First was the dot-com bubble, then the housing bubble. Now comes the commodities bubble. We don’t fully understand the stock market’s current turmoil, but we know it’s driven at least in part by a bubble of raw material prices. Their collapse weighs on world stock markets through fears of slower economic growth and large financial losses.
All bubbles share similar characteristics. There’s a strong, enthusiastic demand for some object (whether stocks, homes, oil or tulips). High demand pushes up prices, which inspires more demand. Prices ultimately reach unsustainable levels so that when spending slows, the bubble implodes. Commodities have now traced this familiar path.
As the Economist reminds us, raw material prices respond to different influences. Weather affects crops; technology (a.k.a. “fracking”) affects oil recovery. Still, despite these variations, prices of many commodities — not just oil — have followed roughly similar trajectories in recent years. They have dropped steeply, according to figures from the International Monetary Fund.
Here are declines for five commodities from 2012 through July 2015: oil, down 48 percent; iron ore, 60 percent; copper, 31 percent; palm oil, 39 percent; and wheat, 37 percent. Many commodity prices have continued to fall.
The bubble formed on hopes that China’s rapid growth would feed an ever-expanding appetite for raw materials, says economist John Mothersole of the consulting firm IHS Global Insight. Demand and prices would remain high indefinitely. Although prices fell after the 2008-09 financial crisis, China’s huge “stimulus” package — intended to offset the crisis’s drag — sent them up again, says Mothersole. China’s demand seemed destined to stay strong, as economic growth would stabilize at a high level.
It didn’t. In 2010, China’s economy grew 10 percent; the IMF expects 6.8 percent in 2015 and 6.3 percent in 2016. Other economists think growth could be lower. As a result, much of the added production capacity — mines and the like — to supply China isn’t needed. “There’s a new commodities era,” says economist Rabah Arezki, head of the IMF’s commodities research. “Everyone was rushing to invest. Now they have to adjust to a new lower level of demand.”
Economies in many emerging-market countries have suffered accordingly. “In Indonesia, coal once bound for China is piled up in port,” reports the Wall Street Journal. “In South Africa, mines that fed China’s voracious demand for metals are firing workers.” Stock markets in commodity-exporting nations have also tanked. From last September through Aug. 24, stock prices were down 28 percent in Brazil (exports: iron ore, soybeans, sugar), 21 percent in Indonesia (coal, oil, rubber) and 9 percent in South Africa (gold, coal, iron ore).
What’s occurring is a profound shift in the global economy, says economist Hung Tran of the Institute of International Finance. It had been hoped that the rapid growth of emerging-market and developing countries — accounting for about half of global output — would sustain a vibrant world economy. But that hope is fading.
Five years ago, says Tran, the expected gap in economic growth between emerging-market and advanced economies such as the United States, Japan and European countries was about 5.5 percentage points. (If advanced economies grew 2 percent annually, emerging-market countries would grow 7.5 percent.) Now the gap is two percentage points or less, he says. Of course, not all of the setback reflects weak commodity prices. An example: Brazil’s economy has suffered from a burgeoning scandal involving Petrobras, the national oil company.
The stock market swoon reflects this larger truth: Future economic growth is being marked down, because the commodity boom artificially (and temporarily) increased past growth. Over-optimism about China caused unneeded investments to be made. It will be harder for commodity exporters to generate jobs for their workers. There are other dangers. The most obvious is that low prices will result in loan defaults or bankruptcies by commodity producers that weaken financial institutions.
The commodities bust has exposed these problems, not solved them. But unlike the dot-com and housing bubbles, whose effects were mostly negative, the commodities bust has a silver lining: Lower prices, especially lower gasoline prices, may strengthen consumer spending. That’s one reason many economists don’t see an American recession anytime soon. “The U.S. recovery seems domestically based on housing and consumer spending,” says economist Tran.
Still, this optimism comes with a caveat. If today’s low commodity prices mainly reflect a surplus of production capacity — oil perhaps being an example — the surplus will need to be gradually worked off. But if the low prices also reflect feeble demand, then the economy may be weaker than we thought.
Read more from Robert Samuelson’s archive.