There is no question that desperate waves of government spending and central bank liquidity have created a dramatic rebound in commodity and stock prices over the past 2 years. But just as government rescues failed to change the long term revision back to mean in housing prices, history tells us that the recent top down efforts to sustain inflation in stock and commodity prices will also fail.
Whether it be China which has propped up its economy on 50-60% government initiated capital spending, or places like the US, Europe and Japan that have propped up their toxic laden banking system with a mountain of government debt, each are different types of ‘centrally’ or ‘government enabled’ economies that are trying to dictate growth independent of organic, sustainable demand in the real economy. This has always been a recipe for economic pain and loss eventually.
Commodities have been in a major secular rally now since 2001, or just over 115 months. Interestingly we saw a similar duration in previous secular bull runs in other sectors like tech stocks and US housing. Yes the world has increasing population (for now at least) and therefore some natural year over year increase in consumption demand, but these trends remain fairly balanced: aging populations use less, while younger populations increase demand.
The real extenuating factor over the past decade has been that the credit bubble and the government spending bubbles that followed have played a huge role in accelerating the development, extraction and excess stock of most hard assets in the world.
We have built years of supply in vehicles, housing, commercial and government buildings all over the globe. In a post credit bubble world, we are awash now in supply of most “things” with fewer and fewer buyers who can afford them—at least, not anywhere near present prices. Trends that cannot continue won’t. Things that cannot find buyers will come down in price, probably by a lot before equilibrium can once again be restored in the global marketplace.
We have spending problems in the west for sure. Big cuts are coming to entitlements. We are all in for a wake up call. But developing countries like China have big problems too. The Chinese government was riding the credit bubble just like the rest of the world over the past few years. Like most people in incredibly good times, they banked on a continuation of endless foreign demand for their exports and tons of monthly cash flow to keep their domestic ball rolling. We westerners were such dumb addicted buyers that the Chinese amassed silly amounts of cash in the process. But times have changed. Recent data “surprised” with China spending more (imports) than they sold (exports) in the first quarter of this year.
Meanwhile less than 35% of Chinese GDP is consumed by its own domestic economy. Two thirds of what they make is meant to be sold to others. This trade deficit is likely to be an increasing phenomenon going forward. And this is where the plot thickens.
It is one thing to waste money on unneeded infrastructure and capital spending when one is awash in cash flow. (Ain’t that the truth?) It is quite another to keep it up when cash flow turns negative and spending must be funded from one’s savings alone. As any person who has experienced a large drop off in income will attest, there is a huge difference between spending from income and spending from savings. Savings are finite, no matter how large. Negative cash flow has a shocking ability to evaporate capital reserves over time and especially when one tries to keep up enormous capital outlays in the process.
Commodities have had a really phenomenal run over the past decade. But those who are banking on continued insatiable demand at elevated prices, are likely to be just as disappointed this cycle as they were in 2008. Countries like Canada and Australia, that have continued their domestic debt binge on over-confident assumptions of a continued commodities bubble, may soon learn their lessons the hard way like everyone else. The debt and commodity bubbles were connected you see--one fuelled the other.
The next recovery, with less government ‘rescues’ possible, is likely to be a much slower, more realistic ride as we work down stockpiles and inventories, while paying off debt and building up savings. Some might call it a slow slog. Painful perhaps for those who refuse to learn lessons, or are unable to adapt. But it is also likely to be a healthier more sustainable path once we all get the hang of it.
