Block’s Indicator of Sustainable Growth

Nikolai Kondratieff, a Russian economist (1898-1938) is mainly known for his theory of the long wave cycle lasting between 48 and 60 years.

Consisting of four distinct phases, echoing the real economy, the long wave cycle mirrors the seasons of the year. It starts with Spring, a period of inflationary growth. Then follows as with nature- Summer, where exponential growth is stifled by real limitations, including a shortage of materials and labour leading to stagflation and recession.

Autumn comes with the economy stagnating into deflationary growth. Finally, Winter buffeted by strong winds leads to retrenchment giving way to depression.

Taking the last 104 years as a guide, we have two Kondratieff cycles namely:

Ø 1896- 1949, a period of 53 years.

Ø Following the harrowing depression in the 1890s, Spring offers sustained growth with rising prices lasting between 1896 and 1907. Summer including World War 1(1914-18), is a period of stagflation and recession ending in 1920. Autumn is a heady period of the roaring twenties to 1929, limited by stagflation and the start of recession. Finally, Winter including World War 2 (1939-45) is a nightmare mix of recession in 1929, turning into a major depression in 1930-32, followed by a short recovery and then deep recession in the late thirties ending only by the long world war.

Ø 1949-2010, a period of 61 years.

Ø Spring in the 1950s and early1960s is a glorious growth period, including the reconstruction of defeated enemies Germany and Japan. Summer starts off nervously in 1966, with the midpoint of the Vietnam War, and stock market growth is sidelined in a holding pattern until 1982. The 1970s is a period of stagflation and recessions sparked off with the three OPEC oil price hikes. Summer between 1982 and 2000 is a volatile period with see-saw patterns, including the stock market crash in 1987, the recession of 1990, the Asian financial crash in 1997, pricking the bubble of the hedge fund Long Term Capital Management in 1998, and the Russian default also in 1998. Autumn between 2000-2007 is again a heady period of sustained growth in equities and property. Winter starts in August 2007 and is expected to drag on to 2010.

Winter this time around is a wretched period with the worst recession since the 1930s, which is expected to engulf most countries. This time around, the bear market in equities is a by play of the main game in fixed income markets, which are many times the size of equity trading. At risk is the whole of the banking industry, and the financial architecture which evolved in the 1980s and 1990s. The bank deregulation model, including the dizzy role of derivatives now trading in trillions of dollars needs urgent change.

The current model, where banks in addition to originating loans to customers proceed to distribute them after warehousing for short periods is too faulty to continue. Until August 2007, the bank loans were then securitised into either asset backed securities for sale into the market, or sold through credit default swaps to investors, usually non life insurance companies and hedge funds.

In this model of originate to distribute, banks only tied up their capital for short periods, and then re-used them with the process repeated many times over, with the velocity of capital increased in the process.

Prior to August 2007, banks increasingly outsourced the origination of loans to brokers doing so with large upfront fees making big profits on the way. Then to gain even larger profits, banks went into very risky derivatives and more greedily even bought risky derivatives for their own account.

In a period of heated frenzy of making even larger profits, almost every institution in the fixed income markets participated, including investment banks originating collateralised debt obligations stuffed with risky subprime debt and selling them to other institutions and the public. The large private equity groups, the greedy hedge funds, and even the big pension funds participated along with the banks, all with their hands out for a share of the rich gains.

The round robin group of participants getting richer and richer has finally come to a sticky end. In the jungle of unregulated financial market liberalisation, the myth that the financial markets are self correcting has finally been blown sky high.

The realisation that the whole architecture of bank deregulation needs urgent remodelling puts back the ability of central banks to quickly end the credit crisis. In the meantime, the credit crunch will continue to grind on. Banks having lost the best part of a trillion dollars in capital and reserves will be forced continue imposing credit rationing and new business growth will be stifled. The end point of the cycle is now put back until 2010.

Super Commodity Cycle

Jim Rogers, the one time partner of George Soros, the legendary hedge fund boss of the Quantum Fund, anticipated a new secular bull market in commodities about to start after a gruelling bear market in the 1980s and 1990s. Now a billionaire in his own right, he created the Rogers International Commodities Index (RICI) on July 31 1998. RICI is a composite US dollar based total return index representing the value of a basket of commodities consumed in the global economy, ranging from agricultural to energy to metal products.

Rogers has now created a new commodities index in July 2008. Known as the Rogers Van Eck Hard Assets Producers Index (RVEI), it will soon become an exchange traded fund. The new index is global in scope made up of 39 countries, meant to capture the global commodities boom.

There were three secular bull markets in commodities in the 20^th Century. The first of these occurred between 1906 and 1923, essentially during the Kondratieff summer of stagflation and recession.

The second bull market in commodities between1933 and1955, stretched between a Kondratieff winter morphing into the following spring. The third bull market in commodities was between 1968 and 1982, occurring during the Kondratieff summer.

Finally comes the fourth secular bull market in commodities, which Jim Rogers says started in early 1999 and is expected to last to either 2014, or even to 2020. This is occurring during the Kondratieff winter and then moving into the spring of new accelerated growth from 2010 onwards.