The New Era of Paradigm Shifts

It’s been a busy month in the world of global macroeconomic announcements. First, Standard & Poor’s downgraded the credit rating outlook for US government debt to negative. Second, a widely-circulated interpretation of an International Monetary Fund report has indicated that the “Age of America” is over… as China’s economy measured according to purchasing power parity is likely to eclipse the US in size within five years. Lastly, Jeremy Grantham has written incisively about what he refers to as “The Great Paradigm Shift” in commodity prices — because natural resources are no longer abundant — and it’s now time to accept a new, and permanent, increase in commodity values. Whether or not you buy into all three of the high-profile transformations in the global economy this April 2011, there’s substantial reason to believe change is afoot.

Based on the IMF’s recent report, MarketWatch senior columnist Brett Arends explains China’s continuing economic boom relative to the US in terms of purchase power parity:

“Under PPP, the Chinese economy will expand from $11.2 trillion this year to $19 trillion in 2016. Meanwhile the size of the U.S. economy will rise from $15.2 trillion to $18.8 trillion. That would take America’s share of the world output down to 17.7%, the lowest in modern times. China’s would reach 18%, and rising. Just 10 years ago, the U.S. economy was three times the size of China’s.”

He places this shift in geopolitical influence into the context of a larger transformational change in global dynamics he believes most economists are being far too slow to pick up on. He describes why:

“Some years ago I was having lunch with the smartest investor I know, London-based hedge-fund manager Crispin Odey. He made the argument that markets are reasonably efficient, most of the time, at setting prices. Where they are most likely to fail, though, is in correctly anticipating and pricing big, revolutionary, ‘paradigm’ shifts — whether a rise of disruptive technologies or revolutionary changes in geopolitics. We are living through one now.

“The U.S. Treasury market continues to operate on the assumption that it will always remain the global benchmark of money. Business schools still teach students, for example, that the interest rate on the 10-year Treasury bond is the “risk-free rate” on money. And so it has been for more than a century. But that’s all based on the Age of America.”

In an interpretation of geopolitics not far from the DR’s own, he sees the “Age of America” as an age that long ago began its decline. The IMF quickly lashed out, and partly refuted his interpretation of its report, by suggesting that “purchase-power-parity… is not the most appropriate measure… because PPP price levels are influenced by nontraded services, which are more relevant domestically than globally.” And, pointed out that when comparing the two economies using market exchange rates, the US “is currently 130% bigger than China, and will still be 70% larger by 2016.”

However, as he argues, currency markets are still likely to experience substantial swings between now and 2016. Many analysts believe the US dollar remains overvalued in part due to its reserve currency status, and also relative to the nation’s unsustainable debt levels. Similarly, the renminbi is broadly believed to be artificially undervalued.

Other geopolitical and macroeconomic shifts behind the eroding “Age of America” support Arends’ points. For example, chief investment strategist of asset management firm GMO, Jeremy Grantham, has been beating the drum in his most recent quarterly letter, entitled Time to Wake Up, about what he refers to as “The Great Paradigm Shift.” He describes the world as moving from a century of declining prices for most commodity sectors to a new era of permanently increasing commodity prices. Production efficiencies gained early in the century, that sharply reduced the costs of most commodities, have now been eradicated due to growth in emerging market populations and consumption:

“[In an example using metals, one type among many similarly behaving commodities, t]he price of all of these metals in response to rising costs and rising demand has risen far above the old declining trend, at least past the 1-in-44-year chance [that it is still on its original declining price trend.]. […] There also might be some hoarding by users or others, but given the extent of the price moves, it is statistically certain that hoarding could not come close to being the only effect here. Once again, the obvious primary influence is increased demand from developing countries, overwhelmingly led by China; and that we are dealing with a genuine and broad-based paradigm shift.

“The highest percentage of any metal resource that China consumes is iron ore, at a barely comprehensible 47% of world consumption. Exhibit 9 shows the spectacular 100-year-long decline in iron ore prices, which, like so many other commodities, reach their 100-year low in or around 2002. Yet, iron ore hits its 110-year high a mere 8 years later! Now that’s what I call a paradigm shift! Mining is clearly moving out of its easy phase, and no one is trying to hide it. A new power in the mining world is Glencore (soon to be listed at a value of approximately $60 billion). Its CEO, Ivan Glasenberg, was quoted in the Financial Times on April 11, describing why his firm operates in the Congo and Zambia. ‘We took the nice, simple, easy stuff first from Australia, we took it from the U.S., we went to South America… Now we have to go to the more remote places.’ That’s a pretty good description of an industry exiting the easy phase and entering the downward slope of permanently higher prices and higher risk.”

Grantham is suggesting the recent surges in iron ore prices are here to stay, and are part of a transformational “Great Paradigm Shift” that will be a mainstay determinant of how this next century unfolds. It’ll surprise no regular DR reader, but witnessing the US decline finally admitted by S&P, China’s ascent grudgingly accepted by the IMF, and Grantham’s view of a world relegated to higher commodity prices — from energy to metals to ultimately agriculture — together demonstrate that a new era of paradigm shifts, both politically and economically, is at last more widely recognized as being upon us.


Rocky Vega,
The Daily Reckoning