Jake's View

Fed to blame for commodities rout, not China

Inflationary boom sparked by policy of zero interest rates is coming to its natural end

PUBLISHED : Wednesday, 25 November, 2015, 6:13pm
UPDATED : Wednesday, 25 November, 2015, 7:43pm

Shanghai steel futures languished near a record low yesterday amid cooling Chinese demand, putting more pressure on raw material iron ore that is only a tad off a seven-year trough.

Reuters, SCMP, November 25

Blame China. A global glut of commodities has emerged because China suddenly decided it no longer wants mineral ores. Prices are now collapsing, which threatens the worldwide supply chain. It’s all China’s fault.

I have one problem with this story. Look at the first chart on the quantity of China’s iron ore imports and you see scant sign that iron ore is no longer in demand. That demand curve has flattened out but this is after a 16-fold growth over the past 15 years. A breather was due at some point.

And what you see in iron ore you can also see in other major minerals and in petroleum. In some cases there has been no slowdown at all. Imports of copper ore and concentrates, for instance, are still growing at double digit rates.

Nor do the figures show evidence of a pronounced slowdown in production of steel or a build-up of steel inventories within the Chinese economy. The statistics are admittedly, shall we say, fragile, but they are generally consistent over time and they show no collapse.

This, however, represents the data for the quantity of imports and production. Most people prefer to look at the value of these things. It’s much easier that way. There are no apples and oranges to compare, only US dollar figures.

And in value terms there has definitely been a sharp decline. Prices have fallen precipitously right across the board. The second chart, for instance, shows you the trend in the prices China has paid for iron ore imports.

There was a seven-fold increase between 2000 and 2011 and now this iron ore import price is headed back down to where it was 15 years ago with most of the trade gloomily predicting that it will have no trouble getting there.

Interestingly, this same pattern of highs and lows shows up in almost all minerals prices and it leads to an obvious question. How is China to blame? Rapidly rising demand from China may have been a major contributor to the commodities boom but a commodities bust can hardly be laid at China’s doorstep when import demand from China is still largely steady.

I think what we have here is actually a monetary phenomenon. It is the US Federal Reserve Board’s policy of zero interest rates that propelled this commodities boom and the boom is now faltering because it was a speculative one alone. It was never supported by any underlying economy.

What the Fed did was keep its eyes on the consumer price index and then justify keeping interest rates low because there was no inflation in the CPI. However, it entirely ignored raging inflation in commodities and securities prices. This is where the impact of unjustifiably low rates went was felt.

And now this inflationary boom is coming to its natural end, which makes finding a culprit outside their own number imperative for the people who are actually responsible.

And they have found one.

Blame China.