Commodity Supercycles The Harper government is pushing hard to exploit a global boom in resource demand, what’s being called a commodity supercycle. Is it a calculated risk, or a risky gamble?
The way the nation lives: Canada bets its buck on commodities Speaking on the phone from Haifa, Israel last month, Natural Resources Minister Joe Oliver didn’t hide his government’s bout of commodities fever. “As I’ve mentioned before, Canada is undertaking many major mega projects,” said Oliver, who was in Israel to secure energy partnerships with the Jewish state. “Over the next 10 years, we could see 500 projects with half a trillion dollars at stake.” “No other country in the world is undertaking energy and mining projects at this scale or at this pace, creating a truly once in a generation opportunity for investors,” he said. He was echoing his boss, Prime Minister Stephen Harper, who used the Summit of the Americas in Cartagena, Columbia in April to expound at resource development’s “vast power to change the way a nation lives.” “Our natural resource sector is of vital importance in ensuring solid job creation and economic growth in Canada,” he said a month after putting forth a budget that deregulated much of Ottawa’s oversight over resource projects, a move that will heighten energy and mining’s already important stature in the Canadian economic pantheon. “We cannot allow valid concerns about environmental protection to be used as an excuse to trap worthwhile projects in reviews-without-end,” Harper said. The enthusiasm went beyond the government’s benches to the Bank of Canada, where Governor Mark Carney, often described as one of the most trusted policymakers in the country, agreed with Harper’s view that resource projects could depend on long-term demand.
“In a world where commodity prices are going to be elevated, it’s better to have commodities,” said Carney at an Ottawa business event in May, according to a Canadian Press article. “We are in a demand-driven commodity supercycle…(and) in our opinion this is going to go on for some time,” he said. That confidence in long-term and sustained high prices for rocks, fuels and foods – described by some as a “commodity supercycle” – amounts to a major bet on Canada’s future. But what if these men are wrong? After all, the godfather of capitalism, Adam Smith, warned politicians against pegging their economies on resource projects. Mining projects are those “to which of all others a prudent law-giver, who desired to increase the capital of his nation, would least choose to give any extraordinary encouragement,” wrote Smith in The Wealth of Nations. And despite a robust rebound after the 2008 financial crisis, commodity prices have been on a rollercoaster over the last year, leading investors to reconsider the notion made popular in the mid-2000s that commodities made an excellent portfolio diversifier. “Looking ahead, given the weak global activity and heightened downside risks to the near-term outlook, commodity exporters may be in for a downturn,” said the IMF in its April World Economic Outlook. In January, the World Bank said in its outlook that commodity prices peaked in early 2011 and then declined due to concerns over slowing demand, especially in China, with metals suffering most. Metal prices would go down by 11 per cent in
2012, the outlook said. Six months later, the bank said metal prices actually rose seven per cent in this year’s first quarter, only to fall below their 2011 levels in the time since. As their centuries-old reputation suggests, commodities can be a finicky business.
“In a world where commodity prices are going to be elevated, it’s better to have commodities,” Mark Carney, Governor of the Bank of Canada. With that in mind, iPolitics asked the Natural Resources Department to provide any “research, study or consultation” on commodity price cycles the department prepared before enacting the policy changes contained in the 2012 budget. The department stated there is constant analysis of the global economy by the Finance Department and the Bank of Canada, and pointed to several independent studies. While many of them suggested emerging economies will continue to grow faster than developed ones, none of them dealt specifically with the demand on commodities expected from that trend, one exception being a report by the Canadian International Council that recommends Canada increase its energy co-operation with China. Our own investigation into the history of so-called commodity supercycles reveals an economic idea filled with uncertainty and assumptions. The debates over the sustainability of
commodity prices range from academia to banking to investing, and finally to policymakers, and reveal that Canada is just one of many places around the world trying to find its way through the resource boom – and most importantly, trying to determine how it will end. While each of these sectors have their own distinct dynamic, this series will stick to digging into the elements of the broader debate. While commodities are typically broken down into three clusters – energy, metals and agriculture – this series will focus on the two former in particular. Each of these sectors have their own distinct dynamics and this series digs into elements of the broader debate. More than ever before, the macroeconomic behaviour of commodity prices are intertwined with Canada’s economy, and it will likely remain a centrepiece of political debate for a while to come. This spring’s rancour over Dutch Disease and environmental assessments are just two recent examples of how resource development have become a wedge issue wielded, in particular, by the Conservatives and New Democrats. In the last year, the government has passed a budget that will deregulate Ottawa’s environmental oversight of resource projects, it’s pushing to sell more oil and uranium to places like China, and it’s building a permanent realignment toward emerging economies like the Northern Gateway oil pipeline. Understanding the nature of the commodities price cycle is key to predicting, to use the Prime Minister’s words, just how our increasingly commodity-based economy will “change the way a nation lives.”
A strange beast: What drives the supercycle? A commodities supercycle is a strange beast in the zoo of economic phenomena. Its existence wouldn’t be anticipated under the normal rules academics use to study the behaviour of wealth, said Thomas Helbling, an adviser in the International Monetary Fund’s Research Department. “One of our concerns is to have a supercycle, you need to make a lot of assumptions which are at odds with the standard assumptions,” said Helbling, in an interview from the fund’s headquarters in Washington, D.C. Like most economic creatures, a commodities supercycle lives off the jockeying between supply and demand. But the normal interaction between them becomes slightly more extreme under the conditions needed to create a supercycle. “You need a lasting or semi-permanent shift in demand and you need a very delayed supply response,” said Helbling. The current supercycle seems to have witnessed the conditions for a strained tug-of-war between supply and demand. The past decade has been marked by an extraordinary need for resources of all kinds in China, a slow rate of innovation in replacing some of those resources, new risks in the hunt for new commodities and a backlash from regulators and citizens in the places where those commodities are supposed to come from. While the assumptions underlying a supercycle may be uncommon, they appear to pan out in the case of the last decade, according to Helbling. A survey of academics and research papers on the topic reveal that the current supercycles, as in past instances, are essentially demand-based creations. But there is
an added dimension to what’s happening today in commodities, which is that supplies might be under more pressure than ever before.
Heart of the beast — demand China’s urbanization over the last decade has seen its share of global metals consumption move to between 40 and 50 per cent from around 10 to 20 per cent in the late 1990s, said Helbling. The metals most impacted are those related to building basic infrastructure — like the iron used in steel and the copper that goes into electrical grids — and the coal, oil and other energy sources used to fuel development.
“The concept of supercycles was more shaped by investment banks rather than in academic research,” Thomas Helbling, adviser at the International Monetary Fund’s Research Department. “Since 1990, China’s refined metal consumption (aluminum, copper, lead, nickel, tin and zinc) has jumped seventeen-fold,” says the World Bank’s World Economic Outlook from June. “China now accounts for 43 per cent of the world’s refined metal consumption, up from just 5 per cent two decades ago.” From 1965 to 2010, China and India’s share of global crude oil consumption went from less than one per cent each to roughly 10 and four per cent respectively,
How commodity exporters are getting the most Take it like a Bolivian: Though nationalization would never happen here, it’s a policy option nonetheless. Bolivia nationalized a Canadian-owned silver mine earlier this month after citizens grew upset over the mine’s impacts and the community’s perception ityt was being short-shrifted. That came after the country nationalized another mine, owned by Swiss miners Glencore, in June. While raising taxes would be a much more likely way for Canada to increase its citizens’ benefits from increased mining, nationalization is done in the same vein.
Refine it like an Indonesian: The opposition New Democratic Party have criticized the drop in refineries in Canada over the course of the Northern Gateway pipeline debate, suggesting more petroleum products should be refined here. With a similar aim, Indonesian policy makers banned the export of 14 raw minerals last May. The minerals include lead, nickel, gold, silver, zinc, chromium, bauxite, manganese, molybdenum, platinum, antimony, iron ore and sand iron, according to Bloomberg. Canada doesn’t have any rules on exporting raw or processed metals, and critics argue exporting raw resources diminishes the returns Canada could make from those exports and reduces innovation.
Save it like a Norwegian: The IMF and the World Bank both encourage countries with a high exposure to commodity prices to save royalties and taxes for a rainy day. Norway is famous for creating its modern welfare state on the money its gets from oil production. Ottawa has no such fund, but Quebec, as part of its effort to boost the economy of the northern part of the province known as Plan Nord, is creating a fund called the Fonds du Plan Nord where taxes from mining and energy projects will be saved. The money will be used to fund
social programs. Alberta, home of the oilsands, has its own savings trust, but it’s been criticized for being misspent in the past.
Cool it like a Brazilian: When the export of one commodity takes a large enough share of exports, its upward pressure on a country’s currency makes other goods less marketable. That’s one of the reasons Brazilian policy makers tried to cool the real’s rise by increasing taxes on capital inflows into the economy in 2008–2009, according to the Financial Times. Canada is actively seeking to encourage investment in the oil, gas and mining sector, and says the benefits of more commodity exports includes more products made by manufacturers. Other Latin American countries, like Chile, are also concerned about the impact commodity prices have on their currencies.
Raise taxes like an Aussie: All of Canada’s major mining provinces and territories have decreased taxes and royalties on mines since 2003, according to data from the Natural Resources department. On the other hand, mining meccas like Australia have increased taxes, including a controversial 30 per cent tax on iron ore and coal mines that took effect this month. Half a dozen metal-exporting African countries have either raised taxes or are currently considering the move.
Green like an Aussie: Australia has also levied a carbon tax to make sure its mining industry pays for its impact on the environment. Ottawa has yet to regulate the carbon emissions from the Alberta oil sands, which provide the bulk of commodity exports. Instead, it shrunk the scale and scope of oversight resource projects will receive from Environment Canada, the Department of Fisheries and Oceans and other regulators in this year’s budget bill.
says the outlook. Within that demand, the key indicator of why a country needs metals and energy is income. “As income goes up, demand for metals goes up,” said John Baffes, senior economist at the World Bank’s development prospects group.
Elastic bonds Baffes explains the bank’s studies on that relationship has found distinct dynamics between the economic indicator and each of the three commodity clusters – metals, energy and agriculture.
Food is the least tied to per capita income, said Baffes. “Agricultural commodities has what economists call very low income elasticity, which is that although incomes increase, people do not really consume more food,” he said. At a base level in impoverished economies, there is clearly a link. But after a certain threshold, “in countries that are above one or two or three thousand dollars per capita income, this is not the case,” he said. There is a closer link between income and demand for energy. While the link is there, it’s not as strong as metals because energy products have a
higher rate of substitutability, he said. Helbling, the IMF adviser, says the fund’s studies revealed consistent shape to the curve in the relationship. With demand plotted on the vertical axis and income laid out horizontally, it resembles an S with each tip stretched out in its respective direction. “At very low levels of per capita income and you have things like subsistence farming, many commodities are not in very strong demand,” said Helbling, describing the beginning of the curve near the bottom of both factors. “As you enter the phase of modernization and urbanization, commodity demand increases more rapidly,” he said. This is where places like China, India and emerging economies find themselves today. When a Chinese person moves from the countryside into the city, everything about their life begins to rely on more stuff. From switching from a wood-fire stove to a gas stove, to filling your house with appliances that need aluminum, nickel and copper, those early increases in salary depend on a major rise on materials. Then there is the plateau where income increases stop creating large increases in commodities demand. In Canada and other developed countries, salaries might be increasing over time, but sustaining them doesn’t demand huge leaps in commodity consumption. “We can replace oil with coal or natural gas,” Baffes said. “As prices goes up the innovations in other fields goes up and so you have innovation in gas go up.” But the tightest relationship to income belongs to metals, which aren’t as easily replaced.
“In metals, you don’t have that alternative – you have to use the metal,” said Baffes, adding that there are some cases of substitution in metals but the innovation period is much longer.
Dusting off an old idea The abnormal conditions that create a commodities supercycle are what have made economists like Helbling leery about affirming their existence. One of the first people to suggest they exist was Austrian economist Joseph Schumpeter, who believed they rose and fell as new clusters of innovation replaced older ones. His study of business cycles fell out of favour by the 1980s, but the rapid growth of China’s economy led investors, than academics to wonder whether they had turned their backs too quickly. “My sense is that the concept of supercycles was more shaped by investment banks rather than in academic research,” said Helbling. Alan Heap, an Australian analyst with Citigroup, shared his discovery of those cycles in a 2005 memo that was later used as the basis for more academic studies.
The forever supercycle? While it was China’s rapid draw on the demand side that triggered speculation about commodity supercycles, the current situation has the added dimension of tight supply. If supply can’t catch up, it will keep commodity prices at a semi-permanent high level. The world’s financial institutions are
Riding a paper tiger: Is the Chinesefuelled commodity ride due for a crash? noticing. Concern about resource scarcity is more widespread now than a decade or two ago, says the IMF’s April 2011 World Economic Outlook. “The scarcity constrains are in crude oil, large copper and some of the other more industrial precious metals,” said Helbling. The signs of resource scarcity are all around us, with difficult to extract resources like shale gas and tight oil emerging among supply sources and expensive sources like Alberta’s bitumen sands gaining wider use. “Maturing is part of the normal life cycle of oil fields,” says the IMF’s outlook. “What is novel since the late 1990s is that such maturing started to affect the supply from major producing countries, beginning with the North Sea fields.” Supply pressures can be even more complex, including heightened regulatory hurdles with the advent of better ecological science and more participation from indigenous groups, for example. Citizens and politicians are also becoming more active about securing their interest in the commodities they sell. Around the world, the nationalization of mines has become a new risk for companies. Over the last years, it’s become a major policy proposal in mining heavyweights like South Africa, while Ghana, Guinea, Zambia and Namibia have all toyed with mining royalties to get a larger share of profits. In Latin America, Bolivia nationalized two mines in the last few months, both Canadian-owned. Furthermore, commodity-exporting nations have put up trade barriers in light of high commodity prices, from Russia’s wheat export ban in 2010 to Indonesia’s
export ban on all raw ores from 2014 onward. The high prices have also spurred a whole new batch of metal substitution, where it becomes more viable to use a different metal than the conventional choice. Aluminum, one of the world’s most widely available ores, is replacing copper in wiring and steel in automobiles, according to the World Bank’s June World Economic Outlook. The high price for nickel has led China to import low grade ores from the Philippines and Indonesia to produce nickel pig iron, says the outlook. There are other factors that impact the longevity of supercycles, like interest rates and the U.S. exchange rate, but both researchers were adamant that at the core of the supercycle theory is demand, with the added dimension today of constrained supply.
Fickle beast But the market can change anytime, leaving theorists at the mercy of a creature on the move. Just last month, Harvard University’s Belfer Center released a report that claims supplies of at least one commodity, oil, were expanding faster than anticipated. “Oil supply capacity is growing worldwide at such an unprecedented level that it might outpace consumption,” says the report. “This could lead to a glut of overproduction and a steep dip in oil prices.” The bottom line is that if supply catches up with demand fast enough, the commodity supercycle will resemble a cycle that’s a lot less strange and a lot more normal.
The satellite pictures of China’s ghost cities terrify Jesse Colombo. The Long Island-based investor, one of ten people the Times of London said predicted the 2008 U.S. housing and credit bubble, sees an inauspicious future for China in those pictures. The cities stretch for miles near the Gobi desert and on the fringes of China’s metropolises – office compounds with no cars parked near them and suburbs with no one driving on the roads nearby. China’s relatively smooth recovery from the Great Recession was “reliant upon government investments,” notably the country’s $586 billion stimulus package, says Colombo. One of the package’s outcomes were the spectacularly-huge housing and office districts that appear to be completely or near completely empty, according to Google Earth photos documented by the World Bank. “In Chenggong, there are more than a hundred-thousand new apartments with no occupants, lush tree-lined streets with no cars, enormous office buildings with no workers, and billboards advertising cold medicine and real estate services – with no one to see them,” writes Holly Krambeck, who works with the bank’s East Asia and Pacific Infrastructure unit, in a blog post from July 2010. “As my colleagues and I wandered, on– foot, down the center of Chenggong’s empty 8-lane boulevards and dedicated bus lanes, never seeing a single person, we marveled about the fiscal and political conditions that would have to exist to create something like this,” writes Krambeck. The so-called ghost cities symbolize the fear that China’s economic growth of the
last three years – and the demand for commodities that has fed it – is a façade that cannot be sustained.
“Who is to stop them from doing another $250 billion stimulus program?” Jesse Columbo, U.S. investor and analyst. Canada is putting in place policies that will extend its economy’s dependence on high commodity prices, from deregulating environmental oversight to building a pipeline to ship oil to Asia. But the extended period of high prices – sometimes called a commodities supercycle – have been due to China’s intense urbanization of the last decade, and more recently, to the flurry of public infrastructure construction after the 2008 global financial crisis. Investments, as opposed to exports or consumption, are leading China’s growth, accounting for nearly half of China’s GDP in 2011, according to The Economist. So what China does next with its economy – whether it builds more highways, government offices and subdivisions or do otherwise – is going to have a direct impact on Canada’s increasingly commoditybased economy, and is going to determine whether the policies put in place today in the resource sector are sound. “Who is to stop them from doing another $250 billion stimulus program?” said Colombo, who predicts China and commodities, and by extension Canada, which relies on exporting many commodities, are in for a major slowdown when China’s
government-backed growth begins to peter out. China’s slowing economy is no secret. Earlier this month, Beijing revealed figures showing its economy grew just 7.6 per cent in the second quarter, a marked decline from its GDP growth before 2008. But it’s where that growth is coming from that should be of deep concern to Canada’s natural resource mandarins. Statements made earlier this year by the National Development and Reform Commission in China, the country’s main economic planning agency, suggest that government-led infrastructure will grow by 15 to 20 per cent in 2012, said Patricia Mohr, vice-president at Scotiabank, during the keynote session of the Prospectors and Developers Association of Canada (PDAC) mining conference which took place in Toronto in March. “The actual formal announcement has not yet occurred, but we are optimistic that we will see some infrastructure announcements move through this year,” said Mohr. In March, investor blogs had a field day parsing over a report released by Credit Suisse, the Zurich-based investment bank, which revealed that three of the bank’s own research team were at odds over the Chinese economy’s ability to keep commodity prices high. “China’s demand supercycle for commodities is over,” wrote the China Economic Team in their opinion. The team believes that if any added stimulus is on its way, it’s going to be “focused on boosting consumption instead of infrastructure investments.” Local governments, despite picking up some slack on some stalled projects, are generally in the process of correcting
their balance sheets and not headed for a construction binge. “Industrial investment has been muted as production costs have surged, fuelled by rising salaries,” wrote the team. “The golden age of infrastructure investment is behind us now,” they conclude, adding that one more leg of urbanization is coming, but it won’t impact commodity demand as before. The China Basic Materials Teams also pin their estimates on slowing fixed asset investments. “We believe that a stagnant outlook for China’s infrastructure and property sectors, combined with construction-biased Chinese commodity demand, will lead to disappointment in growth expectations for Chinese demand,” they write. “We believe that China will manage to soft land and that commodity demand will feel most of the ‘pain,’” they write. “Urbanization” has become a buzz word that leads people to think commodities will still be in hot demand in China, they write. “We highlight that urbanization is not new for China but rather an ongoing process since the mid-1990s,” they add. After visiting over 20 firms in industries ranging from home appliances to local and central banks, the team found that “demand has deteriorated more than perceived.” “Demand in most material sectors was lower than our expectation, with the cement and copper sectors worse than others,” they write. “The iron ore’s market’s surplus is not as serious as expected, at least for now.” The only team to paint a rosy picture of China’s commodities demand is the Global Commodities Research Team, which
sought to reassure that “basic material demand is likely to remain robust in 2012, with the weakest period already behind us.” “Although the intensity of commodity growth is likely to slow over time, we expect this to be a gradual process, not a steep change, this year,” they write. “We believe that the supercycle has further to run,” they conclude. “The fall in house prices has been policy driven (the authorities are rightly worried about the social consequences of housing affordability,) rather than a result of a deterioration in underlying demand.” One basic dividing line between those who predict an end or continuation of the supercycle is the impact of China’s transition from an exporting and investment
based economy to a consumption-based one. Dambisa Moyo, an economist who has made waves for her indictment of foreign aid, has just released a new book on China’s demand for resources entitled Winner Take All: China’s Race for Resources and What It Means for the World. Speaking at an event put on by the Milken Institute in Los Angeles last April, Moyo said economic transition or not, China will continue to devour the dragon’s share of the world’s resources, which should make ghost cities the least of the world’s fears. “The notion that somehow structurally China’s build-up and desire to move investment toward a consumption-based economy is going to have them depend less on commodities is foolhardy,” Moyo said.
The word on commodities
The prospect for commodities is a popular subject — especially with contemporary Canadians, but not to the exclusion of 18th century Brits. Here’s what a few notables have to say on the subject. Bank of Canada Governor Mark Carney, often described as one of the most trusted policymakers in the country, gave his approval to Harper’s push for more resource projects. “In a world where commodity prices are going to be elevated, it’s better to have commodities,” said Carney at an Ottawa business event in May, according to a Canadian Press article. “We are in a demand-driven commodity supercycle…(and) in our opinion this is going to go on for some time,” he said. The godfather of capitalism, Adam Smith, warned politicians against pegging their economies on resource projects. Mining projects are those “to which of all others a prudent law-giver, who desired to increase the capital of his nation, would least choose to give any extraordinary encouragement,” wrote Smith in The Wealth of Nations. Speaking on the phone from Haifa, Israel last month, Natural
Resources Minister Joe Oliver: “As I’ve mentioned before, Canada is undertaking many major mega projects,” said Oliver, who was in Israel to secure energy partnerships with the Jewish state. “Over the next 10 years, we could see 500 projects with half a trillion dollars at stake…No other country in the world is undertaking energy and mining projects at this scale or at this pace, creating a truly once in a generation opportunity for investors,” he said.
Prime Minister Stephen Harper, at the Summit of the Americas in Cartagena, Columbia in April: “Resource development has vast power to change the way a nation lives,” said Harper. “Our natural resource sector is of vital importance in ensuring solid job creation and economic growth in Canada.” “We cannot allow valid concerns about environmental protection to be used as an excuse to trap worthwhile projects in reviews-without-end,” Harper said in his summit remarks. “I think the cycle is still intact,” said
Euro Pacific Capital investor Peter Schiff, who became famous for predicting the 2008 crash. “We’re going to continue to see commodity prices moving higher, particularly when you measure them in terms of currency like the dollar or the euro.” “It’s a reality that commodity prices are not going to stay high for a long time,” said World Bank commod-
ity specialist and economist John Baffes, when asked to provide advice to politicians during a commodities boom. “The extra revenue that countries get from commodities should be treated as permanent, which means that some of it should go to something else, like savings.”
Who can pick up the commodities slack when China’s growth cools? As China’s economy slows down after a rollicking decade, the big question for commodity watchers will be whether other emerging economies can pick up the slack in demand. That question lies high on the minds of Canada’s policy-makers too, since increasing the economy’s reliance on selling commodities, which the Harper government has already begun to do, requires buyers just as hungry as China. When asked if the government’s current politices designed to encourage resource projects were dependent on a commodity supercycle, the Natural Resources department replied that the developing economies in the Asia-Pacific region were going to lead growth in the global economy. Bank of Canada Governor Mark Carney also sees commodities demand growing strong beyond China. “The expanding urban middle class in emerging economies is having a marked impact on a wide range of commodities,” said Carney in an April speech in Kitchener-Waterloo, Ont. “Yet, whether it is travel, housing or protein, consumption levels in major emerging markets are still only fractions of those in advanced economies” “As a result, commodity prices have risen well above their historical averages, and are likely to remain there for some time,” said Carney. “Canada is benefiting from this both directly and via spillovers across our economy.” Carney is not alone in speculating that as places like India will grow, the commodities supercycle of the last decade will continue. “The idea is that we have China now, but in the process afterwards we might have other countries like India, Pakistan and Bangladesh,” said John Baffes, senior
economist at the World Bank’s development prospects group. “When these countries go through what China is going through right now, then this will expand the supercycle.” The World Bank’s own figures make that highly improbable. The biggest impact a drop in China’s GDP, whose growth was pegged at 7.6 per cent in the second quarter earlier this month, will have among commodities will be on metals.
“A slowdown in China’s growth is likely to have a large impact on metal prices, a moderate impact on crude oil prices, and very little effect on food prices” World Bank’s World Economic Outlook. “A slowdown in China’s growth is likely to have a large impact on metal prices, a moderate impact on crude oil prices, and very little effect on food prices,” said the World Bank’s World Economic Outlook in June. There is solace in that finding. Oil is Canada’s most traded commodity and coal is another major export, especially to China. But metals, from gold to iron to aluminum, need a saviour. However, research from the bank’s January outlook reveals just how unlikely a candidate India is for that role. It will take 20 years for India to reach a point where it consumes metals as fast as China does today, the outlook said. Since 2000, Chinese metals
consumption has grown by 15 per cent per year, while demand in the rest of the world remained unchanged. India’s consumption growth has been about half that, the bank said in its outlook. “Should India’s refined metal consumption grow at 15 per cent per annum it would take nearly two decades to overtake China’s current level consumption,” it said. And it’s not just the how much but the how that will determine metals consumption. China’s growth hasn’t been the work of the market’s invisible hand, but of government investment in infrastructure over the past 15 years. Its neighbor in the subcontinent hasn’t made the same policy decisions and thus hasn’t consumed the same amount of metals. “India’s share of world metals consumption has risen from 2 percent in 1990 to only 3 percent currently due to the very different structure of the economy, levels and direction of investment, sector growth trends, trade and policies,” said the bank. So creating the kind of demand that has kept the commodities supercycle alive requires not just the work of businesses selling their wares, but of governments
co-ordinating the consumption patterns of vast swathes of humanity. “India has ambitious plans for growth and has unveiled a significant power generation program,” the bank said. “Thus, a key question is what other policy and structural changes would need to take place to have India’s metal consumption growth double for the next twenty years.” Those policies remain to be seen. But as China slows, it has becoming clear that no country has the same perfect mix of high population and government control that were needed to sustain semipermanent high-commodity prices. For the supercycle to keep going, you need either one very large country or a cluster of countries working in tandem to expand their middle class. And with India, economists’ first candidate to replace China, lagging so far behind, it’s hard to see anyone else filling the gap China will leave. “Clearly India is an easy case in a sense because it’s large too,” said Thomas Helbling, an adviser in the International Monetary Fund’s Research Department. “Because if all you see happening is a great leap in a smaller economy, that just wouldn’t give the same global economic boost.”
As commodity prices slump, Canada puts on little protection The world’s biggest commodity suppliers, whose company Canada aspires to keep, have been bracing for a slowdown for years. But just as Ottawa ramps up commodity exports as a share of its economy, it’s not implementing the insulating policies others have. Canada’s move to join the binge while not preparing for the hangover is happening just as slumping commodity prices are already hitting Canadians in the wallet. To get an idea of what can happen in the worst case scenario, just pull back the curtain on the 2008 global financial crisis. The value of mineral production in Canada went from $47 billion in 2008 to $32 billion in 2009, according to the Mining Association of Canada. Capital expenditures in the oilsands were cut in half from $20.7 billion to $10.6 billion over the same year, says the association.The number of mines increased from 841 to 961, but countless exploration projects were scrapped and shelved. And while employment in the mining sector only dropped from 59,000 to 52,000 jobs, the hit on public finances was staggering. Royalties to all Canadian governments went from $10.5 billion to $5.1 billion, the association says. Now commodity prices are on the decline again — though at a much less perilous rate. While consumption and business investment will lead the country’s economy in the near time, “their pace will be influenced by external headwinds, notably the effects of lower commodity prices on Canadian incomes and wealth, as well as by record-high household debt,” said Bank of Canada Governor Mark Carney in July’s monetary policy update.
RBC’s June Commodity Price Monitor reported that prices for all commodities are down 10.5 per cent — 6.7 per cent when energy is taken out of the mix — compared to a year ago. The IMF, the World Bank and others warn commodity prices look like they’re on their way down.
“We’re in a supercycle and it’s going to have a downside,” John Baffes, senior economist at the World Bank’s development prospects group. Take that with the fact Canada has put in place efforts to increase commodity exports, from agreeing to sell oil and uranium to China to deregulating federal oversight of resource extraction, and suddenly you’re looking at a national dependence on a finite resource with a finicky market. Canada, however, wouldn’t fare as badly as other big-time commodity exporters if prices keep falling, an examination of comparative data suggests. There are two ways to understand a country’s vulnerability to a commodity price bust, write Gustavo Adler and Sebastian Sosa, two International Monetary Fund economists with a focus on Latin America, a region wrestling with the prospect of slumping prices. The first is through calculating commodity exports as a share of gross domestic product. This figure “tells us about the potential impact of a commodity price shock on domestic output,” Adler and Sosa wrote in a November blog post on the topic. So
when a bust comes, the more commodity exports make up the economy, the harder the hit will be. In the IMF’s latest World Economic Outlook, the fund compares just how vulnerable exporting countries are. As far as commodity exporters go, Canada is in pretty sound territory with its commodity exports at 3.7 per cent of GDP, according to the IMF. It’s one of a tiny pack of countries whose commodity exports are between 2.5 and 5 per cent of GDP. That’s no where as a bad as places like Venezuela, Iran or Libya, whose commodity exports take up anywhere between 15 and 25 per cent of their economy, or Saudi Arabia, which relies on commodity exports to provide over 25 per cent of its economic activity. But our reliance on commodity exports is identical or similar to places where politicians are putting in place protections, from Brazil to Bolivia to Australia. The middle-of-the-road position Canada has would seem to jive with the mantra — common with Carney and other policy makers — that it’s not a bad thing to have commodities in a world that has demand for them. It only becomes dangerous when the sector accounts for so much of the economy that when a price bust comes, manufacturing and other industries can’t pick up the slack. The second approach, write Adler and Sosa, is to determine commodity exports’ share of total exports of goods and services. This figure, which indicates export diversification, “tells us about the economy’s ability to adjust to a commodity price shock,” or in other words, how quickly an economy can bounce back from mines
shutting down. On this front too, Canada doesn’t seem that badly off. Its commodity exports count 15 per cent of its total exports, which puts it in a much healthier position than most major commodity exporters. But Canada is seeking to increase that figure while doing so far nothing to insulate the economy from its risks, a trend at odds with other countries’ actions. One of the biggest threats of increasing the export of raw commodities is the upward pressure this puts on a country’s currency, to the detriment of other exported goods, a phenomenon known as Dutch Disease. In Canada, this threat has been largely treated as a joke by the government. New Democratic leader Thomas Mulcair promoted the notion that Dutch Disease was happening this spring, and was ridiculed by the government benches for calling the Alberta oil sands a “disease.” But it’s a real issue for countries with sizable commodity exports. Brazil and Chile are two of Latin America’s largest exporters of goods, the former sells everything from sugarcane to oil, while the latter is one of the world’s biggest copper producers. Both countries have tried to stem inward capital flows to calm its currency, which was hurting manufacturers, according to the Financial Times. A 13-fold increase in exports between Latin American and China since 2000 has put the macroeconomic effect of commodity exports “at the heart of the concerns” among Latin American central bankers, Augusto de la Torres, the World Bank’s regional economist, told the Financial Times in a January 2011 article. “It is a serious risk that needs to be
managed,” de la Torres told the Times. Another major policy which Canada is foregoing is increasing the revenues it makes from mines during an upswing in activity. “We’re in a supercycle and it’s going to have a downside,” said John Baffes, senior economist at the World Bank’s development prospects group. “The extra revenue should not be treated as permanent, which means some of it should go to savings. “ Thomas Helbling, an adviser in the IMF’s research department and an expert on commodity prices, also said that one of the key policy responses to increasing commodity exports should be saving royalties in a fund. All of Canada’s major mining provinces and territories have decreased taxes and royalties on mines since 2003, according to data from the Natural Resources department. On the other hand, mining meccas like Australia have increased taxes, including a controversial 30 per cent tax on iron ore and coal mines that took effect this month. Some provinces are taking action, however. Quebec, as part of its effort to boost the economy of the northern part of the province known as Plan Nord, is creating a heritage fund to save royalties from new mining projects. Alberta, home of the oil sands, has its own savings trust, but it’s been criticized for being misspent in the past. The commodities boom has also led many countries to beef up their environmental regulation of resource extraction, said Baffes, the World Bank economist. Canada has gone in the other direction. Ottawa has yet to regulate carbon
emissions from the Alberta oil sands, which provide the bulk of commodity exports. Instead, this year’s budget bill shrank the scale and scope of oversight resource projects will receive from the Department of Fisheries and Oceans and other regulators. Asked what Ottawa was doing to protect Canada from commodity price fluctuations, a Natural Resources spokesperson responded: “By creating a more efficient and effective regulatory system, the expectation is that there will be positive effects on the entire economy in all regions of Canada.” The spokesperson also pointed to investments in science and technology, including “nearly $8 billion in new investments in Canadian talent, world-class research excellence and linkages between knowledge and the capacity to innovate in the global economy.” On at least one front, Ottawa is making the right move, according to Helbling, the IMF adviser. “The exchange rate is a like an automatic shock absorber,” said Helbling, in recommending commodity exporters keep rates flexible, as Canada does. “Because if you have excess demand, the exchange rate apprciates and puts a damper on exports.” “And similarily, if you have a commodity bust of some kind, then the economy tends to appreciate and you have a boost to the export sectors,” he said. “That balances off from the commodity exports.” While it is impossible to define the point at which more proactive policies should be put in place, and their implementation will require its fair share of political haggling, comparing Canada to the world reveals that while difficulties are not here now, they lie ahead.
All stories by James Munson All photos by The Canadian Press Design by Jessie Willms iPolitics, 2012