Risk Latte - Kondratiev Super-cycles and the very long term view on investments

Kondratiev Super-cycles and the very long term view on investments

Rahul Bhattacharya
Aug 04, 2007

George Magnus, the senior economic advisor to the investment bank, UBS, made an interesting reference to "Minsky moment" in a research report in March this year. In the report he asked a simple but a profound question: "Have we reached a Minsky moment?"

This lead us on a trail in search of Minsky ( Hyman Minsky was another famous American economist, and we'll talk about him in other articles in this colum ) and we found that "Minsky moment" as well as its proponent Hyman Minsky, have suddenly become an all important phenomenon in the stock and credit markets after the debacle in the sub-prime mortgage market in the U.S. recently. As the sub-prime contagion has spread in the last few weeks market watchers and strategists have literally pulled Minsky out of the dead.

And our research on Minsky on the web led us to Kondratiev. Also, in August edition of Bloombeg's Markets we came across a reference to Kondratiev. Faber and Oliver, a Hong Kong based fund manager, was apparently using the theory behind Kondrative cycles to invest in commodities and commodity stocks. Marc Faber is the Hong Kong based legendary fund manager.

Since we couldn't talk to Marc Faber and so we looked up the net, went through research archives, numerous blogs, websites and of course the Wikipedia. But why was the reference to Marc Faber? Marc Faber is amongst a select group of market professionals - a band of "super-cycle" proponents - who are embracing Kondratiev's theory and designing investment strategies around it. Their investment bets are crafted around what we now know as "Kondratiev waves" or the "grand super-cycles." These S-shaped waves have lengths of fifty to sixty years and define periods of high and low economic growths. You can also look at it as giant business cycles.

Faber and some other strategists at Deutsche and Goldman Sachs believe that due to shortages in supply of goods and services and the fast growing economies of India and China will send commodity and commodity related stock prices higher in the coming decade. In other words, they believe that the rising commodity prices that we have witnessed in the last decade could well be the base for a forthcoming long upward cycle of 50 to 60 years.

The theory of grand super cycles was first formulated by the Russian economist Nikolai Kondratiev (1832 - 1938). What is interesting is that theories and ideas of three economists, Nokolai Kondratiev, Hyman Minsky and Joseph Schumpeter intersect each other in a very interesting way and we'll try to touch upon these in other articles. As we mentioned above, Minki has become especially relevant today after the meltdown in the credit markets.

Why was Kondratiev dead for all these years?

Kondratiev cycle, or the long wave theory, which is a fifty to sixty year cycle in prices (commodity and producer prices), interest rates and other economic variables such as GDP, money supply, etc., was never really accepted by mainstream economists for most of the last century. Kondratiev working in 1920s however, predicted that a deflationary wave during his cycle theory. And his theory was vindicated during the Great Depression of the Nineteen Thirties. However, subsequent to that period in history one never really saw any depression or very severe deflation for an extended period of time. This perhaps led many mainstream economists, especially the ones in the academia, to believe that there are no long waves in the economy which gives peaks and troughs, peaks being characterized by period of high economic growth (and prosperity) and troughs signifying severe recessions or depressions.

As one of the interesting web blogs points out (see the reference below) that one of the reasons for an absence of depression could be continuous government and central bank intervention. Governments around the world and especially in the G7 countries have followed an expansionary or stimulatory fiscal and monetary policy in the last 70 years odd years - starting from the New Deal until the beginning of the 21 st century. The fiscal policies have been such that the governments have run near perpetual deficits and have put in more money in the hands of the consumer than it has taken away in taxes; and at the same time the Central banks have continuously and secularly increased the money supply in the economy which has resulted in growth. Such has been the fear of the Great Depression!

And this killed Kondratiev waves, or rather disguised it.

As another interesting web blog points (see the reference below) in the western world debt to GDP ratio has been increasing since the 1960s. The author of the blog thinks that we are not only at the end of the short Minsky cycle as some conjecture given the fall in the credit markets recently but we are also at the end of a fifty year long cycle in the debt to GDP ratio, which is a Kondratiev cycle. The implication could be that we are now headed for a prolonged economic recession.

What lies ahead? Who knows, but this much is certain: Minsky is back and perhaps so is Kondratiev.

Reference: Bloomberg Markets, August 2007; Besides Wikipedia there are numerous websites and blogs that discuss these ideas. Some of them are:

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