The Beginning of the End for the Commodity Boom

George Orwell once noted that“Whoever is winning at the moment will always seem to be invincible.” Over the past decade the economies that have made their way by exporting commodities (best typified by countries such as Brazil and Russia) have enjoyed strong growth. This has lead many to suggest that their rise will continue over the coming years, with the hysteria over the countries that can be grouped into certain acronyms reaching fever pitch. Yet it seems as if there are tangible reasons to the contrary that suggest the opposite is true.

The overwhelming reason of the rise of these economies has been the intertwining of their fortunes with that of China’s. This might be problematic, as although China will continue to grow, it seems likely that its rate of growth will slow as it begins to head towards its ’Lewis Point’. It now needs to overcome the problems that lie between it and the path to becoming a high income country.

There is a lot of evidence to suggest that this will see a reduction in growth. China needs to restructure its economy, which is currently split in half between consumption and investment, so that the former becomes the dominant factor. Furthermore, typically it is difficult for any nation to expand the manufacturing share of its labour force (which drives most Chinese growth) much beyond 20%, and China is already at around 23%. China’s population is also ageing, which increases the future burden on the state and reduces the available pool of labour.

There are also other issues with the Chinese economy, but the short of it is that growth of 6-7% for the moment is the ’new normal’. This sits at odds with the calculations of many companies of the commodity economies that require that China continues to invest at the rate it is now – this seems unlikely.

Furthermore, commodities are simply too volatile to enable long term growth. It is assumed that they will continually increase (though obviously there will be the normal short term fluctuations caused by the uniqueness of the commodities market) but in reality there are two reasons why this is not the case. Much of the increases in commmodity prices depends on fast Chinese growth; for instance, it makes up 9% of demand for oil but 20% of growth in demand. However, as previously implied, the Chinese investment boom might just be running out of steam.
Commodities have also become entwined with speculation in this time of easy money. The cheap money policies pursued by central banks cause what the research firm GaveKal Dragonomics refer to as ’the worst kind of bubbles’. Low interest rates encourage investors to pile into assets that are scarce but don’t have any productive use (such as gold). This bubble has caused commodities to be turned into quantities that are traded and speculated like stocks, and separates prices from demand. Furthermore, there might be more sinister causes for the high prices.

Conservative MP Robert Halfon suggested to the House of Commons that petrol prices are being kept artificially high thanks to the oil market being manipulated by traders who place and then reverse large trades. This creates a false picture of high demand in the market, leading to of temporary gain for a few countries but not a path to long term sustainable growth.

Indeed, if anything, the artificially high prices can often mask the structural problems the economy has, leading to imbalances which will cripple growth later on. An example of this idea would be the UK, where the large gains made in the financial sector allowed policy makers to ignore the widening current account deficit that signified the lack of competitiveness in manufacturing. The underdevelopment of other industries than leaves a country at the mercy of any price fluctuations.

The speculation in commodities has led to several of the commodity economies’ currencies appreciating in value. This has been a particular problem for Brazil and most of Latin America. In Brazil, the wave of foreign money buying up assets has been the problem. These flows into stocks and bonds is up from $5 billion in 2007 to over $50 billion now. Recently in the developed world many countries have been keen to let the currency depreciate, and this increased relative strength of the currencies of most of the commodity economies.

A strong currency is not necessarily a problem (Indeed it might help to cure the inflationary pressure that many Latin American economies have experienced) but it becomes a very serious one when the currency becomes stronger than economic signs suggest. The Brazilian real is currently overvalued compared to the country’s relative purchasing power. In the long run this damages competitiveness; Brazil is a costly place to do business. When Miami based fund manager Bret Jensen laid out 10 reasons why he was not investing in Brazil anymore, he pointed out that ’half the population is illiterate, yet it is more expensive to go out to dinner/clubs in Sao Paulo than Miami by roughly double’.

Since 1945 only 13 countries have been able to sustain growth of 7% or more for a 25 year stretch, and only two of those have been commodity economies. There is more than enough evidence to suggest that this statistic might be accurate for a while longer.