Shifting Demand and Wealth -- Marc Faber
dailyreckoning.com
I have great sympathy for the view that over the last 200 or so years investments in commodities performed poorly when compared to cash flow-producing assets such as stocks and bonds. I also agree that, as the team at GaveKal suggests, “every so often, we experience a massive break higher in commodity prices in which commodity indices triple in less than three years,” which is then followed by a period of poor performance.
Still, we need to ask ourselves why in the last 200 years, commodities, adjusted for inflation, were in a continuous downtrend and whether it is possible that something might have changed in the last few years, which would suggest that this downtrend is about to give way to a sustained out-performance of commodities compared to the U.S. GDP deflator.
The other question is of a more near-term nature. Should commodities, having approximately trebled in price since 2001, be sold, or should we expect far more substantial price increases? I have to confess that I have little confidence that I can answer these questions satisfactorily. Still, the following should be considered.
In the 19th century, and for most of the 20th, industrialization was concentrated in a few countries, which for simplicity we shall call the Western industrialized world. The world’s economy was at the time characterized by an abundance of land, resources, and cheap labor (certainly in the colonies and later in the developing countries) and a relatively limited supply of manufactured goods. At the same time, growth and progress was concentrated among a very small part of the global economy - either in the Western industrialized countries or among a tiny part of the population (the elite) in developing countries. In addition, there were hardly any other sectors in the economy where productivity improvements were as high as in agriculture and mining. These factors - abundance of land, labor, and resources combined with huge productivity improvements and limited demand from the then still small industrialized world - may, at least partially, explain why commodity prices failed to match consumer price increases for much of the last 200 years.
Remember that, in the first half of the 19th century, manufacturing was concentrated in England with a tiny population, while the British Empire could draw on the supply of commodities from an enormous territory. Then, in the second half of the 20th century, we experienced the socialist and communist ideology, and in India policies of self-reliance and isolation.
As a result, about half the world’s population remained largely absent as consumers of goods. (How many motorcycles and cars were there in the Soviet Union, China, India, and Vietnam 25 years ago?) But, while largely absent as consumers, people in these countries continued to produce raw materials and agricultural products. Therefore, I suspect that the removal of approximately half the world’s population as consumers through socialism and communism may have been an important factor in the poor long-term performance of commodities compared to the US GDP deflator, and other assets such as equities.
Since the breakdown of communism and socialism, the world’s economic fundamentals seem to have changed very importantly. Initially, the impact of the end of socialism was muted. Production shifted to China, but as had been the case with production shifting from the West to Japan, South Korea, and Taiwan between 1960 and 1990, rising industrial production in former communist countries largely substituted for production in the West. But over time, in countries such as China, rising investments and industrial production boosted real per capita incomes considerably and made way for a tidal wave of new consumers. In turn, these additional new consumers lifted industrial production further in order to satisfy not only the demand from their export markets but their own needs as well. Thus, industrial production and capital spending increased further. This led to additional income and employment gains, further domestic demand increases and so on (multiplier effects).
In short, the opening of China and of other countries has permanently shifted the demand curve for consumer goods and services (for example, transportation) to the right and along with it the demand for industrial commodities and, notably, energy. Now, if all goes well in India (a big if, I concede), then the demand for goods, services, and hence commodities will continue to increase very substantially for another 10 to 20 years. Indian oil consumption has just recently started to turn up. Should its demand now accelerate, as we believe it will do, it is very likely that China’s and India’s oil demand could double in the next eight years.
There are a few more points to consider. For much of the last 200 years, developing countries, where many of the world’s natural resources are located, had trade and current account deficits with the industrialized world. These deficits were a constant drag on these countries’ ability to accumulate wealth. But now, through its current account deficit, the United States is shifting around $800 billion annually to the economically emerging world.
This represents a huge shift in wealth from the rich United States to the current account surplus countries. That this shift in wealth stimulates their economies and consumption, and along with it their own demand for commodities, should be clear. (Rising domestic energy demand in Indonesia amidst falling production has turned the country into an oil net importer!) Now, for most countries a current account deficit the size of that of the United States would lead to some sort of crisis (for example, the Asian crisis of 1997) and then to a curbing of consumption. However, in the case of the United States, which is endowed with a reserve currency, trade and current account deficits are simply financed by “money printing.”
So, at least for a while (but not forever), the shift in wealth to the emerging world won’t have a negative impact on America’s economy and consumption. And, at least for now, rising demand and wealth in the rest of the world won’t be offset by declining demand and shrinking wealth in the United States. On the contrary, the global imbalances arising from “over-consumption” in the United States have brought about a global economic expansion, which, while unsustainable in the long run, is nevertheless firing on all four cylinders at present. Simply put, the excess liquidity which the Fed has created - and which it is still creating, I might add - has led to a global and synchronized economic boom. (If money were tight, the asset markets wouldn’t rise.)
The following point regarding the demand for commodities is frequently overlooked. In the developed countries, commodities account for a very small part of the economy. As a result, price increases for oil and other commodities have a very minor impact on growth rates and on consumption. However, in the commodity-producing countries (Middle East, Africa, Russia, Latin America), commodity production is an important part of the economy.
So, when commodity prices rise, their economies are, as in the case of the Middle East, turbo-charged. GDP per capita then soars and leads to a consumption and investment boom, which then increases these countries’ own demand for commodities. This is particularly true for resource-rich countries that have a large population and also explains why, in the 19th century, when agriculture was still the dominant sector in the U.S. economy, rising grain prices led to economic booms, while declining commodity prices were associated with crises. (In recent years, financial markets have begun to have a similar impact on economic activity as agriculture had in the 19th century: rising stock markets = boom; falling stock markets = bust.)
In sum, we could argue that the emergence of a large number of new consumers in the world following the breakdown of communism, expansionary monetary policies in the United States, which have led to a rapidly growing current account deficit, the U.S. dollar’s position as a reserve currency, which enables the Fed to create an almost endless supply of dollars, and new demand from the commodity producers themselves, have all led to a significant increase in the demand for raw materials.
I am not predicting here that, from now on, the demand for commodities will always outstrip the supply. In time, new technologies (in particular, in the filed of nanotechnology), which will permit resources to be used more efficiently, and conservation will curtail demand for raw materials. But until the effects of these factors kick in, a tight balance between rising demand and existing supplies could remain in place for quite some time.
Regards,
Dr. Marc Faber
for The Daily Reckoning |
