Bill Emmott - International Author & Adviser


Commodities and global growth
Exame - January 2007

The world economy has had such a fantastic four years that it has seemed almost rude, or perhaps imprudent, to ask why. The usual answer that is given is globalisation, the increase in worldwide openness to trade and capital flows that is associated with rapid economic growth in the BRICs of Brazil, Russia, India and China. Yet there is something wrong with this explanation: it is a long-term trend being used to explain a so far short-term phenomenon. And it misses out something important: the role of booming commodity prices. Now that those prices are falling, we are about to see quite how important they have been.

There is, of course, a connection between globalisation and the boom in energy and other commodity prices that has taken place since 2002. The huge appetite of China in particular, but in future perhaps also India, for oil, iron ore, copper, aluminium, nickel, tin, wheat—almost anything that can be mined from the earth or grown upon it—is taken as the explanation for why commodities are now said to be in a "super-cycle", a long period of high prices.

The trouble is that this is a description, not an explanation. Globalisation has been under way for more than two decades; it broadened hugely in the early 1990s when the Soviet Union collapsed, when India responded to its economic crisis by liberalising itself, and when many countries in Latin America did the same. But there was then no related boom in commodity prices, and nor did the world economy enjoy such strong growth. Moreover, this recent burst of growth has been a big surprise. Since 2002 global GDP has grown in real terms by 4.5-5.5% a year, the best four-year period in at least four decades. But when the IMF met in September 2002 the organisation’s forecast was that 2003 might be a bit better than 2001-02, but that was because those years had been pretty dismal. And it expected oil and other commodity prices to stabilise or fall, not boom.

The joy of synchronicity

Instead, world growth surged, oil prices almost trebled and many commodity prices rose by even more—without hurting growth by reigniting inflation. Economists based in the rich, developed countries explain this by saying that their economies are now more flexible, use less oil and other commodities per unit of output, and have central banks that markets believe will defeat inflation if it begins to become dangerous. Those points are only part of the story. The other part, important to natural resource producers that are mainly poorer and in the southern hemisphere, is that the commodity boom has shared the fruits of growth more widely and, for the time being, has kept the world politically and economically stable.

This synchronicity of worldwide growth has undoubtedly been beneficial. Oil prices at $50-80 a barrel have kept the governments of Saudi Arabia and other Arab nations stable during a period when the Anglo-American invasion of Iraq might have threatened them. Sub-Saharan Africa, the world’s poorest region and a laggard for decades, has been growing by more than 5% a year thanks to high oil and metals prices. Brazil has been less good at cashing in on the boom, but still it owes its expected growth of 3% in 2006 to this phenomenon, as does Chile for its 4.5-5% or Venezuela for its almost 8% growth.

In some respects, the effects have been uncomfortable: provocative behaviour by Iran or by Venezuela’s Hugo Chavez owes a lot to those countries’ sense that they now have economic power. Overall, however, even George W. Bush ought to admit that the commodities boom and the resulting synchronous growth have calmed down a period that could have been politically turbulent the world over, rather than just in the Middle East.

A turning point?

Yet despite continued globalisation, there have been substantial falls in commodity prices during the past six months. Oil prices peaked at $78 a barrel in June, yet by mid-January they had fallen by 35% to $50-52. None of the major oil consumers has suffered much of an economic slowdown, let alone a recession, so there has been no slump in demand to explain this. Copper prices, meanwhile, have fallen by more than a third from their peak in May 2006. Other metals prices have remained stronger, but overall The Economist commodity price index had by January 9th fallen by 9.8% in dollar terms in just one month.

All these commodity prices remain considerably higher than they were four years ago. Oil at $50 a barrel, or copper at nearly $6,000 a tonne, are still extremely attractive materials to sell. But what if they carry on falling?

The fall in prices that has occurred so far might have been caused by financial speculators, who drove prices higher than would have been justified by supply-and-demand fundamentals and have now turned into sellers, partly out of fear and partly because of higher interest rates. Much of the preceding rise, however, can be explained by supply shortages, resulting from low levels of investment by mining and oil companies during the previous two decades of sliding prices. Rising demand from globalisation meets scarce supplies: prices soar.

Yet, as everyone in the resources industries knows, supply will rise as and when new investment makes more production available. Commodity bulls think that this will be a slow process, because mines and oil wells take several years to develop and the skilled labour needed for them is scarce. The opposing argument, though, also depends on the fact that the balance between supply and demand for oil and other commodities is finely balanced. Yes, bears say, it will take several years before there is a substantial increase in reserves or actual supply of oil and other commodities. But prices do not depend on substantial increases; they depend on small swings in the balance between supply and demand. And such swings can occur quite rapidly.

There are already two powerful examples. The slide in oil prices during the opening weeks of January was not caused by the much-feared American recession: it was caused by mild weather in much of America and Western Europe. The slump in copper prices during the past half year may have had much to do with speculation, but another contributing factor has been slowing demand and rising inventory levels in China. High prices have led users to seek substitutes, and supply has been gradually increasing. These are small swings, but they have produced big and sudden effects.

On balance, this columnist’s view tends towards bearishness, even for the oil price. There could be further substantial falls in all commodity prices, as demand eases, supply increases and investment funds withdraw from the market. Certainly, political instability could bring about supply disruptions in oil as in other commodities. But at the very least, observers in Brazil and other resources-exporting countries should accept that big price falls are just as possible as big price rises. Globalisation may well mean that demand will rise in the long term. But technology and investment, in an open world with many potential suppliers, will also mean that supply can rise strongly too. The case for producing countries to diversify remains powerful—for the long term.


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