Tuesday, November 17, 2015

Global Commodities Crash Signals Long Term Economic Slowdown

The economic expansion that followed World War II — known as the post-war expansion — was unparalleled in the 20th Century.

Much of Europe, which had been destroyed by years of warfare, needed to be rebuilt. The Marshall Plan — the American initiative to aid in the rebuilding Western Europe after the war — cost approximately $130 billion in today's dollars.

The rebuilding effort put millions of men to work and utilized huge amounts of resources. Roads, bridges, dams, train stations, railways and buildings all needed to be rebuilt or constructed.

The US, absent any competition from Europe or Japan, became the world’s dominant economic superpower in the latter half of the 20th Century.

Once the rebuilding of Europe and Japan was completed, however, a huge source of economic growth came to an end. But Europe and Japan were then able to redirect their energy and resources from the war effort toward other, more useful economic pursuits.

In the process, Europe and Japan became huge sources of industrial output, manufacturing, engineering, research, development and invention. The US suddenly had some competition.

But all developed economies eventually experience a slowing of their growth rates. At some point, most of the potential growth has been ultimately realized and there is less juice to be squeezed from the fruit, so to speak.

Inevitably, the economies of the US, Japan and Europe have all slowed from the from their postwar glory years.

Enter China to pick up the slack.

China’s expansion over the past 30 years — especially the last 20 — rivals the postwar expansion in Europe, Japan and the US.

The Asian giant became the dominant consumer of many — if not most — of the world’s industrial commodities (copper, zinc, iron ore, coal, etc.), creating an economic boom that spread to other countries that are commodities exporters (Brazil, Chile, Australia, New Zealand, Indonesia, etc.).

Between 2000 and 2011, broad indices of commodity prices tripled, easily outpacing global growth, notes The Economist. That was clearly unsustainable, and we are now seeing the fallout.

China’s economy has begun to slow, and like the US, Japan and Europe, it too is overburdened by debt.

From the New York Times:

The so-called supercycle driven by China’s once insatiable appetite for raw materials has been extraordinary by any standard. Edward L. Morse, Citigroup’s global head of commodities research, likens China’s boom to the three decades after World War II when Europe was rebuilt, or the Gilded Age industrialization of the United States in the half-century after the Civil War.

“The last 20 years have been mind-boggling,” Mr. Morse said. “Between 1993 and 2013, China built 200 cities of a million people or more. This was incredibly intensive in terms of steel and copper and other commodities.”

Consider that for a moment. The US, the third most populous country in the world, has just 10 cities with a population of 1 million or more. But China built 200 of them in just 20 years. That is absolutely stunning!

The Chinese boom is tantamount to the massive buildout that occurred in Europe and Japan after WWII. In fact, it was even bigger.

Yet, that massive infrastructure buildout has finally come to an end, and with it so has the commodities super-cycle. Hence, the global crash we are now witnessing.

Commodity prices have fallen to their lowest level since the financial crisis and — by at least one measure — to the lowest this century.

The Bloomberg Commodity Index, which tracks a basket of 22 commodities, has fallen to its lowest level since 1999.

Copper is a key component in manufacturing everything from electronics to cars and other industrial goods. But copper prices are near their worst levels since 2009. Copper has sunk by about 22% so far this year.


China represents 40% of global demand, says financial blogger Wolf Richter. But China and the rest of the global economy are slowing. Absent demand, supplies have grown, so prices have fallen.

Shanghai steel futures have fallen to a record low, largely due to shrinking demand from its top consumer, China.

China is the biggest buyer of iron ore, but its demand is rapidly dwindling. Construction activity in China has fallen considerably over the last year or so.

A global glut of iron ore has sent prices to below $45 a tonne this year, less than a quarter of record highs seen in 2011.

Think about that: iron ore prices are less than a quarter of what they were just four years ago. That’s an epic crash.

Here’s how the NY Times describes it:

"The fall in prices for a variety of products, including crude oil, iron ore and agricultural crops like corn and soybeans is reminiscent of the collapse of the technology boom in 2000 or the bursting of the housing bubble nearly a decade ago. And behind the pain and anxiety are headwinds blowing from China and other emerging markets, where growth is slowing and demand for the raw materials that drive the global economy has dried up.”

Economists describe trends as either cyclical (repeating in shorter-term ups and downs, aka booms and busts) or as secular, meaning they are long term. There is every reason to believe that commodities are now in a secular down trend.

China is not about to build 200 more cities of at least 1 million people over the next 20 years.

That means the global economy is also likely on a long term downward trend. Growth will not match previous levels.

Slow growth and stagnation are likely the new normal.

The only thing growing at a great clip is global debt.

Slow growth and rapidly rising debt are a really unhealthy combination.

But, again, that’s our new normal.

No one wants to hope for an economic expansion that might follow WWIII.

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