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Commodity Booms and Busts

Commodity Booms and Busts
Profile photo of Robert P. Murphy

An article in The Globe and Mail details the woes of a Labrador mining town that has been crushed by the collapse in iron ore truckprices: “The Wabush mine…is shutting down along with another iron ore mine called Bloom Lake in neighbouring Quebec. More than 1,000 miners will be out of work, not to mention a slew of other job losses from businesses that service the industry. It’s a crippling blow in an area with a population of about 9,000.” The episode is a good case study in the economics of mining as well as the perils of State intervention in the economy.

Is It Too Risky to Focus on Mining?

Whenever a region–or even an entire country, in certain cases–experiences the fall-out from the crashing price of a key commodity, it is natural to lament the foolish dependence on that particular export. It seems to be a classic case of putting all of one’s eggs in the same basket.

However, there is no objectively right or wrong way to gauge the proper amount of exposure that is “just right.” For example, should Canadians completely ignore the rich heritage of their natural resources, not only in the form of iron ole but also oil, natural gas, and timber? That would seem absurd to ignore the wealth waiting to be harvested.

Now given that Canadians are going to extract these resources, should they do so with their bare hands? Of course not. They should use advanced machinery and mining techniques.

OK, given that there are going to be at least hundreds of Canadians working a particular mine, should they sleep in tents? Should they grow their own food and perform their own dental work? That too seems ludicrous. Surely it makes sense for the mine workers to have houses and nearby grocery stores and medical facilities.

Now we see the problem. If humans in today’s advanced economy decide they are going to exploit a stockpile of natural resources, it only makes sense to do so in a way that leaves the region vulnerable to a sudden collapse in price. Of course, this inherent volatility is a reason to be prudent in making fixed investments in the operation, and some workers who want a more stable future may pick a different career, like retail or teaching.

Yet notwithstanding these caveats, it still makes perfect sense for a portion of the Canadian economy to consist of natural resource extraction.

State Intervention Causes the Boom-Bust Cycle

Even though prices–especially commodity prices–are ultimately volatile because of human choice, in practice they are fluctuate much more wildly because of State intervention. Naturally, the Austrian theory of the business cycle is a prime example of this pattern. In a nutshell: The commercial banks (nowadays aided and abetted by the central bank) flood the credit market with new loans, artificially pushing down the interest rate. This spurs an unsustainable boom, which must eventually result in a crash. (In my reply to Paul Krugman’s critique, I give a summary of ABCT.)

When it comes to the Wabush mine, the article explains the causes of the economic hardship: “The price of iron ore, a key ingredient in steel, has been in freefall, falling 60 per cent in three years. Where the resource once traded as high as $190 (U.S.) a tonne in 2011, it is now below $70. The deterioration is due to two factors: less demand from China and an oversupply of iron ore and coking coal, which is also used to make steel.”

Armed with Austrian theory, we can understand this outcome. First, the artificially low interest rates and massive rounds of monetary inflation caused a surge in commodity prices, accompanied by investment in high-cost operations. The Chinese government in particular has been financing an unsustainable boom. As the Federal Reserve halts its balance sheet expansion, and growth in China peters out, it is not surprising that commodity prices are collapsing.

Conclusion

Whenever a small community is devastated by a large movement in the global economy, there is a natural reaction to want to insulate the region from external trade. However, this would be a mistake. People will have the highest standard of living when the State lets them make their own career and investment decisions, taking into account the risks of specializing in a “cash crop.”

However, if central governments and central banks want to help, they can stop trying to manage the business cycle. These “countercylical” fiscal and monetary policies actually cause the boom-bust cycle in the first place.

 

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Profile photo of Robert P. Murphy

Robert P. Murphy is the Senior Economist at the Institute for Energy Research, and a Senior Fellow with the Fraser Institute. He holds a PhD in economics from New York University. Murphy is the author of Choice: Cooperation, Enterprise, and Human Action (Independent Institute, 2015) as well as numerous other books and hundreds of articles.

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