.
Huge numbers of repetitive jobs were eliminated in the office and the factory. Huge masses of paper, that formerly had to be distributed and filed by administrative employees, now are handled with e-mail. Many factories have become a lot more automated and efficient using automation. Even many professional jobs, especially in various financial areas such as budgeting and financial planning, could be cut back because these jobs could be done much more quickly with the help of computerized spreadsheets and other tools. Even management jobs were eliminated, and corporate organization charts flattened, as the tedious repetitive and paperwork management tasks became computerized.
The productivity gains through 1994 or so were enormous, and explains the spurt in the DJIA up to that time. There were additional productivity gains after that time, but not the enormous ones we'd previously seen. If stock prices had leveled off at that time, then we'd be fine today. Instead, something went wrong.
It was perfectly obvious what was going on. Alan Greenspan called it "irrational exuberance," but other less diplomatic commentators called it "hysteria."
Craziness at this level had not occurred in decades -- not since the 1920s, when a similar technology bubble occurred -- but then the technology was the automobile, not computer software. Since then, financial executives remembered the Great Depression and the bubble that caused it, and held enough influence to keep it from happening again. However, most of those executives retired or died in the early 90s, and all the financial decision makers by 1995 were men and women with no personal memory of what happened the last time.
When the personal computer became available in 1981, there were some spectacular moneymaking successes in the 1980s, from such companies as Compaq Computer Corp. and Lotus Development Corp. When new World Wide Web technology became widely available around 1993, every investor in the world wanted to replicate the Compaq and Lotus experience with some internet-based product.
|The DJIA surge between 1982-95 made sense; after that, something went terribly wrong|
Investors poured every available investment dollar into venture capital for these companies, or into stocks for these companies. This continued even though almost none of these companies made money, unlike Compaq and Lotus, which had made money almost immediately when they were launched.
This is an important point to remember when judging how insane this level of investment was. It was pretty well known by 1997 or so that the only internet-based companies making money were online services providing real-time financial data (like stock quotes) or online services providing pornography. Thousands of these companies were being funded by anxious investors, but not one single e-commerce company made money before the year 2000 Nasdaq crash.
How could this possibly happen? Well, consider the following reasoning.
The investing atmosphere of the 1990s led people to be overly optimistic, to the point of making both ordinary citizens and sophisticated investors make irrationally optimistic investments.
Now everyone, to my knowledge, agrees with the above paragraph. Well, what about the next paragraph:
Both ordinary people and sophisticated investors have learned their lessons, and are now becoming increasingly risk aversive (as people did in the 30s). As a result, they will be irrationally pessimistic about making investments.
If you believe, as most people do, that investors were irrationally optimistic in the 90s, why isn't it likely that they would react by becoming irrationally pessimistic today?
So if you're trying to understand the Generational Dynamics explanation in the preceding sections, then this section gives you two reasons to support it: (1) millions of businesses that haven't fully adopted computer technology are too inefficient; and (2) investors are likely to become irrationally pessimistic, just as they were irrationally optimistic in the 1990s.
Now let's look at the issue of financial crisis in another. We're going to show that each of America's crisis war occurred after a bubble burst to create a financial crisis.
This is material that's hard to find in any history book. You'll find the stuff about the wars in American history books, and you'll find the stuff about the financial crises in financial history books. This is the only presentation I've seen that brings these two together.
First, a little background information. For those who are not familiar with finance, let's take a look at what a bubble is.
It's easy to understand what a "bubble" is when you look at a simple example. Suppose I have $1,000, and I put it in the bank. Suppose you borrow the $1,000 from the bank. Then I "have" $1,000 (in the bank), and you "have" $1,000 (in cash). So $1,000 has become $2,000. That's a simple example of a bubble, and there's no crisis unless I go to the bank and demand to withdraw my $1,000. Then either the bank gets the money back from you, or else goes bankrupt. If you've spent the money, then you might go bankrupt as well.
Even worse, you might have deposited the $1,000 in another bank, which then loaned that money to a third person. At that point, there are three people who each "have" $1,000, so $1,000 has become $3,000. This can continue for a long time, with a financial crisis occurring as soon as someone wants to make a withdrawal.
That's the essence of a bubble: People lending money to other people, who in turn lend it to other people, with those transactions occurring millions or billions of times. It's almost like a pyramid investment scheme, and it has to run out eventually. At some point, someone wants his money back. If something causes many people to want their money back at the same time, then there's a "panic," a financial crisis that causes many people to lose a lot of money.
The exact mechanism by which the money is loaned over and over again has varied with each American crisis, but there is always a big bubble that bursts before each crisis.
By way of example, let's start with one of the most famous bubbles in history. However, it occurred in Europe, not in America. It's the first reasonably well-documented bubble in history, and it was called "Tulip Mania" or "Tulipomania" -- because it had to do with the pricing of Dutch tulips in the early 1600s. This bubble grew for decades, but it only burst completely in 1637, just as France was entering a major "world war" of that time, the Thirty Years' War.
It's almost hilarious to compare the Internet products of the 1990s with tulips of the 1630s, but in fact, tulips were the high-tech product in the Netherlands at that time.
Those were heady days in the Dutch Republic. Amsterdam was the major gateway between London and Paris, and the city had benefited hugely from having established Europe's first central bank in 1609, giving Dutch merchants a big competitive advantage around the world. It was still the biggest bank in Europe in the 1630s, and the whole of the Netherlands was prosperous, not having yet been affected by the Thirty Years War.
Tulips did not originate with the Dutch. The first bulbs had arrived from Turkey only a few years earlier, in the late 1500s. By means of breeding experiments, Dutch botanists were able to produce tulips with spectacular colors. These tulips were sought by wealthy people, and by 1624, one particularly spectacular bulb sold for the cost of a small house.
Prices remained elevated for over another decade, and soon investors from all over Europe began purchasing a kind of "Tulip future," a certificate purchased in the fall which can be traded for a specific actual tulip to be grown the following spring. In some ways, these certificates were similar to "stock options" in the 1990s.
In 1636, speculation in tulip futures went through the roof, and on February 3, 1637, the tulip market suddenly crashed, causing the loss of enormous sums of money, even by ordinary people, including many ordinary people in France and other countries.
A mood of retribution began immediately, and even the tulips themselves suffered. Evrard Forstius, a professor of botany, became so reviled by the mere sight of tulips that he attacked them with sticks whenever he saw them! At this point, the Thirty Years War enveloped all of Europe, as we'll discuss in chapter 8.
Let's look at the bubbles associated with each of the crisis wars in American history.
Revolutionary War. In pre-Revolutionary days, the bubble was caused by the issuance of too much paper currency by banks.
In those days, paper currency was issued by individual banks rather than by governments. A bank would distribute banknotes that could only be redeemed at that particular bank. In effect, receiving a bank note was like receiving a loan from that bank. If a bank issues too much currency, then the bank could fail if too many people at once tried to redeem the currency.
In an effort to impose control over the colonies, England imposed the Currency Act of 1864 on the colonies. This act forbade the colonial banks from issuing their own paper currency. This was resented as much as any tax, and it also created financial problems due to the lack of currency. As a result, banks ignored the edict and not only issued paper currency but issued a lot of it. This transfer of paper currency from business to business created a bubble that burst in 1772 when the Bank of Rhode Island failed.
The same sorts of activities were going on in Europe. In particular, the Ayr Bank in Scotland had issued paper currency freely to aid speculators in housing and toll roads. A bad crop harvest on the Continent triggered the failure of a speculative investment by London banker Alexander Fordyce, which triggered the failure of the Ayr Bank, leading to the Panic of 1772. This triggered the failure of the Bank of England, and the collapse of numerous colonial businesses, as previously described in this chapter. How easy it is for a simple problem like a crop failure to trigger the collapse of a bubble, leading to widespread financial calamity!
Civil War. In the 1850s, before the Civil War crisis, the bubble was caused by something called "call loans." A bank would loan money to brokers who would use it to loan money to clients to buy stocks. However, the phrase "call loan" comes from the fact that a bank could call the loan at any time, requiring the broker and its clients to sell stock immediately to get the money to repay the loan.
The "call loan" system was terribly abused in the 1850s, with financiers using the same money over and over again to bid up the price of stocks. The railroads were the high tech items of the day, as people competed with each other to bid up stock prices on railroads and on the public lands that the railroads used.
On August 24, 1857, a cashier in the New York office of the Ohio Life Insurance and Trust Company was found to have embezzled many of the firm's assets, triggering a series of failures reverberating to Liverpool, London, Paris, Hamburg, and Stockholm, leading to the Panic of 1857.
World War II. The high-tech item of the 1920s was the automobile, and it was a variant of the call loan, called a "margin sale," that caused the bubble. It was the same idea -- brokers lending money to clients to buy stocks -- but lenders were required to pay a certain margin or percentage (often as little of 10%) of the cost of the stocks in cash.
Today. In the 1990s, where the Internet was the high-tech item du jour, the bubble was caused by a brand new mechanism -- the stock option. A financier (venture capital company) would lend money to a group of entrepreneurs to form a company and develop a product. The entrepreneurs would pay its workers a lower than market wage, augmented by stock options -- a promise to allow the employee to purchase cheap stock at a later date, and resell it at a much higher price. In essence, the stock options became similar to the paper currency issued by banks in the 1760s. (There really is nothing new under the sun.) When the stock options were finally called, the entire bubble collapsed, resulting in the Nasdaq crash in 2000, and subsequent large drops in stock values on the New York Stock Exchange.
What these examples show is that financial crises are very closely tied to war crises. In fact, they feed on each other, and energize each other.
A war crisis makes people extremely risk aversive, reluctant to make purchases or investments, for fear of being left with nothing, leading to a worse financial crisis.
A financial crisis makes people restless and desperate, looking for justice and retribution against the people whom they blame for causing the financial crisis. In many cases, the result is war.
Ask almost anyone about a depression in the 2000s decade, and they'll give you an answer like this: "It can't happen. In the 1930s, the Roosevelt administration put in new agencies and regulations to prevent another depression from every occurring."
People don't realize it, but the agencies and regulations that were created in the 1930s to prevent another depression have already failed.
Take the Securities and Exchange Commission. When I was high school in the 50s, my teachers all told me how the SEC was going to prevent a future depression. The 1930s depression was caused by the huge stock market bubble of the 1920s, where millions of investors drove up the prices of stocks by borrowing money from each other, a situation that led to a huge stock market correction in the 1930s. The SEC would prevent that from ever happening again by regulating margin rates, which would reduce buying stocks on credit, and prevent another huge stock market bubble. My 1950s high school teachers knew that because they lived through the 1930s, and understood that piece of wisdom.
Well, today all the people who remember that wisdom from personal experience are gone. And guess what? The SEC failed to prevent the huge 1990s stock market bubble. The SEC has completely failed to perform the principal function that it was originally set up for.
Today, there's only one agency left to protect us from a new depression: the Federal Reserve Bank. Among its many duties, it uses "monetary policy" to control the total amount of money in circulation.
The idea is that the more money there is in the economy, then the more money each person and family will have to spend. Therefore, people will buy more products, providing money to businesses to hire employees, preventing another depression.
So far at least, this kind of monetary policy has not been working. The Fed has lowered the prime interest rate to the 1% range -- a move which would have caused massive inflation in an earlier decade -- is not preventing near-zero inflation or even deflation in 2003.
The analysis in this chapter indicates that monetary policy will not forestall a new depression for the following reason: The current economic problems are occurring because firms are producing goods that people don't need or want, and that they won't purchase even if they have the money to do so. In the meantime, the low interest rates keep inefficient businesses going, and only postpone the inevitable.
Let's take a look at one more explanation of why the 2000s decade will be a decade of depression. This is meant to be an intuitive explanation, not a rigorous argument.
As we mentioned above, the 1930s agencies and regulations designed to prevent another depression didn't work because they didn't change human nature. Now we're going to explain why human nature is such that we must always have a financial crisis like the Great Depression every 80 years or so, and that there's nothing we do to prevent it.
I got the idea for this when I heard a television business news story that described some company as having financial troubles because the "crusty old bureaucracy" that was running the company was moving too slowly keep the company competitive with newer upstarts.
The problem with any organization that lasts a long time is that it gets set in its ways; it gets departments and divisions that are slow to change; employees lose their energy and don't want to rock the boat.
Ordinarily, such an organization will go out of business because it's not competitive enough, and its business will be taken over by more up to date and aggressive competitors.
The problem is that a society (or country) can be thought of in exactly the same way. Looking at a country as a whole -- its entire government, all its businesses, labor unions, educational institutions, and non-profit institutions taken together -- a certain, ever-increasing percentage of these organizations viewed as a whole are going to become inefficient. The crusty old bureaucracy will grow with time.
It's the word "ever-increasing" in the preceding paragraph that is the crux of this argument. Some readers may not agree that the amount of inefficiency constantly increases with time; that businesses, government agencies, educational institutions, and so forth, constantly renew and improve themselves, so that they're always just as efficient as ever. If you believe that a society as a whole stays just as efficient as ever over time, then you won't agree that we have to have a Great Depression every now and then.
But if you believe, as I do, that the buildup of bureaucracies, politicians and layers of control, and the tendency of people and organizations to do their job without rocking the boat with changes means that society as a whole becomes inefficient as time goes on, then the conclusion that Great Depressions are always necessary is inevitable.
In my many years of experience as a computer industry consultant, I've seen what happens with my own eyes. There are many businesses that have computerized, eliminating layers of management, streamlining accounting, manufacturing, order processing and other departments, eliminating large groups of employees doing work that can just as easily be done by a computer that doesn't require a salary.
But I've also seen many, many other businesses that haven't done that: doctors' offices with racks of patient records in paper folders; business offices which use computers for no more than word processing and an occasional budget; rooms full of pencil-pushing employees that perform repetitive tasks all day long - tasks that could better be done by computers. These are the businesses that will be wiped out by a new Great Depression.
|A Great Depression is, like war, another of nature's ways of renewing a society|
Elsewhere in this book, I discussed the concept that "war is senseless" to many people. It's true that war is senseless to the individual, but from the point of view of survival of the human species, war -- including genocide and mass rape -- is extremely sensible, because it guarantees that the strongest races, civilizations and nations will survive, and the weaker ones will die off.
A Great Depression is, like war, another of "nature's ways" of renewing a society. When poverty is rampant and the unemployment rate is above 25%, as it was in the 1930s, then not rocking the boat is impossible. Thousands of businesses will shut down, eventually to be replaced by new businesses that are more efficient. Governments at all levels will be forced to shut down and cut back on all its agencies, because the level of tax collections will be way down. Similar observations will be true for educational institutions, labor unions, non-profit institutions, and so forth.
Organizations in all sectors will disappear, as they did in the 1930s. The ones that survive are able to do so only by completely reinventing themselves, and accepting inevitable cutbacks in all but the most essential jobs, and letting employees in non-essential jobs go to fend for themselves. That's how society renews itself.
When I talk about things like this, people criticize me for being too negative. Heck, even I get depressed reading the paragraphs that I've just written. But being warm and fuzzy is for another book on another day, or by a different author. This book was not written to make people feel good; it was written to describe what I, as a mathematician and researcher, consider is likely to happen.
Since the word "depression" means different things to different people, it's worthwhile to point out that in this book it refers to one specific thing: A big drop in stock market value, similar to the big stock market fall in the 1930s.
But what does that mean in terms of people's lives? In the 1930s, it meant massive unemployment, bankruptcies and homelessness. Are we facing the same fate today?
The forecasting tools that I've used to forecast the massive drop in stock prices do not tell us what ups and downs stocks will take before reaching bottom, and do not answer the questions about bankruptcies and homelessness, so we can only guess.
In the 1930s, money was very tight. People and businesses that owed money were forced to pay their debts or go bankrupt. Businesses that went bankrupt laid off employees, causing more unemployment and more personal bankruptcies. People who went bankrupt often lost their homes, becoming homeless.
Today, the Fed is acting to prevent these massive results by flooding the economy with money -- by keeping the federal funds interest rate close to 0%, and possibly by repurchasing long-term bonds. Businesses that are close to bankruptcy can often borrow cheap money and keep going. People who are close to bankruptcy can often borrow against credit cards, which pass along the low interest rates to their customers.
So we're seeing a different effect on people's lives of the massive stock price drop than we saw in the 1930s. In the 1930s, people went bankrupt and homeless. Today, people and businesses are going massively into low interest rate debt.
It's not known what effect this will have in the long run. In the optimistic scenario, it will give businesses time to change to produce 21st century products, instead of the old 20th century products. In the pessimistic scenario, it will keep the "crusty old bureaucracy" in place a few years longer, thus causing an even harder fall when the fall finally comes.