A S developed countries begin to experiment with the first steps in the journey to post-COVID economic normalcy, they are overcome by a new fear. The fear of inflation signalled by a sharp spike in global primary commodity prices affecting markets ranging from those for grain to precious metals and raw materials. Having touched a four-year low in March 2020 when the pandemic engulfed the world, the Bloomberg Commodity Spot Index, which tracks prices for 23 such items, has risen by 70 per cent since then.
The spike appears generalised across commodities. The price of copper has more than doubled over the past year—rising from below $5,000 a tonne to cross $10,360 a tonne—exceeding a previous peak reached a decade back in 2011. Iron ore prices are approaching a record high of $230 a tonne. The price of Brent crude is close to $70 a barrel, having climbed from $55 a barrel at the start of the year. It is expected to rise to touch $80 a barrel in the second half of the year. Prices of key agricultural commodities such as grains, oilseeds, sugar and dairy products have also risen sharply. At around $7.5 a bushel, corn prices are 50 per cent higher than at the beginning of the year and more than double their level a year ago. Soybean is selling at its highest price since 2012. And lumber prices have soared in the United States, up 67 per cent this year and 340 per cent relative to a year ago. In sum, commodity prices are rising across a wide range of categories, and by large margins.
This across-the-board and sharp price increase has triggered speculation in some circles that the world economy is set to experience another commodity “supercycle”. The term has been used not to capture a full cycle but to describe a tendency in which for an extended time span, lasting a decade or more, most commodity prices rise significantly and remain at elevated levels relative to their long period average. Given that definition, it is clearly too early to declare that recent developments are early indications of the unfolding of a supercycle. Yet, one reason why such claims have proliferated in analyst briefings and the financial media is the not-too-distant experience with the previous such boom that lasted through the first decade of this century and ended early in the second. Many commodity-exporting developing countries benefited hugely from that boom. Those were the years when Latin American countries appeared to make up for lost decades of development when they were plagued by debt and financial crises. Those were also the years when African nations were seen to be on the rise.
Three other instances
But since that last experience with a prolonged commodities boom is so recent, the likelihood of another such protracted rise in prices is low. There have been only three other instances of such “supercycles” since the beginning of the last century: one in the early 1900s, the second in the 1930s and the third during the post–Second World War Golden Age. In all of these instances, price buoyancy was driven by rising demand spurred by one or more countries recording accelerated development involving rapid industrial expansion and large infrastructural investments. That was true during the years of post–Second World War reconstruction in Germany and Japan, for example, and of the two decades starting from the 1990s when China grew rapidly and displayed a near insatiable demand for raw materials and directly consumed primary products. Given these features, the probability that another supercycle would manifest itself barely a decade after the last one ended is low. The time gap seems small and there is no equivalent pole of rapid industrialisation that can attract raw material and food supplies from across the world.
There are reasons, however, why the current commodity price spike is likely to persist for a short period, even if not long enough to deliver gains equal to those registered during earlier supercycles. One is the asymmetric movements in supply and demand for commodities that the pandemic and the response to it have resulted in. Initially, with physical distancing, restricted movements and lockdowns in place, both supply and demand were affected. But as countries struggled to counter the worst effects of the COVID-induced crisis with cash transfers, enhanced spending and relaxation of containment measures, demand revived without supply adjusting seamlessly to the increased demand. The result was a rise in prices.
Uneven distribution
These asymmetries have been aggravated because of the extremely uneven distribution of the recovery across countries. Thus, although the first coronavirus infections were confirmed in China, it has been able to put the pandemic behind it to a substantial degree and record the most robust of recoveries currently under way. To support growth and replenish inventories cleared last year, demand from China for raw materials and food has risen. With supply taking time to adjust, prices have risen too. This role for China in explaining recent demand trends has strengthened the supercycle claim, given that country’s contribution to driving the demand that fuelled commodity price inflation in the previous cycle of the 2000s.
Meanwhile, governments in a number of advanced economies have chosen to drop the fiscal conservatism they have displayed for decades now and opt for large stimulus packages in response to the pandemic. According to the International Monetary Fund, globally, additional spending and revenues foregone during January 2020 and March 2021 amounted to $9.93 trillion, of which $7.98 trillion, or 80 per cent, was contributed by the 10 advanced economies in the G20. The U.S. alone accounted for $5.33 trillion, or a huge 54 per cent of the total. This too is spurring demand, including for primary commodities as inputs or final consumption goods, sustaining the commodity price spiral.
Finally, the waning of the pandemic and the developed country-focussed vaccination rollout and stimulus spending are expected to support a “bounce back” from the economic depths into which countries had descended because of the crisis. That will revive demand for commodities as well. For example, travel and transportation are expected to gather momentum; this will increase the demand for oil even when production cuts imposed by the Organisation of Petroleum Exporting Countries and Russia remain in place and support prices.
The combination of these developments, it is reasonable to expect, will substantially strengthen the more than year-long price buoyancy. But the prospect of that turning into a commodity price supercycle is as of now remote since all drivers are likely to lose force after a period. The issue that remains is the impact the commodity price surge will have on developing countries, which include a large number dependent on commodity exports to earn scarce foreign exchange and drive gross domestic product growth. That impact will depend on the benefit from the price increase that will accrue to developing country exporters. While it is inevitable that some of the benefit will accrue to them, the magnitude of that gain will be constrained. With supply constrained because of pandemic-related restrictions, export volumes may take some time to revive, depriving exporters of the full benefit of higher prices. Moreover, much of the price increase may be the result of speculative holdings of commodities as an asset class, which implies that the increase in market prices does not get transmitted to the prices received by producers and exporters.
Potential for speculation
The potential for speculation in commodities, as in all asset classes, has risen substantially over recent years given the liquidity overhang resulting from the injection of large volumes of credit offered at near zero interest rates ever since the global financial crisis. The pandemic-induced crisis saw central banks extending and intensifying the resort to such unconventional monetary policies that place near costless capital in the hands of interested speculators. The activity of those speculators could explain the rather sharp spike in commodity prices over a period in which global economic activity has remained well below levels typical of the pre-COVID economic trajectory. To the extent that these speculators were absorbing the gains from commodity price inflation, the benefits of the higher prices would not have accrued to developing country exporters.
On the other hand, there is an indirect way in which the commodity price rise could work against developing countries. Increases in commodity prices ranging from energy to industrial raw materials would drive up prices in the U.S., where policymakers are already concerned with the economic overheating that could result from the massive stimulus spending by the government. The Treasury has indicated that the Federal Reserve must look to raising interest rates to counter the effect that government spending may have on inflation. If the Fed, which thus far seems reluctant to withdraw its own easy and cheap money policies, were to finally succumb and raise interest rates, an adjustment of the portfolios of financial investors and asset managers would be inevitable. One consequence would be an exodus of capital from equity and bond markets in the developing “emerging” and “frontier” economies, many of which are already burdened with external debt, dependence on which rose during the pandemic.
In short, the implications of the commodity price spike are different for advanced and emerging economies. For the former it makes the task of balancing spending to counter the pandemic and inflation risks that much more difficult. But for the developing countries, the causes and consequences of the spike are crucial. If it is caused in large measure by speculative investments fed by the availability of cheap capital, the gains that accrue to commodity producers and exporters will be limited. And, if in response to the inflation, monetary managers in the advanced economies pushed up interest rates, developing countries would be hit adversely by the destabilising capital outflows that would result.
