How the Collapse of Communism Led to Lower Commodity Prices...

“Would it surprise you to know that the Dow and price of gold were once nearly the same number?” I asked Addison von Lunz, my young assistant. Addison was surprised. HE HAD JUST BEEN BORN WHEN this event had last occurred. Yet, while Bill Clinton was still governor of Arkansas, the gold price and the Dow were in sight of each other. I’m talking, of course, about the very early 80s. The Dow was below 1,000. And so was gold…but not much. It rose to over 800 for a brief time. Gold is now considerably lower than it was then. And the Dow is about 15 TIMES higher. This despite the fact that the currency in which each of these are cited is no longer moored to gold. Loosed from its golden mooring, analysts of the late ‘70s expected the dollar to fall – relative to gold. Instead, it fell relative to the Dow.

It was not long after the current bull market in stocks began that Jim Davidson and Lord Rees-Mogg wrote a book, Blood in the Streets…which predicted a major change. They said the Soviet Union would fall apart as the weaknesses in the communist system could no longer be ignored. In the book, and in their newsletter, Strategic Investment, they made the point that this would cause commodity prices to fall. Russia was a major economic power in 1910. It was growing fast…and already a major exporter of wheat and other commodities. A few financial seers expected Russia, Argentina and America to be the leading economies of the 20th century.

The former Soviet Union covers a lot of the earth’s surface area. Not surprisingly, the former Soviets dug a lot of marketable commodities out of said earth. But communism is not a very efficient system. Taking aluminum as an example, the Soviets would use domestically about 70% of the aluminum they mined. Instead of adding value by using it to manufacture saleable goods, they would then subtract value from it…by turning it into shoddy soviet-style products. The world has little use for the products but…despite the new paradigm…it continues to use aluminum. So, instead of making things with their aluminum, post-Soviet capitalists sell it on the open market.

My thanks to Jim Grant for bringing these figures to my attention. In 1988, the Soviet Union produced 3,500 tons of aluminum. It used 2,900 domestically and exported 187 tons. (What happened to the rest of it is a mystery.) Ten years later, in 1998, production had fallen to 3,307 tons. But instead of using it to make army canteens and the like, the former soviets exported most it…2,228 tons. The story is similar for almost all the raw materials produced by the no-longer-evil empire. They’re not producing more. But they are exporting a lot more. At the margin, where everything interesting happens, this causes a decline in commodity prices. Which makes paper currency look strong in comparison. And helps interest rates stay low…so low that the Japanese…and Internet stock investors…practically give money away. Which makes the average day trader think that he has entered a New Era of low interest rates, low commodity prices, a stable dollar…and ever-rising stock prices.

Davidson and Rees-Mogg were right. The demise of communism was deflationary. But was it the cause of a New Era? Or merely the source of a dangerous illusion? Will the price of gold and the Dow converge again? Stay tuned for more on this subject.

Until tomorrow…

Bill Bonner
August 3, 1999

Davidson and Rees-Mogg are at www.strategicinvestment.com. Jim Grant is at www.grantspub.com.