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The world is experiencing a 'negative feedback loop' decades in the making
(Reuters )
The opening ceremony of the Athens 2004 Olympic Summer Games.
The world is experiencing a "negative feedback loop" as commodity prices fall, according to Goldman Sachs.
What's more, this loop is a huge story decades in the making — and there isn't a country on the planet that won't be affected.
Slowing Chinese demand for raw materials has pushed the Bloomberg metals index down 25%. Liquidity is low. Cash is in shorter supply.
This is all part of a global market cycle, Goldman argues, and commodities are getting caught in the violent shuffle.
Three forces are working together to make this happen: a general oversupply of commodities, a strong US dollar, and weak economic growth in emerging-market economies such as Brazil and China.
"Lower commodity prices reinforce the US recovery and dollar appreciation; while weaker commodity currencies keep downward pressure on commodity cost curves (mainly through lower wage and energy costs)," Goldman Sachs analysts said in a note published Friday.
Here's how this whole feedback loop works: reduced Chinese demand for commodities has put downward pressure on prices, helping lower the cost of industrial production and putting more money in the hands of consumers.
That has helped spur economic growth in countries like the US which aren't reliant on the export of commodities. That in turns has led to a stronger dollar, as the market has priced in expectations of a rate rise.
The prospect of higher rates in the US is pushing funding costs for indebted emerging market countries like China upwards. That puts even more pressure on those countries to delever.
Goldman said in the note: "This deflationary impulse leads to stronger US growth and higher rates, and increasing funding costs for EMs, increasing the need to deleverage. This in turn adds more divergence, dollar outperformance, and downward pressure on commodity prices."
(Wells Fargo)
China's role in all this can't be overstated. The economy is slowing as the country tries to make a painful transition from an economy based on exports to one based on domestic consumption.
A big part of the economy was driven by the property market, which gobbled up copper and iron ore at a stunning rate.
Now the Chinese government is making overtures at exercising some kind of restraint in the sector.
That has made deflation an issue. China's falling producer price index has analysts worried that corporate margins are thinning dangerously.
The longer this goes on, the harder it will hit commodities prices. That fall in commodity prices will help this keep going on longer.
You know ... like a loop.
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