Three Axioms of Globalization

Why is it that laws, like misfortunes, always seem to come in threes? Kepler devised three laws of planetary motion. In classical physics, there are three laws of thermodynamics (though that's sort of cheating, given that there's a 'zeroeth law' and a tentative fourth law.) As he was cutting the grass over a wonderfully warm and sunny weekend, Macro Man got to thinking about an issue near and dear to his heart: globalization. And what he thought about was drilling down to devise some fundamental principles, or axioms, of globalization, from which all other conclusions can be deduced. The following is what he came up with.

1) There are more new entrants to the global economy than there are residents of rich industrialized nations. This is hardly controversial, as the populations of both China and India exceed a billion people: more than the European Union, United States, and Japan combined. The scale of where these people are coming from is staggering: one analyst that Macro Man spoke to last week noted that 400 million people in India still don't have access to full electrification.

2) That which the new entrants buy will tend to rise relative to that which the new entrants sell. For much of this decade, this axiom was misinterpreted as "the price of manufactured goods will be flat to lower forever," thanks to the apparently limitless supply of labour in places like China. However, the sheer size of the new entrants means that when they start buying something (oil, rice, copper, Treasury bonds, EUR/USD) with intent, the price goes up. Ultimately, this means that the wedge between headline and core measures of inflation will not only remain in place, but probably intensify.

However, this does not mean that there will be no inflation in goods and services that the new entrants sell- merely that it will be lower than amongst those things that they buy. After all, the minimum cost for a good made in China is the cost of the raw materials (which is rising), the cost of clothing/feeding/sheltering the employees who assemble it (which is rising), and the cost of shipping it to its final destination (which is rising.) Even the cost of haircuts in Shanghai depends on how much it costs the barber to light his shop and feed his family.

In any event, the empirical data certainly suggests that while the change in the price of manufactured goods remains lower than that of commodities, these prices changes are now firmly positive:
3) Resources are finite. Oil. Food. Water. None of these grow on trees (OK, OK, some food does), and all are in demand by the new entrants to the global economy. And this demand is only going to increase as the new entrants become less poor in aggregate.

The implications, when combined with axioms one and two, are incredibly bullish for commodity prices over long periods of time. This is hardly a revelation, and indeed there are probably some pink flamingos as a result. For Macro Man, the more interesting impact of this axiom is the competition for resources. To date, the competition has been conducted along a set of agreed rules and codes of conduct. Call it the economic equivalent of 19th century warfare, with its fancy uniforms and official declarations and treaties.

Many of the new entrants were not part of that system and show little sign of wishing to join it. So the competition for resources will be more like the type of warfare that evolved in the second half of the 20th century: unconventional conflict wherein practitioners of traditional methods find themselves at a disadvantage against highly-motivated opponents employing guerilla tactics. China's investments into Africa are an example of this: they draw opprobrium from the West (no stranger itself to supporting morally bankrupt regimes!) , but help maintain the Chinese growth engine.

If these axioms are correct, then the world economy (and indeed the world, via the environment) are undergoing a tectonic shift. While it's easy to extrapolate the trends of the past few years into the future, as Friday's discussion highlighted, the true test comes under duress. If, in a few years' time, we can look at these three points and still call them axioms, then be prepared to change the way you live your life, for the world in the 21st century will be very different from the one that people of Macro Man's vintage grew up in.
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Donlast
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May 12, 2008 at 11:11 AM ×

Very fine piece. Cuts out all the cackle from two-handed economists. Seems there is one very clear outcome - long bond yields are cyclically on the way up. Which I suppose also means that the value of China's, Japan's and the Gulf's UST reserves are on the way down. On top of the dollar. Won't happen overnight of course. Never does.

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Anonymous
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May 12, 2008 at 11:27 AM ×

Amen.
Speaking Machiavellistically, we should start figuring out how to keep our hands on some resources instead shipping it all away for a short-term gain. After all, a tonne of copper in ground or a barell of oil in some porous rock is going up in value much more than the copper in thin wires (which no-one bothers to recycle - now), or the CO2+ stuff from a combustion engine exhaust :).
The interesting thing will be (well, to an alien not having to live here), what will happen if China/India hit the peak oil/copper (there's not that much of that either) before they get all the way up?

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Anonymous
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May 12, 2008 at 11:43 AM ×

Amen.
"here are more new entrants to the global economy than there are residents of rich industrialized nations."
I.e. to a good approximation, the world is only just beginning to industrialise.

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Anonymous
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May 12, 2008 at 12:24 PM ×

Excellent post, very insightful. I have been calling for a top in crude/commiditiy prices for some time. So, therefore I have been wrong for a while. I am starting to come around to your camp, thinking that commidity prices are going one way....UP! In all this something has got to give, I wish I had insight into what.

I enjoy reading you updates everyday.

Banker

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Macro Man
admin
May 12, 2008 at 2:05 PM ×

t, I think I like your phrasing better.

Vlade, you don't have to look very hard to find people who would argue vehemently that peak oil is already here...and plenty of others who would say that the peak is just a few years away.

What happens when there is just not enough copper/oil/water etc will be very interesting and, I fear, not very pleasant.

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Anonymous
admin
May 12, 2008 at 2:35 PM ×

you know, whatever one's politics, i ready a very annoying and short-minded investment letter lately. it basically blamed al gore for distracting us with his warning about global warming in "an inconvenient truth" from the issue of resource scarcity, even though the friggin movie makes plain the very connection between the two. australian droughts anyone? water shortages in the southeastern US? there are some very serious forces at work here that are only just beginning to play out and are going to force some very unpleasant choices on societies, create new conflicts and have unexpected impacts on economies. i suppose that's where $1.5 trillion of reserves and counting comes in handy.

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Unknown
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May 12, 2008 at 3:30 PM ×

as many have said before me, insightful and simple. I agree. The question is if the people of my and your vintage are going to experience tectonic shifts in their lifestyles, are their governments going to watch helplessly? In other words, think armed and other conflicts for resources between the developed nations and the IC in BRIC and between "I" and "C".

Doesn't it make the cocktail even more interesting?

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Macro Man
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May 12, 2008 at 3:33 PM ×

Yes, well what makes it even more interesting is that both China and India have a substantial surplus males, thanks to their family planning policies/preferences. No prizes for guessing what might be an easy way to deal with a surplus of males....

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Anonymous
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May 12, 2008 at 4:06 PM ×

I think that the real tectonic shift in next years will be a Malthusian crisis not more linked only to population growth but to economic growth.

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spagetti
admin
May 12, 2008 at 5:26 PM ×

Malthusian indeed ..

and if you speak to the avg westerner, even educated they will prefer to consider you a freak for bringing up ideas like in this post ..

i would be far happier to lose some money on being long commodity futures then face the hard reality of a war over resources or of a lifestyle which will involve much less consumption of food, and energy

what is it an invidual can really do? pile up fiat money on a bank account?? pile up physical goods?? where?? who will safeguard my property rights??

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D
admin
May 12, 2008 at 8:03 PM ×

Re: Spagetti

Emigrate to Brasil/British Columbia, Canada are two of the options I am considering. Brasil is energy independent, but there mineral resources would require them to choose a side and participate. The US just announced plans to roll out a 4th Naval Fleet to tend to Central/South America...go figure.

RE: Rising Oil Prices

Oil prices have done double since January 2007 and are up over 20% since January 2008. The Central Banks are not concerned about prices rising from industrial supply/demand because the productivity of the finished product surpasses the costs.

OTOH, price increases have accelerated on market participants (speculators included) expressing their common belief that prices WILL be higher. Like all trends, it is self-reinforcing until it isn't. I expect Nymex and ICE will raise margin requirements in unison in the very near future. The message of forthcoming intervention has been telegraphed to everyone who is listening.

Re: War

War is a foregone conclusion now. The more likely location is the region connecting China to its natural resource investments...Africa.

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Anonymous
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May 13, 2008 at 1:16 PM ×

Put me in the Julian Simon camp if you want, but some of these comments seem far too pessimistic to me. The inflation adjusted price of commodities has declined throughout history, and will continue to do so (except over the very short term).

China and India have too many people who won't contribute anything to the global economy for at least a generation, and China has its own globalization problems. A third of the manufacturers in Guangdong province, which produces
30 percent of China's exports, will close within three years, due to competition from lower cost locales like Vietnam.

China's growth will eventually slow hard, and don't forget China is much less energy efficient than first world countries - they would see a significant decline in oil use (not likely before they get rid of the subsidies, though) just from matching the energy efficiency of, say, Japan.

We have only extracted eighteen percent of the known oil (yes, the easy part, but we will figure out how to get more and more of the rest). The U.S. has enough coal to supply one hundred percent of its energy needs for hundreds of years.

I don't buy that the commodity boom will go on for decades. The feedback loop works much faster now. Everybody in the world has started to plant, explore, and mine to take advantage of the profit opportunities in commodities. Markets work.

I don't claim that the transition of the global economy over the next few decades will go smoothly, especially given the propensity of politicians to screw things up, but the crises dreamed up by Malthus (and Ehrlich) will remain figments of their imaginations.

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Anonymous
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May 13, 2008 at 3:17 PM ×

Well reasoned, anon at 1.16!

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Scott
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May 14, 2008 at 5:23 AM ×

I think that China's population will be stagnant if not shrinking during the next 50 years due to their demographic policies of the past 50 years. That will ease a bit of the economic growth pressure.

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Anonymous
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May 21, 2008 at 6:36 PM ×

Lawrence Livermore National Lab just held a symposium on the Malthusian possibilities. I believe that were one to judge this in any balanced fashion it is that globalization, as envisioned, and currently practiced, will not last, the developing world and the developed world cannot co-exist with levels of consumption equal to that found in the developed world. Most likely, standards will rise for some in the developing world, highlighting inequalities, televised on more televisions, leading to developing world instability while the developed world has instability itself which will lead to more authoritarian measures as the West seeks to preserve some of its advantages. Were, for but a generation, efforts to be directed toward greater efficiency in the use of resources, than North America, even at current consumption rates would benefit disproportionately from a Canada, with great surplus in its bio-capacity, and a US which is only at twice its biocacpaity compared to a UK at 6 times, a Japan at more than ten. Glad I bought that land, and planted the orchard in the mountains. Also, glad for all the lakes, and the moderate population. Oh it is in,...on second thought, won't tell where

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