Content of the article

It’s tempting to attribute the current shortages of the “old economy” – of energy to other raw materials, and even agriculture – to a series of temporary disruptions largely due to the COVID-19 pandemic.

Content of the article

But aside from a few labor issues, these bottlenecks have little to do with COVID-19. Instead, the roots of today’s commodities crisis can be traced back to the aftermath of the financial crisis and the following decade of declining yields and chronic underinvestment in the old economy.

As infrastructure ages and investment shrinks, the ability of the old economy to supply and deliver the commodities that underpin many end products has also diminished. After years of neglect, the current rise in gas prices, copper supply shortages and China’s struggles with power generation are the “revenge of the old economy.”

In the economic stagnation that followed 2008, policymakers focused their stimulus efforts through the central bank’s quantitative easing programs to support markets. Low-income households have faced slow real wage growth, economic insecurity, tighter credit limits, and increasingly unaffordable assets. In contrast, wealthy households benefited from the inflation of financial assets caused by quantitative easing.

Content of the article

This disparity in results hit the old economy hard. In the old economy, price appreciation occurs when the volume of demand exceeds the volume of supply. High-income households can control the dollars, but low-income households control the volume of demand for commodities given their greater numbers and propensity to consume physical goods rather than services.

As the volume of demand for raw materials declined, so did the returns to sectors of the old economy. Lower returns have led to less investment spending in the old long-cycle economy – which traditionally requires a sufficient demand horizon of five to ten years – in favor of a short-cycle ‘new economy’ in the long-cycle. investments in areas such as technology.

Content of the article

In 2013, this weakness spread to China. As the global manufacturing engine slowed down and commodities began their historic tumble, the flight of capital from the old economy intensified.

Indeed, the old economy was over-built, over-indebted and over-polluted. While the old economy only accounts for about 35 percent of the world’s gross domestic product, it generated corporate losses at least twice, had around 90 percent of non-financial debt, and created 80 percent of emissions. It’s no wonder that investors preferred Big Tech to oil and copper.

After the oil price collapsed in 2015, markets got fed up with the destruction of wealth, almost stopping the flow of deals in the old economy. China has stopped aggressively stimulating loss-making companies such as coal mines. And as climate change has become a priority, investors have placed greater emphasis on environmental, social and governance issues, further limiting capital.

Content of the article

The resulting decline in investment has hampered capacity growth in raw materials. This has been particularly the case in hydrocarbons where disinvestment by investors for ESG reasons has exacerbated an already growing problem of underinvestment.

The severity of these supply constraints was underscored as countries shifted into recovery mode from the pandemic, exposing how strained the old economy has become.

The pandemic also had an additional effect, placing social needs more at the center of policymakers’ agendas. Such inclusive growth has only increased the demand for physical commodities.

The shocks suffered by one part of the system now create ripple effects elsewhere. The reduction in coal production in China has affected aluminum smelting capacity, creating aluminum shortages. The reduced availability of gas has forced the substitution of gas for oil, generating oil shortages. The continued impact of smaller and frequent shocks on a stretched system generates the emerging phenomenon in which transient shocks lead to persistent physical price inflation – which we are witnessing early on today.

Content of the article

This is where the revenge of the old economy will leave its mark. Periods of pressure on commodity prices will recur as widespread demand encounters inadequate infrastructure.

If policy makers’ goals of large-scale prosperity and massive green infrastructure development are to be met, commodity prices will need to be significantly higher to encourage investment. This is necessary to offset the growing risks involved in long cycle investment projects and the complexities inherent in the green energy transition. As we argued a year ago, a new commodity supercycle is upon us.

The author is Global Head of Commodities Research at Goldman Sachs

© 2021 The Financial Times Ltd

___________________________________________________________

If you liked this story, sign up to find out more in the FP Energy newsletter.

_______________________________________________________________