China Overpays: Still In Thrall to Failed Ideology of Central Planning

 

The Aluminum Corp. of China (Chinalco) bought a copper mountain in Peru in 2007, notes Dambisa Moyo. So what? In 2007, according to the International Monetary Fund, copper was selling for over $8,000 per ton and Chinalco’s stock price was $80 per share. Copper is now going for $5,440 per ton, and Chinalco’s stock is below $10 per share. Moyo then reprises the standard neo-Malthusian mantra that world is fast running out of non-renewable and renewable resources, and only China has figured out the need to stash them away for the coming rainy day. While Moyo does note that commodity prices have been trending down lately, she evidently dismisses this as a mere blip on the way to the desperate war-torn resource-constrained future.

To further illustrate the Chinese Dragon’s economic wisdom and growing reach, Moyo warns that “between 2005 and 2014, China’s foreign direct investments were valued at more than $870 billion, or almost $2 billion per week over the nine year period.” We should compare, however: According to the latest comparable figures reported by the Bureau of Economic Analysis, U.S. foreign direct investments between 2005 and 2013 amounted to $2.7 trillion, or almost $6 billion per week.[1]

Moyo is certainly right that countries should eliminate the massive economic distortions introduced by subsidies, especially those aimed at agriculture and energy. She is also right that the United States should downsize it vast military-industrial complex. (Advice she may also want to share with the Chinese government, which has been boosting its military expenditures at double digit rates for nearly 20 years, reaching $145 billion in 2015.[2])

But let’s turn back to Moyo’s main point that by practicing Malthusian zero-sum economics, China’s leaders are exercising uncommon wisdom. This is hogwash.

In the 1950s, economists Raul Prebisch and Hans Singer made the seminal observation that commodity prices had been falling for many decades relative to the prices of manufactured goods. As Singer put it, “It is a matter of historical fact that ever since the [eighteen] seventies the trend of prices has been heavily against sellers of food and raw materials and in favor of the sellers of manufactured articles.” The upsurges in commodity prices during the first decade of this century would appear to contradict this trend. But do they?

“Once—maybe twice—in every generation, the global economy witnesses a protracted and widespread commodity boom. And in each boom, the common perception is that the world is quickly running out of key materials,” observes David Jacks, an economist at Simon Fraser University.[3] We have in just passed through such a situation. Jacks studies the phenomenon of economic “super-cycles,” in which commodity prices rise and fall over periods lasting between thirty and forty years. In 2013, Jacks analyzed the price trends for 30 different commodities during the past 160 years. He finds that fifteen of the thirty commodities he tracked over the past 160 years are in the midst of super-cycles that started in the mid-1990s. In other words, the expansionary phase of the current super-cycle has run nearly twenty years so far.

Jacks also frames a useful distinction between “commodities to be grown” and “commodities in the ground.” The astonishing fact is that as world population since 1850 grew sixfold and the world’s economy expanded more than hundredfold, Jacks found that the prices of commodities that are grown—grains, cotton, wool, and so forth—have generally been falling.  On the other hand, commodities that come out of ground—oil, tin, iron, chromium, and so forth—have remained flat or have been slowly rising.

Price is determined by supply and demand. Between 2002 and 2007, global economic growth was the strongest and longest lasting since the 1970s.The huge boom in the prices for all sorts of resources in the current super-cycle has been chiefly generated by rising demand in fast-growing emerging economies in countries like China and India.

In their 2012 study “Super-Cycles of Commodity Prices Since the Mid-Nineteenth Century,” economists Bilge Erten and José Antonio Ocampo, from Northeastern University and Columbia University, respectively, confirm that the recent price increases in commodities are the result of a super-cycle upswing.[4] Parsing real price data for nonfuel commodities such as food and metals from 1865 to 2009, they find evidence of four past super-cycles ranging in length between thirty and forty years. The cycles they identify ran from 1894 to 1932, peaking in 1917; from 1932 to 1971, peaking in 1951; from 1971 to 1999, peaking in 1973; and the post-2000 episode. The increases in commodity prices during these cycles are driven largely by increases in demand arising from strong periods of industrialization and urbanization such as those experienced by Great Britain, Germany, and the United States in the nineteenth century, Japan in the twentieth century, and China and other emerging economies at the beginning of the twenty-first century.

The super-cycles are driven by periods of accelerating economic growth that boosts demand for commodities, thus pushing up their prices. Rising commodity prices in turn encourage the development of more supplies and the invention of resource-conserving technologies. As economic growth slows down during the second part of a super-cycle, the real prices of the now copiously supplied commodities fall. In fact, the researchers find that the prices for nonoil commodities do not generally recover to their preboom averages. The IMF’s commodity price index has fallen by 43 percent since peaking in 2008.

The Economist magazine has developed a widely cited commodities index that tracks the real prices of an extensive variety of mineral and agricultural goods. “Since 1871, the Economist industrial commodity-price index has sunk to roughly half its value in real terms, seeing annual average compound growth of –0.5 percent per year over the ensuing 140 years,” pointed out Council on Foreign Relations energy adjunct fellow Blake Clayton in 2013.[5] He added, “Even after the boom years of the 2000s—in 2008, for instance, as commodity indexes soared, the Economist index never climbed more than halfway above where it stood 163 years earlier, in real terms.”

 

Figuring out when a super-cycle has topped or bottomed out is a fraught exercise. Nevertheless, many researchers believe that the current super-cycle in commodity prices has peaked and is moving into its downward phase. A recent analysis Colorado School of Mines researcher John Cuddington and his colleagues reports that super-cycle for crude oil reached its trough in 1994 and likely peaked in 2010; the natural gas super-cycle low was in 1994 and topped out in 2006.[6] They also look at the various economically important metals and find that the super-cycle troughs for copper, aluminum, zinc and tin occurred in 1998, 1995, 1999, and 1998 respectively. They suggest that copper peaked this year; aluminum in 2011, and zinc and tin were still heading toward their peaks.

Cuddington and his colleagues argue, “As of 2014, most of the LME (London Metal Exchange) six are past their super-cycle peaks and headed downward toward their troughs.” As it happens, according to IMF figures, the price of price of copper peaked in 2011 and has since fallen by 45 percent; aluminum topped out in 2008 and has dropped by 47 percent; tin peaked in 2011 and is now 56 percent cheaper; and zinc topped out in 2006 and is now 54 percent lower. If the past is any guide, commodity prices could well fall to levels even lower than the price nadir of the 1990s as the expansionary phase of the current super-cycle begins to fade.

Proponents of peak depletion get it wrong because they treat natural resources as fixed stocks, failing to take into account the inherent dynamics of market forces and technological innovation. Amazingly, some still claim that the era of cheap resources is over, when in point of fact nearly all resources in the past were much more expensive than they are today, even taking into account the continuing after-effects of the current super-cycle.

Resources are defined by advancing human knowledge and technology. A deposit of copper is just a bunch of rocks without the know-how to mine, mill, refine, shape, ship, and market it. “Innovation has arguably been the dominant force in determining the path of real prices for primary commodities over the past three and a half centuries,” assert economists Harry Bloch and David Sapsford.[7] They add, “The influence of innovation has been sufficient to result in negative trends in real prices for numerous individual commodities and for aggregate indexes of commodities. The negative trends occurred in spite of massive increases in output with growth in the world economy.” China’s leaders have mistaken the commodity prices increases of the current super-cycle sparked by their own development as a permanent condition.
Moyo oddly asserts that “a cohesive, coherent, and explicit global framework that defines and manages competing resource interests and explores strategies for cooperation could help mitigate the risks of conflict and help rebalance the market.” Well, yes. In fact, the World Trade Organization and the current Doha Round of trade negotiations aim at bolstering just such a global framework to manage competing interests. That framework is called free trade, or at least, the freer trade that the WTO process seeks to foster. Moyo would do well to advise China’s leaders to stop their economically ignorant pursuit of resource nationalism. Such neo-imperialist mercantilism undermines the very system that would ensure China (and all other countries) secure access to copious supplies of goods and services from around the globe.[8]

Moyo makes the same mistake as China’s leaders in taking the current super-cycle’s recent run up in commodity prices sparked by China’s own economic development as signaling permanent scarcities in natural resources. She is, however, surely right that in order to maintain power China’s Communist Party leaders “must continually move the population to better living standards,” or at least claim credit for doing so. But wasting money by overpaying for natural resources abroad instead of investing in productivity enhancing innovation and education at home will not achieve that goal. The Party leaders evidently are still in thrall to the failed ideology of economic central planning and the ultimate results of those policies will not be pretty.