At the Crossroads of the K-wave

August 16, 2000

Every financial panic must have a catalyst, a lynchpin upon which the cascading effects of monetary disaster spreads across large segments of the economy. When speaking of major financial panics, it is common to blame them on such exogenous events as a shocking news revelation which shakes the markets, or perhaps a sudden rise in the rate of interest. But what few analysts consider is that major financial calamities always begin in the farm sector. This was the pattern observed in 1929 and most certainly will be the pattern repeated this year as we stand on the verge of the Year 2001 financial crisis. And it is precisely the state of farm prices that is the basis of all long-wave cyclical analysis, including the 50-to-60 year Kondratief Wave. Before we can consider fully the extraordinary events that soon will be surrounding us, therefore, we must first examine the state of affairs in the U.S. agricultural sector.

 

It may come as a surprise that the United States is still, technically speaking, an agrarian society which depending heavily upon agricultural production. According to labor statistics, more people in the U.S. are employed in the food services, agricultural, or related industry than any other single job sector. The farm sector represents not only the staff of life for everyone but to a large degree is the foundation of our economic infrastructure. And the all-important grains prices which determine the health of this sector were used as the starting point for Kondratief's cycle research. He theorized that recurring intervals of inflation and deflation are first reflected in grains prices, and since everyone must spend a portion of his income on grain, it represents the sector which most influences the physical economy.

The grains market is a weather market, and the K-wave, which determines the overall course of financial affairs, is a measure of the long-term cycles that influence weather. Having thus prefaced our comments, we now proceed to explain some of our most recent findings of our long-wave cycle research.

Knowing as we do that the K-wave influences most major economic currents within the life span of the average human, we may make a few observations concerning its rhythm and internal structure. We have stated in previous essays that our present K-wave began in 1949 and will likely extend for 60 years (ending approximately in 2009). This is because every K-wave (in fact, all cycle waves) may be divided exactly in half from trough to trough. It is abundantly clear that the inflationary leg of the present K-wave peaked between 1980-81, as measured by the price of gold (the best barometer for measuring the current of inflation and deflation). Since then we have seen 20 years of deflation, with approximately nine more years to go before a new inflationary leg can be expected to commence.

What is more, the deflationary leg of the K-wave can be divided into three segments: early deflation, late deflation and late runaway deflation (terms coined by cycle expert P.Q. Wall). We have now entered the final-and most severe-portion of the downward leg, that of late runaway deflation. This can be proven by noting the following historical traits.

Wheat and other grains prices have historically bottomed out approximately 10 years before the K-wave deflationary leg itself bottoms. During the previous K-wave deflationary leg of the Great Depression, wheat prices on the Chicago Board of Trade bottomed in 1939-40-a full decade before K-wave deflation ended in 1949. From this, grains staged a broad rally for the rest of the decade, even as other commodities languished. But this paved the way for the others, including gold, to join along later. The massive surpluses in grain supplies which build up and contribute heavily to deflation take time to dissipate. Perhaps this explains why grains prices tend to bottom well before the K-wave itself.

Presently, we have just recently a 10-year low in wheat, corn and soybean prices on the CBOT. From a chart perspective, a major low last seen a decade ago is being tested but has already successfully held up. According to commodity cycle expert James Flanagan, who edits the widely-read Past Present Futures newsletter, this year will likely mark the bottom of the long-wave cycle in the grains market. If true, this confirms our position in the K-wave as having entered the final third of the deflationary leg.

Cycle studies are studies in market history. And history has an uncanny way of repeating itself. The K-wave itself testifies to this common failure among humans of learning from the mistakes of the past and repeating them over and over. No better instructor in this truth have we than in historical price charts. And the long-term chart for wheat futures is perhaps the best instructor of all, especially since it is the fullest expression of the forces which govern the K-wave.

Take for instance 1925-1929. This, as we all know, was the most dynamic phase of the great bull market of the '20s, and the fateful period which preceded the great stock market crash of October '29. In 1925, wheat prices-after having been under considerable pressure from high supplies and overproduction throughout the 1920s (when the prior K-wave deflationary leg began)-staged an impressive rally (really, a bear market rally) in reaching a decade high of 205 7/8 cents per bushel. Four years later, wheat prices collapsed to its lowest price of the decade at 93 ¼ cents, a price reached on May 31st, 1929. Four months later, the U.S. stock market saw its peak and began its long descent, culminating in the crash of October.

Fast forward 70 years later to our present day: Wheat prices, after having declined throughout the past decade under the intense pressure of all-time high global surpluses and overproduction, rallied to a decade high price in 1996. Four years later in August of 2001, prices have fallen to a 10-year low. If history is any indication, we should witness a similar pattern of general economic weakness later this year. This is a spill-over effect, since we have established that economic crisis always begins in the farm sector. And never in U.S. history has the farm sector been in a more precarious situation than today, when massive farm debt, record production and carryover stocks, and near-record low prices threaten to plunge agriculture into a repeat of the Great Depression. This weakness cannot help but suffuse into the broader economy, and will almost certainly do so this year.

In his book The Great Boom and Panic, author Robert T. Patterson found in his research of the causes of the great speculative mania and subsequent stock market panic of the 1920s that among the immediate factors leading to the panic was the fact that U.S. farmers in 1929 were sitting on one of the heaviest production seasons on record. Farm prices were already under severe weakness from the preliminary deflation which characterized the 1920s, but were on the precipice of disaster in that year. When farmers went to harvest the crop in the late summer and early fall of 1929, the tremendous drawdown of money stock from the banking establishment put a severe strain on the financial edifice and contributed greatly to the crash of October of that same year. Since harvest time is an expensive proposition, and since farmers must withdraw funds and even borrow heavily in order to finance it, this explains why financial panics tend to occur in the fall season. With U.S. farmers sitting on record crops this year, and with so many heavily in debt to begin with, we can expect a similar drawdown from the banking system this fall. And as we have pointed out in previous essays, the monetary base and MZM money supply when viewed from a rate of change perspective, is getting smaller by the month. It won't take much to topple the fragile U.S. financial structure at this point, and the farm sector may very well be the first domino to topple.

Yet another consideration to our present examination of our financial standing is a point made by the great Austrian economist Ludwig von Mises in his seminal work, The Theory of Money and Credit. He stated that whenever the rate of interest asked by banks rose above the natural rate of interest (as best expressed by the 30-year Treasury yield), the demand for money and money substitutes (i.e., credit) would be bound to contract. This is what contributes in large measures to financial panics and depressions. We have now exactly this situation: Fed Funds interest rates are nearly a full percentage point higher than the natural rate of interest. The last time a similar situation occurred was in 1929 immediately prior to the Great Crash.

Yet another K-wave consideration is the fact that we are more than 50 years into the present K-wave that began in 1949. In the book of Leviticus, chapter 25:8-55, God revealed a set of laws which had profound consequence to the economy as it existed in those days. It established the concept of a "Jubilee," or year of debt cancellation, which would act to cushion the previous decades of debt buildup and prevent severe economic decline. This Divine decree of laws concerning the Jubilee was a recognition of a regularly recurring inflation/deflation cycle, most likely what we now know as the K-wave. It must be noted that we have reached the 50-year mark in this climactic buildup of global debt, and no relief is in sight. But resolution there must be, even if market forces must effect the needed reform. All of this portends a financial collapse of cataclysmic proportions in the very near future.

The real millennium crisis is not a tech-related computer glitch, but a debt-related phenomenon that will have profound impact on the economic condition of nearly every country in the world, including (and especially) the United States. Look for the problems to begin in a big way this fall.

Clif Droke is the editor of the three times weekly Momentum Strategies Report newsletter, published since 1997, which covers U.S. equity markets and various stock sectors, natural resources, money supply and bank credit trends, the dollar and the U.S. economy.  The forecasts are made using a unique proprietary blend of analytical methods involving cycles, internal momentum and moving average systems, as well as investor sentiment.  He is also the author of numerous books, including “2014: America’s Date With Destiny.” You can view all of Clif's books here. For more information visit www.clifdroke.com.

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