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Material world

28 January 2016

A fall in the price of oil and other commodities could fuel an economic boom in the long run.

For the past six months the markets have been fretting about the slowdown in China, and with good reason. Since the financial crash of 2008, most of the Western world has been struggling to grow at the rates which were normal in the post-war period. World trade has continued to expand; but only because, in the years following the crash, China continued with its breakneck expansion, producing goods for export and sucking in raw materials – everything from iron ore to cement – from the four corners of the world. Now that has come to an end, some investors and economists fret that without China there will be no locomotive strong enough to pull the world economy along. The alternative they see is deflation, stagnation and despair.

But it may not be that bad. Indeed, there is a strong case to be made that the world should be pleased, not frightened, by China’s slowdown: its breath taking expansion has commanded a disproportionate share of the world’s resources and left precious little room for anyone else. Economies have grown fast in the past, of course, but never has the world seen such a transformation take place so rapidly in such a large country. The upside is the arrival of a major new force on the economic stage; the downside is that its gargantuan appetite for raw materials to feed its expansion and infrastructure investment has shaken the world.

This is what the commodity boom-and-bust is all about. With China going flat out, all the world’s metals, coal and oil prices went through the roof. Shipping fleets were expanded, mines were developed; and oil fields were drilled – all to feed a boom in which the record-high prices looked like they would last for years. Then the Chinese changed course, deciding that their investment- and export-led model must change to a strong, domestically focused, consumer-led economy.

Such an economy consumes fewer natural resources. The change marked the beginning of the end for the rise of commodity prices and they have been falling ever since. This is most visible in the more than halving of the price of oil, but is shown no less dramatically in copper iron ore, zinc, and all the other essentials of a modern economy. Many of these prices are at their lowest in six or more years. Mining and oil shares, which had been the highest of high fliers, have tumbled back to Earth. Raw material producers, from countries such as Brazil to Nigeria and South Africa to Australia, have prospered from the commodity boom but are now struggling to cope with the bust.

History teaches us that, when commodities fall, economies boom. That is what happened in the 1950s when commodity prices collapsed at the end of the Korean War, and in the 1980s with the normalisation following the Iranian revolution. Such price drops are effectively big shifts in purchasing power from producers to consumers. In a rational world, people in those countries which are big importers of commodities should be hanging out the bunting to celebrate their good fortune.

Cheaper oil makes everything else cheaper too, from the fertiliser that goes on the fields to grow our food, to the packaging that wraps our purchases in the shops, to the cost of filling up the family car. It amounts to a tax cut on a scale that no government itself could ever afford. And it gives the Bank of England more headroom by reducing the inflationary pressures which normally come with expansion.

But the problem is that this does not happen overnight or even in the first few months after a significant fall. We react much more quickly to pain than we do to gain. If something bad happens we try to deal with it immediately; if something good happens we store it away to see if it’s a one-off or permanent. So while we get the downside of a price shift immediately; the upside takes time to come through.

In the business world, the collapse in commodity prices has triggered closures and disposals of mines, as well as a freeze on development. In oil, new exploration has been slashed, development plans are shelved and tens of thousands of people have been laid off. Don’t expect them to be celebrating low oil prices in Aberdeen, where unemployment is soaring, or low metals prices in Redcar, where steel production has come to a halt. The bankruptcies in the North American shale and fracking industry have been painful and played a large part in bringing down the Conservative government in Canada.

The silver lining to all this gloom is that there is now more money in consumers’ pockets than there has been for years, and pretty soon they will begin to spend it.

Demand has long been depressed by the squeeze on middle-class incomes, but now there is a good chance it will come back. Increased sales will prompt increased investment and a further boost to productivity and incomes – a virtuous circle leading to a further round of economic growth.

Already we are seeing signs of a pickup in the eurozone, spurred by cheaper oil, and the US consumer is also beginning to respond.

We live in an uncertain world; but, provided there are no further unanticipated shocks, it looks like the turn of the world’s developed economies to have some time in the sun.


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