Behind the commodities bust

By Bob Samuelson [The Washington Post]:

First was the dot-com bubble, then the housing bubble. Now comes the commodities bubble. We don’t fully understand the stock market’s current turmoil, but we know it’s driven at least in part by a bubble of raw material prices. Their collapse weighs on world stock markets through fears of slower economic growth and large financial losses.

All bubbles share similar characteristics. There’s a strong, enthusiastic demand for some object (whether stocks, homes, oil or tulips). High demand pushes up prices, which inspires more demand. Prices ultimately reach unsustainable levels so that when spending slows, the bubble implodes. Commodities have now traced this familiar path.

As the Economist reminds us, raw material prices respond to different influences. Weather affects crops; technology (a.k.a. “fracking”) affects oil recovery. Still, despite these variations, prices of many commodities — not just oil — have followed roughly similar trajectories in recent years. They have dropped steeply, according to figures from the International Monetary Fund.

Here are declines for five commodities from 2012 through July 2015: oil, down 48 percent; iron ore, 60 percent; copper, 31 percent; palm oil, 39 percent; and wheat, 37 percent. Many commodity prices have continued to fall.

The bubble formed on hopes that China’s rapid growth would feed an ever-expanding appetite for raw materials, says economist John Mothersole of the consulting firm IHS Global Insight. Demand and prices would remain high indefinitely. Although prices fell after the 2008-09 financial crisis, China’s huge “stimulus” package — intended to offset the crisis’s drag — sent them up again, says Mothersole. China’s demand seemed destined to stay strong, as economic growth would stabilize at a high level.

It didn’t. In 2010, China’s economy grew 10 percent; the IMF expects 6.8 percent in 2015 and 6.3 percent in 2016. Other economists think growth could be lower. As a result, much of the added production capacity — mines and the like — to supply China isn’t needed. “There’s a new commodities era,” says economist Rabah Arezki, head of the IMF’s commodities research. “Everyone was rushing to invest. Now they have to adjust to a new lower level of demand.”

Continue reading here.

Workers carry pipes to install an irrigation line in a coffee farm in Santo Antonio do Jardim, Brazil, last year. (Paulo Whitaker/Reuters)

Chile's Housing Market

Chile's housing market developments in six charts (from the IMF's latest report):

Spain's Housing Market

The Spanish housing sector appears to have bottomed out, says the IMF's new report on Spain. The report notes that the construction activity has started to recover, mostly driven by the non-residential sector. Moreover, construction permits have stopped falling and house sales are picking up. And housing prices started to increase slightly, albeit unevenly across regions.

Below are six charts that show the developments in the housing market in Spain. 

China: How Big Is the Risk of a Real Estate Slowdown and Does It Matter?

"China’s housing market has softened visibly since 2014, reflecting oversupply in most cities. More adjustment is likely", says the IMF's latest report.

How big is the risk of a real estate slowdown? The report says:

"All indicators point to weakness in China’s housing market. Housing prices have been moderating both at the national level and across all city tiers, with the weakest performance among the smaller cities. (...) Housing inventory ratio—floor space unsold to floor space sold—shows a buildup since 2013, suggesting oversupply. Even though there is uncertainty regarding the level (National Bureau of Statistics (NBS) data show inventory of four months, while data from local housing bureaus suggest higher than two years), the direction of the buildup is clear. Inventory is especially high in Tier 3 and Tier 4 cities."

Johan Norberg: India Awakes

Since 1991, 250 million people have been lifted out of poverty in India. Johan Norberg’s documentary India Awakes discusses how this happened.

It used to be said that Indians succeeded everywhere except in India. Now Indians are starting to succeed in India.

At an event at Cato, Norberg said that "India is waking up because the government is starting to take a nap every now and then (imposing fewer regulations)".

"What you can do and at what price matters more than who you are or what caste," said Norberg.

"It's morning in India but that is when the work day begins."

India has set the goal of being in the top 50 countries in the World Bank's Doing Business Index. Today it is at number 142 out of 189 countries.

A lesser known fact about Norberg is that he helped me inaugurate the IMF’s Book Forum: the topic was “Capitalism and its Critics”. The transcript makes for very interesting and prescient reading today – all the speakers (Jerry Muller, Ann Florini and Norberg) brought their ‘A’ game. For a short summary of the event click here.

Recent Labor Market Reforms in Spain: A Preliminary Assessment

From a new IMF study:

"The 2012 labor market reforms are making a difference. Wage moderation is contributing to a visible recovery in headline employment growth, and the reforms have made the labor market more resilient to shocks. There is also some evidence that the contribution of temporary contracts to employment growth has started to decrease. However, the reliance on temporary workers remains strong overall and further structural reforms will be required to reduce the still very high level of long-term, structural unemployment."

House Prices in Jordan

"Mortgages slowed down in tandem with real estate prices; exposure of banks to real estate credit risk has remained limited", notes the latest IMF report on Jordan.

House Prices in United Arab Emirates

"The real estate market in the UAE has cooled down after expanding strongly in 2013 and the first half of 2014. By end-2014, sales price increases moderated in Dubai and Abu Dhabi, and in March 2015, growth in residential sales prices turned slightly negative in both Emirates, in year-on-year terms (...). These developments are taking place amid increased supply, particularly in Dubai, and reduced demand associated with lower oil prices and appreciating US dollar, and following the introduction of mortgage regulations based on loan-to-value ratios and an increase in the property transfer fee in late 2013. With the additional new supply in the market, Dubai’s sales’ prices are expected to further decline over the course of the year, while constrained supply through 2017 will support prices in Abu Dhabi. (...) Price-to-rent ratios have declined since mid-2014 in both metropolitan areas, indicating a healthy correction in the UAE’s likely overpriced housing market", says the IMF new report on UAE. 

Price Expectations and the US Housing Boom

A new IMF paper by Pascal Towbin and Sebastian Weber looks at the shifts in house price expectations as an important driver of the US house price boom that preceded the financial crisis. 

The authors find "that the contribution of price expectation shocks to the U.S. housing boom in the 2000s has been substantial. In our baseline specification, price expectation shocks explain roughly 30% of the increase. Another 30% of the increase in house prices remains, however, unaccounted for by the four identified shocks. This indicates that attributing the entire residual that cannot be explained by standard shocks to price expectations will lead to an overestimation of their contribution. We also find that a model-based measure of house price expectations is strongly positively correlated with leads of a survey based measure of house price expectations. This indicates that our measure contains similar information as a survey-based measure, but tends to provide the information more timely. Our approach to identify price expectation shocks leaves the reason why expectations change open. When using an additional constraint to distinguish realistic from unrealistic price expectation shocks, we provide evidence that the housing boom was driven to an important extent by unrealistic price expectations."

House Prices in Europe

"Credit growth is still low and the housing market recovery is still at an early stage. Macroprudential policies are the first option, although responsibility in this area is shared between the ECB and national authorities" notes the IMF report on the Euro Area. 

House Prices in Singapore

"Recent macroprudential measures have contributed to smoothing the cycle for credit and house prices", says IMF's annual report on Singapore. More specifically, the report notes that "House prices have continued to decline modestly and are below their peaks by 9 percent and 6 percent in the public resale and private market segments as of the first quarter of 2015, respectively. The pace of house price decline has been slower over the past 7 quarters, suggesting that policy actions such as the introduction of the total debt service ratio (TDSR) framework in mid- 2013 have helped engineer the soft landing targeted by policy makers."

Moreover, the report says that "A further measured decline in residential real estate prices seems likely. The large supply of new homes coming on the market in the next two years should alleviate supply pressures and the expected increase in interest rates will reduce demand, helping moderate prices and increasing affordability. Price adjustments to date have been modest and gradual, and robust demand for new housing projects suggests that the risk of disorderly adjustment in house prices is low. Therefore, core macroprudential measures such as the TDSR, ceilings on loan-to-value ratios and loan tenure limits should be maintained to prevent a buildup of excessive leverage that could lead to systemic risks. Other measures, for example stamp duties, could be relaxed to arrest potential adverse feedback loops between economic activity and financial conditions, without loosening banks’ lending standards. But this should only be done in case of signs of excessive house price declines, associated with clear evidence of a tightening of financial conditions."