The com­mod­ity roller coaster

Financial Mirror (Cyprus) - - FRONT PAGE -

The global com­mod­ity su­per-cy­cle is hardly a new phe­nom­e­non. Though the de­tails vary, pri­mary com­mod­ity ex­porters tend to act out the same story, and eco­nomic out­comes tend to fol­low recog­nis­able pat­terns. But the el­e­ment of pre­dictabil­ity in the path of the com­mod­ity-price cy­cle, like that in the course of a roller coaster, does not make its twists and turns any eas­ier to stom­ach.

Since the late eigh­teenth cen­tury, there have been seven or eight booms in non-oil com­mod­ity prices, rel­a­tive to the price of man­u­fac­tured goods. (The ex­act num­ber de­pends on how peaks and troughs are de­fined.) The booms typ­i­cally lasted 7-8 years, though the one that be­gan in 1933 spanned al­most two decades. That ex­cep­tion was sus­tained first by World War II and then by the post-war re­con­struc­tion of Europe and Ja­pan, as well as rapid eco­nomic growth in the United States. The most re­cent boom, which be­gan in 2004 and ended in 2011, bet­ter fits the norm.

Com­mod­ity-price busts – with peak-to-trough de­clines of more than 30% – have a sim­i­lar du­ra­tion, last­ing about seven years, on av­er­age. The cur­rent bust is now in its fourth year, with non-oil com­mod­ity prices (rel­a­tive to the ex­port prices of man­u­fac­tures) hav­ing so far fallen about 25%.

Com­mod­ity-price booms are usu­ally as­so­ci­ated with ris­ing in­comes, stronger fis­cal po­si­tions, ap­pre­ci­at­ing cur­ren­cies, de­clin­ing bor­row­ing costs, and cap­i­tal in­flows. Dur­ing down­turns, th­ese trends are re­versed. In­deed, since the cur­rent slump be­gan four years ago, eco­nomic ac­tiv­ity for many com­mod­ity ex­porters has slowed markedly; their cur­ren­cies have slid, af­ter nearly a decade of rel­a­tive sta­bil­ity; in­ter­est-rate spreads have widened; and cap­i­tal in­flows have dried up.

Just how painful the down­turn turns out to be de­pends largely on how gov­ern­ments and in­di­vid­u­als be­have dur­ing the bo­nanza. If they per­ceive im­prove­ments in their terms of trade as per­ma­nent – a view that gains trac­tion as prices climb – in­creases in consumption and in­vest­ment tend to out­pace in­come gains, and pub­lic and pri­vate lever­age grows. The risk is that when the roller coaster ca­reens down­ward, a debt cri­sis will de­rail mar­kets.

And, in­deed, dur­ing com­mod­ity-price down­turns, bank­ing, cur­rency, and sov­er­eign-debt crises tend to pro­lif­er­ate – and cri­sis-avoid­ance be­comes a hot topic for pol­i­cy­mak­ers, as high­lighted in the In­ter­na­tional Mon­e­tary Fund’s most re­cent World Eco­nomic Out­look. It is no accident that the last com­mod­ity-price col­lapse, which ran from the late 1970s un­til 1992, co­in­cided with more than a decade of sov­er­eign-debt crises in the de­vel­op­ing world.

Of course, that was no or­di­nary down­turn. On the con­trary, it was the most se­vere com­mod­ity-price col­lapse to date, re­sult­ing in a 40% peak-to-trough de­cline. More atyp­i­cal, it in­volved three waves of price de­clines, di­vided by 1-2 year respites. The first wave was con­nected with the US Fed­eral Re­serve’s ef­forts to bring in­fla­tion un­der con­trol in the fall of 1979, which caused in­ter­na­tional in­ter­est rates to spike, trig­ger­ing a deep re­ces­sion in the US and else­where. The sec­ond wave, which be­gan in 1985, re­flected a sup­ply glut, as many com­mod­ity ex­porters si­mul­ta­ne­ously sought to raise hard cur­rency, of­ten in the midst of eco­nomic cri­sis. The third wave, from 1989 to 1992, was fu­eled by the dis­in­te­gra­tion of the Soviet Union, which caused out­put there to col­lapse.

The ques­tion now is whether the cur­rent crash will fol­low a sim­i­lar tra­jec­tory, with the re­cent break soon giv­ing way to an­other drop. The an­swer lies pri­mar­ily (but not ex­clu­sively) with China.

If China’s eco­nomic slow­down per­sists – as those fol­low­ing in­vest­ment booms and fu­eled by debt over­hangs of­ten do –the com­mod­ity down­turn is likely to con­tinue, as no other econ­omy is ca­pa­ble of pick­ing up the de­mand slack. The US eco­nomic ex­pan­sion is likely to slow soon, as the Fed raises in­ter­est rates. And Europe’s rel­a­tively re­cent re­cov­ery will prob­a­bly be mod­er­ate and tilted to­ward do­mes­tic ser­vices.

Fur­ther­more, at this stage of the com­mod­ity cy­cle, price de­clines typ­i­cally re­tain down­ward mo­men­tum. By the end of the boom, many com­mod­ity ex­porters had al­ready ini­ti­ated in­vest­ment projects to ex­pand pro­duc­tion. As th­ese in­vest­ments bear fruit, the in­creased sup­ply will sus­tain down­ward pres­sure on prices. And many emerg­ing-econ­omy gov­ern­ments’ un­der­stand­able aver­sion to run­ning sub­stan­tial and per­sis­tent cur­rent-ac­count deficits will lead them to counter weaker ex­port prices by in­creas­ing ex­port vol­ume, even if that drives down prices fur­ther.

This com­mod­ity-price roller-coaster ride is prob­a­bly not over yet. While we can­not know for sure what will hap­pen, it would be pru­dent to brace our­selves for an­other drop – and do what we can to avoid a crash.

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