Commodity Prices and Paradigm Shifts

By Rick Bookstaber

Jeremy Grantham put out a great quarterly letter about the scarcity of commodities and the marked rise of commodity prices, calling this “the mother of all paradigm shifts”.

Two interesting points in his letter are:

1. China consumes between 25% and 50% of many important commodities.

2. Prices for nearly all commodities are two or more standard deviations above their long-term mean; four standard deviations for iron ore, coal, copper and silver.

The recent drop in commodity prices notwithstanding, this and other analysis lay down the groundwork for his concern about the end of falling commodity prices. No one can deny that, absent one hundred per cent recycling, non-renewable resources extracted from a finite world will finally run out. And, furthermore, that we are using these resources more now than we have in the past, and given the growth of China and other countries, there are major sources of consumption that were a rounding error even a few years ago.

But insofar as the large dislocations in prices are due to the rapid increase in demand from China (and the lag in production gearing up to increase supply in response), the increase in commodity prices does not forebode a paradigm shift. Just an increase in demand. And much of the increase in demand is short term. China’s explosive demand will finally drop from its stratospheric level, either because China’s economic development falters or because China is finally totally covered over in cement.

Paradigm Shifts — The Usual Suspects

The rise in demand from China does not constitute a paradigm shift – nor does a continuing rise in demand as other countries move up the development trajectory and follow suit.

Nor does the recent rise in speculative demand. This has been a focus early on of Michael Masters. The relatively small supply of commodities compared to the demand that can arise from pension funds and other institutions investors, which lately has trickled down through the use of EFTs to include retail investors, all can create sizable distortions; big money chasing after a limited supply of commodities, coupled with underlying inelastic demand — because, for example, people still need to eat.

Nor is there a paradigm shift due to technology, though obviously technological change alters resource demand, sometimes for the better and sometimes for the worse. Two examples in the positive column are the reduction of copper demand due to fiber optics and wireless, and the drop in demand for silver due to digital photography. One in the negative column is the increased demand for rare earths for electronics. But technological improvements and increased efficiency are a given in our current paradigm and cannot be considered paradigm shifts; neoclassical models of growth theory have included adjustments for technological change since the 1960s.

The mother of all paradigm shifts

But there is a paradigm shift underway, maybe even the mother of all paradigm shifts, and it is coming from a direction where Grantham and other bears are not looking.

The real paradigm shift, or more like a paradigm drift, because it is slowly enveloping us, is that we are moving toward preferences and lifestyle where we will simply consume less. A lot less. Like improvements in efficiency, changes in tastes and preferences are nothing new, but this time is different.

I have already discussed this in previous posts on life in the experience machine and the world of smaller scale. In The Accidental Egalitarian I make the point that with the increased focus on technology – where we spend more and more of our time on our cell phone, doing emails, watching DVDs and surfing the web – there is less of a difference between how the super rich and the reasonably well off spend their time hour by hour during their typical days. The point of that post is that in practical terms the income gap is not as large as it might seem; that several orders of magnitude differences in income don’t make all that much difference in what these people do with their time. The point here is a corollary: those activities do not require much in the way of material consumption, and therefore not much in terms of commodities.

In The Technology-Driven Consumption Trap I argue that in the not-so-distant future the main items we will demand, beyond food, clothing and shelter, are “game systems” that approach the level of Nozick’s experience machine, allowing us to have the experience of being anyone we want, wherever we want (even in a world we have designed), accompanied by whomever we want, all in Realicta Immersion 3-D® with full sensory feedback.

Our demand for housing and transportation, two of the biggest commodity hogs, will be lower. McMansions will be totally passé. It should already be dawning on people that most all of our non-sleeping hours at home are spent in the kitchen and its adjacent family room. Living rooms and dining rooms are relics. When people internalize the fact that they spend most of their non-sleeping, non-bathroom, non-eating time in a ten by twelve foot space with their various experience machine prototypes, large homes will, by and large, go the way of cars with fins and chrome.

We obviously will not need to drive around as much, given that so much of what we want is delivered to us electromagnetically. And, getting back to real goods and technological advances, if we take the web-based distribution a few steps further, rather than having thousands of cars running from one store to the next, a couple of delivery trucks will ply the streets. So per-capita consumption of energy and resource-intensive infrastructure will decrease.

Given our evolved interests a few decades hence, most of us will be spending a fraction of our income on consumption. There just won’t be a lot that we will demand that requires nonrenewable resources. What we will demand will be in the way of electronic products, which will only consume a few ounces of such commodities. We will basically eat, sleep, work and then veg out. Give us food, plumbing, heat and our two-hundred dollar experience machine games, and we will be happy as a clam.

People who are staring at a tsunami of demand for commodities from the developing world and predicting a doomsday of $400 oil and $4000 gold are missing the longer-term retreating tide of demand as citizens of the developed world actually demand decreasing amounts of energy, large goods, and heavy infrastructure. We won’t be packing up and moving to Mars, as the science fiction solutions to resource depletion propose. We will pack up and move into the virtual world.