Commodities Are Getting Squeezed Between China and the U.S. Economies

US and China EconomyFalling commodity prices are not simply the fault of China or the United States, but both. The world’s two largest economies are pulling in different directions, driving oil prices below $50.00 and disturbing the prosperity of neighbouring countries. A U.S. economic recovery has led to better gross domestic product (GDP) growth, but China’s trade balance has seen falling exports, leading to an economic slowdown.

The price of oil has fallen more than 53% over the previous 52 weeks. Many analysts attribute the decline to oversupply issues generated by adding Libyan oil back into the market. After years of civil turmoil, the renewal of Libya’s exports was a positive step for the country, but it had disastrous implications for global oil prices.

Now, as prices continue to stagnate, we should re-examine the relationship between China, America, and commodities.

China’s Economic Slowdown is Hurting Commodity Producers

China is in the midst of a titanic shift towards broader consumption in the economy, a move aimed at delivering higher living standards to its impoverished citizens. Although the country’s national output stands above $18.0 trillion, its GDP per capita is less than $8,000 per person. (Source: World Bank, last accessed August 14, 2015.)

This discrepancy is central to China’s story. Cumulatively, it is one of the wealthiest countries on the planet, but it remains a country in transition. Massive levels of investment fostered double-digit growth every year from the 1980s onwards while consumption occupied a minor part of the economy. This is typical for what economists label “middle-income” nations; they grow quickly before living standards catch up.

During July 2015, Chinese exports fell eight percent and factory-gate prices dropped by 5.4%. Although the data signals a pivot from investment to consumption, markets panicked on the news. China has been the engine of global growth since the 2008 financial crash, meaning a decline in China will ricochet all over the world. (Source: the Economist, August 15, 2015.)

Commodity producers in Brazil and South Africa will certainly feel the brun of China’s slowdown, especially since the government just devalued the currency. The country just underwent an enormous stock market crash, so a shift to consumption is ill-timed, however needed it may be. Depreciating the yuan will make Chinese exports more attractive, hopefully putting the country’s economic destiny back on track.

U.S. GDP Growth Speeds Up

In the interim years, the United States had an oil and gas boom from advances in shale extraction technology. “Fracking,” as it later became known, allowed American oil companies to blast apart layers of shale rock beneath the Earth’s surface, unleashing previously inaccessible reserves of oil and gas.

The innovation occurred during a period of elevated prices, when oil topped $100.00 a barrel. It was economically feasible to explore reserves at that price, but we’ve fallen a long way from that level. After a shaky first quarter, 2015 is looking positive for the world’s biggest economy. Over 215,000 jobs were created in the last month as the topline unemployment number hovers just above five percent.

The U.S. dollar has appreciated by 15% in the last two years. And with oil below $50.00, American consumers are in a good position. The situation is less favourable for U.S. exporters, but the oil industry is proving more resilient to lower prices than analysts expected one year ago.

A possible interest rate hike this year would obliterate emerging markets by providing investors with higher yields in the U.S. The capital flight from emerging markets would be disastrous for global growth, something the Federal Reserve will take into account. At present, the devaluation of the yuan will likely force Janet Yellen and her team of central bankers to postpone the rate hike. The world economy is simply too fragile.