Unsettling news of the day

The Dow Jones closes below 6800, its lowest level since April 1997. Lost decade, indeed.

Commodity price collapse: who wins and who loses?

One of the great back stories of the ongoing economic crisis is the collapse in commodity prices, which occurred in the second half of 2008 after a record boom period lasting at least five years. The bursting of the bubble has produced clear winners and losers. Thanks to our fantastic contributors, zzzeitgeist has had excellent coverage of these repercussions. I thought I’d try to tie things together.

The biggest winners are consumers, particularly first-world automobile drivers. In the last 7+ months, oil has fallen from $147/barrel to about $37/barrel now. Economists reckon that amounts to a ‘stimulus’ of more than $240 billion. Also, now that the world food crisis has largely subsided, developing-world consumers stand to benefit from cheaper food prices. This means a lot when you spend more than 50% of your budget on food.

The mining sector is obviously a huge loser. Mining is often a boom and bust industry, because it takes a long time to develop new mining projects. It’s hard to forecast future supply/demand fundamentals (remember when this seemed like a good idea?) and unfortunately they can change drastically and rapidly, which is exactly what has happened in the last year. As a result, a number of firms are closing mines, because prices are too low to justify operating costs. Mining firms often take on a lot debt out of necessity – digging mines ain’t cheap. But thanks to the financial crisis and the disappearance of cheap credit, heavily indebted companies are suddenly struggling to stay afloat. Case in point: Rio Tinto, the world’s second largest mining conglomerate. See Rory’s excellent treatment of Rio’s debt woes here.

Finally, commodity-dependent countries suffer perhaps the worst. When prices are high, resource-rich countries are suddenly flush with cash, which they can use to advance geopolitical aims, reward cronies, or invest in infrastructure, education and health to avoid the resource curse (don’t hold your breath). Falling commodity prices have scaled back these ambitions. See Dan’s analysis of Venezuela, Rory’s take on Russia, or this money quote about Iran.

In my mind, these are the biggest winners and losers, but this list is by no means exhaustive. Falling commodity prices also have an enormous effect on agricultural trade, international cooperation, foreign direct investment, Guinea, South Africa, Australia, several Latin American countries, etc. Who else am I missing?

(photo from jeff-o-matic’s photostream)

China: the ultimate value investor

On Febraury 12th, Rio Tinto announced plans for a $19.5bn cash injection by Chinese state-owned firm Chinalco. The heavily indebted mining group will issue convertible bonds and receive investments in three strategic partnerships, giving Chinalco minority positions in some of Rio Tinto's best mining assets and increasing its total share of the firm to 18%. The plan is subject to shareholder approval and requires official permission by the governments of Australia (which swiftly moved to amend its foreign investment rules to consider convertible bonds as equity) and Chile; approval is far from certain and the deal is already highly controversial amongst Rio's existing shareholders.

Rio is effectively selling pieces of its best assets to one of its biggest customers; empowering a shareholder whose self-interested desire for low commodity prices directly conflicts with the interest of the others (high prices). But should the deal succeed, it would be the biggest Chinese investment ever in a foreign company, and herald a new focus in China's pursuit of resource security. China's investments in Africa are well-documented and readers of zzzeitgeist will surely be familiar with China's "FDI for access" bargain. But an 18% capital investment in one of the world's largest mining groups suggests a higher profile campaign to leverage the relative economic strength of the Chinese government towards the acquisition of strategic corporate assets.

While the era of the sovereign wealth funds came and went with a whimper, state-owned companies with decent balance sheets seem primed for a foreign buying spree, particularly in the heavily indebted mining sector. With mining assets cheap, and the financial backing of the Chinese state strong, the opportunities for Chinese companies abroad are immense. That is, if they can overcome the tricky little problem of economic nationalism.

A final academic point: the US has been referred to as the world's largest venture capitalist. Perhaps we should begin referring to China as its largest value investor.

(photo from kt_bluesky's photostream)

Comics in crisis

I always knew Bill Watterson was prescient, but this is just scary.

(Nice job World Bank; really, I didn't think you had it in you) 

The new green economy: what role for government?

The Economist has an interesting leader this week on the perils of government-led investment in solutions to climate change. If I understand the arguments correctly, the thinking goes that there is an upside to climate change; namely, the naissance of a new and profitable green-tech industry to combat it. Millions of new “green collar” jobs will be created as money is funneled into alternative fuel and energy research and implementation. If the government subsidizes this industry, it will lock in those jobs domestically, boost the economy, and achieve policy goals like energy independence and fighting global warming.

Of course, the problem with any government-led subsidy program is the issue of picking winners. Resources are scarce, especially if you’ve seen the federal debt numbers lately. You can’t subsidize everything, and by subsidizing any particular form of alternative energy, the government is expressing its confidence in that fuel’s viability. But the government, a semi-closed organization with limited human capital and a bureaucratic (read: slow) outlook, is almost certain to be less efficient at distributing resources and picking winners than a market. That’s why we live in a market society, and that’s why communism doesn’t work (sorry, Ms Klein.)

None of this is new, but it bears repeating for two reasons. First, Mr. Obama has named energy independence as his top domestic priority behind stabilizing the financial system and the economy. Second, the financial crisis has so badly tarnished the reputation of markets that resistance against government leadership on green investment is unlikely. Thus, we may be on the cusp of a massive government-funded research program for green technology, and so we need to carefully consider the downsides of such a policy prescription. After all, the United States is still happily subsidizing corn-based ethanol, which is a terrible idea.

There is a central role for governments to play in a market society. Moving forward, there will be a leading and constructive role for government to play in the fight against climate change (please can we have a carbon tax?) However, in an ideal situation markets and government complement one another. Each has its own strengths and weaknesses. But above all else, we should strive to avoid a situation where one of these institutions usurps the role best played by the other.

(photo from montanaraven's photostream)

This is your brain on ethanol

As the other half of the Zeitgeist editorial board, I'd like to take this opportunity to strongly endorse my coauthor's denunciation of corn-based ethanol. By this point, I think it's safe to say that the only ones who are really benefitting from our flirtation with domestic ethanol production are the people of Iowa. The rest of us are really getting the short end of the stick. Some thoughts:

The relatively new and historically-unprecedented demand for corn is putting an enormous strain on American farmers' production capacity. Land that could be used to grow other crops is now devoted to corn, which causes the prices of those agricultural products to rise (this is why historically the grain futures markets track each other very closely, and why soybean prices almost mirror corn prices.) Meat is becoming more expensive, because a good deal of livestock feed is corn-based, and it takes about 700 calories of corn to produced about 100 calories of meat. A USDA economist recently estimated that about 3% of corn's price increase could be attributed to ethanol demand. Compare that with the UN Food and Agricultural Organization, which argued that it was almost 30% (did the USDA forget to move a decimal point?), and the World Bank who've put the number as high as 70%.

What to do about all of this? There are a few sensible steps to take. First, stop subsidizing ethanol production. It's an enormous waste of money and it's never going to be anywhere near efficient enough to justify. Another oft-repeated but damning statistic: you could feed a person for an entire year with the amount of grain it would take to fill an SUV's 25-gallon gas tank once.

Second, encourage investment in other energy projects. I'm skeptical that governments have the know-how to pick winners in these situations, so why not let venture capital markets take the lead? Anyways, they more or less already are. Governments might consider helping spur further research with calculated tax breaks/credits for green investment.

Third, import Brazilian sugar-cane based ethanol. In contrast to our ethanol made with corn, sugar-cane is more efficient (hence cheaper) and there's no worry about anyone starving because you use the cane to make ethanol instead of sugar. Besides, Brazil has plenty of land to grow the stuff on, without destroying the Amazon rain forests. They are investing heavily in the industry and already exporting significant amounts.

I might have lost the "energy independence" crowd with that last point. But here's an uncomfortable truth: energy independence is not going to happen anytime soon, if ever. As a country, we just consume far too much energy to realistically produce it all at home. (But why is that such a bad thing? Have we all forgotten about comparative advantage?) Anyways, if you are concerned with security, doesn't it make sense to start buying more fuel from a friendly, stable democratic state and "transfer less wealth" to backwards, authoritarian nations in the Middle East? Think of what that would do for our image in Latin America! Why, you can almost hear Mr. Chavez gnashing his teeth already!

(Picture from Rolling Stone Magazine.)