Buttonwood
War dividendNov 2nd 2006
From The Economist print edition
SourceHigh commodity prices are a bad omen for peace loversWHEN Katyusha rockets fly in the Middle East, the oil price tends to rise. The price of crude is now commonly seen as an indicator of geopolitical risk, a role traditionally associated with gold.
In the past wars have led to inflation and higher commodity prices. Fighting disrupts trade and prevents raw materials from being shipped from one country to another. In second-world-war Britain, a banana was the height of luxury.
But does the link only go one way? Just as wars may cause commodity prices to rise, might higher prices of raw materials lead to more wars? That is the argument of Marc Faber, a well-known contrarian and Hong Kong-based fund manager.
If he is right, then the surge in many commodity prices over the last few years may carry a disturbing message for everyone. Investors, in particular, should worry a lot more about geopolitical risk.
Higher prices are often a symptom of scarcity. When those scarce goods are vital for the smooth running of the economy (as oil is), it is natural for countries to get a bit desperate. One motivation for Japan's expansionary policy in the 1930s was the perceived need to secure raw materials. The oil embargo imposed on Japan by President Roosevelt in 1941 helped to provoke the Pearl Harbour attack.
Today's rising Asian power, China, is attempting to secure its commodity supplies by doing deals with producers. But even this approach is adding to political tensions since some of these deals are being done with regimes that America dislikes. Attempts to send peacekeepers to Sudan, or to impose sanctions on Iran, may be frustrated by Chinese opposition. In turn, that may increase hostility towards China in American political circles.
At the same time higher commodity prices are giving increased economic power to countries that dislike American hegemony. Russia has already used its gas supplies to put pressure on neighbours in Georgia and Ukraine. High oil prices have given Venezuela's Hugo Chávez and Iran's Mahmoud Ahmadinejad a chance to throw their weight about.
That brings us to another reason why high commodity prices lead to global tensions. Raw materials are usually found in troublespots, rather than liberal democracies (Canada and Norway being among the honourable exceptions).
This is no coincidence. Raw material wealth is often described as a curse, having an effect similar to inherited wealth on younger generations. Governments simply skim the wealth from the resource sector, rather than build up other industries or create legal structures that give property rights to the broad population. Corruption flourishes.
So high commodity prices tend to take money away from “nice” people and give it to “nasty” people. Falling commodity prices do the opposite. Mr Faber argues that it was the plunge in oil prices in the mid-1980s, as much as the arms race with America, that led to the collapse of the Soviet Union.
Furthermore, the presence of commodities in “nasty” countries often makes scarcity worse. International companies become reluctant to invest in countries where their property rights may not be respected and where political turmoil may disrupt production. New resources are not developed as quickly as the global economy needs.
Global warming may make matters significantly worse. Arguably, the recent surge in wheat prices (prompted by an Australian drought) is an early indicator of the potential for climate change to disrupt food output. If nations get twitchy about their oil supplies, how might they react if food, or water, are threatened?
Clearly, most investors have not seen higher commodity prices as inauspicious, merely as a symptom of robust global demand. Most measures of risk, such as stockmarket volatility or the spread (extra yield) on corporate and emerging-market bonds are low.
Perhaps this is because betting on geopolitical worries in recent years has turned out to be a mug's game. The American economy recovered quickly from September 11th, while the start of both Gulf wars triggered big stockmarket rallies. This year neither the Israel-Lebanon war nor the dispute over Iran's nuclear programme has led to the disruption of oil supplies. North Korea's nuclear test was a damp squib in market terms.
But just because markets have muddled through so far does not mean that they will always do so. The global economy is so interconnected these days that even a local disruption to supplies can have widespread effects, as Hurricane Katrina showed. Protectionism and “blaming the foreigner” are tempting solutions to harassed politicians. A hedge against conflict, in the form of cash, short-term bonds and gold, should be part of any portfolio. Failing that, buy a helmet.
Post Edited (11-06-06 00:12)