Mistaking Peak Prices for "Peak Everything"

Economic Super-cycles and Falling Commodity Prices


Commodities Image

Plunging oil prices have been big news over the past year. Since mid-summer 2014, the price for benchmark West Texas Intermediate (WTI) crude has fallen from $105 to $48 per barrel. But it's not just the price of petroleum that has plummeted. The prices of lots of other industrially important commodities have also been dropping.

The International Monetary Fund Metals Price Index soared to 250 points in March 2011 over its 2005 baseline of 100 points. By February 2015, the IMF Metals index had dropped to 137 points—a tumble of about 55 percent from its high. In other words, commodity metal prices are now back to where they were in early 2006. The IMF metals index covers copper, aluminum, iron ore, tin, nickel, zinc, lead, and uranium.  Similarly, the IMF price index for all commodities—including fuel, food, beverages, and metals—topped 210 points above the 100 point 2005 baseline in March 2011 but has now sunk to 121 points, a fall of about 57 percent. Again, it's about back to its level in early 2006.

The steep run-up in commodity prices that occurred over the past decade provoked numerous predictions that the world was about to run out of all sorts of resources. And why not? Higher prices, after all, would indicate that resources are becoming scarcer relative to demand. The classic of the doomster genre is Peak Everything: Waking Up to a Century of Declines by Post Carbon Institute fellow Richard Heinberg. In 2010, Heinberg doubled down and asserted, "The world is at, nearing, or past the points of peak production of a number of critical nonrenewable resources—including oil, natural gas, and coal, as well as many economically important minerals ranging from antimony to zinc."

If everything was "peaking" when prices were going up; what does it mean when they are coming down? This is where explanations based on the theory of economic "super-cycles" might shed some light. Economists Nikolai Kondratiev and Joseph Schumpeter noticed that since the late 18th century the prices of most commodities tended to rise and fall in waves lasting 40 to 60 years. However, the troughs of each successive price wave tended to be lower than the last, indicating that the real prices of commodities were falling over time. In general resources are becoming ever more abundant, not scarcer.  

According to Kondratiev and Schumpeter these "long cycles" in commodity prices are driven by periods of rapid industrialization and economic growth spurred by technological progress. In 1938, Schumpeter identified three cycles: the first associated with the beginning of the Industrial Revolution in the early 19th century; a second characterized by "railroadization" and industrial expansion in Western Europe and the United States; and third that based on "electrification" and the internal combustion engine.

Another way to conceptualize the price upswings of past super-cycles is that each occurred as new countries joined the global capitalist enterprise system. This would include cycles associated with the successive industrialization and economic expansion of Britain, followed by the United States, then Germany and Japan, post-World War II reconstruction, and lately the rise of China and India.

Commodity prices ramp up as economic growth speeds up in the early part of each cycle. Incited by rising prices, entrepreneurs then work hard to develop new supplies, increase resource use efficiencies, and find substitutes. In essence, this process is technological progress. On the downswing of the each super-cycle supplies catch up with demand and prices begin falling.

Are we on the downward sloping side of the latest super-cycle? Very likely. In his 2014 working paper, "150 Years of Boom and Bust: What Drives Mineral Commodity Prices?," Dallas Federal Reserve Bank economist Martin Stuermer analyzed the real price and production trends of four industrially important metals—copper, tin, lead, and zinc—between 1840 and 2010. 

Stuermer reports that "price surges caused by rapid industrialization are a recurrent phenomenon throughout history."  The most recent surge in commodity prices, according to Stuermer, is due mostly to "large demand shocks attributable to China in 2003 to 2007." The effects of China's demand shock are now dissipating. Stuermer asserts that if "there are no new positive demand shocks, the results [of this analysis] suggest that current prices might further fall, as supply catches up and prices return to their long-run trend." He adds, "Commodity exporters should thus prepare for a further down swing of mineral commodity prices." Ultimately, Stuermer expects that mineral commodity prices will "return to their declining or stable trends in the long run."

Stuermer's analysis bolsters the conclusions on super-cycles reached by Northeastern University economist Bilge Erten and Columbia University economist Jose Antonio Ocampo. In their 2012 super-cycle working paper, Erten and Ocampo report evidence for four commodity super-cycles between 1865 and 2009, each one lasting between 30 to 40 years. They find that "for non-oil commodities, the mean of each super-cycle has a tendency to be lower than that of the previous cycle." In other words, the real prices of commodities have been undulating downward for more than a century.

Erten and Ocampo also point out, "The magnitude of cumulative decline during the downward trend is 47 percent for the non-fuel commodity prices, with recent increases of around 8 percent far from compensating for this long-term cumulative deterioration." The recent upswing phase of the current super-cycle did not boost commodity prices to nearly what they were a few cycles back.

However, Erten and Ocampo report that metals have been an exception—the mean of the last cycle was higher than the preceding one. Still, they note, "The contraction phase of this cycle has not even begun yet, which can lower the mean of the whole cycle in the upcoming years." It now appears that commodity prices were just reaching their pinnacles when Erten and Ocampo were writing up their results back in 2011. Instead of peak resource production we are most likely now past peak commodity prices—and heading lower for at least for the next ten to fifteen years.