Copyright © 2010 by Norman P. Poire. All rights reserved.

By Norman P. Poiré

Introduction

This essay will document a cycle of financial bubbles in Western economies going back to the Tulipmania of the 17th century. It will be shown that this 84-year cycle is but one of a number of synchronous cycles that includes a 42-year Birth Cycle, an 84-year Generation Wave, and three cycles lasting 168 years each: the Discovery Cycle, the cycle of musical movements, and the cycle of Great Power births.

It is hypothesized here that the 42-year Birth Cycle underlies the 84-year Generation Wave, which is a constellation of four generations. Every constellation of generations experiences one financial bubble followed by one bubble related economic depression. Apparently this painful lesson is all that society needs to refrain from making the same errors more than once in any lifetime. Unfortunately, the constellation of generations that follows ignores the lessons learned and instead eagerly commits a similar folly of its own making.

The 168-year Rhythm of Discovery

When Homo sapiens first appeared on Earth some 4000 centuries ago they made mastery over fire their life's work. Harnessing this powerful energy source was a vital first step on the road to civilization that would provide warmth in cold, lighting at night, better tools and weapons for building and hunting, safer and more palatable food. It took more than 65,000 cold, dark years for these hominids to develop the competence to create fire at will, but by doing so they achieved the first meaningful separation between themselves and the other species on Earth.

If the entire timeline of Homo sapiens' existence were condensed into a single day beginning at 12 o'clock midnight, we would find that dexterity with fire was achieved by 4:00 a.m. It was not until around 8:00 a.m. that humans would dispense with grunts and manual gestures in favor of verbal communication, freeing their hands so that demonstrating could be accomplished simultaneously with explaining. The next fourteen hours were spent improving shelter construction, domesticating plants and animals, and developing the arts of painting and instrumental music.

At 11:32 p.m. mastery over copper provided humans with tools and weapons far more sophisticated than their non-metallic predecessors. Yet copper is a soft metal with little strength so earthen instruments continued to play a significant role in the Homo sapiens culture. When primitive writing first appeared in ancient Mesopotamia around 11:40 p.m., recorded history was born and the pace of technology accelerated. For better or for worse, permanent records gave human beings the ability to build upon the work of their predecessors in a way they never had before. And build they did.

After innovators in the Near East discovered that adding tin drastically improved copper's utility, the Bronze Age elbowed stone and bone into obscurity. Before long plows, potter's wheels, and horse-drawn wheeled carts speckled the landscape. At 11:47 p.m. the ancient Hittites of eastern Asia introduced the world to the benefits of iron, laying the groundwork for the fabulous cultures of Hellenic Greece and Rome.

In the last 2 1/2 minutes before the clock struck midnight, technology began moving at supersonic speed. In that compact span human beings mastered the oceans, conquered the art of printing, unlocked the secrets of the solar system, harnessed the power of steam, electricity, and the atom, traveled beyond Earth's atmosphere, introduced intelligent machines, and learned how to reproduce without sex.

While technology was accelerating at mind-bending speed, however, the capacity for society to adjust to world-altering technological innovations -- what I refer to as revolutionary inventions -- remained relatively unchanged over time. What distinguishes revolutionary inventions from all other inventions is their capacity for igniting technology revolutions that take on lives of their own and steer society in completely unexpected directions. Recent examples include the Maritime Revolution in 1275, the Knowledge Revolution in 1440, the Scientific Revolution in 1608, the Industrial Revolution in 1769, and the Digital Revolution in 1939.

The revolutionary invention that triggered the Maritime Revolution was the modern magnetic compass, which appeared late in the thirteenth century. In his book The Riddle of the Compass: The Invention that Changed the World, author Amir D. Aczel describes the compass as "the most important technological invention since the wheel" because it "opened up the world to maritime exploration." Eight generations later, the Knowledge Revolution replaced the Maritime Revolution after Johannes Gutenberg invented the first printing press that used a metallic movable type.

Galileo Galilei, upon fashioning his astronomer's telescope in 1609, ushered in the Scientific Revolution and inadvertently changed forever the relationship between science and religion. The Industrial Revolution arrived shortly thereafter when James Watt unveiled his much-improved steam engine in 1769. By 1939 a fifth technological revolution had begun. In that year, Professor John Atanasoff with assistance from graduate student Clifford Berry invented the electronic digital computer and, unwittingly with it, the Digital Revolution.

The number of years separating each of these revolutionary inventions are, in order, 165, 168, 161, and 170 years -- a remarkably tight band and evidence of a cycle with an extraordinarily regular periodicity. That cycle is displayed in Chart 1 as a 168-year Discovery Cycle. Situated at the top of the cycle are the revolutionary inventions. At the bottom of the cycle are the paradigm shifts which provide the spark for the development of subsequent revolutionary inventions.

Chart 1. 168-year Discovery Cycle

For example, the Arabic philosopher Averroes who published between 1169 and 1195 a series of commentaries on the works of Aristotle and Plato introduced the Two Truths Theory. His writings had a major impact on Europe where at the time the population believed in the teachings of St. Augustine who had laid out centuries earlier the accepted view that the City of God was separate from the City of Man and, in fact, superior to it.

When Averroe's work made its way into Europe, it was apparent through his writings that Aristotle did not accept the Augustinian view. Indeed, Hellenic Greece's most respected philosopher and scientist was shown to be more interested in the mundane aspects of life than he was in theology. This gave Western Europeans the impetus to move beyond the spiritual realm and explore the material world, eventually leading to the invention of the magnetic compass which triggered the Maritime Revolution.

Likewise, the Italian Renaissance engineered a revival of learning in Western Europe that demanded the invention of the printing press to remedy a scarcity of books; the theory that the Earth orbited around the sun and not the other way around cried out for an astronomer's telescope to test the Copernican model; and Newton's new science showed us that the world no longer needed to rely on human and animal sweat for survival and the steam engine was the first invention that bore this out.

And finally, Darwin's theory of evolution got scientists to thinking about those aspects of the world that moved too slow, too fast, or were too small to be detected by the human senses. Evolutionary science (too slow) led to theories like Einstein's relativity (too fast) and Bohr's quantum mechanics (too small) -- new sciences that relied on complex and time-consuming mathematics. The electronic digital computer was just the machine needed to keep pace with the scientific community's expanding array of differential equations.

Chart 2 summarizes the paradigm shifts, revolutionary inventions, and related technology revolutions in tabular form. Included in the table are two additional cycles that run in tandem with the 168-year Discovery Cycle. One is a cycle of musical movements with the years assigned to the beginning of each movement coming from Theodore Karp's Dictionary of Music. [1] On average each musical movement precedes the genesis of its respective technology revolution by fifteen years. The final entry, African-American music, represents the shift in Western center of culture from Europe to the United States when mainstream jazz was all the rage in the 1920s.

Chart 2. Other 168-year Cycles that Move in Synchrony

The second addition is a cycle of Great Power births which trail the start of technology revolutions by two years on average. The year chosen for the birth of the Habsburg Empire, 1273, is when Rudolf I from the Swiss house of Habsburg seized power over a loose federation of German principalities. The rise of France began during the Hundred Year's War when Joan of Arc convinced Charles VII to liberate the French territories from English rule, reclaiming the traditional capital city of Paris in 1437.

Great Britain was born in 1604 when England, Ireland, and Scotland were merged under King James VI of Scotland, a member of the Stuart family, who declared himself King James I of Great Britain, the first monarch ever to embrace that title. The U.S. became an independent federation in 1776 when Thomas Jefferson penned the Declaration of Independence. And finally, the European Union traces its origins to the European Coal and Steel Community formed among six countries in 1951 (France, West Germany, Italy, Belgium, Luxembourg and the Netherlands).

The 84-year Rhythm of Sex

The Discovery Cycle is comprised of two pivotal events -- a paradigm shift at the trough followed by a revolutionary invention at the peak. That eighty-four years separate paradigm shifts from revolutionary inventions is significant because that time span matches the period of another social cycle that was uncovered by two academic researchers, William Strauss and Neil Howe. In their acclaimed best seller Generations: The History of America's Future 1584 to 2069, these two authors were able to organize more than four centuries of U.S. history into a repeating succession of four generations.

According to Strauss and Howe, the idealist generation is a somewhat self-indulgent group that rebels against the status quo and lights off a process of social change. The hard-edged and realistic reactives act as a counter-balance to keep their idealistic parents from 'throwing the baby out with the bath water'. While civics are in their youth, society becomes involved in culture wars that eventually lead to a period of crisis.

The crisis is met head on by civics in young adulthood who do the water carrying, by middle-aged reactives who make the tough decisions, and by elderly idealists who provide moral guidance. Together they resolve the crisis and erect a new social order of which the adaptives eventually become the caretakers. So thoroughly convinced of the merits of the new construct are this final cohort that they fail to acknowledge its weaker elements, thereby planting the seeds for a new wave of idealists.

In the period lasting from 1674 to 1981, Strauss & Howe identify fourteen generations, for a per generation average of twenty-one years. The time it would take to move through the entire sequence of four generations, then, would be eighty-four years -- the same amount of time it takes the Discovery cycle to move from trough to peak (i.e., half of a cycle period). A strong case could be made, then, that this cycle of generations, what I refer to as the Generation Wave, is at the root of the Discovery Cycle.

Evidence suggests that the driving force behind the Generation Wave is the cyclical ebb and flow in the U.S. birth rate. This Birth Cycle is presented in Chart 3 and although the available data only traces back to 1909, it hints at a cycle that requires about four decades to complete. Because two of these cycles combined are of the same time length as a single constellation of four generations, it may well be that a cause-effect relationship exists between the Generation Wave and the Birth Cycle.

Chart 3. U.S. Birth Cycle

Data source: Historical Statistics of the United States, infoplease.com

Further substantiating evidence of this hypothesis can be found in the way Strauss & Howe group the four cohorts. They classify idealist and civic generations as being dominant while the intervening reactive and adaptive generations are recessive. The most recent idealist generation is the familiar Baby Boom generation. According to Generations the Boomers were born between 1943 and 1960. The other dominant generation, the civics, started to appear around 1982 and continued to multiply until about 2000. The recessive adaptive and reactive generations were born over the years 1925 to 1942 and 1961 to 1981, respectively.

In Chart 4, these four generations are overlaid on the Birth Cycle chart. The picture that emerges is that the dominant idealist and civic generations formed as the Birth Cycle was approaching its peak, while the recessive generations were born when the Birth Cycle was into its trough periods. The conclusion I draw is that for the twenty-one years the birth rate is near its peak, the larger and growing numbers of births produce a dominant generation. Likewise, as the birth rate slumps for another 21-year period, the smaller and tapering numbers render a recessive generation.

Chart 4. The Generation Wave Tracks the Birth Cycle

It is very telling that the five most defining episodes in the formation of the United States appear every eighty-four years on average. These are the founding of the Jamestown colony in 1607, the Glorious Revolution of 1689, the War for Independence in 1775, the Civil War in 1861, and World War II in 1941. Add 84 years to 1941 and you can be assured that the 2020s are certain to be dynamic. A comparison between these formative dates and the turn dates of the Discovery Cycle (see Chart 1) is also quite revealing. In order, the time separating these two phenomena is two years (1609, 1607), two years (1687, 1689), six years (1769, 1775), two years (1859, 1861), and two years (1939, 1941) -- a remarkable correlation.

To summarize the interaction of the various social cycles identified to this point, a 42-year Birth Cycle spins off a four-generation sequence known as the Generation Wave that takes eighty-four years to complete. A crisis and social change occurs every eighty-four years on average in the United States in synchrony with the Generation Wave. Two Generation Waves placed side-by-side covers 168 years, the same time it takes to complete a single period of the Discovery Cycle. One constellation of four generations develops a paradigm shift while the following one constructs a revolutionary invention.

The 84-year Rhythm of Bubbles

In 1637 Netherlands, anyone with a sizeable amount of money to spend was confronted with an unusual dilemma. The cherished prize of a comfortable home nestled against one of Amsterdam's canals suddenly commanded no more value in the market than a single tulip bulb. It was not that housing prices were in decline, but rather that tulip bulbs were growing in price, seemingly without end. During normal times, agonizing over the choice between a flower and an attractive piece of real estate would have been ludicrous. But these were not normal times.

The price of tulip bulbs was escalating so rapidly that an important part of the calculus had to be how many houses would a tulip be worth next year? For many Dutch consumers in 1637, the answer was simple: tulip prices could only move in one direction and that was up. Just one year later, however, the picture looked entirely different after the market for exotic tulips evaporated and bulbs traded for no more than what a lowly onion could muster.

When prices were at their peak everyone in Holland wanted as many as they could get their greedy hands on. Now that prices were thousands of times lower, tulips were the last place folks wanted to spend their hard-earned money. The story of the Tulipmania is one of the more curious sagas in Western financial history.

Tulips were relatively recent additions to the Netherlands, having been introduced there by Conrad Gesner in 1559. They were completely different from any flowers the local people had ever seen, with colors more intense and more concentrated than ordinary plants. The Dutch fell in love with them, though their scarcity made them too expensive for all but the very rich. That, naturally, added to the allure and before long the tulip became a symbol of social rank.

Carolus Clusius planted the first tulip bulbs in the Botanical Gardens of Leiden, Netherlands in 1593 and others soon followed. Although supply was increasing it could not keep pace with the slow but steady increase in demand. As with any scarce product, sellers were marking prices well above costs. Then sometime in the middle 1620s word got around about the handsome profits tulip dealers were enjoying and speculators began piling into the market, increasing demand yet further.

With tulip bulbs now the focal point of conversation, no sophisticated buyer did so simply to own them. They could sense that gamblers had displaced collectors and that prices now outstripped rational expectations. Tulip trading was evolving into a guessing game -- who would be left holding the bag when the merry-go-round stopped? Then suddenly, at a routine bulb auction in Haarlem, the greater fool failed to show. In just a matter of days panic spread across the country and existing contracts everywhere fell into default. The market for tulips simply vanished into thin air.

According to Charles Mackay's account in his book Extraordinary Popular Delusions and the Madness of Crowds, "Those who were unlucky enough to have had stores of tulips on hand at the time of the sudden reaction were left to bear their ruin philosophically as they could; those who had made profits were allowed to keep them; but the commerce of the country suffered a severe shock, from which it was many years ere it recovered."

As the bubble in tulip bulbs collapsed, investors who still had substantial funds were undeterred by the turn of events and redirected their animal spirits into yet other markets. Shares in the Amsterdam Chamber of the Dutch East India Company more than doubled from 1636 to 1640 at the same time that investors poured money into canal building. As is often the case even today, real estate is seen as a safe haven when financial manias implode into panic, and an 'echo bubble' in real estate escalated precisely at the time that the Tulipmania collapsed.

Anyone reading about this historical episode for the first time might be tempted to conclude that the Dutch are quite the odd lot. But that would be a mistake. Financial bubbles are not exclusive to the Netherlands -- nor are they entirely random events. Since the sixteenth century such episodes of irrational exuberance have erupted in the Western world at intervals so regular that every person who survived a full lifetime experienced at least one of them.

Manias and their subsequent panics are so periodic, in fact, that they align surprisingly well with technology revolutions. As Chart 5 illustrates, two financial bubbles are associated with the Scientific Revolution, Tulipmania being the first followed four generations later by the South Sea bubble. These were followed to date by three financial bubbles in Europe and the U.S., two falling within the Industrial Revolution in 1835 and 1929. The third financial bubble represents the first one of the current Digital Revolution with a second one likely to appear near the end of the 21st century.

Chart 5. Two Financial Bubbles for Each Technology Revolutions

The financial bubbles of the 19th and 20th century can be readily observed in a chart of stock market prices if two simple adjustments are made to the data. The unadjusted index I begin with is a composite average that covers over two centuries of market data (Standard & Poor's popular S&P 500 index from 1918 to 2005, Cowles's monthly index from 1871 to 1917, and data prior to 1871 from a relatively obscure and now defunct periodical known as Cycles). [2]

When market data span long periods of time they are normally divided by some measure of inflation to obtain 'real' price data. There are a number of price indices available to perform this first adjustment but the one that is most frequently used is the consumer price index (CPI). Chart 6 shows annual prices of the composite stock market index going back to 1800, just eight years after the founding of the New York Stock Exchange. The price distortions due to inflation have been removed leaving prices for the index in constant year 2000 dollars.

Chart 6. The U.S. Stock Market with Inflation Removed

Chart source: Stock data from Standard & Poor's, Historical Statistics of the United States And Cycles magazine;
CPI data from the Federal Reserve and Historical Statistics of the United States.

History and logic tells us that the S&P 500, which represents more than 70 percent of total market capitalization in the U.S., is so large it can be used as a proxy for the entire U.S. economy. If the S&P 500 index were to double, the size of the economy would approximately double along with it. If that were to occur while the population remained constant, per capita wealth would also double. If, on the other hand, the U.S. population doubled at the same time, per capita wealth would remain unchanged.

Correcting the inflation-adjusted index by changes in population, then, gives us a pretty clear picture of how much real wealth is changing for each individual (on average) over time. Chart 7 presents the results of taking the data in Chart 6, dividing it by population growth, and setting the adjusted index to 100 at the peak year of 1835. What that chart shows us is a corrected index that doesn't appear to be growing over time, but rather oscillates in a more or less horizontal trading range.

Chart 7. The U.S. Stock Market Adjusted for Inflation and Population Growth

Chart source: Population data from the Federal Reserve and Historical Statistics of the United States.

This pattern is quite consistent with modern portfolio theory. Known as the Dividend Discount Model, this theory holds that investors ultimately purchase shares in corporations simply to pocket the cash dividends paid out over time. In other words, the market serves as a gigantic money machine that rewards shareholders with cash payments while reinvesting just enough money to keep the gears humming along in perpetuity -- thus real per capita prices trade horizontally over the long run.

A close inspection of the data reveals that there is a long-term periodic component to this sideways movement in the stock market. When an oscillating horizontal channel with a 168-year cycle period is drawn over the data, virtually all of the squiggles are neatly contained within it. Having done that in Chart 8, it can be observed that there have been just three occasions when the adjusted stock index flirted with the upper resistance line of the channel.

Chart 8. The 168-year Stock Market Cycle

These were the instances when the American money machine let go of its senses and allowed animal spirits to push prices to irrational heights. The market manias that resulted are labeled with their respective designations beginning with the Mechanization Bubble in 1835, moving on to the Mass-production Bubble in 1929, and ending with the recent Digital Bubble in 2000. All three stock market manias occurred at inflection points in the cycle where the slope of the channel changed direction.

The chart also indicates that devastating deflationary depressions that took roughly a decade to unwind followed every one of these financial bubbles. The first one on the chart was the Depression of 1764 where an act of the British Parliament destroyed the paper money being used in the colonies and led to a serious contraction in liquidity and commercial activity. The depression ended in 1769 but was quickly followed by a rebound recession from 1772 to 1775. It was Benjamin Franklin's opinion that this economic hardship was more responsible for the colonial drive for independence than any other factor.

The Panic of 1837 produced a sharp five-year downturn in the economy that led to mass unemployment and nationwide food riots in large cities. Leading up to the panic, state governments got themselves deeply into debt competing with each other building canals and railroads while average Americans were consumed in wild land speculation. It was also a time when U.S. demand for foreign goods led to a worrisome trade imbalance. When the bubble burst, mass bank failures led to a crisis of confidence in paper currency until the country clawed its way back to prosperity in 1843.

The Great Depression began with the stock market crash of 1929. Almost immediately, international trade declined sharply and along with it personal incomes, tax revenues, prices, and profits. Agricultural prices tumbled forty to sixty percent causing enormous distress to farmers while industrial unemployment soared to twenty-five percent by 1933 at the depression's nadir. The economy recovered from its worst ever economic catastrophe into 1937 at which time a rebound recession drove unemployment back up from fourteen percent to nineteen percent in 1938. It wasn't until 1940 that GDP returned to 1929 levels.

In the wake of the Digital Bubble the United States is once again faced with the highly likely prospect of economic depression. As of 2010 the word depression has rarely been used to describe the economic hardships most Americans are facing. The term of choice is the Great Recession but any significant downturn from here will likely bring the D word back into vogue. In the case of the Mechanization and Mass-production bubbles, the economy did not move into recovery until after the adjusted stock index of Chart 8 reached the lower channel line. Based on current levels within the channel and prior experience, that is not likely to occur before 2014.

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[1] While Karp lumps the eight centuries of European music that precede the Renaissance period into a single medieval category, I have subdivided the final 160 years of that period into the Late Medieval era. I use the date 1260 as the beginning of the period because that was the year Franco of Cologne published his music treatise Ars cantus mensurabilis where he introduced an innovative notational system that endured to the end of the medieval period.

[2] Cycles, "Stock Price Record, 1789 to Date" (Foundation for the Study of Cycles, Inc., February 1965). Data sources listed in the article were the Clement-Burgess Index and the Cleveland Trust Company Index for data between1831 and 1871, and a "Confidential Source" for the years prior to 1831.

Posted August 2010