Will the world economy really benefit from cheaper commodities?
The tide is turning in commodity markets. Food prices, after a year of reasonably good harvests, look stable. Supply-demand fundamentals, eased by weak global economic activity and new discoveries in ‘frontier’ markets, are looking better for nickel, iron ore, and other mining products. And oil markets are looking less tight: the World Bank, the IEA and the IMF all recently concurred that, barring a major diplomatic fall-out with Iran, efforts to lower crude prices are likely to bear fruit.
Good news for the world economy? One would think so. Dearer commodities bear down on global demand: they shift income from commodity consumers to producers, who typically spend less. They also feed stronger inflation, inducing central banks to tighten monetary policy and constrain credit growth. And they dig a hole in importing countries’ balance sheets – especially lower income economies, where energy and food are largely subsidised. With the global recovery threatening to go off track again, expensive commodities are the last thing the world needs right now.
Yet a retreat may not be the boon many hope for. Lower prices will bring little relief to consumer markets: Europe’s lack of growth has more to do with its declining economic competitiveness, rigid job markets and oversized public sectors than the cost of raw materials. Stiff pump prices may pose a threat to Barack Obama’s re-election prospects, but they’re not the main reason behind wobbles in American job figures and manufacturing data. Neither will keener iron ore, coal or copper significantly boost Chinese growth. Beijing’s slowdown results more from an effort to deflate the credit and real estate bubble than from higher input prices.
Worse still, a decline in commodity prices could do serious damage to large exporters of raw materials, like Brazil, Russia or Indonesia, who largely contribute to global growth. A lot of them are ill-prepared to deal with a market downturn: as a recent IMF report illustrates, they lack the fiscal buffers and institutions to support counter-cyclical policies should the going get tough. Buoyed by commodity revenues, their strong currencies have rendered other industries less competitive. And relaxed financial policies mean that they rely on ever-higher prices to balance their budgets. Smaller exporters, like Chile or Peru, have been more cautious; but overall, commodity producers look seriously exposed.
The picture is not entirely negative. Falling prices could still support a rally in stocks and bonds: in addition to lower input costs, restrained commodity prices help keep interest rates lower for longer, thereby giving a nudge to debt and equity valuations. But early signs are not encouraging. The one commodity analysts are frankly bullish about in the long-run is gold, with Thomson Reuters predicting that the bullion – a traditional safe haven in troubled economic times – could hit $2,000 within 12 months. David Rosenberg, Gluskin Sheff's Chief Economist, even told the FT last week that gold could eventually reach $3000 by the end of next year. Commodity consumers may soon be getting more for their bucks, but they will need to dig deeper to find reasons for solace.