PERILS AND PAIN OF EVER-RISING PRICES / THE FINANCIAL TIMES COMMENTARY & ANALYSIS ( A MUST READ )

Perils and pain of ever-rising prices

By Stephen King

Published: April 18 2011 22:47


Rising commodity prices are a permanent new feature of the new global economic landscape. Their ascent reflects the world’s shift in economic power from west to east. It is time we got used to it.


Recent price rises have been extraordinary; so much so that Robert Zoellick, World Bank president, warns of “a toxic brew of real pain”. He was talking mostly about those in poverty. Yet with food prices doubling since 2000, and oil and metals rising three or fourfold, no one is immune.


This is not just a story about loose US monetary policy, or the rise of large commodity businesses such as Glencore. Instead, we are seeing the growing pains of emerging market success. Gone are the days when rapid Asian growth was taken to reflect strong US or European demand. Chinese consumers now contribute almost as much as America’s to global consumer spending growth, while Chinese investment has outstripped the US since 2001. Global decoupling, once a fantasy, is our new economic reality.


For all their progress, however, both China and India are still poor countries. This matters, because at low levels of income rapid growth is synonymous with large increases in demand for raw materials. Here, the infrastructure that already exists in the developed world is only now being built, while people shifting to meat-and-dairy-based diets cause demand for crops to rise too.


Of course, rising demand need not always be associated with higher prices. In the long run, at least, higher prices should trigger supply increases, and see scarce resources used more efficiently. But supply cannot be created at the flick of a switch, particularly when agricultural land once used for food is now often being used for biofuels.


There are other limits too. Take passenger air travel. Cost per passenger mile has fallen by 75 per cent since the 1950s. Passenger numbers, however, have risen sevenfold, and distances travelled have also risen dramatically. Here, as in other areas, efficiency gains have not been enough to ease the pressure on the use of scarce resources.


Worse, under normal market conditions, this problem is only going to deepen. Rapid productivity gains in China and India are pushing domestic incomes higher, increasing consumer demand. China’s and India’s terms of trade are also improving: in the future either the renminbi and rupee will rise in value or, alternatively, China’s and India’s domestic prices and wages will rise relative to those abroad.


Whichever prevails, China and India will be able to afford more commodities, forcing prices higher still. But this is part of a wider pattern, namely that all industrialising nations need access to the raw materials that underpin growth. Historically, European powers solved this dilemma through colonisation and slavery. That path not being open today, China and India need other options.


This is why China is still busily negotiating bilateral deals with commodity-rich nations, notably Iran and various countries in sub-Saharan Africa. The terms of these deals are often murky, reflecting their blurring of commercial and state interests. They are also often only a stone’s throw away from protectionism. Other emerging nations, meanwhile, are using generous subsidies and draconian price controls to protect their most vulnerable members. With inflation at its highest level for more than two years, China, for instance, has recently resorted to controls on consumer items. And it may soon be forced to allow a faster appreciation of its currency too.


Yet such moves simply impose bigger costs on others; costs that are increasingly visible elsewhere in the world. As the east rises, so the west finds itself picking up part of the bill – as higher commodity prices seriously threaten fledgling recoveries. Inflation on both sides of the Atlantic is now squeezing real incomes, and threatening to throw economies back into recession.


After the biggest meltdown since the Great Depression, economic theory tells us that world commodity prices should not be this high. But they are – and the west quickly needs to wake up to this new economic reality. Commodity prices are now permanently higher. We are entering a period of austerity not just because of the debts of the past, but also because of the higher costs of the present.


To escape this trap, western growth in the future must rely on building new trade linkages with the emerging world. As these emerging economies come to dominate the global economy they will need new products and services, appropriate for aspirational citizens with just one foot on the development ladder. If advanced economies can provide these, rather than the complex and expensive products more typically consumed, we too can benefit from the success of the emerging world.


This is not quite a zero sum game: the global economy is, after all, expanding healthily at present. But it is a game where the success of the emerging nations is imposing an unexpected burden on western progress. Fail to recognise this new reality, and the world could descend into the protectionism, financial chaos and conflict that scarred the first half of the 20th century. To avoid this fate, we all need to work out how to live within our new and increasingly modest means.


The writer is Group Chief Economist at HSBC and the author of Losing Control: The Emerging Threats to Western Prosperity


Copyright The Financial Times Limited 2011