Since the crisis, global investors have been searching for a new safe haven. In the core industrial OECD economies both the public and private sectors face dangerous structural challenges. Fiscal deficits present governments with the unpalatable choice between the risk of loss of investor confidence and retrenchments which may provoke renewed recession. Manufacturing is losing to Asian competition and so is in long term decline: I predict that 2008 will turn out to have been the all-time OECD peak. These structural problems are compounded by the legacy from the recession: the banking sector has been shored up, but the dysfunctional incentive structures remain unreformed. The only thing keeping OECD markets up has been the vast injections of liquidity from the OECD central banks, but these buoy up all markets, not just the OECD. Global investors rightly regret that they are so heavily invested there.
The predominant new safe haven for investors has been China. But China has three serious strikes against it. First, it is awash with its own savings: despite a very high rate of investment Chinese savings cannot find enough attractive domestic opportunities and so invest abroad. Global investors are seeking opportunities in China that domestic investors have decided to pass over. Second, China is a political anomaly: a middle-income autocracy. Most middle-income countries are democracies. The rapid growth in its per capita income, which as an economic phenomenon is the central attractive feature of China, actually deepens the political risks. Statistically, as per capita income rises in autocracies they become more subject to political violence, completely contrary to the pattern in democracies. China may be so exceptional that it may buck this pattern, but this merely transforms risk into uncertainty: there is some unknowable chance that the political process becomes mired in a violent transition. The final strike against China is that its promising prospects are so widely recognized that on average opportunities are fully priced in.
The other new safe haven has been commodities, and the commodity-exporting economies which have grown on the back of a decade of rising prices. Among these economies it now is useful to make a distinction. One group of resource exporters is either dominated by resource exporting (the Middle East), or is already efficiently transmitting the gains from resource extraction across the rest of its economy (Australia, Canada and Norway). While the Middle East and Australia-Canada are very different economies, they have in common a direct relationship between the level of global commodity prices and macro performance. Investing in these economies essentially carries equivalent risks and rewards to investing directly in the commodities themselves.
The other group of resource exporters is currently not efficiently transmitting the gains from resource extraction to the rest of the economy (Africa, Central Asia, Latin America and Russia). For this group, changes in the quality of the transmission mechanism are more important for economic performance than all but massive changes in the level of commodity prices.
During the decade of rising commodity prices the former group of commodity exporters have been the better bet for investors. The direct connection to commodity prices has offered higher returns with lower risk than investment in those commodity exporters where the inefficiency of the transmission mechanism is the critical issue. Within the former group, the true safe havens have been Australia and Canada: like China, the Middle East is awash with domestic savings and has faced a potentially difficult political transition.
But global commodity prices may be peaking. Historically, periods of high prices have induced supply-augmenting investments and demand-reducing innovations in technology. These forces are slow but sure: after a decade in which prices have been strongly rising, (albeit with a hiccup due to the OECD recession), they are probably now setting in. If the rising trend in commodity prices is over, what remains is high volatility which, for a variety of structural reasons, has been a long term feature of commodity prices.
This has two fundamental implications. First, there are no longer any safe havens: each major market now carries substantial risks. Second, the neglected investment category of inefficiently managed commodity-exporting economies now looks relatively promising. As long as commodity prices remain historically fairly high, which seems likely given Asian growth, these economies have the potential for transformative growth. While historically these societies have failed to manage resource wealth, some of them will learn from that failure: around Africa awareness of past plunder is creating a burning sense of ‘never again’. The key knowledge for investors is which societies will learn to harness the massive untapped potential constituted by their commodity exports.
This article originally appeared in Social Europe Journal.