Commodity Supply Shock 2012

Despite sluggish economic growth in the U.S. and much of Europe outside Germany, and low low interest rates coupled with a weak dollar, economic and population growth in Asia continue to push up commodity and energy prices. Looking at some critical commodities: oil, coal, corn, wheat, copper, these are all hitting two year (post collapse) highs and trending resolutely upward back toward prices not seen since the pre collapse peak. Economists expect continued phenomenal growth in energy and commodity demand from China and India over the next decade. JP Morgan is predicting a return to $120 oil by 2012, with the caveat that the U.S. economy cannot grow under $120 oil.

Relentless Chindia demand has decoupled commodity prices somewhat from the U.S. economy, meaning that economic growth elsewhere will be bidding energy, food and other critical prices up for Americans and Europeans at a time where Americans and many European economies, several of them in the midst of national austerity programs, have no reason to expect healthy economic growth over the next 3-5 years.

So, What Can We Realistically Expect?

Caught between the rock/hard place and, er, third hard place of supply-side inflationary pressure from commodity prices that steadily return toward, and in some cases exceed, the record levels of pre-crash 2007-2008, ongoing sluggish economic growth, and the liquidity trap resulting from the last bailout, the U.S. will absolutely, unequivocally have to vent additional GDP. Unemployment may double from current rates and the financial system may crater again without any hope of a bailout. The U.S. government simply cannot afford to repeat the 2008 bailout exercise.

Conservatively, this is what we can expect to see:

- A second recession for the U.S. and most of western Europe, beginning no later than 2012, but perhaps as early as mid 2011

- A round of international bank collapses. This time, big banks will be allowed to fail. Instead of bailouts, the government will be forced into increasing the numbers of FDIC takeovers and restructuring.

- A second round of housing price collapses. This time, home prices will fall back to 1990s levels.

- In Europe, the paradigm will shift from bailing out indebted nations to allowing those nations to directly default on debt. This will induce a tertiary wave of bank failures.

- global stock market crash, take two. The markets will crash to 20-30% below the 2008 trough.

- rising unemployment across the U.S. and most of western Europe will begin to affect the Asian economies as well.

- Within the U.S., state governments will be pushed into debt default and draconian levels of service reduction. Many states may lose an additional 20% or more of public employees.

The great recession is about to shift into Great Depression II, at least for the western world. There is literally nothing that can stop it.

 

Edit: Nevermind..

 

The silver lining, if there is one, is that boom times for American grain and coal exports are coming. To the extent possible, the U.S. will try to follow the Australian model of exporting all its vital commodity resources directly to China. Coal prices are reaching levels at which it is quickly becoming economical to float coal barges from the U.S. west coast all the way across the Pacific.

 

Does that mean Obama gets a second term?

If I may ask, where are you getting this information from?

 

The internet. So you know it's true.(TM)

Jabbaddoo theory: Great Recession of 2008 was caused in large part (not wholly) by broad-based energy and commodity price spike driven by rising Asian demand and U.S. economic peak

Fact: commodities are closing in on those bubble peak price levels again

coal prices: (Bloomberg, December 3) Benchmark coal for delivery next month in Northwest Europe has climbed 40 percent this year to $116.50 a metric ton as of 4:30 p.m. in London, the highest since Oct. 24, 2008

copper prices: (Bloomberg, December 3) On Nov. 11, the price reached a 30-month high of $4.0875. The record high was $4.2605 on May 5, 2008.

Same holds true more or less for oil, corn, wheat, steel, etc. Prices are retracing the curve leading to the pre-precession peak, perhaps at a slightly slower pace.

Plain fact: commodity prices are retracing the last peak even without a robust European/U.S. recovery.

My opinion: In other words, commodity prices now have the capacity to hurt our economy without us having benefited in the slightest from the kinds of economic activities that tend to bid up commodity prices. The U.S. and much of western Europe, it seems to me, have been locked out of this recovery cycle. Economic growth is much more of a zero sum game this time around, with China gaining share of the global economic pie as we lose share.

Also, I think that people would be surprised by just how much more it is possible for Americans to pull back on their consumption levels if pressed by higher prices. This is a reason retailers are afraid to raise consumer prices despite increasing costs. They are swallowing cost increases to the extent possible. And that will mean a slowdown in corporate profits. And that in turn will delay improvement in unemployment or make it worse. And the cycle amplifies as commodity prices rise.

 

So, now what. We declare war on China?

 

Better to just quietly ride the downslope of the decline and fall of western civilization. Try not to make the Chinese angry or get in their way. Speak softly and carry a big English-Mandarin dictionary. Maybe we'll get another turn at the top in a thousand years or so. Also, marry a cute asian girl and try to breed your DNA into asian stock.

 

[image=http://graphics8.nytimes.com/images/2008/03/16/world/16dalailama-600.jpg]

 

I haven't lived nearly long enough on this planet to become an expert, but I'm pretty sure most predictions are crap. Especially when they come from doom and gloomers. And the news. Which is itself a doom and gloom organization.

I'm not saying that predictions don't have merit. Just that most of them are oftentimes wrong or not even close to reality.

 

People have a hard time recognizing major paradigm shifts, whether in science or politics or economics or culture. The United States has been in relative economic decline since the 70s, but the collapse of the Soviet Union and being hailed briefly as a hyperpower in the 1990s (and then letting it go to our heads in the 2000s) obscured the fall. The decline of western civilization has been so slow that it takes us a while to catch on.

But the European media is all over it. They see their own decline and the see the decline of U.S. economic and political hegemony. That was I think more or less the overriding theme of German and French reporting on the WikiLeaks diplomatic cables.

The U.S. and Europe are now secondary economic powers, not militarily, yet, but soon, since relative military decline always follows economic decline. Fire_Ice_Death, you will see it in your lifetime - as the Russian military is to the U.S., so will the U.S. be to China in 25-30 years. We'll still be dangerous and strategically impregnable, but much diminished into a regional military power. If the Chinese ever achieves the per capita wealth of the U.S. or western Europe, its GDP would dwarf that of the U.S. and Western Europe combined. And in 30 years, they'll have the technology to field weapons more advanced than anything we can design or build ourselves.

In Europe, the currency union was a last ditch bid to make Europe the dominant economic region on the planet, but that has now failed. Europe, like the U.S. will fall farther and farther behind Asia.

In any case, back to the more specific prediction of high commodity prices decoupled from the health of the U.S. economy and eventually throwing us back into recession, the evidence for that is absolutely overwhelming. I have not seen one argument to successfully dispute it. We have food and coal and possibly Liquified Natural Gas (LNG) for export, but I don't think that will be enough to generate a trade surplus. The nation is still too deeply leveraged, both publicly and privately, and too ravenous a net energy importer for us to build a recovery in the face of a weakening dollar and rampant commodity price inflation.

 

Jabba, you are oversimplifying to an extent.

For example, a lot of banks bought up oil futures and ran them through the roof in an attempt to tell their creditors that they had enough cash on hand (when in reality, it was only on paper) to cover all the subprime loans that they had signed on to. Of course, when the jig was up, the price of oil dropped, along with the slowing economy, and that helped the bubble burst.

I think what is more likely is that we will see a major slowdown of, if not an end to, globalization as the price of energy and commodities rise. It will become cheaper to buy local goods and foods, and the incentive to continue global trade will fall as fossil fuels become scarcer and scarcer.

This is why I am so strongly for green energy. We can solve almost all of this with a new, realiable, renewable, cheap energy source...but that is the pipe dream, isn't it? On things like rare Earth metals, until we are able to successfully and cost-effectively mine the asteroid belt, there is going to be a pinch in this particular market.

I wouldn't be surprised if future wars were fought over metals, as opposed to oil.

Peace,

V-03

 

If the Chinese ever achieves the per capita wealth of the U.S. or western Europe, its GDP would dwarf that of the U.S. and Western Europe combined. And in 30 years, they'll have the technology to field weapons more advanced than anything we can design or build ourselves.

Except that it won't happen. China's growth is akin to that of a bacterial colony-exponential at first, then plateau, then decline. China simply can't lift 700 million people out of poverty and sustain anything even remotely near America's per capita income or national GDP. The small segment of the population that is driving their economic explosion-and it is small, percentage-wise-won't be able to sustain these levels when everybody else wants in on the action. As we are seeing now in the US with the need for real austerity, when you want to include everyone for less, there will be less for everyone. There aren't enough resources on the planet to make China come even close to what you are suggesting, and recent reports from their pharmaceutical industry show just how far they are behind the US in innovation on many levels.

Most of what they have gotten in technology, they steal. Especially military. The idea that they will field "more advanced weapons" than anything in the US is simply untrue. China reminds me of Morgoth from The Silmarillion. Yes, he had the strongest army, but he couldn't really make anything of his own, only copy other lifeforms made by Iluvatar. China may have figured out how to undercut the rest of the world on cheap manufacturing of consumer goods, but when it comes to technology and innovation, they have a long way to go, and many, many internal challenges to even begin to approach the level you suggest.

What is more likely is that they will remain a sharply divided society with a certain percentage of the population being "haves" and everyone else being "have-nots", almost like America to an Nth degree. They simply cannot sustain any real growth or power otherwise. I wonder if the leaders of China have come to realize this yet.

Peace,

V-03

 

The truth is, I agree with you that China will never achieve per capita wealth parity with the U.S., unless U.S. per capita wealth is halved over the next 20 years, and halved again in the 20 years after that, which is I think entirely within the realm of the possible.

There is not enough energy to go around for that kind of per capita gain in China, unless it comes at the expense of the developed world. And that's a huge caveat because it could easily happen.

I find the comment about Chinese technological capabilities to be naive though. China is not just stealing technology, they are sending their brightest to the west for higher education. And western companies are falling over themselves handing industrial technology directly over to them. I just saw an article a day or two ago (I'll look for it) about how the major western nuclear power plant builders are in a frenzy giving over nuclear power tech to the Chinese if it means contracts to build plants in China, which of course it does. Eventually, though, the Chinese tech boom will be self sustaining, and they won't need the west for technical innovation. That will happen sooner than you think.

And in the short and possibly medium term, Chinese absolute GDP leadership (not per capita) will continue to widen its gap ahead of everyone else.

At the end of the day, the Achilles heel of world economy is the same for the Chinese as it is for everyone else: fundamental constraints on the global supply (at the very least on the rate of increase in the supply) of critical commodities.

 

Rising oil prices, the recession and a new world order

The trade bargaining position of developed countries is expected to continue to worsen with the rise in prices of natural resources, so developed countries' economic growth will remain slow.

What does it mean for debt-laden Europe and the U.S. that commodity price inflation arises primarily as the result of economic growth other than their own? Chinese and Indian growth demands freeing up resources by inducing American and European austerity from middle class consumers. In the U.S., we achieve our additional savings by continuing the ongoing process of dismantling the middle class through job losses and stagnant wages.

 

Jabba, what do you think of reports/feelings that China is heading for a real-estate bubble-burst?

 

I'd like to ask Jabba what he thinks of the doubling in price of cotton over the last 9 months.

And working in the bedding industry, I have seen latex prices more than double since Feb.

The crazy thing is though is we haven't passed those increases onto the consumer yet. We've absorbed them into our existing prices.

 

A friend of mine taught law in Beijing last year. She has some pretty amazing stories to tell about housing costs. I'm not entirely sure a real estate bubble bursting, and it does seem like it has to be heading for a correction, would mean the same thing in China as it meant in the U.S.

Shanerjedi, cotton prices are directly on point. You're not passing rising costs onto consumers yet because you can't - consumer demand in the U.S. is still too fragile. And I don't see that changing until consumer debt deleveraging reaches some critical mass it hasn't yet hit. I wouldn't be surprised if U.S. consumers need to reduce revolving credit and secured debt by another 50% before they really free up additional sustainable household spending.

The U.S. is never going to return to the consumer debt economy of 2007. Those days are gone. We have to boost our savings rate and deleverage, just like federal and state governments will have to deleverage. It means years of austerity ahead.

 

If it teaches Americans fiscal responsibility as a whole, it's not necessarily a bad thing.

Austerity might mean a more focused citizenry, on things like education, hard work, and sacrifice. Culturally, the debt economy is a symptom of a collective laziness in our national mindset.

Peace,

V-03

 

True. Consumerism was the national religion in the U.S. for decades, although a lot of people don't seem to have heard the news yet that the party's over. You won't get the message from watching tv, that's for sure.

Inequality, Leverage and Crises

This is a great piece on the subject of inequality, the debt, and the recession and how they're all related. It's not just American laziness to blame but a deliberate effort to dismantle the middle class then loan them money to keep buying so that instead of being merely poorer, they're also poorer and massively in debt.

The conservative agenda in the U.S. is aimed squarely at the creation of a two tiered caste structure in the U.S. of rich people and indentured servants. The IMF paper calls the Great Recession nothing less than "a crisis driven by income inequality."

 

Jabba: Yeah we've held off raising prices for exactly the reason you cite: We can't. Everyone is looking for bargains and value. They're not simply buying on the spot. So the "new normal" is more value for less money(which is kinda the point great salespeople always should emphasize anyway but when times are good sales are easier).

And both yours and Vaderize's posts about austerity and educating Americans I completely agree with. I just hope that really happens.

edit I do think your point Jabba about the destruction of the middle class being a "conservative" agenda tells only half of the story. If it's a conservative agenda, then Obama, Geithner, Bernanke, and all the people pushing monetizing the debt and more spending are conservative.

It's an elitist versus the middle class struggle now. The only difference is the republicans want to use the eventual two class society for the corporate interests benefit while the democrats want to do the same thing but will give the poor a welfare program to "help" them.

Either way is a squeeze on the middle class.

 

Given the volatility of the stock market this week and the bad jobs data in the U.S., I think it's worth another look about whether my predictions from the end of 2010 are bearing out at the 2011 halfway mark.

-The PIGS debt issue continues to fester in Europe
-Consumer mortgage and credit card debt and downward pressure on home prices remains a drag on consumer spending
-commodity prices, particularly oil price increases have been an additional drag on consumer spending and producer prices
-state public debt problems will continue to have a negative effect on employment and consumer confidence
-Republican threats to eviscerate the federal budget increase fears of even more job losses to the economy.

-The media is talking a lot more about double dip recession now than it did six months ago.

-Despite the short term downward effect on commodity prices sparked by economic slowdown news, the real driver of commodity prices continues to be Asian growth. The U.S. consumer economy is no longer driving these prices.

 

"Fester", nicely put.

It has not become an acceptable opinion over here to want Greece 'kicked out of the EU'.

 

was that a "not" or a "now"?

 

Oh, yeah: now.

Not in this house, though!

 

I'd like to make a comment about Peak Oil. Yes, oil production in the world has peaked - but the peak is not going to follow Hubbert's peak.

As oil gets more expensive, the massive quantities of oil in more expensive locations becomes more profitable to go after - hence, while the upside of the peak may have been really steep, the slow down of the peak will not be like a Saudi oil field's peak.

We'll find more creative ways to get oil, and it will gradually run out and get more expensive, and it'll make the transition easier. It won't be nearly as bad as you think, Jabba.