Commodity Bubble Disaster Can Only be Stopped by Capital Controls

Worrying long post in Debtonation‘s Ann Pettifor who has been right about these things before…

…We’ve been here before. Akyüz argues that the post-2000 ‘swings in commodity markets show strong correlation with those in capital flows’ to developing and emerging markets (DEEs) and with it ‘the exchange rate of the dollar’. After rising constantly, both commodity prices and flows declined in 2008, when falling prices triggered the exit of capital from commodity-rich economies. Both recovered rapidly afterwards.

These factors are reinforcing with ‘greater force’ argues Akyüz, the ‘macroeconomic imbalances and financial fragility in several DEEs….Imbalances that started with the subprime bubble but were interrupted by the Lehman collapse.’

Akyüz cautions that the continued boom in commodity prices could eventually cause rampant inflation in China, which could lead to a sizeable slowdown. ‘This, together with the global oversupply built during the boom, would bring down commodity prices, and the downturn would be aggravated by an exit of large sums of money from commodity futures. This would make investment in commodity-rich countries unviable and loans non-performing, leading to risk aversion, flight to safety and a reversal of capital flows to DEEs.’ The most vulnerable of these are countries in Latin America and Africa that have enjoyed the twin benefits of global liquidity and the boom in commodity prices. They could be hit twice – by falling capital flows and commodity prices, he argues. South East Asian economies are less vulnerable, because they have built up substantial current account surpluses and large stocks of reserves.

Akyüz concludes correctly that these unstable capital flows and commodity price booms show that ‘the international monetary and financial system needs urgent reforms’. He quotes Ben Bernanke’s speech to the Banque de France in February, 2011:

“Looking back on the crisis, the US, like some emerging-market nations during the 1990s, has learned that the interaction of strong capital inflows and weaknesses in the domestic financial system can produce unintended and devastating results. The appropriate response is…to improve private sector financial practices and strengthen financial regulation, including macroprudential oversight. The ultimate objective should be to be able to manage even very large flows of domestic and international financial capital in ways that are both productive and conducive to financial stability.”

Fine words indeed. But words are not enough. Akyüz argues that ‘macroprudential regulations, as usually defined, would not be sufficient to contain the fragilities that capital flows can create’. Instead, controls over both inflows and outflows should be part of the arsenal of public policy, used as and when necessary and in areas and doses needed, rather than introduced as ad hoc, temporary measures.

And we do not have to re-invent the wheel. ‘The instruments are well known and many of them were widely used in the advanced economies during the 1960s and 1970s.’

While politicians, economists and regulators may be more alert than they were in advance of the 2007-9 slump, they remain submissive to a global banking lobby and passive at the wheel of the global economy. This leaves commodity speculators unfettered by regulation and free to steer the global economy towards another financial precipice. Only this time central bankers and governments will have fewer tools and resources (i.e. taxpayer largesse) available with which to rescue bankers and speculators from their reckless and worthless endeavours.

Nevertheless, soon after this coming crisis – which will again cause massive economic failure and dislocation, intense human suffering and pain – controls on capital flows will finally be applied. Be sure of that. But by then, it will be too late.

This article was simultaneously posted on PRIME (Policy Research in Macroeconomics).