This is not a subject I am an expert in but I'll give it a go
There are long cycles in the commodity markets, partly due to the effect of business cycles and partly due to the cycle of investment in infrastructure.
The first real experience I can remember, where the rapid change in the price of commodities affected my life was in 1974 during the three day week. I was at junior school at the time. The rapid rise in oil prices after the Yom Kippur war of Autumn 1973, had brought about a recession in the industrialised economies and lax lending during the Barber boom had brought about a credit crunch. It should be added here that the extent of lax lending and the credit expansion at this period were miniscule compared to the credit expansion and dire lending standards that extended over the period 1982-2007. The culmination of this crisis was the “3 day week” when there was electricity rationing.
The price of oil was just part of a worldwide commodity boom which saw nearly all industrial and agricultural goods hit all time nominal highs, but certainly not all time real high prices. I remember my mother complaining about the cost of sugar which saw one of the most spectacular bull markets ever. The reality though was this bull market had its genesis in something that happened in the 1950’s. The colonial powers discovered that the widespread availability of small arms and explosives made guerrilla warfare the most effective form of warfare for the first time since the days of Machiavelli. The cost of maintaining armies and administrative structures was prohibitive and one by one the British, French, Portuguese, Dutch and a few minor powers withdrew from there empires. Predictably as little more had been done in these countries than build a mine, a port and a road from the mine to the port, they fell into political chaos. Many of the shares in companies in Africa and Asia sold for less than the money they had in the bank. The economic chaos that ensued meant that little investment was made in opening mines and oil fields. By the end of the 1960’s supply of metals and energies was beginning to become limited. Things were set for a large rally in industrial commodities. This occurred during the mid 1970’s.
Agricultural commodities had a bull market for different reasons. After the second world war, much of Europe saw widespread hunger. When I was postdocing in Germany in 1988/89, they still spoke of the hunger years around 1947. Food security was central to the major industrial powers and they had a cheap food policy by guaranteeing minimum prices and meeting the extra costs over world market prices by subsidies. The problem with agricultural production in industrialised countries is that it lacks comparative advantage relative to agricultural production in non-industrial countries and so North American, West European and Japanese farming were uncompetitive. Subsidising agriculture kept food cheap for two reasons. One the farmer could sell below cost and claim subsidies, but also the encouraged excess production was dumped on the world market which depressed world prices. This however discouraged investment in agriculture in the non-industrialised countries that did have comparative advantage in food production. There was little point in investing to export to Europe, North America and Japan as they had high import tariffs. The thing that really drove world market food prices high in the mid 1970’s was the failure of the Russian harvest in 1974, when the Russian government brought up the worlds reserve stores of grain.
The world’s monetary authorities accommodated these price rises as they thought it would allow them to liquidate the lending excesses, without the rise in unemployment that would have occurred if they had maintained more appropriate tighter monetary conditions. Inflation took off and in the severe recession of 73-75, unemployment rose massively anyway. So much for Keynesianism. It is in general much better to liquidate excess and inappropriate borrowing by deflation than inflation. This is because extent of deflation is limited and is therefore self liquidating. That is it will come to an end on its own. Inflation is not self liquidating, in fact it selfreinforcing. The price of accommodating the raw material price rises in the mid 1970’s was an economic crisis which largely lasted until 1982. The severe recession of 1979-82 would have been unnecessary if inflation had not been allowed to run amok in the mid 1970’s.
The consequences of high commodity prices in the 1970’s, would be obvious to anyone with an O Level in economics. Loads more crops were planted, and loads more mining engineers and oil geologists started working to open more mines and oilfields. A fantastic amount of investment was made to increase raw material supplies, at a time when the world monetary authorities began to contain inflation by strictly targeting money supply growth in the early 1980’s. The recession at the time reduced demand for commodities and prices collapsed. By 1986 oil was 6 dollars a barrel.
Real commodity prices fell until 1998 and precious little investment was made in finding more oil reserves, opening mines etc.
At this point the cycle was complete
More to come on the present cycle later...
