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Winter is coming…are you ready?

/ 04:01 AM August 26, 2020

A poet once said that if you study the rhythm of life on this planet, you will find that everything moves in perfect symphony.

Just as the oceans could replenish themselves with waves to wash ashore, the earth can heal and regenerate itself.

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In the early 1920s, a young Russian economist by the name of Nikolai Kondratiev theorized that the long-term expansion and contraction of a capitalist economy tends to move in a certain rhythm every 50 to 60 years.

Kondratiev explained that these rhythms, which would later be known as K-waves, consist of four distinct phases.

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The first phase is what we call the “spring” time, which lasts for about 25 years. This is the period where economic growth is driven by technological innovations, resulting in strong employment numbers and increased productivity.

As wealth accumulates, the overall prosperity starts to create increasing demand for goods and assets, which eventually leads to inflation.

At first, the rise in prices will be benign because it will encourage more production, but the economy will come to a point where it has already reached its limit.

This is the part where the economy will enter its second phase that we call “summer” time. During this phase, which takes about five years, the economy begins to slow down due to rising costs brought about by shortage in resources.

Businesses will have slower growth, falling profits and lower returns on investments. But once the economy endures a brief contraction, it will enter another phase called “autumn” season where it will have a stable period of relatively flat growth that can last for about 10 years.

By this time, the economy will have low inflation and interest rates. The low interest rate environment will encourage consumers to borrow, causing a rapid increase in debts.

When the excesses of the “autumn” period finally catches up with its limits, the economy will collapse into a depression. This phase, which we call “winter,” will be characterized by rising bankruptcies and high unemployment rates.

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The crisis will persist for about three years as consumers try to unload their debt burden. The deleveraging process will eventually lower aggregate demand, leading to a 15-year deflationary period.

According to Kondratiev, this great depression will serve as a cleansing period for the economy to adjust its imbalances and prepare it for the next growth cycle.

Kondratiev, who was able to predict the Great Depression of the 1930s, unfortunately did not live to see his theory gain wide acceptance because he was executed during the Great Purge in 1938 for criticizing the economic reforms of the Soviet dictator, Joseph Stalin.

If we apply this theory to our current situation, given the trends in inflation and interest rates in the past years, it appears that we are about to enter the winter phase of the K-wave cycle.

For example, the historical monthly headline inflation rate has been declining from a high of 7.3 percent in October 2008 to 2.7 percent in July this year.

Interest rates, on the other hand, have also been on a downtrend, with the 10-year Philippine bond yield falling from 9.6 percent in 2008 to 2.61 percent today.

Although we never had an economic contraction in the past, our economy almost declined in 2009 with only 1.1 percent growth before it entered a period of stable growth.

If we check the level of indebtedness in the economy, total loans exposure of banks as a percentage of GDP (gross domestic product) has almost doubled since the financial crisis from 25.3 percent in 2008 to 47.9 percent in 2019.

Real estate related loans have almost tripled from 3.7 percent in 2008 to 9.0 percent in 2019 while credit card and auto loans have more than doubled to 4.5 percent last year from only 2.1 percent in 2008.

Assuming we are indeed in the winter phase of the cycle, it will take about three years of cleansing for the economy to deleverage, which could send us to a depression.

Whether the K-wave cycle is valid or not, there is no doubt that we are in the phase of decline brought about by the coronavirus crisis that could last for some time. INQ

Henry Ong is a registered financial planner of RFP Philippines. Stock data and tools provided by First Metro Securities. To learn more about investment planning, attend the 85th batch of RFP program this September 2020. To register, email [email protected] or text at 09179689774.

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