Do Not Believe American Economists
They Haven't Got a Clue About the Economy
by Robert B. Gordon, Sc. D.
September 7, 2004

I have no special reason to jump on one of our learned professions except they have been so hide-bound, narrow minded and conceited as to make a colossal mistake in (a) predicting a mild recession in 2001 and a slow recovery in 2003 and (b) totally missing the fact that we are moving slowly and steadily and helplessly into our Second Great Depression in less than 80 years. And, Horror of Horrors, this is happening despite the fact that this once distinguished profession has been telling our country and its leaders for decades that another Depression was impossible with their current bag of tools to prevent it. The very sad reality is that they have no tools to prevent it, they have no tools to predict it is coming, and once here, they have no golden wand to sweep it away.

The Economics profession is so infatuated with its own techniques and group of Nobel laureate experts that they have literally made no progress since Yale's famous economics professor Irving Fisher made his great prediction of an unending period of prosperity just before the 1929 market crash and its ensuing Depression 1.

My growing unhappiness with the economics profession in this country has been building ever since my reading of Robert Prechter’s earth shaking book At the Crest of the Tidal Wave published in 1995. From the apparent lack of any outcry from our economics profession at its revolutionary vision of market crashes and depressions, one must assume that every senior economist in the U.S. was busily writing a paper for submission to the Noble prize committee. I wonder if its title might have been "How we ended Crashes and Depressions in the USA."

RALPH NELSON ELLIOTT - GREAT AMERICAN

One of the truly great original discoveries by a citizen of this country was a retired accountant’s discovery of a set of natural laws that govern stock market waves. He did this by visual inspection of many stock charts over a fairly brief period of years. He discovered a series of about 30 rules to describe the chart characteristics, which have been increased somewhat by subsequent investigators. Robert Prechter and associate authors have published the recognized standards for the modern Elliott Wave Theory, which are now used around the world since the rules apply to all types of securities at all time levels from seconds to centuries.

Elliott’s followers have traced the 20th century stock charts back to London in 1700, which now makes it possible to provide 3 centuries of continuous stock waves following the rules laid down by Elliott. These waves bring some very interesting conclusions of where we are now and where our stock market is going in the century ahead. It is not very encouraging as we will see in the summary that follows.

THREE CENTURIES OF ELLIOTT WAVES

Some talented successors to Ralph Elliott have painstakingly carried the long wave formations back to the start of American stock prices in 1785 and then, using British stock prices, have gone back to the early 1700s with great success. So we now know that the huge stock mania in London between 1720 and 1722, known as the South Sea Bubble, was the starting Wave I of a Grand Supercycle whose Wave 3 ended at the 2000 market top in this country and Europe. Bearish Wave 2 in London lasted 62 years from 1722 to 1784 and Wave 3, usually the longest of the 5 waves, lasted from 1684 to 2000. We are now just starting into a long wave IV that may possibly last about 62 years, or equal to the length of Wave 2, since this relationship is often seen in waves 2 and 4 at lower wave levels.

Since the 1929 Crash was at the lower Supercycle level, there is every reason to expect this crash starting in 2000 to be deeper and longer than that of 1929. It has already been longer and in the years to come should prove to be deeper as well. In fact, Robert Prechter has predicted that Grand Supercycle Wave 4, now underway, should eventually go below Dow 400 based on the patterns followed by all other major crashes. For instance, in 1929 the Dow started at 100, peaked at almost 400 and fell to 32 at the low. This means that many investors will be greatly shocked at the Dow level when it bottoms many years from now.

A FORECAST FOR THE GREAT BEAR MARKET

According to the rules discovered by Elliott and completed by other workers, it is quite common for Waves 2 and 4 in the same 5 wave sequence to have a similar structure. This fact, though not a law or occurring every time, can be quite helpful. Historic study of the 62 year Wave 2 from 1722 to 1784 showed that it consisted of a number of large waves forming a horizontal parallel pattern. If the current Wave 4 were to follow this pattern over its expected long life, it would confuse nearly every market technician not conversant with Elliott Waves. But, you can be sure that the Elliotticians will be looking for it and make the most of the advantage given by that knowledge.

Although Elliott’s great pioneering work is still recognized and used by only a small number of market "experts," perhaps its use will spread in coming decades. However, I believe that its rules are too many and the interpretations are too complex for laymen to use. I chose at the very start not to become an expert analyst, but to use the interpretations of experts as my guide. This has worked out very well and I recommend it to others.

A BRILLIANT CHILEAN ECONOMIST WRITES ON ELLIOTT

What Macroeconomists Don't Know by Hernán Cortés Douglas,
Professor of Economics, Catholic University of Chile , September 12, 2003
(reprint of published work January 24, 2002)

"History does not repeat itself...but it rhymes —Mark Twain

"This expansion will run forever." Not two years, or three, or ten. Forever. That was how an MIT Professor of Economics summarized his vision of the U.S. economic expansion in the July 30th, 1998 issue of the Wall Street Journal. Nowadays his assertion appears extreme. It did not then. This exuberance was rationalized by the obvious fact this was a New Economy with no room for recessions. Dornbusch himself said the American economy would "not see a recession for years to come." Mmmm, why? Because, Dornbusch again, "We don't want one, we don't need one, and, as we have the tools to keep the current expansion going, we won't have one." "We," apparently, are the macroeconomists. More Dornbusch: "Only natural causes, and not the Fed, can bring the economy to a standstill. Fortunately, we have the monetary and fiscal resources to keep that from happening, as well as a policy team that won't hesitate to use them for continued expansion."

In the latter part of the 1990s, euphoria was rampant and not only in the States. "It is hard to imagine any article with worse timing than, say, 'Asia's Bright Future,' by Harvard Professors Steven Radelet & Jeffrey Sachs, writing in the November/December 1997 issue of Foreign Affairs." So J. Orlin Grabbe told us. Their article was published at the precise moment East Asian financial markets and economies were deepening their collapses. As Grabbe put it: "Of course Asia probably does have a bright future, much as Europe could have been said to have had a bright future during the Black Death years of the 14th Century."[1]

It is one thing to say crises are undesirable, but another to say macroeconomists are, firstly, so skilled at forecasting they can predict trend breaks to the downside; and secondly, they have the tools and the policy teams to avoid economic and financial crises. If this were so, why do they utterly fail over and over again at forecasting economic downturns? Why do they have to adjust their projections over and over in times of trend change? Why has Japan stagnated for 11 years and had three recessions during that time?

The dismal record of forecasting crashes and recessions we economists have is not new. The crash of 1929 and the Great Depression came as an unexpected avalanche to economists, particularly those in the hall of fame. Fourteen days before Wall Street crashed on Black Tuesday, October 29, 1929, Irving Fisher, America's most famous economist, Professor of Economics at Yale University, said: "In a few months I expect to see the stock market much higher than today."

Days after the crash, the Harvard Economic Society informed its subscribers: "A severe depression such as 1920-21 is outside the range of probability. We are not facing a protracted liquidation." After continuously issuing erroneously optimistic forecasts, the Society closed its doors in 1932. The two most renowned economic forecasting institutes in America at the time failed to understand that a crash and depression were forthcoming, and continued their optimism even as the Great Depression swept over America.

Irving Fisher lost 140 million U.S. dollars[2] in the stock market crash. Fisher was a man of many talents, a great economist, excellent theoretician, one of the founders of econometrics and pioneer in index number analysis. He was also the inventor of the c-kardex file system which he sold to Remington Rand for millions, which he subsequently lost in the crash. John Maynard Keynes, the most famous British economist and the father of macroeconomics, who made fortunes in the financial markets for himself and Cambridge University, lost one million English pounds[3] in the crash. With two exceptions, no academic economists forecasted the crash of 1929 and the following depression.

Seven decades have gone by. Surely we must know more today? In 1988, sixty years after the crash and the depression, Kathryn Domínguez, Ray Fair and Matthew Shapiro concluded in the American Economic Review, the leading journal of the American Economic Association, that employing sophisticated econometric techniques of the late nineteen-eighties and even using data unavailable in 1929, the Great Depression could not have been forecasted.

In October 2000, sixty economists gathered at the Minneapolis Fed to present papers and discuss the Great Depression of the 1930s. The cream of the macroeconomic profession was present: Nobel prize-winner Robert Lucas, Ed Prescott, Tom Sargent, Ben Bernanke, Finn Kydland, Nancy Stokey, Kevin Murphy and many others. The gist of the conclusions may be found in the headline that the Minneapolis Fed's review, The Region, used for the conference's article: "Something Unanticipated Happened." "In his summary remarks at the close of the conference, Robert Lucas made a pitch for the continuing investigation of macro fundamentals. . . . 'We should continue to seek common factors,' he said, and offered monetary instability as one area for further exploration. Big deflations are related to depressions, he said, and everywhere in the 1930s there was deflation."[4]'

The concluding paragraph of the article states: "In the end, if the Great Depression is, indeed, a story, it has all the trappings of a mystery that is loaded with suspects and difficult to solve, even when we know the ending; the kind we read again and again, and each time come up with another explanation. At least for now." [5] Economists, especially since 1936, and as Bob Lucas' quote reveals, look at macroeconomic fundamentals. Yet history teaches us no financial collapse has ever happened when things look bad. On the contrary, macroeconomic flows look good before crashes. Before every collapse, economists find the economy in excellent shape. In a major boom, the economy is a "New Economy." As President Hoover tells us in his Memoirs about the period preceding the Great Depression: "With increasing optimism, they gave birth to a silly idea called the New Economic Era. This notion spread all over the country. We were assured we were in a new era where the old laws of economics no longer applied."[6] Too familiar, perhaps.

In these new eras, everything looks rosy, stock markets go up and up, and macroeconomic flows (output, employment, etc.) appear to be improving. Macroeconomic fundamentals, however, tell us about the past, and the good times are invariably extrapolated linearly into the future.

Friedrich von Hayek, 1974 Nobel Laureate, was the only academic economist who wrote prior to the Great Depression that a crisis and downturn in America were imminent. Interest rates in the world would not fall, he wrote, until the American boom collapsed. And "the boom will collapse within the next few months." This prediction, printed in the Austrian Institute of Economic Research Report February, 1929, generated interest in Austrian economics and Hayek was offered a Professorship at the London School of Economics in the early 1930s.

Ludwig von Mises, also an Austrian, anticipated a worldwide depression in the 1930s, as reported by Fritz Machlup, Mises' assistant at the time. Mises' wife Margit wrote in her husband's biography that in the summer of 1929 he had rejected a high position in Kredit Anstalt, one of the largest banks in Europe at the time. His explanation was "a great crash is coming and I do not want my name in any way connected with it." Less than two years later, Kredit Anstalt was bankrupt.

Did rational economists adopt the economics of Hayek and Mises? Alas no, they adopted the economics of Keynes.[7]

But Hayek and Mises were exceptions. Not only did economists fail to forecast the Great Depression of the 1930s, but they have also failed to forecast economic contractions in general. The present contraction (in 2001) is only the latest example. "Economists have a dismal record in predicting recession" is the subtitle of an article in the November 29th, 2001, issue of The Economist. Why is this so? What is it that economists do not know? Or what truths did they once know—ones since forgotten or neglected?"

RBG Note:
Please read this great writer’s words again. Imagine the temerity of our leading economists in 1929, claiming powers over the economy they did not possess either then or now. This brilliant paper goes on to tell the author’s fellow economists the details of the Elliott Wave Theory, but there is no evidence that any of them have read it. It was originally published in the New Scientist and made no observable stir.  So, about a year ago, I received the author's permission to republish it in FSO or any other publication. It is written for economists using their language. It is very unfortunate that they are not reading his brilliant words. I can only hope that some Economist will read this paper and open the door to a new wave of knowledge among his fellows.

The rest of Prof. Douglas’ paper is couched in economics language, but has an important message for all readers. Read the full text of this brilliant paper. It will give you a great understanding of what Elliott’s remarkable work will do and cannot do.

THE TRAGEDY OF IGNORANCE

I have been telling this extremely sad story for at least two years. Just think about the serious problem in our country. Our leaders in Washington are being advised on economics by truly blind people. They haven’t a clue on what is now going on in the economy and have been truly blind to the Elliott Wave break thru for more than 70 years. As a result, we have suffered a second great stock market crash with no warning or corrective action. Alan Greenspan thought he detected some "irrational exuberance" in 1996, but he quickly discarded the thought and became a supporter of the "perpetual growth" theory in the "new" economy. Even his words resemble those of Irving Fisher in 1929.

I am not saying that our stock market crash and its following depression could have been avoided. But economists following the Elliott Wave theory might have alleviated some of the excesses in the stock market mania leading up to the Crash. Perhaps our economists will do a little better in the future, but I am not too optimistic. Their big problem is they seem to write and talk only to each other and that habit may be too hard to break. Hopefully, perhaps some other way may be found to bring Elliott’s great work into the leadership ranks of our nation.

THE ECONOMY

Attention all readers. The current down leg in the bear market is just getting started and has a long way to go. If you haven’t safeguarded your portfolio, please do it now before more losses are accumulated. The first major bottom may be at least two years away. And that will be just the first of several market bottoms. This is not a time to listen to the optimists who are constantly proclaiming a new bull market. Failure to heed this warning may cause you to lose most of your hard earned capital.

© 2004 Robert B. Gordon, Sc. D.
Sun City West, Arizona
September 7, 2004
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Footnotes from Prof. Douglas' essay,
"Forecasting Crashes and Recessions - What Macroeconomists Don't Know" Complete Essay

[1] J. Orlin Grabbe, "And Now, the Financial Apocalypse", orlingrabbe.com/Apocalyp.htm.
[2] Calculated by the author on the basis of nominal figures provided by Irving Fisher´s biographer son, Irving Norton Fisher.
[3] Figures provided by Keynes´ biographer Professor Skidelski.
[4] "Something Unanticipated Happened", The Region, Minneapolis Fed, December 2000.
[5] Ibid.
[6] As I have lost the English text, and translated back into English from Spanish, some words may be different in the original.
[7] They did not however pay attention to key insights contained in Chapter 12 of Keynes' The General Theory.