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Why Current Commodity Bust Cycle May Be Different Than Before? China, Says One Harvard Professor

(Kitco News) - The current commodity bust is in its fourth year, and although past commodity-price downtrends have lasted on average seven years, one Harvard professor says it may be a different this time because of one major economy -- China.

“Since the late eighteenth century, there have been seven or eight booms in non-oil commodity prices, relative to the price of manufactured goods,” noted Carmen Reinhart, professor of international financial system at Harvard University’s Kennedy School of Government, in a Project Syndicate post Thursday.

“The booms typically lasted 7-8 years, though the one that began in 1933 spanned almost two decades,” she added, noting that commodity-price busts – with peak-to-trough declines of more than 30% -- typically have a similar durations.

According to Reinhart, during commodity busts – using the one that ran from the late 1970s to 1992 as an example –  banking, currency and sovereign-debt crises tend to increase rapidly, and “crisis-avoidance” jumps to the top of policymakers’ to-do lists.

However, Reinhart questioned whether this commodity crunch will be similar to the almost two-decade long correction, and said it is best to look to China for answers.

“The question now is whether the current crash will follow a similar trajectory, with the recent break soon giving way to another drop,” she said. “The answer lies primarily (but not exclusively) with China.”

According to Reinhart, if China’s economic slowdown continues, the commodity downturn is likely to continue because no other economy has the capacity to pick up the “demand slack.”

“The U.S. economic expansion is likely to slow soon, as the Fed raises interest rates. And Europe’s relatively recent recovery will probably be moderate and tilted toward domestic services,” she noted.

Another factor to predict just how painful this downturn could be, she continued, really depends on how governments and individuals behaved during the boom – or what Reinhart referred to as “the bonanza.”

“By the end of the boom, many commodity exporters had already initiated investment projects to expand production. As these investments bear fruit, the increased supply will sustain downward pressure on prices,” she explained.

“And many emerging-economy governments’ understandable aversion to running substantial and persistent current-account deficits will lead them to counter weaker export prices by increasing export volume, even if that drives down prices further,” she added.

The current commodity bust has seen gold fall by 10% over the last year. Oil and copper had it far worse, losing 47% and 31%, respectively, based on continuation charts for nearby New York futures.

“This commodity-price roller-coaster ride is probably not over yet. While we cannot know for sure what will happen, it would be prudent to brace ourselves for another drop – and do what we can to avoid a crash,” she said.

By Sarah Benali of Kitco News;
Follow me on Twitter @SdBenali



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