For a long time I’ve studied the works of Gann, Elliott and Kondratiev trying to gain some foresight into the economy cycles. My costly conclusion is that none of these methods work. However, before throwing them out of the window, let’s see why they fail, when they fail and to what extent they may have some validity.
First, let’s say that at some point all of the above methods worked. It is that past performance that keeps practitioners attached to them. Those methods, particularly Kondratiev and Elliott, touch an area that Traditional Economics and consequently mainstream market analyst don’t dare touching: that of mass psychology.
In our society it is better to celebrate the triumphs of the great investors than assign to them the inevitability of larger social forces. Above all, if they pay your salary. However, disregarding the animalistic, organic, and patterned nature of human economic activity is not only anti scientific, but also counterproductive.
I am working on a book which will try to provide a scientific framework for understanding and predicting limits for human economic activity, but that will not be ready for at least another three years. In the meantime, I will share some ideas here.
The most interesting aspect of Gann, Elliot and Kondratiev, is the often even violent response they received. While Gann and Elliott are militantly ignored, dismissed or ridiculed by the capitalist academia, Kondratiev was executed by Stalin. You may wonder why the establishment has such a powerful reaction to these theories.
If you want to start with some basic and contemporary evidence that Traditional Economics is unable to describe human economic activity, you have to nothing but to look at the ongoing melting down of the global credit structure. There is an obvious irrationality to the decision making process of every and all participants in the economic process, from the Fed to the buyers of houses.
Elliott Wave theory and Kondratiev works both provide some insight in why this happened, pointing out to animalistic or natural macro processes that overcome and supersede the individual decision making process. Both works are incomplete, and new scientific evidence may improve upon them. For instance, it is necessary to study the brain chemistry of the inflationary process and how we humans are naturally an inflationary animal. The psychological process that we identify as desire (and which may manifest itself as greed, lust or simple general neurotic dissatisfaction) is at the base of both market activities and the capitalist society as a whole. This is a chemical process that combines the emission of certain reward compounds and the memory of the effect that those compounds had on our brain cells. While most other animals seem to lack this memory of the effect (or at least have a much higher threshold) and they may repeat the same activities over and over obtaining the same level of satisfaction, we humans need to increase the amount of those compounds to better the previous experience. The study Evolutionary Cognitive Neuroscience, and further studies in evolutionary cognitive neuroscience may start providing the basis for further study in this area.
If scientific studies prove that our desire for making money is just an environmental response based on an evolutionary trait, they will help providing a better answer to the existence of capitalism than the mystical "invisible hand of the markets" or a supposed inherent and natural desire of humans for making profits. It will also explain why the Marxist theory failed to describe the economic reality and why the experiments of dictatorship of the proletariat eventually reverted to the same patterns of search for individual profit common to the capitalist society.
The most current criticism of Gann, Elliott and Kondratiev is that they don’t work a fact that is true. However, those theories worked in the past and my own simulations of past market activities show that they did explain certain economic processes and were able to predict future economic processes. However, they were all created during an historical period while prices were all expressed in constant money, money attached to the actual production capacity of the whole of human society by its correspondence to the amount of gold accumulated by humans and assigned to monetary activities.
After 1973 in the US, and in general from the 1930 period onwards for different countries, any analysis of the past could not be extrapolated into the future. The reason is that the market prices in the US after 1973 have not correlation whatsoever with market prices prior to 1973. The last great Elliott prediction was during the 80s, when the current data series was close enough to the previous data series as to make a projection feasible. After that, as the new data series diverged more and more from the previous data series, any and all predictions tended to be wrong by definition. A similar destiny awaited those trying to use Gann and Kondratiev to look into the future.
For instance, measured in "constant" US dollars (as if they were still gold backed) the Dow Jones shows the pattern predicted by Elliott and it is now in a great depression. However, the economic reality is not based on those dollars, and thus the Elliott pattern does not reflect the economic reality. This may be heralded by the proponents of the floating currency as the ultimate defeat of the natural forces by sheer use of intelligence. My contention, however, is that those forces are not defeated; are pretty much alive and they show in other areas of economic activity (although that needs to be demonstrated and is not the object of this article).
Let’s just say that before disregarding the theories, it is necessary to make further study of why they stop working and that before embracing them it is necessary to create a framework of reference in which they may prove useful.
Franklin @ May 25, 2008