Falling commodity prices and emerging-market equities are bad omens for the world economy
FIVE years ago, two views were fairly common. The future belonged not to the sluggish, ageing advanced economies but to the emerging markets. Furthermore, those economies had such demand for raw materials that a “commodity supercycle” was well under way and would last for years.
Commodity prices peaked in 2011, and have been heading remorselessly downwards ever since. Their decline of more than 40% so far is a huge bear market; had it happened in equities, the talk would be of calamity and collapse.
News coverage in the Western media tends to view the decline in commodity prices as a benign phenomenon, as indeed it is for countries that are net importers. But it is not good for commodity exporters, many of which are emerging markets. That helps explain why emerging-market equities have had only one positive year since 2011, and have underperformed their rich-country counterparts by a significant margin in recent years (see chart). The latest sign of trouble came in China, where the Shanghai Composite fell by 8.5% on July 27th.
The growth rate of emerging economies is likely to slow in 2015 for the fifth consecutive year, according to the IMF. Of the BRICs, Brazil and Russia will see their output decline this year, while China is slowing. Only the Indian economy is set to accelerate. Developing economies were boosted in the first decade of the 21st century by the rapid expansion of Chinese demand, as the world’s most populous country underwent an investment boom. This was good news for commodity exporters; China comprises almost half of global demand for industrial metals. But the fall in commodity prices indicates that Chinese demand has slowed in recent years. It also shows that high prices did their job, by bringing forth new sources of supply, such as shale oil and gas.
At the same time, China has shifted its manufacturing industry from the assembly of components made abroad to the creation of finished products from scratch. This has hit other Asian economies. Emerging-market exports are down 14% over the past year in dollar terms. In terms of volume, they continued to grow, but only by 1.1%, according to Capital Economics. Such anaemic growth is becoming a trend. World trade, which was expanding faster than global GDP before the financial crisis, is no longer even keeping pace: last year, it grew by 3.2% while GDP advanced 3.4%.
China’s investment boom may also have created a problem of overcapacity in manufacturing, leading to pressure on profit margins in the corporate sector. The latest figures show that the profits of China’s industrial companies were 0.7% lower in the first half of the year than in the same period of 2014. Chinese producer prices dropped by 4.8% at an annual rate in June, the 40th consecutive month of decline. The effect may be spreading to Asian competitors: the purchasing managers’ indices for the manufacturing sector in Indonesia, South Korea and Taiwan all pointed to declines in output in June.
The big question is whether this weakness tells us anything about the global economy. Will the Federal Reserve be acting unwisely if it pushes up interest rates later this year, as markets concluded it would after its meeting this week? On July 9th the IMF cut its forecast for global growth this year from 3.5% to 3.3%. That would be only marginally lower than last year’s rate of 3.4%, but it would still be the most sluggish performance since 2009.
Government bond yields are another indicator of economic sentiment. When they decline, it is a sign that investors are worried about the outlook for growth. Although ten-year yields have recovered from their lows of late January, they are still well down on their levels of a year ago—half a point or so lower in the case of Canada and much of Europe.
Given the background, this does not seem the most obvious time for the world’s leading central bank to be tightening monetary policy. Of course, the Fed is supposed to focus on domestic conditions, not the international environment. But higher American rates will probably mean a stronger dollar, and thus tighter monetary policy for countries that peg their currencies to the greenback. And it will create a problem for economies with lots of dollar debt. Several emerging-market currencies are already at multi-year or record lows.
The hope is that the signs of a slowdown will prove mistaken. The IMF expects both the global growth rate and that of emerging economies to pick up in 2016. Perhaps it will be right. Unfortunately, it has often been over-optimistic in the past.
