Recession Watch: Falling Commodity Prices to Hurt America

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Leading indicator of trade, economic growth, and geopolitical instability.

By Larry Kummer, editor of the Fabius Maximus website:

US exports, a problem that even the Fed warned about, depend on the health of other economies that are buying US products. The emerging markets are important customers for US goods, growing as they evolve from exporters to have more balanced trade. Trade figures from emerging markets (EMs) are only somewhat reliable, but imports’ share of EM’s seaborne trade has grown, and equaled that of exports for the first time in 2014.

So falling commodity prices are now a mixed blessing for the US economy. It multiplies exposure to slowing growth in China, the third largest buyer of US exports, with a 7% share of total exports year-to-date (Census, through September) — as China’s slowing continues to depress commodity prices. Several nations that rely on commodity exports are big customers of the US: Canada, Mexico, Brazil, and Australia — totaling 38% of total exports. All are slowing; Brazil might implode.

The other commodities exporters are in aggregate significant to the US, and some of them are hurting, such as Russia and Venezuela.

As a secondary effect, falling commodity prices slow growth throughout the emerging and developing nations. Their GDP grew 6.3% in 2011, slowed to +5.0% in 2013, +4.6% in 2014, and +4.0% this years. Next year will be worse if China continues to slow and commodity prices continue to fall.

That means hard times for much of the world. For example, metals exports are 15% of GDP for Chile and Zambia, 6% for Peru and Niger, and 5% for Australia and Bolivia. Mining (esp. copper) produces one-quarter of GDP in the Democratic Republic of Congo.

While oil began to crash in mid-2014, other commodities began slowing in 2011, a process that has turned into a rout.

It’s not just oil that’s in oversupply. It’s a broad collapse in prices, from the big three metals (iron ore, copper, aluminum) to agricultural products. There’s even a glut in diamonds. Non-fuel commodity prices have fallen also:  down 1% in 2013, -4% in 2014 , and estimated by the IMF to be -17% in 2015. That’s probably optimistic; -20% looks more likely. The 2000-2011 commodity supercycle has died.

Commodity prices are ruled by positive feedback. As prices fall production often increases as extractors increase production to pay their bills. “High-grading” allows them to survive as prices fall (tapping higher grade, more profitable reserves to offset lower prices). Also, lower commodity prices themselves often reduce costs. But this magic works only for a while.

Eventually the “cure for low prices is low prices,” as capital investments are cut — which eventually reduce supply. Glencore has announced cuts in zinc and copper production. Freeport has announced major capex cuts. Eventually everybody will slash capex to survive, with the total drop in capex probably 50%.

“Eventually” means it takes several years for industrial metals production to fall. Oil could react more quickly if OPEC decides to cut production. A big production cut, if it materializes, could hit the oil market like a thunderbolt. The effects of capex cuts last even longer; it takes a decade or two to open a new mine – even after the burns of CFOs’ heal so that they’ll again sign checks for capex.

EM economies are highly cyclical, as their weak governments (both politically and financially) provide few counter-cyclical stabilizers (e.g., the highly effective food stamps and unemployment insurance). Worse, both their private and public sectors often have too much debt, especially at the end of a boom. Falling commodity prices can easily cause recessions in these economies, or worse.

Then conditions worsen. Those with freely-floating currencies (most of them) see a substantial drop in their values vs. those of developed nations. That acts as a natural shock-absorber. But their falling currencies lead to outflows of foreign capital, making it difficult to borrow in their own currencies to either stabilize their economy or maintain capex.

And most have not learned the perils of borrowing in foreign currencies, attested to by a record $9.6 trillion in US-dollar denominated non-US debt outstanding. As their own currencies weaken, their external debts grow larger, and their debts denominated in foreign currencies become more difficult to service [read… World Is Now “More Exposed than Ever” to Explosive Dollar].

All of this means less buying from American companies. If it continues, there will be defaults by corporations and eventually governments, contagion of economic stress to neighbors and trading partners, and political instability. The history of the Middle East, Latin America, and Africa shows how these trends can feed on themselves, and turn ugly quite quickly.

Of course, economists predict an upturn in prices and economic growth in 2016, as they usually do – just as the housing bust was “contained” in early 2008. The magnitude and duration of trends often surprise economists, who tend to have exaggerated faith in systems acting for regression to the mean.

Watch commodity prices as a leading indicator of trade, economic growth, and geopolitical instability. They are among the major risk factors for 2016. By Larry Kummer, Editor of the Fabius Maximus website.

A new era has begun for the US and global economy. Read…  Recession Watch: Turning Point in Unemployment Claims?

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  9 comments for “Recession Watch: Falling Commodity Prices to Hurt America

  1. Petunia
    November 24, 2015 at 7:06 pm

    The last computer parts store in the state of Florida, Tiger Direct, is closing its Miami store before Christmas. That’s a leading indicator to me. If a city of over one million people, a banking center, considered the gateway of the Americas can’t support one computer parts store, the economy is not improving.

    • Nick Kelly
      November 24, 2015 at 9:14 pm

      I trained as a computer hardware tech and I was not sure what you mean by computer parts.
      Do you mean stuff like monitors, speakers, e.g., accessories

      or next level: whole boards ready to plug in, like video boards, or power supplies etc.

      or final level- actual chips- DRAM etc.

      If you mean the last one, this is a developed world phenom- most consumer electronic stuff is not economically repairable. The geek- hobby market is too small to have a bricks retail outlet- it’s mail order. Part of Radio Shack demise. You used to be able to buy components there.

      In a large US center I would have thought you could buy enhanced video boards and power supplies.

      Little trivia segue- at the tech were I trained, someone had donated a round screen vacuum tube TV. On the back instead of “Do not open”
      was a pictorial with a short description of what each tube did: e.g. ‘ horizontal sync pulse’
      Back when it was around, the owner was expected to change tubes and the diagram helped him diagnose the prob. Times have changed.

      • night-train
        November 25, 2015 at 4:16 am

        NK – As a kid, a guy came to our house with a big toolkit containing tools and tubes. Sometimes, you could take off the back of the TV and tap on the tubes and make them work a while longer. Dangerous? Of course, but we had our three channels to watch. And few had a second TV in those days.

        Sometime I will tell you about my first transistor radio.

        • Nick Kelly
          November 26, 2015 at 2:11 am

          Or the pocket rocket- just one diode, no amplification so no distortion.
          At night with a good antenna and ground you could get hi-fi- as long as the station wasn’t too far away.
          Then there is the pre-diode- the cat’s whisker- a pin you moved around on a small pad of germanium until it acted like a diode.

      • Petunia
        November 25, 2015 at 9:51 am

        My son builds computers mostly for gaming and he built all of ours. The radiator cooler on his computer burst and he had to rebuild it . That’s how he found out about the last Tiger Direct closing. He orders parts online but it is more fun to shop retail. We will miss the store.

  2. michael
    November 24, 2015 at 9:05 pm

    No sign of any slow down on the here in the SF Bay area. Cranes and consruction everywhere and housing prices continue to ratchet higher.

    • NotSoSure
      November 24, 2015 at 10:26 pm

      Yep Bay Area economic activity remains at elevated level. The malls are crowded, etc, etc.

  3. xabier
    November 25, 2015 at 1:37 pm

    Maybe this sums things up:

    ‘Our feet might be in the brown stuff; but our eyes are on the glittering construction cranes soaring overhead!’

  4. Cannuck
    November 26, 2015 at 4:18 pm

    An Englishman once said that every church should bear the inscription: “Important if true!” The same could be said of this article. Well done, argued and documented. However, rather discouraging. It’s a dangerous world out there!

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