Bull and Bear Markets in International Tensions

WHEN REFLECTING UPON the last 30 or so years, strategists will likely focus on the 1980-1982 period, which marked a milestone in asset markets with the end of accelerating consumer price inflation, a peak both in commodity prices (January 1980) and in interest rates (September 1981), a major low in US equity prices (August 1982), and the beginning of a disinflationary trend which, according to the “deflationists”, may continue.

Only seldom are these economic and financial trends brought into the context of political events, such as the end of the Vietnam War (1973), China’s introduction of the Open Door Policy (1978), the end of the socialist and communist ideology, culminating in the breakdown of the former Soviet Union in 1989, and the end of India’s policies of self reliance and hostility towards foreign investments in the early 1990s. The consensus holds that the West “won” the Cold War because of President Reagan’s military build-up in the early 1980s, which intimidated the Soviet Union and led to its demise.

However, one could also argue that, under normal conditions, the military build-up of one super-power would lead to a similar increase in military spending by a rival super-power and that, therefore, factors other than President Reagan’s Star Wars initiative may have been at work, leading to the demise of the Soviet Union and bringing about a period of diminishing international tensions and the much talked about “peace dividend”.

Bear Markets in International Tensions

One reason the Russian economy is doing so well today may be because of the increase in commodity prices — notably the quintupling of oil prices since 1998. Rising oil prices have led to trade and current account surpluses, and a soaring stock market (from its 1998 low at less than 50, the stock market index is now at over 1,400), and have boosted Vladimir Putin’s international prestige and power.

Consequently, if rising commodity prices have had a miraculous impact on the Russian economy over the last few years, we can safely assume that declining commodity prices and the collapse in oil prices in 1985/1986 must have dealt a serious economic blow to the former Soviet Union. Hence, I could argue that the catalyst for the demise of the Soviet Union wasn’t the US military build-up in the 1980s, but the decline in commodity prices, which crippled its economy.

Nikolai Kondratieff observed empirically that in the course of the long wave cycles (which last for between 45 and 60 years from peak to peak), the downward waves (1810-1817 to 1844-1851, 1870-1875 to 1890-1896, 1914-1920 to 1940-1945) are “accompanied by a long depression in agriculture” (Nikolai Kondratieff, The Long Wave Cycle, Richardson & Snyder, 1984).

Kondratieff showed that during the downward waves, the prices of industrial goods also slumped, but that the decline in agricultural prices far exceeded the decline in industrial goods prices and, therefore, “the purchasing power of those commodities decreased”.

If we look at the 1980-2000 period it is obvious that there wasn’t only a relative depression in agriculture, but a devastating collapse in commodity prices in real terms (inflation adjusted — see also Figure 2). Thus, I can argue that with the onset of the decline in commodity prices in 1980 (note from Figure 2 that, in real terms, commodities had already peaked out in 1974), economic and political power shifted from countries that were natural resource producers (the Soviet Union, OPEC, and Latin America) to the industrial world (the US, Western Europe, and Japan), which were already large importers of commodities (especially oil) and hence benefited from their price declines.

(Note the total collapse of oil prices between November 1985 and March 1986 and the ultimate low in real terms in 1998.) Another beneficiary was the corporate sector, as input prices and interest rates, which follow commodity price cycles over longer periods of time, both declined and allowed profit margins to expand (see Figure 4). I am purposely not mentioning China here as a beneficiary of declining commodity prices, since its economy was then still so small that it was largely commodities self-sufficient. (It became a net importer of oil in 1994.)

Therefore, we can conclude that following 1980, the decline in commodity prices had several important consequences. It led to the demise of the Western world’s archrival, the Soviet Union, and in conjunction with the decline in interest rates it boosted asset markets in the industrialised countries (including Japan, South Korea, and Taiwan, which were in the midst of their industrialisation).

Falling oil prices, rising asset values, and a disinflationary environment lifted consumption in the US and brought about strong economic growth. Rising asset values also lifted economic growth rates, because they contributed to the secular decline in the US saving rate beginning in the early 1980s. At the same time, the end of the Cold War and rising US GDP in the 1990s allowed defence spending as a percentage of GDP to decline, which, according to Gary Shilling, further reinforced the disinflationary trend that began after 1980 (see Figure 5).

Declining oil prices after 1985 had two further consequences. Capital spending by oil companies declined and freed capital for other economic purposes. Moreover, again according to Gary Shilling, declining energy prices led to declining fuel oil expenditures as a percentage of US personal consumption and boosted, as indicated above, consumer spending on goods and services. Declining oil prices in the 1980s and 1990s had another important consequence for the US economy.

Faced with a global oil glut, US policy makers either didn’t pay attention or were simply not concerned that America’s oil production had begun to decline after 1971 (see Figure 7) and that the US was becoming increasingly dependent on oil imports (see Figure 8). As an aside, Figure 8 shows how the US economy is today much more vulnerable to oil supply shocks because oil imports as a percentage of total supplied oil have risen from 20% in 1969 to over 60% at present. It’s no wonder the US isn’t going to leave Iraq any time soon!
In sum, I note that in the 1980s and 1990s, the decline in commodity prices – and especially in oil prices — diffused international tensions significantly by shifting economic and political power to the industrialised countries, and by bankrupting the Soviet Union. (Note also that the Russian crisis of 1998 occurred following the sharp drop in oil prices between the end of 1996 and 1998 — see Figure 3.)

At the same time, the increase in asset values and the peace dividend lifted US standards of living despite poor households’ real income growth rates. In fact, one could argue that the economic and military superiority of the Western alliance, including Japan, under the then uncontested US hegemony reached its peak relative to the rest of the world in the early 1990s.

The Soviet Union was in disarray, China wasn’t yet a factor in the global economy, and the commodity-producing nations of Latin America, Africa, Central Asia, and the Middle East were essentially either bankrupt or close to bankruptcy.

Bull Markets in International Tensions

Nikolai Kondratieff established empirically that within the long wave cycle, the periods of the rising wave are characterised by a rise in commodity prices and “are considerably richer in big social upheavals and radical changes in the life of society (revolutions, wars) than are the periods of downward waves”.

But why?! Kondratieff refutes the notion that wars are the cause of rising commodity prices and improved economic conditions (the rising wave of the long cycle). According to him:

“…a much more likely assumption is that wars themselves occur because of an increase in the tempo and tensions of economic life, and intensification of the economic struggle for markets and raw materials. And such tension in economic life is especially typical of periods marked by an upswing in business conditions.

Likewise more probable is the assumption that social upheavals are most easily touched off under the strong impact of new economic forces. Thus both wars and social upheavals are a part of the rhythmic process of the development of the long cycles; and they turn out to be not the forces making for its development but forms of its manifestation.

Once they come into being, however, they of course exert, in their turn, a potent and sometimes disruptive influence on the pace and direction of the economic dynamics…. The upward movement in business conditions, and the growth of productive forces, cause a sharpening of the struggle for new markets – in particular, raw materials markets. On the one hand, this makes for an expansion of the orbit of the world market and the involvement of new countries and regions in the trade network.

On the other hand, it makes for an aggravation of international political relations, an increase in the occasions for military conflicts, and military conflicts themselves. At the same time, the rapid growth of new productive forces, intensifying the activity of the classes and groups within that have an interest in that growth, creates the prerequisite for sharpening the struggle against socioeconomic relations that are obsolescent and hinder development. It creates the prerequisite for big internal upheavals. [Emphases added in above paragraph – ed. note.] (Nikolai Kondratieff, ibid)

In Chapter XIII of his empirical study on the long wave cycles, Kondratieff shows that major conflicts such as the Napoleonic Wars (1793-1814), the Crimean War (1853-1856), the American Civil War (1861-1865), the Franco-Prussian War (1870-1871), the Sino-Japanese War (1895), the Spanish-American War (1898), the Russo-Japanese War (1905), the First World War (1914-1918), and the February Revolution in Russia (1917) all occurred during the rising wave of the long cycle. I might add that the Second World War and the Vietnam War also occurred in periods of the rising Kondratieff wave.

From the above it is clear that the rising wave, which is accompanied by rising commodity prices, brings about three conditions which intensify tensions:

(1) Rising commodity prices intensify the struggle for raw materials.
(2) The upward movement in business conditions, the growth of productive forces, and the rise in commodity prices expand the orbit of the world market and lead to the involvement of new countries and regions in the trade network.

(3) During the rising wave, rapid growth coming from the application of new technologies and the entry of countries into the global economy intensifies social tensions as the classes and groups of society that have an interest in growth and economic development increasingly “struggle against socioeconomic relations that are obsolescent and hinder development”.

Why do rising commodity prices intensify international tensions?

One of my first experiences of shortages leading to belligerent behaviour was during my childhood. When the Suez Crisis broke out in 1956, everyone in Switzerland, including my mother, stocked up on food and other necessities from grocery shops, fearing that a closure of the Suez Canal would lead to serious shortages. I witnessed housewives fighting like hyenas over whatever they could find on the shelves of stores.

Another childhood experience relates to boarding the train that carries skiers from Wengen to the Kleine Scheidegg during the Christmas holidays. Since between Christmas and New Year the demand by skiers for seats on the Wengen-Kleine Scheidegg train vastly exceeded the available number of seats, as soon as the train pulled into the station the skiers would engage in real fights, using their fists and skipoles, in an attempt to board the train first and secure a seat.



Simply put, when markets are glutted and over-supplied, no one is going to fight in order to satisfy his demand. Conversely, when markets are characterised by acute shortages, people will fight and go to war in order to secure their required supplies, particularly when the shortages that might arise or that have already arisen threaten the physical and economic survival of the groups or countries involved.
This pattern can be observed throughout history. In primitive societies, if there was a shortage of women the members of one tribe would attack another tribe and kill the men, in order to secure the women. And even in more advanced societies (for example, the Easter Islands), shortages of resources — in particular, food — led to cannibalism. (Incidentally, Easter Island — a worthwhile place to visit — is a good example of the fact that natural resources can run out. A more recent example is the island of Nauru.)

Rising commodity prices are a manifestation of shortages. So, when commodity prices rise and shortages threaten to undermine economic development and growth, countries that require a steady or increasing supply of resources from foreign sources do tend to become more belligerent.

An interruption of supplies could cause enormous damage to such a nation’s economy, society, and military prowess. But it’s not only the commodity-importing nations that become more belligerent when shortages drive prices higher. The commodity producers themselves find they are in a sweet spot and become more aggressive in their relationship with their clients — the resource-importing nations.

So, whereas we have seen that in the 1980s the balance of power in the world began to shift towards the industrialised nations as commodity prices fell, today it would appear that the balance of power has already shifted back to the resource producers — especially the oil producers.

In this respect, I should mention that 1994 marked a milestone in economic history and geopolitical trends in as far as China became, for the first time in modern times, a net importer of crude oil (see Figure 9).

In a situation characterised by shortages and rising commodity prices, the producers of resources tend to play out the established buyers of their resources against their new clients (China, India), who, in order to satisfy their growing domestic demand, bid very aggressively for those resources that are in short supply.

But there is another reason for the shift of power towards the resource producers when shortages emerge. Money! Suddenly, the governments’ coffers of the resource producers swell because prior trade deficits caused by falling commodity prices are, in an environment of rising prices, replaced by robust trade and current surpluses, which allow the resource producers to become geopolitically more active and to build their military capabilities (for example, Hugo Chavez, Amadi-Nejad, and Vladimir Putin).

In this regard, it is interesting to note that for the first time in recent history, even Latin America has a trade and current account surplus with the United States (see Figure 10)!

Remarkably, the US now has a trade deficit with every region of the world…

To be continued,
Marc Faber
March 14, 2006