Raw materials and recession

A notable feature of the recent crisis in the major imperialist nations has been the impact of changes in raw materials prices (or commodities). Marx explained in Capital that changes in raw materials prices will have a direct and disproportionate impact on the rate of profit. Other conditions being equal, the rate of profit, therefore, falls and rises inversely to the price of raw material. (Marx, Capital Volume 3, Chapter 6)

The impact of raw materials price changes is particularly significant as the value of raw and auxiliary materials passes entirely and all at one time into the value of the product in the manufacture of which they are consumed, while the elements of fixed capital transfer their value to the product only gradually in proportion to their wear and tear.

Fixed assets are already purchased and only slowly depreciated over a number of years. In contrast raw materials are required immediately and enter entirely into the calculation of the rate of profit. This exacerbates changes in profit rates as the price of the product does not rise in proportion to that of the raw material, and that it does not fall in proportion to that of raw material. Consequently, the rate of profit falls lower in one instance, and rises higher in the other than would have been the case if products were sold at their value.

Marx further noted how stocks of raw materials and output could offset increases or falls in raw materials prices, as their value changes in line with that of the going market rate. This is particularly important at present as manufacturers, like auto and steel producers, are incurring large losses as they devalue their stock in line with the collapsed price of raw materials.

The wild swings in raw materials prices through the course of the last year have had a direct effect on the direction and depth of the crisis, transforming a financial disaster into a world recession. The collapse in raw materials prices through the 1990s was a direct result of the restoration of capitalism in the former centrally planned economies between 1989-95, and significantly contributed to the recovery of profit rates worldwide through that period.

After capitalism was restored in the Stalinist former centrally planned economies China, the USSR, central and eastern Europe, there was a glut of new raw materials supply on the world market for, while physical output slumped with the destruction of the central plan, domestic consumption fell even faster. For example, Russia’s oil consumption in 2007 was still 47% below its 1992 level. In contrast, by 2007 production was 21% higher. The additional oil output of the USSR added 14% to world capitalist oil production in 1992, rising to 16% in 2007. As a result oil prices collapsed through the 1990s falling to $12pb (per barrel) in 1998 and only exceeding $30pb from 2004 onwards.

Slowing exploration

The fall in oil and raw materials prices in the nineties hit the profits of the oil companies and mining conglomerates. New projects were put on hold; with oil at $12pb in 1998, there was no incentive to expand production or to prospect for new supplies. This in turn limited the production of oil exploration equipment, so although oil prices rose from 2004 onwards, investment in exploration was further limited by a delay in the production of exploration equipment. Oil rigs don’t grow on trees, as one analyst explained:

“More than a decade of very low oil prices depressed investment in the energy sector. One would expect that sustained high oil prices would prompt investment and thus increase supply. Yet, investment has lagged revenue growth . . . Skyrocketing exploration and development costs, general capacity constraints from global expansion, greater technology needs and uncertain investment climate have limited investment. Meanwhile much investment is needed just to maintain current levels of production let alone increase output.”

All this meant that when the war on Iraq, the third largest oil producer, further hit the supply of oil after 2003  Iraqi output in 2007 was still 18.3% below its pre-war level  the oil producers had a very limited capacity to respond to any increase in demand.

And while supply was curtailed, demand in the shape of rapidly growing emerging markets, particularly in China surged, so oil prices in particular and raw materials prices in general soared.

But these fundamental changes to the supply and demand for oil and raw materials provide only the context for the dramatic rise and fall this year, they do not explain it. That too is another product of the credit crunch.

Falling dollar

By cutting interest rates from the summer of 2007 onwards, the Federal Reserve sought to limit the scale of the credit crunch, by reducing the price of mortgages and enabling banks to rebuild their balance sheets. But this had an important side effect.
Foreign investors buy US debt based on the interest rate the government will pay so, as the US have slashed interest rates while the rest of the world either kept theirs on hold or even raised them as in the Eurozone, US debt became less attractive. Demand for it fell  at least up to the summer of 2008  and the dollar tumbled as a result.

As oil is denominated in dollars so, with the fall of the dollar, the price of oil  measured in dollars  increased. According to Bloomberg, the financial information company there is a 93% correlation between a fall in the dollar and a rise in oil, or vice versa.

But from September onwards the process went into reverse, the freeze on inter-bank lending led to a rush back to US government treasuries  the safest form of investment besides gold. The Eurozone and UK financial authorities slashed their interest rates and the dollar rose sharply, by 25% against the Euro in two months. The price of oil plummeted as a result, falling from a July peak of $147pb to $62pb barrel by the end of October, returning to its levels of the summer of 2007. In addition, there has been a decline in oil consumption, with an unprecedented 5% fall in the US this year.

So the rise in raw materials prices from 2005 onwards reduced the rate of profit in the major oil importing nations, Japan the EU and the US. As prices surged through the first half of 2008, doubling in six months, demand for raw materials from the Middle East and Russia soared.

Massive reserves were built up in the energy and raw material exporting emerging economies. Inflation accelerated in the major importers, reducing incomes and hitting profit margins, transforming slowdown into recession, just as the full effects of the credit crunch were being felt in the summer of 2008. All this had the effect of bringing the business cycle to an end and synchronising the recession within the major OECD countries.

Sat 28, February 2009 @ 12:20