The Cycle of Political Change

The Cycle of Political Change

Republicans will Sweep Capital Hill in 1994
© Martin A. Armstrong

Far too many analysts constantly compare every downturn in the stock market and economy to the Great Depression. The majority of stock market analysts have been looking for a major top and a big crash ever since they missed calling the 1987 fiasco. We hear Democrats pounding away at Republicans telling us that this is the worst recession since t he Great Depression. Both camps are wrong, although behind closed doors the politicians must know they are distorting the facts.

The wind of change is blowing strong in American political circles. However, this same feeling among Americans that something is wrong is a worldwide phenomena. It has surfaced in China and Russia and even caused the Berlin Wall to finally fall. It has led to the potential breakup of Canada. Sweeping political changes are still underway Downunder in Australia and New Zealand. I n Europe, the very economic fabric is wearing thin and the collapse of the ERM is just the beginning as recessionary forces emerge in Germany.

People around the world know that something is stirring on the horizon and more than one-third seem to be expecting a major economic catastrophe in the years ahead. Indeed, the debt crisis that we at Princeton have been writing about since 1985 is unfolding with uncanny predictability according to our Economic-Confidence Model first published back in 1979. But these feelings for a need to change may become the final straw that breaks the back of the post- depression prosperity era.

Domestically, we are supposed to believe that supply-side economics is to blame for everything from the current recession to recent natural disasters. Such an argument might be worth entertaining if the United States were the only nation in the midst of a recession. However, nations that have been taking a highly socialistic approach, with government running nearly every aspect of private life (as in Sweden), Canada and Australia are facing the same economic reality. What is really on trial here is the big picture -big government itself!

It seems that the natural la w of cyclical activity demands that the subject of the cycle move between two completely opposite extremes. Thus, markets reach a top and eventually they reach a bottom. The Great Depression marked the end of non-interventionist form of government an d the beginning of a new form of activist government. All forms of government, from communist, socialist and democratic, have embraced some principles first espoused by Karl Marx. Stalin took Marx to the ultimate extreme whereas our democratic form of government has adopted just a little bit of Marxism by establishing a progressive income tax to get at the rich. This, at times, has become quite extreme in the initial stages when the top personal income tax rate in the United States reached 91% during the ’60s. From an economic perspective, there is not much difference between being left with 9 cents on the dollar versus the state owning all your property.

During the 1980s alone the CPI doubled, which most people can easily see when they go shop around for a house or a car, even at the depressed prices today. But the cost to run Congress has increased more than 500% -far outpacing anything within the economy during that same period. Government now employs one-third of the civil work force. Throw in the unemployment and welfare rolls and we are over 40% of the people depending upon the tax revenues that can be gathered from those who are gainfully employed regardless of income.

The debt crisis that is now becoming more noticeable to Americans, has been far worse on a percentage basis in just about every other nation. While interest expenditures to support the US national debt are staggering, they are s till within the 15% range compared to 40% in Canada. The Keynesian model was conceived as a partnership between the private and public sectors. Whenever the private sector moved into a recession, government would be there with the courage to increase its expenditures thereby smoothing the cycle out.

Unfortunately, our modern day politicians of all parties in the postwar era enthusiastically embraced the Keynesian model after labeling Keynes a madman in 1923. The Keynes’ model was appealing be cause it basically said that government could participate and control the economy. The notion of deficit spending had only been entertained as prudent during time of war under the non-interventionist philosophy. Keynes legitimized deficit spending f or times of economic decline. But politicians, once unleashed, degenerated from statesmanship to partisanship and used the treasuries of all nations as a carrot to gain reelection.

Two major causes of the Great Depression are often overlooked in the doom and gloom forecasts of most analysts. First, agriculture accounted for 40% of the civil work force compared to 3% today. When commodities prices fell and drought destroyed farms, a significant amount of jobs were lost as a direct result. Secondly, a major debt crisis began in Europe with all nations permanently defaulting on their debt with the exception of Britain. South America defaulted for the fourth time and much of Asia. The peak in broker loans on the NYSE in 1929 was $6.5 billion compared to the German bond default alone of $10 billion. Capital was wiped out and jobs were lost. The protectionist barrier did NOT cause the depression – it was a response to it in 1931. Through it all, unemployment topped 25%.

There is little doubt that we have a MAJOR DEBT CRISIS looming for the ’90s on a worldwide basis. The nations who will survive in the best shape will be those who recognize the problem and begin to prepare by reversing the trend. But governments as a whole have lost touch with the private sector. They have graduated from the partner, who would chip in when times got tough, to the source of the problem itself. Governments are the single largest player in the economy, both from a jobs perspective as well as from a borrower’s perspective.

We are entering the final 5th wave up in Elliot terms of big government. We are witnessing the culmination of this major long-term cycle that will eventually switch back toward the non-interventionist form come 2003. But to get to that point, activist government must take itself to the complete extreme and that is where the increased spending and debt crisis play their respective roles.

Government has become far too big in the scheme of the economy. People trading stocks look toward the Fed for guidance rather than at underlying book values and long- term growth. That is why the stock market became so oversold allowing the take-over binge to unfold as companies could be bought for $20 a share and their assets sold for $40 per share. The market lost touch with reality because traders paid too much attention to politicians rather than value.

Governments worldwide are being run without a clue as to what they are really doing. The name of the game is power – not long-term, cohesive planning. No one in their right mind would when buying a house, sign a mortgage without some plan for the future and a budget that would achieve that goal. But today, politicians care only about the immediate victory without worrying about the consequences 5 or 10 years down the road.

Regardless of who wins the election in the United States, the die was cast years ago when politicians saw fit to stretch the Keynesian model to build their little castles of personal perks and power. Inflation will be renewed, interest rates will rise significantly and the deficit will double again within less than 4 years. The growth rate in interest expenditures alone is in excess of 11%. Nearly 70% of the national debt is funded short-term leaving the US government vulnerable to the swings of confidence within international capital markets. Every 1% “up” tic k in interest rates will add $28 billion to the current year’s deficit.

The future does NOT hold in store another great depression like that of the 1930s. That took place under a completely different form of government and under a gold standard that precluded an inflationary spiral fueled by uncontrollable and automated government deficit spending. The historic spread between short and long-term rates in the US are a forewarning of what lies ahead. Capital will continue to flee from long-term bonds into shorter maturities, as well as filtering over into commodities and the stock market. We do not see the Dow crashing in a major way just yet. But there is a risk of bonds declining and stocks rising as confidence in government diminishes exactly as what took place between 1927 and 1929.

Let us hope that as this current cycle reaches its maximum point of entropy in favor of activist government that the pendulum doe s not swing completely to its opposite extreme. Keynes had the right idea. It’s just that politicians become too greedy in terms of personal power while some individuals are inclined to vote for whoever gives them the most at the expense of their neighbor. A true partnership between government and the private sector could lead to a new world economic order and a higher standard of living for all if we could just for once learn from the mistakes made at both extremes of the cycle.

For now, this immediate recession began with the peak of our Economic-Confidence Model in 1989.95. We expect to see unemployment generally rise going into 1994 for various reasons, including deeper defense cuts, forced layoffs of government employees at state and local levels and cutbacks in the private sector with regional variations. For example, employment on the East Coast looks to be more promising than that on the West Coast. The same is true in the real estate sector and business in general.

The period just ahead going into 1994 will be marked by greater fiscal problems and pressure toward higher taxes also on the state and local levels of government. We also expect to see a very severe recessionary problem begin to take shape in Germany. The economy in Russia will also take a turn for the worse which could result in additional political change in the same direction going into 1994.

Ironically, the US corporate outlook is positive. The worst is over and corporate profits as a whole will rise. US companies will become the more profitable group in the world community, especially when compared to Japan and Germany. In part, a renewed bullish trend for many commodities will have a lot to do with this trend as well.

On the US political scene, we see 1992 as a year of only minor political change with a major political change coming due in 1994. This suggests that the Clinton victory in 1992 could be followed by a sweeping Republican victory on Capital Hill in 1994. Of course, 1994 could also be a victory for perhaps marked by further gains for an independent party as well. If Clinton’s election now removes the veto check against a Democratic Congress which, in the early stages, may lead to much greater spending than even Clinton currently sees.

From a market perspective, many commodities, along with gold, will begin a new bull market phase following the first quarter of 1993. The 30-year bonds should drop like a stone and eventually become extinct from the new issue scene by as early as 1994 but no later than 1996. The outstanding 30-year bonds will be discounted to take into account the risk associated with an uncertain future when confronted by a government unwilling to make the hard choices. The stock market will benefit and new highs will be seen going into 1994 as capital flees from government debt seeking refuge in the private sector.

The one cardinal rule about cycles is what goes up eventually goes down and when it’s down it eventually goes back up. This applies not merely to market behavior, but to all human behavior including political systems. Perhaps the “Age of Aquarius”, as popularized by a rock band more than 20 years ago, may be attainable as volatility declines following this political cycle if man learns from his mistakes made at both sides of the extremes. Unfortunately for now, hope seems but a fleeting moment in the middle of a bizarre dream. Politicians refuse to tare down their castles of perks, privileges and power while voters still remain self-centered reaching for t he biggest carrot on a merry-go-round destined for near-term disaster.