The recent hype surrounding commodity economies from Australia to Brazil has been stoked by outlandish rationales for why the spike in commodity prices over the last decade represented a permanent upward shift—a high-speed edition of the “new normal.”
The case for rising commodity prices builds from the assumption that demand from emerging markets will continue to rise as it did in the last decade, but that wave has already broken up. China, Brazil, India and Russia are slowing. Given the burdens of high commodity prices, the coming downturn will encourage the revival of confidence in the West, where most nations are major commodity consumers.
This is the true return to normal. Over the last two hundred years, the prices of commodities as a group not only have declined steadily but also have traveled along predictable lines. Prices for a given resource rise continuously for a decade, which inspires inventors to come up with ways to conserve existing stocks, to extract the commodity more efficiently, or to invent cheaper substitutes. Then prices fall for two decades. Today we are nearing the end of a decade of sharp increases in the price of oil, and the historical pattern is indeed repeating itself.
A slowdown in China could shock the stars of the past decade, when the best-performing stocks in the world were materials and energy companies, and the best-performing stock markets were in resource-rich Brazil and Russia, which rose by around 300 percent in dollar terms, with large gains in their currencies boosting returns.
Falling commodity prices could change all this in a snap, not only adding to the threat of instability in the Middle East but also shrinking the ambitions and the financial war chests of disruptive petro-states like Venezuela, and even of aspiring regional powers like Brazil.
The commodity bulls tend to talk mainly about skyrocketing demand, but the rising price of oil over the last decade has inspired enough investment in new supply—new oil fields, new pipelines, new refineries, and alternative sources of energy such as shale gas—that a glut may emerge this decade. And what goes for oil goes for many commodities, from steel to soybeans. This overbuilding is typical of the late stages of a bubble, putting many investors, companies, and countries at high risk.
As commodity prices ease, one obvious group of beneficiaries would be commodity importers, including India, Turkey, and even Egypt. A decline in commodity prices will ease inflationary pressures that can be a major obstacle to growth in these nations.
A common mistake of bearish forecasters is to believe that as a current fad ends, the world will come to a halt rather than move on to a new chapter. Antoine Lavoisier, the father of modern chemistry, best captured the reality of such changes in his observation “Nothing is lost, nothing is created, everything is transformed.” The coming slowdown in China and the end of the commodity mania will bring transformation, not disaster. It will not derail the continuing strong growth of the consumer sector in emerging markets, which will make up a larger and larger share of the Chinese and the global economy.
A Big Plus for the West
A sharp decline in commodity prices is likely to be a major plus for the beleaguered Western economies, which spend heavily on importing oil and other raw materials. More capital could also then flow to the productive parts of the global economy, and I would not be surprised if U.S. technology again becomes the mania of the coming decade.
All the hottest new things, from tablet PCs to cloud computing to social networking, are emerging largely from the United States. This is likely to keep the U.S. well up to speed in the global growth game. Meanwhile the nations that have reveled in the commodity boom are likely to face a disheartening return to the mundane ordeals of a normal life. Buddhist monks have a phrase for it: “After the ecstasy, the laundry.”
The author is Head of Emerging Markets at Morgan Stanley Investment Management and this article has been adapted from his new book, Breakout Nations: In Pursuit of the Next Economic Miracles.