The Much-Touted Growth Prospects Of BRICS Is Nothing More Than A Commodity-Boom-Fuelled Mirage

Tyler Durden's picture

Originally posted on LinkedIn by Erico Matias Tavares

Dr. David Jacks is the Chair and Professor of Economics as well as an Associate Member of the School for International Studies at Simon Fraser University. He is also a Faculty Research Fellow at the National Bureau of Economic Research (“NBER”) in Cambridge, MA. He has also served as a consultant for Asia Pacific Economic Cooperation, the Richard Chandler Corporation and Tsao Family Holdings.

Dr. Jacks’ research spans the areas of economic and financial history, as well as international trade and finance. He has been invited to give presentations at over 75 conferences, organizations and universities in 17 countries and has been a visitor at 9 universities. His research has been funded by the Economic and Social Research Council of the UK, the French National Research Agency, the National Science Foundation of the US and the Social Science and Humanities Research Council of Canada.

He received a Bachelor in Economics and History (summa cum laude) from the University of Memphis, followed by a Masters in Economics from the University of Memphis and a Masters in Economic History (with distinction) from the London School of Economics. He received his PhD in Economics from the University of California, Davis.

Erico Tavares: Dr. Jacks, thanks for being with us today. You have recently published “From Boom to Bust: A Typology of Real Commodity Prices in the Long Run”, a paper which looks at price performance for forty commodities over 160 years. Contrary to popular belief, your research showed that the commodities sector as a whole has been in an uptrend for the better part of the 20th century, despite some big swings in the interim. Can you talk about your approach and key findings?

David Jacks: I like motivating this topic by first considering a famous bet which emerged from an academic debate in the 1970s. It begins with Paul Ehrlich, a biologist, winning acclamation and fame for his book, The Population Bomb. As the name would imply, Ehrlich saw the prodigious growth in human population over the past two centuries as a big problem in a world of finite resources. In his mind, population growth in time would hit a hard constraint, and humankind would be consigned to a fate of conflict, disease, and famine.

One of his biggest intellectual opponents was an economist by the name of Julian Simon. They sparred for the better part of a decade with Simon finally responding with his book, The Ultimate Resource. As the name would imply, this turned Ehrlich’s reasoning on its head: yes, we live in a world of finite resources but humanity in all of its creativity and ingenuity represented the ultimate resource, one which would figure out better means for both extracting and substituting away from scarce resources.

This gave rise to the Simon-Ehrlich wager, a bet on the direction of commodity prices from 1980 up to 1990. The terms were such that they would essentially construct an equally-weighted portfolio of chromium, copper, nickel, tin, and tungsten and track its performance over time. For every percentage point decline in the portfolio, Ehrlich would pay $10. And for every percentage point increase in the portfolio, Simon would pay $10. At the end of the day, Ehrlich lost decisively by writing Simon a check for $600, representing a nominal decline in the value of that equally weighted portfolio of 60%.

In the past few years, large increases in commodity prices once again lead to the view that the world was quickly running out of key materials. The necessary consequence of this scarcity is that economic growth must grind to a halt. But for others, this view is misguided as history suggests otherwise: that is, going long commodity prices is equivalent to shorting human ingenuity. Thus, we were basically watching the re-emergence of the Simon-Ehrlich debate 30 years later.

My contribution to this debate is that we have to start with the idea that commodity prices are cyclical. That is, commodity prices have both trends and cycles which may be long in duration. Because of this, long-run patterns can be easy to miss because we have a natural tendency to confuse cycles for trends.

As cycles and trends can span decades, we need very long-run commodity price data to accurately detangle the two. And as cycles and trends can differ across goods, we need a wide range of commodity price data. To these ends, I have collected annual price data for 40 commodities back to 1900, representing 8.72 trillion USD of production in 2011.

The bottomline of my research comes in two parts: 1.) real commodity prices increased by roughly 0.75% per year in real terms from 1950; 2.) 2012 marked the peak of above-trend pricing, that is, the peak of the currently-evolving commodity price cycle which began in 1998.

ET: One important distinction that you make is that the uptrend has been much more pronounced in “commodities in the ground”, like petroleum, natural gas and metals, relative to “commodities to be grown”, like grains, which have actually been in a long term downtrend. What accounts for this difference in your opinion?

DJ: For “commodities in the ground”, most of the price increase has been from 1950. This upward trajectory has been driven by deregulation of key markets (in particular, petroleum but also to a lesser extent, gold). We also have to contend with much higher capital costs in the mining sector from having to go into more remote areas and deeper into the ground.

For “commodities to be grown”, most of the decline has been from 1970. This downward trajectory has been driven by radical improvements in crop science resulting in greater resistance and higher yields for grains and soft commodities.

ET: You divide historical price performance between a long term trend, and shorter term cycles, which oscillate around that trend. This is quite interesting because we sometimes get lost on short time movements without taking into consideration the long term perspective. What has driven these cycles, in some cases quite pronounced, over the last 100 years or so?

DJ: Talk of cycles may seem a little mystical to some of my economist colleagues, but it really is a story rooted in ECON 101. Generally, we can think of these cycles emerging from the interaction of: 1) surging demand related to episodes of mass industrialization and urbanization; and 2) acute capacity constraints in energy, metals, and minerals. The result is that we can see above-trend commodity prices for years, if not decades, on end because it takes substantial time to build additional capacity in some of these sectors.

ET: How stable are these cycles going forward? What is often found in capital markets is that the duration and magnitude of such cycles can vary a great deal going forward, and therefore using them as a predictor or forecast can produce quite inaccurate results.

DJ: I would agree with that assessment and would say that any predictions must be taken with a grain of salt. Having said that, the empirical distribution of past cycles suggested a typical length of 14 years. This coupled with an unambiguous start-date of the current cycle in 1998 made 2012 the most likely year for the peak. This has proven to be a relatively accurate hunch, given the performance in commodity markets over the past two years.

ET: The graphs above show the real price index since 1900 for the commodities sector as a whole, highlighting the trend (graph on the top left) and the cycles (graph on the top right). It seems that the cycles shown here are peaking. Is this saying that the commodities sector may correct even further from here?

DJ: I have incorporated the recent crash in petroleum prices into some preliminary (unreported) analysis. With a WTI price of $50 per barrel, this analysis suggests we are around two-thirds of the way there in terms of establishing a definitive floor for commodity prices. Again, this must be taken with a grain of salt since commodity markets are so unpredictable...and therefore, so much fun to study.

ET: OK, so let’s just focus on crude oil. The cycle shown in the graph on the top right seems to be peaking, but we are in a long term bull market correct?

DJ: That is correct. The world is hungry for energy in all of its forms. And a few years out from now, I have a hard time believing we will be looking at such low prices for petroleum. Indeed, my work in decomposing trends and cycles in petroleum suggests a long-run price of $75 per barrel for WTI.

ET: In contrast, the price of rice, a food staple particularly in Asia, has been in a big downtrend since the 1970s, as per the graph above. Your thoughts here?

DJ: This is actually a crop and a sector for which I am mildly bullish at the moment. The Chinese transition from fixed capital accumulation to a consumption-based economy —and suburbanization—is tentatively beginning. If the Communist Party of China is successful in this effort, we are likely to see an increase in demand for goods “to be grown” and a potential inflection in its long-run trend. Here, I emphasize that quality matters—both in terms of the form of consumption (e.g., the switch in caloric consumption away from grains and into animal products) but also in terms of the safety of sources (e.g. the switch in Chinese consumption away from domestically produced grains and into those sourced abroad).

ET: On the whole, what does your research suggest of where we are in the overall commodities cycle? And what implications does this have for major producers, such as Australia, Canada and many emerging markets?

DJ: It suggests that the boom years of the past decade and a half were the exception and not the rule. Australia and Canada will have a bit of rough patch in the years to come, but will manage through as they always do. The much touted growth prospects of many of the BRICs will prove to be nothing more than a commodity-boom-fuelled mirage.

ET: That’s quite concerning, and we may be seeing some of that already playing out right now. Final question, what else are you working on right now?

DJ: I have some work addressing the question of what drives commodity prices in the long run, particularly in the context structural VAR models. These allow us to decompose fluctuations in commodity prices into global demand shocks, commodity supply shocks, and an inventory/speculative demand shock. The first results are interesting in that they suggest supply shocks just are not that big of a deal in the long run and that demand in its various form seems to be running the show.

Finally, I am very interested in the theme of cyclical resource investment and see obvious implications for investment decisions on the ground. At the same time, I am lacking sufficient data and time to have made much progress on this front.

ET: This has been great, thank you very much for sharing your thoughts with us today. Keep up the great work!

DJ: Thanks for giving me the opportunity to speak to a topic which is near and dear to my heart!

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Chuck Knoblauch's picture

And what the hell is the alternative?

Full faith and credit in magic.

Save it for the young fools.

Stuck on Zero's picture

So true Chuck.  The alternative to a commodity boom seems to be a debt boom.

Icelandicsaga...............................................'s picture

You nailed it .. thanks. We call the Western alternative . the Federal Reserve system .         the BRICS have resouces .. we have WAll Street and hedge funds produce little real wealth .. import much of our food .. and turn the rest of into ethanol.. we do not make our own necessities .. and export trash and hides.. we have the same export profile as a third world country . .except for aircraft pats and even most of those are now made in the BRICS . the . US . UK depend on paper that is worth less than an origami sail boat. If commodities mean  little why does the Western cabal try so damn hard to grab as many as they can from Africa to the ME to .. the four winds.Tylers must be messing with us to keep us on our toes.. Linkedin .. why not CNBC comment blog. if World War ever comes.. how long will it take us to gear up .. the machining skill sets are gone or quickly dying uot .. and most people have NO clue about growing their own food, making their own clothes, or surviving without an elaborate supply system in place... the BRICS .. in the long run are better off . we .. are .. screwed.

disabledvet's picture

QE has always been about ramping up a war effort.

 

 

And indeed...the Democrats have now found it and are fleeing the Battlefield while sticking the Republicans (who say they will pay) with the bill.

 

Right now that be 600 billion...

Chuck Knoblauch's picture

The IRS doesn't care what your political affiliation is, unless you're a Tea Party member.

ebworthen's picture

Yeah, sure, unlimited resources and we are all going to live forever.

Harbanger's picture

As the global economy grinds to a halt, there will be an excess of resources and people.

Harbanger's picture

I just saw some young talking head on TV saying how countries are now running out of storage space for oil, they're already filled to the brim.  He was hoping the US consumer would drive more to burn up the excess.  fucking hillarious.

TBT or not TBT's picture

Self driving cars could burn the gasoline americans won't do.  

thestarl's picture

That's the mentality of these dickheads Harbangar the average punter is either drowning in debt or subsisting week to week.There is no recovery.

Rootin' for Putin's picture

Just pump it down into some of those dry wells in ND, it will keep ok down there.

 

Dugald's picture

They have bombs for that.

No, I think there will be a deadly strain of Influenza, and no

cure.......and it will "escape" from a lab in America.

TBT or not TBT's picture

That's how bad America is. 

Chuck Knoblauch's picture

GOOD.

The faster I can transfer money into a real bank the better!

Harbanger's picture

Fox news is already talking about how you will buy things in the future.  They're easing people into full electronic currency.

Charming Anarchist's picture

A cashless economy would kill the war on drugs.  Therefore, I would expect a state will never do away with cash.

Harbanger's picture

The state depends on taxes from it's plebs.  That's one reason Drugs are being legalized and taxed.  Not sure what will be used in the new underground economy, silver coins maybe.  Would have to see what people in other police states are using, although they're probably using US paper dollars right now.

10mm's picture

World War kills this entire article.

Bell's 2 hearted's picture

In order to save the world ... we need global war ...

Chuck Knoblauch's picture

In order to get to heavan you have to die first too.

Bummer.

Consuelo's picture

Did I miss something, or did the esteemed professor mention - or factor in monetary debasement on a global scale never before witnessed in history, by orders of magnitude...?    And the the 'war' thing too, of course...

ronron's picture

yep, the fools should just buy a printing press.

HonkyShogun's picture
HonkyShogun (not verified) Mar 17, 2015 4:06 PM

Wait, so financial mirages are bad now?

DrData02's picture

Missing sentence from bio. Dr. David Jacks is a shill for the status quo.

TheReplacement's picture

More likely he looks at the world through the periscope of his education.  Depth of focus is very constrained and there is a lot of detail outside his field of view.

Hohum's picture

But, Dr. Jacks, what's the marginal cost of production?  That's part of economics, right?

Z_End's picture

He don't know Jacks...

Z_End's picture

He don't know Jacks...

itstippy's picture

As long as we humans have access to plentiful supplies of oil and fresh water we can develop new sources/alternatives for the other commodities we need.  There are bountiful supplies of "in the ground" commodities and land to grow crops.  Just supply the necessary fresh water & petroleum energy and we'll extract or grow everything else and transport it to where we want it.  Internal combustion engines kick ass, baby.

If something were to happen to the plentiful supplies of oil & fresh water, nation states would squabble over who gets what supplies remain.  That could get ugly.

 

 

Ides of November's picture

Are you arguing Ehrlich was wrong?  Would anyone here seriously argue Ehrlich was wrong?  Seriously? 

Clearly Ehrlich was fundamentally right - he just got his numbers wrong.

If you want to argue Ehrlich was wrong can you explain to me what planet Earth would look like with 500 septillion humans running around trying to make a living????

Very interested to hear any answers..........

Circle of DNA's picture

Bricks just opened their bank only some weeks ago…don’t you think it is too soon trying to predict their future?

localizer's picture

BRICS - a mirage? Then how do we call the Western ponzi system, huh?

And what is this anyway - an article from LinkedIn??? Next up - "research pieces" from twitter and facebook? Come on...

TheReplacement's picture

A look at the countries on the list suggests that there are a lot of dishonest players in that group.  There is no reason to believe the BRICS will ultimately behave more congenially nor thrive more successfully than the corrupt system they are trying to replace.

Odds are that if you live in a palace while people in your capital cities don't have running water, can't breath the air, have to trade on the black market for staple items that are either rationed or simply not available in open markets, or fear the police more than criminals then odds are you are gonna end up trying to screw everyone else if you can get away with it.

If you are left wondering whether I'm talking about The Empire or the BRICS then the answer is, yes.

localizer's picture

Oh, yes, I can generally agree with you here. I don't mean to idolize BRICS, they all have massive problems on their own... However, to dismiss them as a "mirage" when they do have REAL assets and many of them have much lower debt levels compared to the Western countries, is rather strange... I believe BRICS should be given time to pass judgment on them. It's rather obvious that they do have the power and resources to offer some sort of alternative to the parasitic ponzi scheme model that has taken over the West. And as per Wolfowitz doctrine USSA is extremely worried about the emergance of ANY serious competitor in any shape or form, that is the reason for their antics.

Our first objective is to prevent the re-emergence of a new rival, either on the territory of the former Soviet Union or elsewhere, that poses a threat on the order of that posed formerly by the Soviet Union. This is a dominant consideration underlying the new regional defense strategy and requires that we endeavor to prevent any hostile power from dominating a region whose resources would, under consolidated control, be sufficient to generate global power.

Totentänzerlied's picture

"DJ: It suggests that the boom years of the past decade and a half were the exception and not the rule."

Should read:

"DJ: It suggests that the boom years of the past 1-2 centuries were the exception and not the rule."

The BRICS were just the last* to the concentrated insanity+absurdity of the planetary one-shot-only industrialization party/Ponzi/galactic credit binge.

* Technically subsaharan Africa is last, I guess.