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The Deflation Shock: Geopolitical Ramifications of the Global Commodity Price Drop

Deflation driven by loss of global demand like this is not easy to combat, as the Chinese are now realising. For commodity prices to be where they are now, it is clear that the world as led by China is suffering a slump in demand, which suggests that economic growth is much lower than the world’s stock markets are trying to reflect.

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David Murrin is the author of Breaking the Code of Historythe culmination of decades of personal research across a wide range of disciplines. David compellingly argues that human behaviour is not random, but determined by specific, quantifiable and predictable patterns fuelled by our need to survive and prosper. He has called this cycle The Five Stages of Empire, which due to its fractal nature is applicable to empires, all the way down to the cycle of the individual. According to David, to resolve the issues confronting us today we cannot merely study the past. The human race will need to understand this precise algorithm of behaviour that has caused us to re-enact the same destructive cycles in ever-greater magnitudes, in order to change our future. He is also a Global Fellow at PS21.

We have for quite a while now been predicting a sharp period of deflation from 2015 to as late as 2018. This prediction has been based on the Kondratieff cycles’ second phase, which corrects the first impulsive stage of commodity inflation. We maintain our view, despite the assurances of various central banks, that this is only a short-term dip. Indeed, the ongoing decline in global commodity prices suggests that these deflationary dynamics will accelerate in the next 12 to 18 months.

One of the interesting questions about the Kondratieff cycle is that its price history has–until the past decade–been based on the cycle of the Super Western Christian Empires as these were the dominant industrial powers across the globe during the past two centuries. With the current dip in Chinese demand, we are now able to confirm that the rising Super Asian Empire has phased its commodity demand cycle with that of the West.

Why? Because this deflationary cycle has to a large extent been driven by the loss of demand within the Chinese economy. As such, we should expect to see that loss of Chinese demand continue for the next 12 to 18 months and the Chinese authorities wrestle with increasing economic dislocation.

Deflation driven by loss of global demand like this is not easy to combat, as the Chinese are now realising. For commodity prices to be where they are now, it is clear that the world as led by China is suffering a slump in demand, which suggests that economic growth is much lower than the world’s stock markets are trying to reflect. This suggests that an imminent and very large asset reprising will take place in the months ahead.

My concern is that this event will represent a global financial shock of greater magnitude than 2008 and possible of a similar magnitude as 1929. The Western Central Banks had financial levers to contain the shock of 2008, which are now no longer available, so the impact will be much greater. Indeed, the use of the printing presses in what we know as QE has inflated stock and asset prices to completely unrealistic levels, and the gap below to reality is probably greater than ever before. Hence, we should expect not only very deep price drops, but moves that are very powerful.

In Breaking the Code of History, we discussed the concept that shocks such as this deflationary shock affect every economy simultaneously and usually with the same magnitude. However, what differentiates the strong from the weak nations is the speed of the recovery and whether that recovery subsequently reached new highs.

Although this shock started in China, this is not the all clear signal that the Chinese challenge is ending, as I would anticipate that they recover faster than any other nation. Conversely, I reckon that the greatest losers will be the weaker Western nations. Certainly the EU is top of that list, but close behind is America. Thus, I would expect this shock to accelerate the power shift from West to East.

In addition to the effects associated with the long-term five stages of empires cycles, changes in the commodity cycle create geopolitical shifts in power of smaller cycle degree. In assessing the oncoming ramifications of global deflation, the first nations to consider are the commodity producers themselves.

Russia

Russia has been hit threefold with economic mismanagement, Western sanctions and lower oil prices, which have placed it in a very precarious situation. On one hand, there are the forces of economic implosion that might lead to civil unrest against Putin, but on the other hand, there is the argument that the West caused the problem via sanctions. Putin could use any external event to trigger a war to unite his people in a common cause to save himself. This situation needs to be carefully monitored and managed and is a very high-risk scenario.

The United States

The effect of the price decline on America as a high-cost oil shale producer seems to have been neglected with the ramifications of a massively shrinking nation’s shale oil industry. America will be forced back into the geopolitical sphere of oil importation and dependence on the Middle East and thus will have to show a greater engagement against ISIL. The boost to its economy from lower oil prices will not counter the overcooked price levels of the stock markets hyped on QE. However, in the long term the inactive oil shale fields will act as a national hedge for America as they could be reactivated when the oil price goes up again after the bottom has been reached.

Government subsidies would enhance this process. Politically, this shock will ensure that Obama’s popularity plumbs new depths and that he will go down in history as the most unpopular president ever, almost guaranteeing a Republican winner the next time round. As per 1929, American investors will be forced to withdraw their overseas capital to shore up the onshore balance sheets, especially in the emerging markets. This will create future opportunities for Chinese investment and increased influence.

Middle East

Saudi Arabia and Iran will once more become important due to the low cost of their oil. However, the civil war in the Middle East is expected to continue and intensify in complexity, especially if nuclear proliferation takes place.

Africa

Growth in Africa has been driven by the investment boom in commodities coupled with indigenous demographic expansion. The latter is powerful enough to maintain growth on its own, although at a lower level without the commodity boost. However, nations such as Nigeria with dependence on oil production will undergo considerable economic stress compounded by poor governance.

Meanwhile, the importer of commodities might not find lower prices as beneficial as one would have expected.

China

China will undergo a phase of significantly lower growth and retrenchment with the demand gap. However, this period of economic uncertainty should not be used to argue that a central demand economy does not work and will fail, but rather be seen as a similar dip to the Asian crisis and a healthy retracement. We would not expect to see no change in the aggressive expansive Chinese foreign policy, indeed it may become more so, in balance to its internal economic weakness. In addition, the Chinese will use this commodity dip to keep buying the best assets at the lowest prices, as they maintain a long-term view of their own growth just not present in the West.

Europe

The failed economics of Europe will make it most vulnerable to the effects of deflation and asset price depreciation. This will most probably provide the catalyst for the restructuring of the EU, with further knock-on effects for global markets.

Thus, in summary, we expect the months ahead to produce both large economic and geopolitical stress globally. Astute consumer nations should use these price dips to acquire cheap assets and reduce future dependency on importation. However bad the deflationary period may be, the ensuring inflationary period will bring its own significant geopolitical changes.

Earlier versions of this article originally appeared on DavidMurrin.co.uk on Monday, August 24, 2015 and Wednesday, August 26, 2015.

PS21 is a non-national, non-ideological, non-governmental organization. All views expressed are the author’s own.

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