The Paradigm Shifts: Global Imbalances, Policy, and Latin America – Mark Carney – Governor of the Bank of Canada Calgary [Commodities] Speech (March 26, 2011)

Remarks by Mark Carney – Governor of the Bank of Canada – Inter-American Development Bank, Calgary, Alberta (26 March 2011)

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“Commodity markets are in the midst of a supercycle. …This surge in demand is the result of rapid growth in the emerging world, particularly in Asia. …Rapid urbanization underpins this growth. Since 1990, the number of people living in cities in China and India has risen by nearly 500 million, the equivalent of housing the entire population of Canada 15 times over. …Even though history teaches that all booms are finite, this one could go on for some time.” (Governor of the Bank of Canada – Mark Carney, March 26, 2011)

Introduction

Globalization is the opportunity and the challenge of our age. It has the potential to lift billions out of poverty, vastly expand economic prospects, and develop a more diverse and resilient global economy. However, globalization also brings stresses, so policy-makers will need both discipline and new frameworks to realise its promise.

The financial crisis has accelerated the shift in the world’s economic centre of gravity. Emerging-market economies (EMEs) now account for almost three-quarters of global growth—up from just one-third at the turn of the millennium.

Although this paradigm shift to a multipolar world is fundamentally positive, it is also disruptive. Labour, capital and commodity markets are changing rapidly. The effective global labour supply quadrupled between 1980 and 2005 and may double again by 2050.1 Cross-border capital flows have exploded, growing at a rate almost seven times the peak during the last wave of globalization.2 Commodity markets are in the midst of a supercycle.

Large imbalances are a natural consequence of globalization. These imbalances can be good or bad. Good imbalances are the product of capital moving to where it can be best used, production being reoriented and expanded, and the economic cycle becoming more commodity intensive.

Bad imbalances arise when countries resist or misread the consequences of this shift of activity and demand from advanced to emerging economies.

Indeed, the response to such pressures will influence the resiliency of the globalization process itself. In the run-up to the crisis, poor policy choices reinforced vulnerabilities. Countries frustrated exchange rate adjustment, and the recipients of large capital inflows squandered them. Price stability was achieved, but financial stability was forfeited. The result was unbalanced, unsustainable growth, culminating in economic catastrophe.

It is not clear that the commitment to open markets will withstand a repeat of such mistakes. Today, I will concentrate on two current policy challenges for our region that could prove decisive:

1) maintaining price stability in the face of a major commodity shock, and
2) maximizing the return to large, volatile capital flows.

In each case, there is a risk that policy-makers downplay longer-term forces when setting short-term policy. As a consequence, destabilizing global imbalances could re-emerge and undermine the globalization process itself.

Commodities

Major commodity exporters, including Canada and much of Latin America, are experiencing a large, positive terms-of-trade shock (see Appendix, Chart 1). Real prices for energy and metals have been well above their long-term averages for more than five years, and real food prices are now at their highest levels in twenty years (Chart 2).3

The question is whether such strength will persist.

From a policy perspective, it matters whether prices are being primarily driven by demand, supply or speculation. In general, supply shocks and speculative overshoots tend to be short lived and can be looked through. Demand shocks are different.

While there have been supply disruptions due to geopolitical unrest and natural disasters, and while speculative pressures have reinforced, on occasion, the direction of fundamentally driven price moves, the Bank’s view is that a large, sustained increase in demand is the primary driver of this boom. The breadth and durability of the commodity rally underscores this conclusion.

This surge in demand is the result of rapid growth in the emerging world, particularly in Asia (Chart 3). With convergence still a long way off, the demand for commodities can be expected to remain robust for some time. Based on the experiences of Japan in the 1960s and Korea in the 1980s, emerging Asia’s energy and metals intensities should gain momentum.4

Rapid urbanization underpins this growth. Since 1990, the number of people living in cities in China and India has risen by nearly 500 million, the equivalent of housing the entire population of Canada 15 times over (Chart 4). This process can be expected to continue for decades, since urbanization rates in China and India are currently 30 to 50 percentage points below those in Brazil, Mexico and Canada.

In parallel, a massive new middle class is being formed. The world’s middle class is growing by 70 million people each year and will double to 40 per cent of the global population by the end of this decade.5 The ramifications will be considerable for a wide range of commodities, through higher protein diets, refrigeration and travel. Whether it is cars, airports or meat, consumption and development levels in major emerging markets are currently fractions of those in advanced economies (Table 1).

Even though history teaches that all booms are finite, this one could go on for some time.

With the demand story intact, the profile of commodity prices will turn on supply. Time will tell whether new supply will be sufficient, and whether consumption converges at current Western levels or whether price signals and serious attempts at reducing carbon intensity will ultimately force a more sustainable equilibrium.

The fundamental issue is that the relationship between U.S. economic activity and commodity prices has changed, and that this is complicating the policy response for exporters and importers alike (Chart 5).

Policy Implications

All IDB member countries are currently facing some similar challenges, which are best addressed with an eye to these longer-term trends.
For the remainder of Mark Carney’s Speech and links to a variety of charts and graphs, please go to the Bank of Canada website: http://www.bank-banque-canada.ca/en/speeches/2011/sp260311.html

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