Economist Says Mood Wave About to Crash

When a young Karl Marx predicted in the 1840s that capitalism was going to self-destruct, he didn't say when. Most of his followers gave up hope a long time ago.

But now the holdouts can take heart. An influential U.S. stock analyst who studies long-term economic cycles says the world is in the beginning phase of a financial collapse that will make the Great Depression look like a hiccup.

"I think we're already in it. We're rolling over into a deflation very much like it were 1928 to 1930, but it's going to last longer," says Robert Prechter, author of Conquer the Crash: You Can Survive and Prosper in a Deflationary Depression.

On the phone from his office in Gainesville, Georgia, Prechter says that, like the 1930s Depression, the coming meltdown will cause political turmoil around the world, including an eruption of wars, secessionist struggles, and extremist movements. He believes the downturn will see a fascist or libertarian president elected in the U.S., and he also has bad news for those who thought Quebec separatism was dead.

"Secession and conquest are common political results of bear markets. Quebec is on a long-term track toward secession," Prechter says.

"It's the beginning of a very long period of conflict, unfortunately. We're only at the beginning of the downtrend of mood here, so you don't see it quite strongly in the economy yet or even in the world political scene. But you can tell there's been a change."

Prechter is not a raving antibusiness doomsayer. Politically, he is a smallgovernment libertarian. He started his Wall Street career as an analyst at Merrill Lynch. He rose to prominence in the late 1970s when, in the middle of a decade of economic stagnation, he announced that the stock market was poised to explode. Prechter was ridiculed for his optimism, but it turned out he was right; the markets entered an unprecedented boom. In 1989, the Financial News Network (now CNBC) named him the "financial guru of the decade", and he became president of the U.S. National Market Technicians Association in 1990.

Prechter says market booms and busts are based on long-term trends that are reflected in everything from skirt lengths to rock lyrics. His research on these "mood waves" has led to some uncanny market calls for his clients at Elliott Wave International, his market-advisory service. In 1984, he won a major U.S. stock-trading championship, setting a record with a 444-percent rate of return in four months.

In an updated version of Conquer the Crash released last fall, Prechter wrote that a series of huge waves had just crested and was starting to tumble down in a kind of "perfect storm" for the economy.

Prechter believes that 2000 was an important year. The world saw the dot .com stock crash, but something even more ominous also happened. It was the end of a so-called supercycle, a wave of economic expansion that had started in 1932 during the low point of the Depression. Prechter believes that five of these supercycle waves form a "grand supercycle". When one of these babies ends, run for cover.

The last grand supercycle hit bottom in 1720. That was the miserable year that saw history's worst-ever stock conflagrations--England's South Sea Bubble and France's Mississippi Scheme. The two crashes saw spectacular speculative manias based on the promise of riches from the New World come apart amid revelations of fraud and illusory profits. Both countries were left virtually bankrupt and entered downswings that lasted 60 years.

The hard times set the stage for the American and French revolutions of the 1770s and 1780s, depressions in the 1790s, the Napoleonic wars of the early 1800s, the end of the feudal order, the rise of industrial capitalism, and the ascension of the United States as a new world power.

Out of this mess, a new grand supercycle emerged that saw 200 years of dramatic economic expansion. Prechter divides this cycle into five periods: three supercycles of economic growth interrupted by two downward waves of depressions, 1835 to 1842 and 1929 to 1932.

This grand supercycle also ended in 2000, Prechter says. That means we are poised for a collapse worse than anything since 1720. The 9/11 attacks and the U.S. invasion of Iraq are just a whiff of the turmoil still to come, he says.

"You can see we're already involved in wars. This is the early part of the trend. Just multiply it out a few more times and that's what it'll be at the bottom," Prechter says.

"As the mood deteriorates, you get a waxing of both fear and anger, and those things generally require expression in some way or another."

Prechter readily acknowledges that his views are way outside the Wall Street consensus and that he has made mistakes in some of his previous predictions. (Most famously, he wrote in 1995 that the end of the grand supercycle would happen that year; he now says he was only off in his timing.)

What makes Prechter's forecasts troublesome is that Wall Street is starting to agree that the economy is in for some ugly times, even if no one will go as far as he does. The financial press is full of articles that say the glory days of the 1980s and 1990s are over and that this decade will be a throwback to the economic doldrums of the 1966-1982 era.

"I don't think anything like a smashup is around the corner, but we're in a troubled economic time," says Doug Henwood, a progressive economist who edits the Left Business Observer monthly newsletter.

"So much stimulus has been thrown at the economy, and it should be doing a lot better than it is. The potential for disruption is large. We could really have a serious problem."

On the phone from his office in Manhattan, Henwood says he has followed Prechter for years and is dubious about his talk of mood waves and supercycles. "It sounds like astrology," he says, laughing.

Henwood also disagrees with Prechter's view that an economic bust-up is inevitable. "Someone like Prechter is coming from a very right-wing political position. They don't think governments can manage crises, sort of like the orthodox Marxist point of view," he says.

But Henwood also acknowledges that he often finds himself turning to Prechter's analyses to understand the economy, especially after the 2000 crash. "Prechter may be onto something," he says.

"You could say the U.S. is topping out. Its day in the sun is over, and maybe China is going to be the wave of the future. There is some sense that the era of American domination might be ending."

On the other hand, Henwood doesn't believe the coming downturn will be as bad as 1929. Rather, he thinks North America will see something like the long, wrenching deflation that Japan has struggled with since 1990. (Deflation is a nasty state of affairs in which prices go down and no one wants to buy anything because they think it'll be cheaper tomorrow.)

Japan has spent the past 15 years trying in vain to restart its deflationary economy after an 80-percent crash in the Nikkei 225 stock index and a collapse in housing prices.

One of the biggest problems facing the U.S. and Canada, says Henwood, is record personal debt, brought on by historically low interest rates and two decades of stagnant wages. In 2002, the average Canadian's debt was 98 percent of his or her disposable income, compared to 56 percent in 1984.

A sign of the dangers came last February when Alan Greenspan, chairman of the U.S. Federal Reserve Board, issued a chilling statement. He warned that two huge U.S. government탔ší‚ ­sponsored mortgage institutions, Fannie Mae and Freddie Mac, had accumulated so much debt--US$1.75 trillion--that they were vulnerable to an economic downturn. The failure of the two companies could spark a financial crisis, he said.

"People contracted debt on the assumption that the low interest rates are going to stay that way," Henwood says. "When the rates go up, they don't realize how much they are going to pay."

The low rates have led to a housing bubble that could burst if rates go up too much, Henwood says.

Henwood's warnings are echoed by a growing number of analysts in the financial press who predict a painful downturn in 2005 and 2006. Their concerns are based on yet another kind of wave that is expected to crest after the U.S. presidential election in November, the so-called presidential cycle.

This four-year cycle is so named because of how the economy typically expands in the third and fourth years of a presidential term and contracts in the first and second years. The cycle exists because U.S. administrations usually juice up the economy prior to elections, only to slam on the brakes afterward with interest-rate hikes and spending cuts.

It's no coincidence that some of America's biggest market downturns started the year after an election--1929, 1937, 1973, 1981. This time around, things could be worse than normal because the explosion of personal debt has left the economy essentially teetering on the edge of a precipice.

"I totally agree with Robert," says Ian Gordon, vice-president of Vancouver brokerage firm Canaccord Capital and author of the Long Wave Analyst newsletter. "We're repeating the depression of the 1930s, and in some ways it's going to be more difficult because of the record debt," Gordon says on the phone from his office.

"He [Prechter] is predicting that we're going back to the 500 years of the dark age. I don't want to think about that. What I predict is the destruction of the middle class. Essentially, their retirement plans are going to be worthless."

Not all experts are as pessimistic. Marc Lee, an economist in the B.C. office of the Canadian Centre for Policy Alternatives, cautions that it's impossible to predict the economy's future. "It's kind of like guessing at the weather," he says on the phone from his Vancouver office. "You can't know, and anyone who pretends they do know has drunk the Kool-Aid."

But Lee still calls Prechter's scenario "plausible" because of the debt time bomb. "A major ramp-up in interest rates would hurt a lot of people. If we saw a one-, two-, or five-percent rise in interest rates, then all of a sudden people wouldn't be able to make their payments and would lose their homes. That certainly is the doomsday scenario nobody is talking about," he says.

Jim Stanford, an economist with the Canadian Auto Workers Union, disagrees with Prechter's forecast. He says that although the stock markets are unlikely to do well this decade, this won't necessarily hurt ordinary Canadians because most stocks are owned by the rich and the wider economy is reviving nicely.

"I tend to agree the stock market is certainly in for stagnation and possibly worse than that. [But] what happens on Bay Street doesn't necessarily affect Main Street," Stanford says from his Toronto office.

"I don't think it's a crisis of capitalism. The people who manage capitalism have, for the most part, figured out how to do it. If capitalism ends, it will be because people have had enough of it, not because it collapses of its own accord."

Back in Gainesville, Prechter says that governments are powerless to stop the coming crash and no one will be immune, even those who don't own any stocks. "When the market falls a long way, you always get an economic contraction," he says.

He advises clients to keep their assets in cash, government bonds (preferably Swiss) and gold, pay off debt as fast as possible, and avoid risky investments. When the economy hits rock bottom, it'll be a great time to snap up real estate and stocks at bargain prices.

"Protect your resources, and if you're smart enough make money from it," Prechter says. "I'm trying to tell people, 'Get safe.' Everyone else who claims to be an optimist is just telling people, 'Throw your money at risk. Buy more stocks at this ridiculous price. Buy more land on margin.' I think that's risky action.

"All I'm telling people is, 'Take a vacation. Keep your money safe.' That's not a doom-and-gloom message. I think that's a message to keep people happy and hopeful."