12,000 YEARS OF ELLIOTT WAVES:

Part 5: Potential causes of an X-wave correction starting in the new millenium

Introduction

According to the long term Elliott wave count presented in the body of this document, we are at the brink of a new Dark Age – longer than the periods of substantially reduced economic activity that characterized the corrective waves that occurred earlier during the current Z3Y1X1 wave, yet not nearly as long as the substantial interregnum that followed the Fall of Rome at the end of wave Z1.

The first of the two corrective waves of the Z3Y1X1 wave occurred as a consequence of the Bubonic Plague that swept through Europe during the 14^th century. The second of the two corrective waves followed the stock market bubbles of the early 18^th century. These have been estimated at lasting only 50 and 60 years respectively. On the other hand, it required almost 700 years for Western Civilization to get back into gear again after the vacuum left by the decline of the Roman Empire – represented as the interregnum between the end of wave Z1 and the beginning of wave Z3 in about 1000 AD.

As a rough estimate, the Elliott count predicts a period of ranging from about 100 to perhaps as long as 200 years of declining economic activity before the nadir is reached and a new sustainable upswing begins. Most of us today have never experienced a true bear market and hardly remember even the best approximation of such a market we have had; namely that extended sideways drift from 1966 through to 1982 – from the time when the Dow Jones index first breached 1000 points until it finally could penetrate that barrier and begin the long, sustained bull market that has only now approached its peak.

During that mainly sideways trend there were four occasions of steep bear trends of which the worst was the 40%+ decline from 1972 to the end of 1974. Compare that 40%+ decline with the approximately 90% decline reached during the aftermath of the 1929 Crash, and the almost decade long Depression that followed, and it is clear the 40% bear market spread over not even two years is for Americans the best example of a down trending stock market in recent memory. Even during the better remembered events of October 1987 the overall decline on Wall Street was only about 35%+, and the bull market resumed its steeply rising trend after less than 4 months. Today, on any long term chart of the Dow Jones or S&P500, what happened in October 1987 and its aftermath appears as hardly a blip within the 1982-1999 bull market.

No wonder we cannot begin to imagine a bear market that just might last the better part of two centuries. Yet, as will be shown below, this grim outlook might not be all that farfetched if certain already established trends are carried through to what may well be a feasible scenario of events.

Even if this deeply gloomy future, strongly suggested by the Elliott analysis, does not materialize, there is some evidence to suggest that at least the next few decades may not present such smooth sailing as we would otherwise look forward to enjoy. And the effects of the potential trauma may last long enough to severely inhibit the circumstances our children and perhaps even their children will experience.

The following factors are discussed as potential causes or, at best, contributing factors to the situation foreseen in the Elliott analysis: the Y2K problem; the high level of debt, particularly in the USA; global instabilities; global warming and/or depleting oil reserves. These factors are listed in the order in which they can be expected to appear and have effect. It so happens that the order in which they were mentioned is also likely to reflect their duration and the degree to which they could contribute to an episode of the magnitude of an X-wave correction.

1. The Y2K problem.

Nobody really knows how severe the Y2K problem will be and how long its effects will be felt – or even if there really are going to be any significant effects into the Year 2000.

Expert opinion ranges from a smooth transition into the new ‘digital’ millenium – the true historical millenium will only commence in 2001 – with relatively minor and isolated hiccups of no great consequence, to severe interruption of world trade and other mishaps that are expected to trigger a long lasting depression. At one extreme of the anticipation spectrum, a large part of the general populace are either unaware of the potential risk or uncaring about what the year 2000 could bring, and thus completely unprepared if anything should go wrong. People at the other end of the spectrum are busy digging bunkers and assembling the food, water and armaments they perceive as necessary for survival in the utter chaos that could erupt due to computer glitches as we transition to the new millennium.

Perhaps the biggest real threat of Y2K is that it is going to take place at a critical moment for many markets. In the US and in Europe equity prices are near their all-time highs, which make markets sensitive to shocks. Price/earnings rations in the US are well above previous high levels attained during strong bull markets and thus imply that investors expect strong earnings growth during years to come. Elsewhere, markets are either in the process of regaining the confidence of investors following turbulence over the past 2 years, or they are resting on quite unstable foundations as the economies they reflect are subjected to all kinds of stresses and strains.

With the US market in the stratosphere on prospects of sustained growth, with most Asian economies barely settled on the path to recovery, and with Latin America and the old Iron Curtain countries hovering on the brink of major economic dislocations, the global economy can do without new shocks for the time being. To what degree Y2K could be such a shock is difficult to anticipate. It is not really necessary to speculate, though, as we will know soon enough.

2. Debt

On a global level debt has risen to levels not considered possible in earlier times.

We know that in Japan the banking system is even now in dire straits because of high levels of debt that initially were justified on the grounds of the wealth implicit in the high prices of equities on the Tokyo stock market as well as the extremely high valuations placed on real estate. During the 90’s the equity and real estate bubbles popped to devastate the Japanese financial system. Absurdly low interest rates have left Japanese citizens no other option than to save every Yen they can in order to provide for an increasingly uncertain future. With consumer spending contracting all the time to sustain the savings drive, the Japanese economy has entered a deflationary spiral that is yet to end.

The US has entered much the same kind of over-valued market environment, if perhaps not to the same degree as had been the case in Japan in the late 80’s. Property prices in many areas of the US have risen sharply in recent years. Exploiting the situation, many house-owners have substantially increased their mortgages, thereby obtaining funds to purchase durable goods and to invest on the stock market. At the same time, they have added substantially to the overall amount of debt.

As the value of household investments on Wall Street increased by leaps and bounds over the past 5 years, this rapidly growing private wealth provided collateral for further loans that helped to fuel spending on consumer goods – thus adding substantially to the trade deficit in the process – as well as releasing new funds that could be channeled back into Wall Street to keep the bull market roaring ahead.

In this way, the self-fulfilling prediction of sustained economic growth was good for Wall Street, while the strong equity market in turn provided the funds flow to keep consumer spending at a high level and thus keep the economy in high gear. This circle of events has now reached a degree of interactiveness that might make it impossible for the equity market to wind down gracefully.

If consumer spending is reduced, the current high PE ratios of the stocks will no longer be justified and equity prices would begin to fall. If prices decline, the collateral value of household investments decrease and the more highly leveraged people are compelled to sell to reduce their level of debt. By doing so they add supply to Wall Street, forcing prices even lower. Falling equity prices in turn reduces the amount of debt-funded consumer spending that can be afforded even further. Earnings forecasts turn pessimistic as consumer spending is no longer increasing as steeply as before and anticipated PE ratios rise further, putting more pressure on equity prices, causing these to dip further and even more people have to sell some of their holdings in order to reduce exposure to debt. Soon the market is spiraling downwards in a steepening and sustained bear trend.

Potential shocks that could trigger this chain of events range from actions based on Y2K fears, as mentioned above, to actual Y2K problems and the disruption of world trade. However, shocks could arise from an unexpected direction – good news. For example, if a sharp resurgence in Asian economies definitely gets under way, or when Latin American and other markets currently perceived as high risk return to equilibrium, such inherently good news could also be bad news for Wall Street.

Any one of these events could trigger an outflow of funds from the US into the promising new markets. This would reverse the “flight to a safe haven” of the past two years, which have substantially improved the liquidity of US markets and thus helped to make the above cycle of wealth creation and consumer spending possible. This inflow of funds also supported the US dollar and the strong dollar helped to keep these funds invested in the United States.

Even a partial withdrawal by foreigners from US market will put equity and bond prices under pressure, much as the reaction to a significant shock to the markets would do. As before, this would serve to reduce the amount of collateral borrowers can obtain from their stock holdings. Further selling becomes imperative and, as discussed earlier, events follow each other in a descending spiral that rapidly accelerates until prices plummet steeply in pure panic.

It could be argued that should the Federal Reserve supply liquidity to the market to offset any repatriation of funds by foreigners, this might later be viewed as having added even more explosive to an already volatile situation. The vacuum left by repatriation would have to be filled from domestic sources of funds, which implies a greater degree of investment on Wall Street by American residents. This medicine worked wonders in the aftermath of the July-September sell-off on Wall Street in the wake of the Russian crisis. At the time a large injection of liquidity by the Federal Reserve, coupled to multiple cuts in interest rates, was first reflected in extremely heavy turnover on Wall Street during September and into October as panicking sellers were met by optimistic buyers with pockets full of borrowed funds. The latter triumphed and the Dow gained almost 50% during the next few months. Whether this would work again at present elevated levels of consumer debt is difficult to judge.

One other factor to keep in mind is that if a deflationary spiral does begin in the US, the result will probably be deeper and more lasting than was the case for Japan and the other troubled Asian economies. They enjoyed the advantage of an “importer of last resort”, as the US economy remained voracious in its demand for imported goods, while their own economies languished. On the other hand, US manufacturers and exporters will not enjoy a similar advantage if they should experience severe problems at home.

A comparison with what has happened in Asia and elsewhere and using that example as a reason for saying the US should at least do as well as these countries have done over the past few years, might thus be too optimistic a view. A collapse of the US economy would have more severe global effects than what have been experienced so far, would affect the US itself to a greater degree than what has happened in other countries and thirdly, would last much longer before a recovery can begin than was the case in most other countries.

The events that would be unleashed on the world should this collapse come to pass will find a fertile breeding ground in the current international political arena and precipitate even more serious problems, as described below.

3. Nodes of instability.

After the Iron Curtain rusted through, it was widely believed that the world was now due to enter a period of stability and relief from the threat of nuclear war. Since then there has been military intervention in Iraq and recently in Kosovo – which, despite the apparent limited extent of these conflicts consumed military resources at a far greater rate than any previous conflict – and also many other skirmishes in out of the way places nobody pays any real attention to, probably because the media find it inconvenient to cover these adventures in such difficult to get to places.

More recently, however, new nodes of instability have flared up, mostly not for the first time. What has changed however is that in some cases the threats on both sides of these face-offs have escalated to a degree not experienced since the Cold War. India and Pakistan have fought wars over Kashmir ever since the partition in the late 1940’s in the wake of the British retreat from India.

However, now they are two nuclear powers who have recently engaged in a war in extremely difficult terrain where conventional warfare can only achieve limited success. For either of the two combatants the temptation to exploit the nuclear option could easily become irresistible.

North Korea is strongly suspected of also having become a nuclear power. Why else would they be on the brink of testing ballistic missiles with a range of thousands of kilometers? The expense of building and deploying such missiles in limited numbers makes no sense if they are armed with only conventional explosives. While relations with South Korea is still far from satisfactory, the North sits with internal problems of such severity that the classical antidote to the threat of an uprising might just seem attractive, namely to seek a casus belli and begin a war that would take people’s minds off their own problems and focus their attention on the ‘common enemy’.

Tensions between China and Taiwan have reached breaking point, with statements and misstatements from Taiwan threatening severance of the umbilical cord that, at least in the dreams of many Chinese, still bind the island to the mainland. Secession from “China” by the island nation is likely to be treated in much the same way the North reacted to a similar action by the Confederacy in the United States, more than 120 years ago. Then the result was the devastating American Civil War.

This is not the place to speculate about the ramifications of a Chinese attack on Taiwan – presumably in reaction to Taiwanese intentions to formalize what is already in effect, namely secession from mainland China. It seems more than likely, though, that countries that have signed treaties with Taiwan will have to intervene to a greater of lesser extent, with unknown consequences.

If a major disruption of global financial systems should occur, such as can result from events discussed above, there would clearly be a need for the Great Powers to salvage what they could and to use all available resources to contain the damage that is being done. This just possibly might be seen by one of the contestants in any of these potential theatres of war as an opportunity to take precipitate action, in the belief that once completed it will be seen as a fait accompli by the rest of a world too concerned about internal problems to get involved in some remote corner of the world, where the outcome will be uncertain at best.

Nevertheless, once such a step has been taken it will have repercussions elsewhere, triggering similar action from other parties in similar confrontational situations and spreading havoc on an increasing scale to involve many more peoples than the original combatants. As legends have it, once Pandora’s Box has been opened it is impossible to reverse the action or to avoid the consequences.

In the wings, too, is waiting another phenomenon that could also serve to disrupt the status quo and perhaps precipitate rash action from affected people, including the use of force to get hold of dwindling resources.

4. Global warming

Much has been written about global warming during the past decade or so. Initially, speculation about a trend that could have widespread and very grave consequences was made out as merely the nightmares of the doomsayers who crop up in every generation. When it became clear that there has been a definite trend since about 1980 for the average annual global temperature to keep rising, there initially was a rear guard action that tried to ascribe this trend to more complete coverage of the globe and the improved statistics this has made possible.

It is now clear that since 1980 the world has experienced the warmest 20 years since good global climate measurements first became available in about the 1860’s – and since 1990 the warmest 10 years over this period have occurred. Over the past 20 years the sustained increase in average global temperature has been so marked that it no longer can be wished away.

Proponents of the global warming hypothesis used to look at an increase in hothouse gasses as the cause of this phenomenon. They have modeled the biosphere extensively on super computers and these results indicate that warming is likely. However, so far the results tended to be ambiguous and very sensitive to the basic assumptions that are inserted in the models. More reliable evidence comes from historical data.

The study of an ice core extracted from the Antarctic polar cap and going back over 400,000 years has shown, firstly, that there is a good correlation between the concentration of hothouse gasses and global temperatures and, secondly, that the current concentration of these gasses are by far the highest within the span of the record contained in that ice core. If the relationship between the concentration of hothouse gasses and higher global temperature remain in place, a warmer global climate will become a reality.

At the moment the warming trend has become so marked that it outstrips the predictions of the computer models. Either the basic assumptions reflected in the models are way off or another factor has entered the equation. One explanation now being sought elsewhere has its origin outside the earth. Evidence was reported that suggests the sun has been ‘heating up’ for some time now, and that recent higher average temperatures are – at least in part – the result of absorption of the increased radiated energy by the earth.

While the sun is known to be approaching a more energetic phase, as evident from the increased incidence of sun spots, this warming of the sun would have to be abnormally conspicuous to influence temperatures within the terrestrial atmosphere to the degree that is being experienced. During previous peaks in the 11-year solar cycle, no similar marked effect was experienced.

If the evidence of solar warming is confirmed, two possibilities exist. Firstly, the heating up is associated with the solar 11-year cycle and should soon disappear again. In that case, the risk is that global weather patterns are changed substantially through the course of the next few warm years, with widespread and probably mostly harmful effects on many aspects of human life, including many crop failures.

The second possibility is that the increased temperature of the sun is not linked to the solar 11-year cycle, but is a different phenomenon of which there is one known example from the not too distant past. If so, this development could easily be the cause of the surprisingly long duration of the next X-wave correction that is anticipated from the Elliott count.

In the late 1600’s the sun decreased its level of radiation for a period of about 60 years. The effect of the cooler sun was a “little ice age”, during which, for example, the Thames in London froze solid for much of the winter – something that has not happened since then. If the rising energy output of the sun is a warning that we are now due to experience a period of similar duration of a substantially hotter sun, weather patterns can be expected to show changes of equal or even greater magnitude than 300 years ago.

Evidence from Antarctic ice cores shows another disturbing fact. At various times over the past 400 thousand years of intermittent glaciation there have been periods of sudden warming, with a gain of as much as 10 degrees centigrade in a matter of about 50 years or less. This by far outstrips the effect of hothouse gasses as modeled by supercomputers.

The cause of these events is not known, but a recurrence of those events might now be taking place, seeing that we have had 20 years of warmer temperatures and secondly that the process appears to be speeding up.

What the changes in global weather patterns will be and how they will affect the areas suitable for crop production and the yields obtained from them are very difficult to estimate. Yet, it can be expected that even slight reductions in crop yields will have an effect on an already over-populated earth. Just thinking of what will happen if drought and other changes in the global climate pattern severely reduce the production of food, even in isolated years, raises a nightmare all of its own.

5. Reduction in oil supplies.

During the 1970’s much was made of the coming oil crisis as available resources were depleted. Massive exploration succeeded in the discovery of a number of new oil fields and suddenly the picture looked promising well into the 21^st century. These successes have dulled any remaining pessimism to the extent that few people are now really concerned about the possibility of oil running out. If exploration should discover no new fields and oil should become scarce, it will happen long after most people living today are dead. It is a problem for future generations, not for the decision-makers of today.

Yet, in seeking a possible cause or factors that could contribute to the extended decline in economic activity predicated in the long wave Elliott model, the depletion of oil reserves has to be considered. It might not have immediate effect, but could kick in much later after early and temporary shocks have already set the stage for what is to follow. For example, the episode anticipated in the Elliott model could begin with a collapse in the US equity market with or without a real Y2K global crisis. Such events would trigger a lasting depression, which would be exacerbated by any reductions in food production as a result of changed weather patterns.

If oil supplies begin to dwindle during or even subsequent to these developments, the extent and duration of the depression would be magnified. The automobile market and the private transport system are likely to feel the effects early on as oil and oil derivatives become scarce and ever more expensive. Nuclear energy could in time fill the void left in the production of electricity by the reduction of oil supplies, but the lead time to provide nuclear generated electricity is long – the more so now that the building of new nuclear power stations has been politically unacceptable in many countries for so many years. However, apart from transportation and the generation of electricity there are many other uses of fossil fuels in a developed economy where it would be less easy to find substitutes.

For example, without a ready supply of oil or natural gas much of the chemical industry would grind to a halt or have to find substantially more expensive alternatives. Coal could fill this void, but at substantial inconvenience and cost to industry.

While even less quantifiable and immediate than the currently observable rising pattern in global temperature, it is true that oil reserves are finite and will one day run out if current consumption continues. Depletion of oil reserves therefore has to be considered as one of the likely contributing factors in the search for reasons to explain what the Elliot long wave analysis anticipates for the next 100 years and more.

6. Global warming and the use of fossil fuels

As mentioned earlier, indications from annual global temperatures are that some degree of warming is already under way.

Despite uncertainty of exactly what its effects on the weather are likely to be, one thing is certain. If it should happen that the incidence of cyclones and hurricanes, extreme heat waves or extended and extreme freezing spells, either drought or a superabundance of rain, on a global scale increase to where people’s lives are disrupted or threatened and where the effect on food production begins to pose a threat to personal survival, people will react as they have always done in the past in similar circumstances.

We have experienced such scares as the Tylenol sabotage in the US, the reaction to the fear of salmonella eggs in Britain and development of the BSE panic in Europe and in Britain, and others. It is clear that when people become suitably apprehensive about their own safety, they tend to behave in near irrational fashion to neutralize the threat.

And always there are some politicians with an eye on the main chance who stand ready to fan and then to exploit these fears.

If the effects of global warming should begin to assume major proportions, with indications that the situation could get a lot worse before it gets better, the search will be on for a scapegoat to carry the blame and to offer a solution to the problem – which will not be too difficult to find!

Media exposure over the years has established in the public mind a direct link between the burning of fossil fuels and global warming, through its release of hothouse gases. In this scheme of things, the use of the internal combustion engine has been given place of prominence. Since political pressure has caused the end of expansion in nuclear power generation, fossil fuels have increasingly been used to generate electricity.

If conditions should deteriorate to where enough people become scared enough, there will be a rush among politicians to be the first on the bandwagon to push for sharp and punishing reductions in the use of fossil fuels in transportation and, when this provides no instant solution to the problem, for the generation of electricity too. In due course, many other factors that can add to the hothouse effect will also be included in what could become a total ban on activities we today take for granted and consider essential to a civilized life.

As the situation becomes more critical, most probably because on occasion food is in very short supply, the level of panic will rise to where measures instituted to limit or turn around the rise in global temperatures will cut deeply into the level of economic activity of all industrialized countries. And the crowds are likely to cheer whenever a smokestack ceases to exhale black smoke, even though it means the factory goes silent and people lose their jobs.

If a crisis of this nature should develop, it will require decades to scale down suspect activities and even more decades to get the economy into gear again.

If the use of fossil fuels for the generation of electricity is banned, or even just sharply reduced, there is no alternative source of energy ready to take over. Even if nuclear energy gets the green light again, it would take decades from the time the go-ahead is given before the whole process from site selection, design and construction is completed to where power is downloaded into the electricity grid.

The use of the automobile might suddenly be seen as a lot worse than smoking cigarettes, because the perceived effects of vehicle emissions will not be viewed as requiring years to make themselves felt; the effects will be current, visibly with us right then. The fact that what is being experienced happens to be the accumulated effects of many decades of high industrial and other activity will be disregarded in the public mind; only one matter will be relevant, and that is to eradicate the source of the problem, hothouse gases.

While in this scenario oil supplies do not run out, strict curbs on the use of petroleum products may have much the same effect.

Again, this scenario is not presented as a prediction, but as a plausible development should global warming begin to affect food production in particular, and weather patterns in general, to a degree that presents a threat to life and property. As with oil reserves, this scenario does not so much apply to the immediate future, but these considerations could play a significant role in extending any near term reduction in economic activity over the much longer time horizon implied by the Elliott long wave analysis.

7. Conclusions

It bears repetition to state that while the above factors can potentially contribute to the kind of future that emerges from the Elliott long wave analysis, the discussion is not a detailed prediction of what will happen, nor does it provide an exhaustive list of possible reasons why the substantial correction implied by that model should come to pass.

Please observe that the events postulated here are in the domain of the real world – they either have a significant probability of occurrence, or conceivably could even already be beginning to affect our lives. We have avoided other possible causes of global doom and gloom favored by some of the more extreme doomsayers and catastrophe prophets.

We began this Appendix with the question whether there exists any reason or reasons that might cause an extended (more than just a few decades) correction in the upward curve of civilization as predicated by the Elliott model. This objective has been served. There is indeed a range of factors that could contribute to a substantial period of depression and worse.

The situation is not clear-cut. Opinions on what may or may not happen will be divided and different people will assign widely divergent probabilities to the occurrence of these events. Further, while some of these developments, particularly those anticipated to take effect over the near term, will almost surely take place, it is uncertain to what degree they will disrupt normal day to day life and economic activities.

This list of events and developments that could conceivably bring about the full extent of the anticipated corrective wave is not exhaustive. However, should history later show that the third millenium started off with exactly the extended corrective X-wave anticipated by the Elliott long wave model, then one fact is clear: one or more of the events described above will be in place shortly after the beginning of the third millenium.

Part 6 is an appendix containing an introduction to Elliott Wave Theory.