Commodity Driven Role Reversal

by: Eric Coffin posted on: July 04, 2008    
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David Coffin co-wrote this article.

In the 1970s, Baby Boomers were swelling job ranks and women were moving out of the home and into the paid workforce in most of the industrialized world.  At the same time, OPEC pushed crude oil prices through the roof to overturn what it viewed as a predatory system of resource transfer set up by colonial powers.   

The expanded wage earner base in the industrialized economies was able to absorb the imposed cost gains well enough to create an upward spiral of inflation that had to be choked off by heavy handed interest rate jumps in the late 1970s.  Even though this meant an economic hang-over in the early 80s, inflation also created permanent price gains for big ticket items like housing and cars in wealthy economies, and the former became a mainstay of increased wealth in the industrialized world.

That hangover, ironically, was most heavily felt in resource exporting economies that crashed because the excess pricing had in turn generated excess funding and created an oversupply of most mineral resources.

The downside of this included a banking crisis, first from South America in the late ‘80s and then from Mexico in the early ‘90s. Both resulted from over lending in dollars that could not be repaid because mining venture profits had been reduced to zero and producer currencies had dropped like stones in dollar terms.  OPEC members had their own problems, but oil extraction costs in many of them were so low they did avoid bankruptcy by undercapitalizing their sector.

The upside from this was political, with Latin America, the Soviet system and parts of Africa tossing off dictatorial rule that had lost its hard currency funding base.  India and China were both reforming in largely closed economies outside of the direct impacts of the hangover, until recently.

In the 2000s, Baby Boomers are leaving the wage earning economy and women, more or less, are a fully integrated part of the Industrialized economy other than in Japan.  Wealth has become large enough in industrialized economies that people are having fewer children, to the point of creating what is in essence a domestic undersupply of people.

This is made up by immigration or guest worker programs in most places, but this has none the less generated an upward spiral of per capita wealth creation.  In China, a forced “one child” policy has been a large aid in creating the economic miracle there, especially in urban areas where the one child rules were harder to dodge.   

Low inflation rates resulting from a shift towards a more ephemeral industrialized world service economy and goods export from low wage economies became the norm.  This allowed long term decreases in the cost of capital which, among other things, has driven the price and in many areas the supply, of housing to unrealistic levels.  

Large population economies finally hitting their stride in terms of accelerating per capita income and 20 years of under investment have driven the commodity boom that is familiar to all by now.  This is leading to a role reversal in terms of money flows and wealth generation.  Its still unclear how all this will settle in the long term but its making for some serious economic strains in the short run.

When OPEC had its way in the 1970s, it helped create some structural changes that were, in retrospect at least, good for all.   There was a drive to greater energy efficiency in the industrialized nations that held until a low oil price in the 1990s brought back the SUV.  Even after the return of mega-cars energy consumption is a much smaller proportion of the G8 economies than it was 40 years ago.  That is one reason why oil prices could and did move though $100 a barrel without western economies wilting, though they are looking frayed at $135.

These increases in energy efficiency were not mirrored in the developing world for the simple reason that they were very low per capita energy users to begin with. The last energy price run did not affect them as much.

During the OPEC price surges, it was easier for developing nation governments to install energy price subsidies. They became commonplace in Asia and in developing countries that had a domestic oil producing sector.  A lot of the world’s population has been sheltered from energy price gains until very recently.  That was manageable with $30 a barrel oil, but at $130 it just doesn’t make any sense. 

There is much talk about high oil prices leading to demand destruction.  That will only happen where the price signals are transmitted to the marketplace.  In many of the world’s most populous countries, consumers are paying a fraction of the real cost of energy.

In the past few days, several Asian countries have cut subsidies, but there hasn’t been a move yet from China.  Cheap energy is considered a right in many of these countries.  Its political suicide to allow more than token increases.  That is one reason why energy consumption is rising so rapidly in the BRIC nations even as it stalled out in Europe and North America.

Energy aside, many developing countries have been on the right side of the commodity boom and generating surpluses from trade in general.   Their better financial condition has allowed them to retain subsidies on oil and other staples.  These have helped keep inflation imported from the US thanks to pegged currencies, at manageable levels.  The US alone appears to have inflation under control, but that is a fiction based on false statistics and the export of loose money.

The combination of exported inflation, false price signals on many “soft” commodities thanks to pegged currencies and subsidies, and stupidities like grain-based ethanol production is now coming to a head.  Economies are reaping what they sowed.  With food staples, like energy, meddling in the marketplace has ultimately made things worse.

With oil hitting records, the meddling will continue.  Politicians are looking for someone (else) to blame.  The current villain of choice is commodity markets and “speculators”. (For the record, speculators are people who drive up the price of things you want to buy.  Investors are people who drive up the price of things you already own). Politicians are likely to discover what most of you already know; prices of “stuff” are rising because more people what to buy them than sell them right now.  There are definitely funds and other larger investors taking larger positions in just about everything commodity than every before.  In that sense, the politicians are right.  Where they are wrong is viewing it as “mere” speculation. 

Investors view many commodities, and especially oil, as “anti dollars”.  It’s no coincidence that some of the biggest climbs in prices for energy metals and soft commodities came in the midst of US financial crisis.  Commodities are getting viewed as both portfolio stabilizers and plays against the Dollar.  This has created a market backdrop where energy prices are becoming a major drag on consumers in the G8 while foodstuff prices are in danger of having similar effects in the developing countries.

Is there a happy medium here?  In one sense, no, because not all of the prices increases are mere market moves.  A lot of the demand surge is real. Enforcement of some commodity market rules, like position limits for “non commercial” traders will help but higher prices for most commodities are a fact of life for the foreseeable future.

At the end of the day, to even be partially successful, price signals will have to be allowed to function.  The best way to start that will be for developing countries to start loosening up their currencies. No one expects that to be a painless maneuver, but it will benefit those economies by cushioning increases in US dollar priced goods like commodities.   It will also help developing economies start to get inflation under some control before it gets completely out of hand.  

This partial solution would have some very direct benefits for the US, though they might not be appreciated.  As a debtor nation, the US would benefit by having cheaper dollars to pay off debts.  This is a time honored method used by banana republics everywhere to get rid of foreign debt. 

Developing countries would see increases in purchasing power, though that would be weighed against higher export prices due to stronger currencies.  Energy and other dollar priced commodities would become cheaper.  This could ease some of the strain due to subsidies and allow some of them to be decreased or phased out. 

Properly handled, increased currency values and lower input prices should enable fast growing countries to keep productivity gains coming while rewarding workers with greater purchasing power.  It would also help ease inflation that is ramping up dangerously in many countries.  One good example of the impact of a floating currency is Brazil.  For decades, Brazil was a basket case when it came to inflation.  It now has the lowest inflation among developing nations.  The reason for this is a floating currency.  A rising Real has created some other problems to be sure but it has kept inflation in check.

This would help the US as a debtor nation but it’s less clear that it would help individual Americans in the short run.   US exports would become more competitive still.  Exports are already one bright spot in a weak economy.  Rising foreign currencies would make US goods that much easier to sell.

The US would obviously not escape the trap of rising energy and commodity costs in dollar terms.  The only way that will happen is if the world finally moves away from dollar pricing, and if real price signals in other economies generate enough fall off in demand. 

Many in the US administration are aware of the fact that some commodities, notably oil, may move away from dollar pricing. There were a couple of bounces for the dollar thanks to (marginally) better economic news and saber rattling by  Fed chief Bernanke.  Many observers suddenly got bearish again on metals, gold and oil.  They pointed out that “you can’t fight the Fed” so you’d better lose those long commodity positions.

While we think oil is overbought and due for a pull back we think this is a case where nothing could be simpler then “fighting the Fed”   After all, just what could the Fed do to enforce its wishes?

With horrible housing numbers and falling employment, the odds of an interest rate increase look close to zero right now.  With investment  banks set to release yet another set of lousy quarterly numbers and banks choking off  credit, changes in things like reserve requirements are a non starter and unlikely to have any effect anyway.  Bernanke’s bluster seems an empty threat and the market is quickly discounting it.

In the longer term, the answer for foodstuffs is more production and less protection.  Barring weather disasters this is the commodity segment that can respond most quickly.  Sustained higher prices are manageable in many high growth economies.  Indeed, higher food prices should inordinately benefit the countryside.  That   sort of income leveling is exactly what many of these countries have been looking for to keep farmers from streaming into the cities.

Higher energy and metals prices are less fixable.  They should be viewed as a fact of life we will all have to deal with. Especially if one thinks in dollars.  The trick will be managing this historic wealth transfer to minimize the pain in the G8 while maximizing the gain for all concerned.

From the June 2008 HRA Journal

Disclaimer: We do not receive or request compensation in any form in order to feature companies in these publications.  We may, or may not, own securities and/or options to acquire securities of the companies mentioned herein.

This article has 25 comments! Add yours below...

Eric Coffin

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This article has 25 comments:

  •  
    redbaron
    Jul 04 08:20 AM
    I agree. One cannot be for free trade, and then be opposed to the results that concept brings.
  •  
    jlounsbury59
    Jul 04 10:05 AM
    My Website
    Excellent discussion. I have been wondering if the unspoken policy of our government is to devalue the dollar so that our accumulated debt will be less in real terms. This can't work if the debt rises faster than than the dollar devalues. Thus, for this strategy to work, we must reduce defiicts. However, if we balance the budget, the value of the dollar will tend to rise. Bottom line: bite the bullet and balance tax revenues and expenditures. Painful in the short term? Yes. Long term benefit: priceless.
  •  
    jjason
    Jul 04 10:18 AM
    This article is too wordy...therefore too long.

    I stopped after you said " Enforcement of some commodity rules...like position limits...will help " because this contradicts what you said about no speculation.

    Do you know that the Commodity Futures Trading Commission is not doing their job? Did you read:

    www.star-telegram.com/...

    and

    www.commerce.senate.go...

    When Henry Paulson and Sam Bodman say "There is no speculation going on in the oil futures markets", they are either uninformed or are lying.

    I suggest you read these two articles and write an article about these two authors in your next piece.

    Also, please explain why Enron was able to manipulate energy markets.

    Price fixing is going on and it is ignored by the MSM, talking heads and everyone who is profiting from it. That includes the eastern investment banks.

    Some members of Congress are aware of the market manipulation gimmicks and are trying to stop it.

    Which side are you on?

    And, that as whole in the white house is also complicit in all of this.

    On a National Geographic documentary this week I learned that the largest consumer of gasoline in the world is the US MILITARY!

    Maybe getting our troops out of foreign countries can help balance the federal budget, strengthen the dollar and put Americans back to work in the USA fixing roads etc.

    Disclosure = no long or short positions in any commodities or energy stocks
  •  
    fireball
    Jul 04 12:01 PM
    a little wordy but worth the read. so be more cautious with soft comodoties. gold silver energy energy energy. i still think a lot of stabalization would occur with metal backed currency. i am aware that gold and silver would go astronomical but i sense that the backing of good faith in our gov. is waning. sarcasm intended. i lost faith in washington long ago. a few statesmen and true public servants could do so much good. i read awhile back that gold should be about $40,000 per ounce to match our supply with our currency abundance. do you think those awful white rich men (sarcasm intended) the founding fathers gave us good rules to follow after all. i do believe that those same men would be horrified if they saw what time and corruption have done to the republic they sacrificed so much to begin. the mob rule of democracy would make them sick. i wish every american would take the time to read the constitution and bill of rights. only a lawyer or politician is twisted enough to talk about interpretation. it is in plain language of the day for the common man to understand. so please on this day at least consider reading about where the greatest (with no apology or compromise) nation in recorded history came from. read the second ammendment as the easiest example of plain language being twisted by legal gymnastics. it was never about hunting, home protection, or fighting indians. it is very simply about keeping government afraid of the people instead of the people fearing government. if you have no fear try telling the irs next spring that it has been a rough year and you can not afford to pay in 2008. maybe if you read those documents you will become interested enough to take a closer look at the tax by force and terror that exists today. one other thing, when the country began lawyers were not allowed to hold office. thus no of the lawyers by the lawyers for the lawyers. who makes money no matter what you try to do? how does a lawyer sink lower in the scum? he becomes a politician. have a nice independence day.
  •  
    icandoitdon
    Jul 04 02:02 PM
    "Rising foreign currencies would make US goods that much easier to sell."

    yes, this is the same snake oil that countless administrations have used to excuse themselves from mismanaging the budget and having to beg foreign nations to support us in our never ending quest for thosethings we cannot ourselves afford.

    there are two sides to this coin. a cheaper dollar also means substantially higher prices for imported goods. how would you like to see what's happen to oil happen to automobiles, electronics, clothes, etc. etc.....

    you cannot borrow your way to prosperity and you cannot devalue your way to prosperity. those who advocate these policies are ignorant.

  •  
    Jan
    Rogozinski
    Jul 04 06:08 PM
    My Website
    Why is everyone afraid to say that oil prices have gone up because of the colonial occupation in Iraq. Which was financed by borrowing.

    Why does everyone let McCain and the other Republicans get away with calling the Democrats big spenders. War is the most expensive thing there is. Saving 20, 30 100 billion a year in "earmarks" woudl be penny pinching with no benefit no effect, as long as the colonial adventure continues cosing 100 billion a month, which then is borrowed..
  •  
    JREB777
    Jul 04 08:41 PM
    It all looks very good. But now comes the real thing.
    I live in three different countries: USA, Taiwan/China, and Peru.
    I move between these 3 every month.
    If you think the US consumer is hurting with high prices you can't imagine what is happening in the other two.
    US feels bad.
    Taiwanese are very much afraid and taking action to curtail spending.
    Chinese are being squeezed and their budgets can't sustain even $2 gas right now due to all the inflation.
    Peruvians are just plain dead. They now can't even feed their families because 50% of their budget has now gone up in price 200%

    So deman destruction takes time as people adapt, but it is taking place right now at an unprecedented level.
    By next year we will all realize that the world will be consumig 80million bpd from the current 87 million. The last 7 million bpd then, will be looking for a buyer and they will not find one until it is below $50
    This is how recessions work and this time it will not be any different.
  •  
    crudeoilcrac
    khead
    Jul 05 12:57 AM
    "Why is everyone afraid to say that oil prices have gone up because of the colonial occupation in Iraq"
    It is little more complicated than that. Trying to attribute one variable to the rise of the price of oil is not a very practical and makes little sense.
  •  
    crudeoilcrac
    khead
    Jul 05 01:05 AM
    I forgot to source the quote above "Why is everyone afraid to say that oil prices have gone up because of the colonial occupation in Iraq" to it's author, Jan Rogozinski. Colonial occupation in Iraq is neccesary because oil prices will go up would have been closer to the truth.
  •  
    jjason
    Jul 05 06:24 AM
    Push up oil prices and you push up food prices. If no one wants to get involved in solving the problems caused by the high cost of oil then some people in the world will starve.

    Calling commodities an asset class and allowing speculation is part of the problem..and I do not see enough bloggers on SeekingAlpha doing anything about it.

    Sorry about the people in Peru, JREB. However, I agree with you that we might see oil at $50.00 a barrel.

    Then watch all the highly priced coal companies take a dive too.

    In the meantime, if you are concerned, go back to the first comment I made and do more to bring oil prices down.

  •  
    jjason
    Jul 05 06:35 AM
    To crackhead,

    On the National Geographic channel this week I learned that the biggest consumer of gasoline in the world is the US MILITARY.

    Too bad the mindset of the US public is war, war, war.

    And if you are a Republican and supported GWB in his misguided effort to save the world, you are partly responsible for high oil prices.

    Oil prices were lower when Saddam was in power and he had the SOB's under control. It's control of world oil prices that Bush and Cheney were involved in and now we are seeing the benefits of Bush's policies.

    Aren't you all hopeful that John McCain wins the next election so we can bomb, bomb, bomb, bomb, bomb Iran?

    Happy Independence Day.
  •  
    fireball
    Jul 05 11:51 AM
    we have oil. we can not get it because it would step all over environmental sensibilities. o.k. because of past restrictions it cannot be producing until 2010 or 2012 or even later. so we sit on our oil companies and talk about global warming and do nothing. meanwhile the bric countries rape the environment. but they signed kyoto and we did not. yet as far as i can tell the u.s. is more cautious and concientious than any of those who signed. it was not hard for the rest of the world to agree that we must be pristine while they do whatever is necessary for their prosperity. we clean up our messes better than most. i do not care for mccain but i know if we do not start going after our own oil in 2012 we will be saying but it will not come to market until 2014 or 2016. like it or not we are stuck with oil for years. i am all for the new greener energies but the trasition time leaves us with oil. will we let a baboon like chavez or our arab friends continue to threaten our national well being. i love nature and i love animals but i also know we are the nation that can get our own oil with the least environmental damage. yes america and americans first no apologies.
  •  
    fireball
    Jul 05 11:52 AM
    almost forgot i do not like obama either.
  •  
    icandoitdon
    Jul 05 01:26 PM
    "Colonial occupation in Iraq is neccesary because oil prices will go up would have been closer to the truth."

    oil prices have quadrupled since the time we invaded iraq and this blind patriot says they'd have probably gone higher had we not done so. it's a good thing this kind of blind patriotism, utterly devoid of rational thought, didn't exist in the late 18th century or we'd all still be speaking the queen's english.

    "will we let a baboon like chavez or our arab friends continue to threaten our national well being."

    more of the same nonsense. i'm hard pressed to understand why other countries are supposed to operate in america's interest. i would think that each country operates in it's own self interest...isn't that the essence of capitalism that we all embrace?

  •  
    fireball
    Jul 05 02:22 PM
    icandoitdon. you are putting words in my mouth. i have never been for war in iraq or afghanistan. yes i am aware of the problem of price. if the gov said let us occupy and take their oil at least there would be a reason. i am very much against imperialism. i am saying let us solve our problem ourselves. i do not expect any country to see to our best interests unless they benefit. i am saying let us look after our own best interest. the response from you seems odd if you read what i said. my blind patriotism is for the well being of this country and to try to bring it back to the boundaries of legal (constitutional) government. i am not a bush supporter either. the only president i really like from this century was jfk. you misunderstand me if you think i am blindly patriotic. i look at what we should have as compared to what we have. yes the price of oil is a mess. i am saying let the u.s. get to work on our own oil production now. let our supply counter the demand while we move to alternative energy. it will take time so let our nation profit while we solve our problem. domestic production domestic jobs is not a hard concept. a metal backed currency is for currency strength. forgive me my faith in amercans and my belief that if we must we can stand alone. i share the belief of george washington that we should avoid foreign treaties and entanglements engage in fair trade and show the people of earth that freedom is the path to prosperity. your responses make no sense if you were responding to me unless you are a lawyer.
  •  
    fireball
    Jul 05 02:52 PM
    perhaps i should not refer to chavez as a baboon but my girlfriend is venezualan. her father was a very successful businessman. now they have nothing and her family is spread across the globe. chavez has confiscated everything almost. the rest is tied up in red tape and bit by bit is taken by this brutal dictater. so yeah chavez is a baboon. but i am not calling for invasion of venezuala to take their oil. if we invade to enforce the monroe doctrine i am all for it but only if we follow through. there are plenty of hostile governments in this hemisphere.
  •  
    ehart500
    Jul 06 01:03 AM
    The biggest problem, both economically and in terms of national security, is a cohesive and wise, long term, rational, sustainable, and all inclusive ENERGY POLICY. (Do not conserve while we drill ANWR does not qualify).

    Three trillion$ in Iraq was wasted. The tragedy is that this money should have been spent on a Manhattan Project style energy policy to develop all of this nations energy potential: nuclear, coal, gas, fuel cell, wind, wave, etc.

    By picking the wrong war, and responding to the wrong crisis, Cheney and his understudy have put the nation on weaker footing, and have damaged our freedoms, security, and prosperity.

    But we will vote for McCain because everyone is scared of the bogeyman.
  •  
    icandoitdon
    Jul 06 11:00 AM
    fireball....

    thank you for clarifying your comments. if i misunderstood the context i apologize. our views are similar.

    ehart500...

    i don't understand the reference to "the bogeyman," not that it matters. while i am not convinced that barak obama is the savior that some think him to be, i am convinced that this country does not need an old man bitter about failed u.s. efforts in vietnam and iraq as our next president. i am normally not single issue voter but this year is an exception. i will not support any candidate that supports the single largest foreign policy blunder in the history of our country, which is the iraq war.

  •  
    Neal
    Vanderstelt
    Jul 06 01:50 PM
    hello
  •  
    Neal
    Vanderstelt
    Jul 06 02:00 PM
    Oil will only go up in price if physical quantities are taken off-line. Obviously the Iraq war is not the only reason for any evaluation of oil. Did anyone even mention China? China has accounted for something like an increase in 20 percent of the new demand for oil. Think about this. China is a huge country, I think their population is 3-4 times the USA and India is also similar in size in population. What's happening here? Well you see everyone wants to link this back to the US somehow because of hatred (OPEC countries - Muslim Jihad) but if you think about what happens when people come out of poverty they place a new demand on a commodity and that is what China has done. As more people from over-populated countries come out of poverty it will drive up the cost of oil and hence inflation. It's not too difficult to understand but easy to dismiss if your trying to make a different arguement why oil is going up but the fact is more demand will drive up price when there's less supply and that demand is primarily coming from China.
  •  
    Neal
    Vanderstelt
    Jul 06 02:08 PM
    The other misconception is that speculators drive up the price. This can not change the fundamental picture because no oil is taken off-line by speculators so it does nothing to the supply and demand issue. People (especially OPEC Jihaders) will try to deceive people of the true manipulators of price which are the ones that control the physical supply - ie OPEC. When supplies are limited there is a battle to stock up on oil as global users fight to get supply. This happens when a supply chain is disrupted or manipulated and has nothing to do with people who speculate a contract will go up or down. In fact speculation works in both directions and if this was true the price would also be driven down. The actual price is because of fundamental supply and demand which OPEC Jihaders will have you believe otherwise.
  •  
    fireball
    Jul 06 02:17 PM
    icandoitdon thank you. good luck to you and all of us on monday morning. i am trying to learn more about gbrc. i have entered a small position but am likely to increase it if half of what i have learned is true. i am much more interested in the gleanings of this posting community than i am in the bloggers opinions.
  •  
    iThinkBig
    Jul 07 02:12 AM
    My Website
    It is a long article but states a lot of big picture cause and effect and this is good to see time to time. American has but one clear choice: Increase it's own energy supply and fast.

    On the political comments, neither politician running for POTUS is talking about drilling on top of the alternatives. McCain's plan for nuclear is somewhat of a no-brainer and old news to me, U.S. automakers are staging a comeback through plug-in electrics that are stellar. That will solve a lot of our demand equation in the mid to long-term but we should also increase supply of oil by drilling in our own back-yard in the short-term, if nothing else to take some speculative froth off the market.

    Truth is, the higher energy prices are good for taxes and doing little or nothing on adding oil supply seems to make sense for this government, especially if you consider personal investments by both Dems and Republicans, family members etc.

    They obviously by there lack of actions have not read much history of economics over the last 2500 years and the outcomes of running out of energy supply (Romans) to what a population does with taxation without representation.

    This is treasonous behavior and as a data base guy, I am taking names. No retiring to a comfy ivory tower for many of these guys in office, they will at least be publically humiliated.

    I give Bush and Cheney credit for submitting a great energy plan to vastly increase our supply of energy in several areas, including drilling and coal liquification, that was in 2002, 2 year PRIOR to Iraq. The Republican vote for was 89%. The Democrat vote was 91%. So before all you sing the high praises of socialism, let's remember 30 years of inaction from Washington. And yes, the last President with energy independance vision was Carter. That was the one bright spot in his otherwise moronic Presidency.
  •  
    iThinkBig
    Jul 07 02:14 AM
    My Website
    Dem vote AGAINST was 91% in 2002. Need a supermajority of 60% to pass a bill.
  •  
    crudeoilcrac
    khead
    Jul 09 02:49 AM
    jjason
    I was already familar that the U.S military was the largest user of petrol. Thank you for sharing your intrests in the program National Geographic with me. I think you fail to missunderstand a few points however. The first problem is that you have your history wrong. Oil prices spiked to their highest ever when Iraq invaded Kuwait the first time. (I did not find that on National Geographic, but you can check various references.) I never said that these actoions would make oil cheaper now, that is your mistake. These actions by the Government were to prevent future disruptions. Maybe I should repeat that JJason. These actions were to prevent future disruptions. Oil supply is critical for the U.S. military, the U.S. was not likely to leave a dictator in place with ambitions to invade Iran and Kuwait. The invasion of Iraq has nothing to do with oil prices today, it has to do with oil prices 10 years from now.
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