The unpredictability and volatility of commodity prices, capital movements and revenue flows are well known—often from bitter experience of inflation, Dutch Disease and boom & bust in public expenditure and borrowing in resource-rich countries. A couple of recent data points usefully bring home the continuing and particular dangers that come with the opportunities of volatile natural resource windfalls.
First, Andy Home at Reuters graphed the dramatic impact of quantitative easing on investment flows into commodities. As summarized by his colleague Felix Salmon: ‘if you look at commodities as an asset class, total commodity assets under [exchange-traded fund] management have risen from just over $150bn at the end of 2008 to over $400bn today’, presenting resource-rich countries with an influx that is rapid, large and likely transitory.
Second, Graham Bowley at the New York Times reports on a civil law suit filed by the US government’s Commodity Futures Trading Commission against a small number of international traders for illicit manipulation of US oil markets in 2008. According to the suit, the traders created a price-hiking illusion of an oil shortage by purchasing just 4.6m barrels of West Texas Intermediate at one of its key benchmarking sites at Cushing, Oklahoma. The alleged consequence: the acquisition and hoarding of about two-thirds of the 7m barrel excess at the key Sooner State delivery site, with a corresponding impact on prices.
Investment bubbles, temporary policy interventions by central banks and alleged speculation—they are all reminders, if any were needed, of the importance of stabilization for resource-rich countries.
To take just one historical example: Mexico. Its 1982 default on substantial debts partially incurred on the back of a resource boom was in part caused by oil revenues falling 40% below expectations in 1981. This substantially damaged the country’s capacity for raising capital. In 1986 the already-struggling economy suffered from a drop in the price of oil between of $15 per barrel (from $25 to $10) between February and March, a loss of $8.5bn in expected foreign currency inflow. This was the harbinger of further grim recession.
On the other hand, in 1991 the Mexican government successfully hedged against the temporary price spike caused by the Persian Gulf War, so that the impact of its appearance was not so disruptive and that of its disappearance was not as damaging. Admittedly, this was a different kind of price shock and, by this time, the oil production was well advanced in its decline from 14% of Mexican GDP at the start of the 1980s to under 2% by the end of the century. However, it is significant that harsh experience had influenced an appropriate policy response. Such painful lessons learned can be lessons shared with other resource-rich countries as they confront current volatility and its sources as identified by Home and Bowley.