Preach Mauldin

John Mauldin:

I think history will show that the result is a massive misallocation of capital.

1. With central banks driving down interest rates, savers and investors saw their incomes reduced. The losses they incurred limited their ability to invest in business startups. While we all celebrate Silicon Valley and the venture capital business, the reality is that most small businesses are not started with venture capital but with personal savings and investments or loans from friends and family. When you reduce the amount of money available on Main Street, it should be no surprise that you get fewer new business startups. In fact, for the first time in the history of this country, we are seeing more businesses close than are started. The Federal Reserve would contend that low rates make the cost of money lower, but very few new businesses get started with just bank loans from a small community bank.

I am shocked at the amount of money that banks will lend me today. I truly am. But back in 1977 at the tender age of 28, all I could get was $10,000 for inventory. And I paid 18% interest. Well, there is an example of a bank lending to small business. Except I later found out they really didn’t. My mother went to them and guaranteed the loan without telling me. Otherwise, I was just some kid with a business idea. It was literally friends and family at the beginning, after all.

How many great ideas died in the last decade for lack of funding? I think the answer would startle us. I’ll bet some of them would have boosted productivity enough to get GDP to that 4% Jeb Bush thinks would be wonderful.

2. Instead of going to the people and businesses who could have made best use of it, all that money simply drove asset prices higher – mainly stocks and real estate.
3. Financial engineering became the mantra of the day. It is now cheaper to buy your competition than it is to actually invest in equipment or people and compete with rivals. Or you can borrow money cheaply to buy back your own stock, thus engineering increased profits per share and bonuses for management all around.
4. Meanwhile, the Obama administration and Congress gave us financial regulations (Dodd-Frank) that drove a lot of innovation out of public markets and into Silicon Valley’s private ventures. This is certainly spurring innovation – but innovative people elsewhere still struggle to raise capital.

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end of commodity supercycle

Moreover, there is a growing consensus among commodity bears that the boom-bust commodity cycle was a natural consequence of the past several decades of rapid liquidity growth and excessive debt accumulation.
It is important to note that accentuated commodity boom supercycles that deviate greatly from their physical fundamentals are not possible without a permissive monetary environment. Indeed, supercycles have their origins in reflationary monetary conditions and are fueled by negative real interest rates or excess liquidity growth.

The fact that reflationary monetary measures were left in place for such a long time aggravated the problem, since they fueled a powerful debt-financed consumption and investment boom that eventually became unsustainable. The reflationary measures did succeed in igniting global recoveries in 2003 and 2009, but they also created new asset bubbles. In particular, they set the stage for the increasing “financialization” of commodity markets. Indeed, the growing participation of financial market investors in commodity trade likely contributed to the excessive rise in prices during the boom, worsening the subsequent bust.

For some commodities, such as iron ore and aluminum, abundant capacity will likely ensure downward pressure on prices for some years.

So the odds are that commodity prices will remain relatively flat, rather than recover strongly, for at least several years. Indeed, IHS believes commodity prices will not regain their early 2014 levels for the rest of this decade.

The economies that have benefited most from the lower prices are those that are primarily manufacturing or service oriented

only three major net commodity exporters that are advanced economies—Australia, Canada, and Norway. These three countries had benefited immensely from the booming commodity prices during the last decade and a half, but they are now facing a very challenging period of austerity that will likely last several years

The biggest losers at the end of the supercycle are the developing countries that earn most of their foreign exchange inflows from exports of energy and/or minerals—in other words, most countries in the Middle East, Africa, and South America, as well as some in Asia. The economic situation of these countries has already deteriorated rapidly since 2014, and their prospects are expected to remain negative as long as commodity prices remain depressed.

China’s ascension to the World Trade Organization (WTO) in December 2001 was a watershed event, without which the supercycle might not have been possible. At a minimum, the cycle’s amplitude and duration would probably have been far smaller. WTO membership not only boosted tremendously China’s exports to the rest of the world, but also attracted huge volumes of foreign direct investment (FDI) into the country’s manufacturing sectors. These, in turn, led to vast amounts of domestic capital being invested in precisely those industries that are intense users of energy and raw materials.
The domestic investment binge, which was easily financed by the Chinese people’s excessive savings, generated an insatiable appetite for energy and raw materials during the last decade. Indeed, not only did levels of physical consumption of commodities rise, but the rate of their growth accelerated as well. It was this acceleration that started to strain commodity markets and pushed prices progressively higher—far above previous nominal cyclical peaks. Commodity prices roughly doubled between 2002 and 2004. They doubled again between 2004 and early 2008, before crashing during the Great Recession’s global credit crunch.