This essay by Robert R. Prechter, Jr. originally appeared in The Elliott Wave Theorist in July 2002 . Its citation is: Prechter, Robert R. (2003). Pioneering Studies in Socionomics. Gainesville, Georgia: New Classics Library, pp. 77-82. The book is also available for purchase as part of a two-volume set.

Both supporters and critics of the Federal Reserve System agree that the first cause of paper money inflation and credit expansion in the U.S. since 1913 is the Fed. How does a socionomist respond to this assertion?

Conventional statements about social causality always treat the purported cause as an isolated force, as if it appeared from nowhere, with no antecedent causes of its own. Likewise, the Fed is taken as akin to the Law of Gravity, and all consequences flow therefrom.

Certainly the Fed is the primary engine of inflation via money creation and the fostering of easy credit through the banking system. But an engine and a first cause are different things. The motor of an automobile is the engine of locomotion but it is not the cause of it. Somebody built the motor in order that locomotion could occur. Likewise, people built the Fed in order that credit could be made easy.

The socionomic insight provides a principle of social causation that requires an inversion of conventional statements of causality. To reverse the presumed direction of causality expressed in the first paragraph of this report, we may conclude that the proper reformulation is as follows: The Fed is not the root cause of money and credit inflation; the desire for money and credit inflation is the root cause of the Fed.

If this re-statement is true, then a socionomist should be able to find evidence of it in the record of the formal structure of social mood fluctuation, which is best manifest in the fluctuations of aggregate stock prices. As we shall see, a review of that record suggests that the Fed did not appear out of nowhere at a random time but in fact was a product of social mood forces desiring an engine of credit inflation. We come to this conclusion because in three out of four instances, central-bank formation occurred at almost exactly the same place in wave structure, i.e., in the progression of social psychology.

Credit Engines as Products of Fourth and Fifth-Wave Psychology

Figure 1 shows the stock-price record from its beginning in 1695 in England. I would be remiss as a socionomist if I neglected to mention that the very appearance of reported stock prices was itself a symptom of fourth and fifth-wave social psychology, just as the appearance of financial network television was in the early 1980s. In other words, minds were turning to finance, and these outcomes were simply manifestations of that orientation.¹

Figure 1

 

 

 

 

In Figure 1, the points of three central-bank formations are marked with arrows. The ensuing period that encompassed fourth and fifth waves are traced with a bold line. By the way, the labels on the graph are not retrofitted to this discussion. For over twenty years, publications of Elliott Wave International have labeled the wave structure consistently as shown.

 

 

 

 

 

Observe that there is a remarkable correlation between the wave position and central bank creation. These central banks all came into being during fourth waves of large degree:

 

The first modern central bank was the Bank of England, constituted in 1694. It appeared during wave 4 of III, just prior to wave IV of (V).

The second American experiment with central banking was the second Bank of the United States, chartered in 1816. It appeared during wave 4 of III, just prior to wave IV of (I).

The latest incarnation of central banking in the U.S. is the Federal Reserve System, which was signed into law in 1913. It appeared during wave IV of (III).

 

In each of these three cases, government constituted the central bank in time to provide credit for the excesses of a Cycle-degree fourth wave and the ensuing Cycle-degree fifth wave. The Bank of England financed the ongoing Nine Years War (also known as King Williams War and the War of the Grand Alliance) with France during wave IV and then the South Sea Bubble, wave V. The second Bank of the United States created the credit to finance the War of 1812s debt legacy and then wave V, the Era of Good Feeling. The Federal Reserve System created credit to finance World War I during wave IV and then the Roaring Twenties, wave V. Probably because the next major correction was itself a fourth wave, wave (IV), the Fed remained in operation to finance the New Deal of wave (IV) in constant-dollar terms and the major expansion of wave (V), which culminated in wave V of (V), the Great Asset Mania of the 1980s and 1990s. So the Fed has accompanied not only a fourth and fifth wave of Cycle degree but also a fourth and fifth wave of Supercycle degree.

The second Bank of the United States was an object of political controversy. The presidential campaign of 1832 between Jackson and Clay was fought largely over the issue of re-chartering the second bank. Clay, who supported the bank, lost the election. The bank operated just long enough to finance waves IV and V of (I). In 1836, the first down year after the top, its 20-year charter was allowed to expire.

There is little question that the Federal Reserve System was a product of a certain necessary social psychology as well, because it came into being only after decades of political opposition to the idea of a central bank. In the 77 years following the expiration of the second Bank, promoters of central banking in the United States lost all of their political battles. In 1913, during a major fourth wave, resistance melted away, and proponents got their central bank.

There is one exception in our period of record. The first Bank of the United States, which Alexander Hamilton guided to formation in 1791, did not appear in the same wave position as the other three examples. It was formed in the midst of an economic depression substantially to finance Revolutionary War debts that had already been incurred. Thus, while we may postulate that the social psychology of fourth and fifth waves is conducive to facilitating the formation of a credit-expansion engine, such engines may come into being and operate at other times as well. It is probably pertinent that after the debts were paid, Congress closed the bank in 1811. Until we get evidence to the contrary, we might suggest that central banks formed in fourth waves will continue to operate through the ensuing fifth wave. Those formed at other times, such as the first Bank of the United States, will be discontinued fairly quickly because they have no fourth and fifth-wave social imperative to keep them going.

First Cause

The chronology we have explored supports the socionomic premise that psychology is the first cause of the credit excesses of fifth waves. I conclude, then, that governments have formed central banks to facilitate credit in response to the psychological demands of major fourth and fifth waves. Fourth waves induce society to build the credit engine, and then fifth waves are propelled by it.

Because the Wave Principle is the first cause of the tenor of social events, we should properly conclude that had the specific event not occurred, had the Federal government not authorized a central bank, then during the terminal waves V of (III) and (V), other banks and financial institutions would have exploited credit anyway, through their own ingenious methods and with much of the public happily participating throughout the process. Major fourth and fifth waves, we may safely postulate, encourage and thrive on easy credit no matter what the mechanism.

A Moral Question

If this thesis is true, then is there any reason to object to central banking monopolies? Yes, because a free market in money and banking would allow prudent banks to operate independently from the incautious majority. They would advertise their safety services, and prudent people would have the opportunity to protect themselves with sound banks. Then only those choosing to take risk would get hurt. Under central banking, the innocent suffer the most.

Regarding this topic, what might we postulate with respect to the fact that at Grand Supercycle degree, the stock market is in wave IV with wave V due thereafter? Clearly, if a credit engine generally appears during major fourth waves to finance their attendant social profligacies and conflicts and then to accommodate the desire for speculation typical of fifth waves, and if fourth and fifth waves of immense degree are due, then we might anticipate the emergence of an unprecedented credit engine for waves IV and V over the next two or three centuries. Some economists, such as Charles Kindleberger in the appendix to his book, Manias, Panics, and Crashes, advocate a lender of last resort to stave off deflation, in other words, a global super-Fed. This is like advocating crack smoking to save a cocaine addict, but sense has no force against the formological imperative. The existence of such a lender provides an excuse allowing people to abandon prudence under the assumption of safety, thus fueling the society-wide extension of credit to ever-weaker debtors. Such a proposal would forestall the next deflation only by generating an even greater credit expansion than has been accomplished by any previous monetary experiment. The ensuing crash and deflation would then be the largest ever.

Given the imperative of Grand Supercycle waves IV and V, I suggest that authorities will embrace the lender of last resort proposal, or something like it, some time in the next hundred years as wave IV progresses. Wave V will be the most spectacular credit inflation in the history of man and lead to the greatest credit bust in the history of man. After that experience, the wave position suggests that fiat-money central banking will go out of style for a millennium or so.

NOTES

¹ As Marshall McLuhan said, The medium is the message. That financial news networks came into being is far more important than their content. When (if) they go off the air in response to public disinterest, it will be in the vicinity of a major bottom in stock prices.

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