The world is experiencing a rare 'negative feedback loop' - and Australia is right in the firing line

Globe olympicsReutersRunners carry illuminated batons they ascend to a globe which illuminates cities the Olympic torch visited during the opening ceremony of the Athens 2004 Olympic Summer Games August 13, 2004.

The world is experiencing a “negative feedback loop” as commodity prices fall, according to Goldman Sachs.

What’s more, this loop is a huge story decades in the making — and there isn’t a country on the planet that won’t be impacted.

Lets go back to last week, when prices for all kinds of commodities — including gold, oil and all manner of metals and agricultural products — fell in concert.

For some of these commodities, it marked the dramatic acceleration of a year-long trend. Slowing Chinese demand for raw materials has pushed the Bloomberg metals index down 25%. Liquidity is low. Cash is in shorter supply.

This is all part of a global market cycle, Goldman argues, and commodities are getting caught in the violent shuffle.

There are three forces working together to make this happen — a general over-supply of commodities, a strong US dollar, and over-indebted emerging market economies like Brazil and China trying to delever.

“Lower commodity prices reinforce the US recovery and dollar appreciation; while weaker commodity currencies keep downward pressure on commodity cost curves (mainly through lower wage and energy costs),” Goldman Sachs analysts said in a note published Friday.

China’s role in all this can’t be over-stated. The economy is slowing as the country tries to make a painful transition from an economy based on exports to one based on domestic consumption.

A big part of the economy was driven by the property market, which gobbled up copper and iron ore at a stunning rate.

Now the Chinese government is making overtures at exercising some kind of restraint in the sector.

That has made deflation an issue. China’s falling producer price index has analysts worried that corporate margins are thinning dangerously.

That is great news for the US and its dollar. It is bad news for the countries that rely on commodities like Australia and Brazil.

“This deflationary impulse leads to stronger US growth and higher rates, and increasing funding costs for EMs, increasing the need to deleverage,” wrote Goldman. “This in turn adds more divergence, dollar outperformance, and downward pressure on commodity prices.”

The longer this goes on, the harder it will hit commodities prices. That fall in commodity prices will help this keep going on longer.

You know… like a loop.

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