The market and media view about the mining giant Rio Tinto’s $44 billion bid for the Canadian aluminum company Alcan is that the buyer overpaid. It’s generally believed that commodity prices are close to the top of the cycle, so Alcan earnings can be expected to decline going forward. Certainly Alcoa, the other bidder for Alcan, seems to think so; it has terminated its own lower bid. However, the market may be wrong; there are factors which suggest that the rise in commodity prices may not simply be cyclical, but will instead be an important feature of a new and more difficult world.

The theory that commodity prices are simply in a cyclical upswing is at first sight highly plausible. The Fed has been printing money like confetti since 1995, and other central banks have since joined it, allowing the world’s supply of foreign exchange reserves to soar to a total of $5.82 trillion, 11.8% of Gross World Product, compared with $1.6 trillion, 5.4% of Gross World Product in 1997. While consumer price inflation has remained under control, it is reasonable to suppose that such a gigantic increase in money supply would produce price rises in assets, housing and commodities. Naturally, in the cyclical theory, once the world’s central banks come to their senses, and resume their traditional role of fighting inflation, commodity prices will drop back as they did after 1973.

There’s just one nagging factor. Consumer price inflation shouldn’t have remained under control with such a huge increase in the world’s money supply. Indeed, world consumer prices in dollar terms should have roughly trebled in the last decade, fueled by the increase in the money supply. Thus the simple cyclical theory cannot be correct; something else must be going on.

Examination of the technological and economic changes of the last decade immediately suggest two possible causes of the mismatch; the emergence of China and India from their half-millenial slumber into rapid growth, and the world telecommunications revolution of cellphones and the Internet, which has allowed international product sourcing to be carried out much more efficiently.

To take the second possibility first, it is clear upon examination that the Internet/communications revolution in international sourcing is similar to the railroad/refrigeration revolution of the 1880s. Rather than introducing new products to our daily lives, as did electricity and the automobile, it has revolutionized the cost structures of existing products, as with farm products in the earlier period. Thus if money supply had been held constant, as it was with the 1880s Gold Standard, consumer prices would have declined steadily.

That explains the lack of consumer price inflation in the last decade. It also suggests that the Internet/communications inflation-suppressing effect is likely to prove temporary, as costs in the outsourcee countries rise and the market equilibrates to the new production and consumption patterns. Just as the railroads/refrigeration revolution condemned British agriculture to a decline lasting half a century, so the Internet revolution is hollowing out many Western industries, while producing new classes of productive consumers in India, China and elsewhere, who for the first time have enough money to live at above the subsistence level.

In Western countries, the last decades have seen a massive move towards services and away from products you can “drop on your foot.” It has been calculated that the per capita weight of US GDP in 1900 was several times the per capita weight of GDP in 2000, as wood and steel were replaced by composite materials, and heavy physical products were replaced by software and financial services. Naturally, since most commentators on the world economy live in Western countries, they have tended to take this de-materialization of output as part of the natural order of things, and to suppose that commodity prices were in overall long term decline, as usage increased little if at all while extraction techniques improved and recycling became more widespread.

However in poor and emerging countries, the pattern of demand is very different. While some modern lightweight goods, such as software and cellphones, spread rapidly to poor countries, so their inhabitants’ consumption patterns are not simply replicas of Western patterns 50 years ago, much of the demand in emerging markets is for goods that are already plentiful in the West.

The most startling example of this is the automobile sector. Automobiles satisfy a human need for transportation that cannot be replicated by electronic means, so are high on the priority lists of the new Third World middle class. Chinese consumers purchased over 7 million vehicles in 2006, and demand is increasing by around 20% per annum. While US automobile demand is stagnant at the 16-17 million per annum level, increasing only in line with population, Chinese automobile demand is rising at around the double the growth rate of real output. Since China’s population is four times that of the United States, a China with Western living standards would have automobile demand, not perhaps of 4 times US demand, but at least of 2-3 times. Similarly India has a population of 3.5 times that of the United States; there annual automobile demand is still only around 2 million vehicles, but it is increasing rapidly and there is no reason to suppose it won’t follow the same path as China.

Automobiles are a quintessential “drop it on your foot” product; they are little lighter than in 1910, and there is no way to manufacture them without using several thousand pounds of commodities of one type or another. Furthermore, they create their own demand, for oil obviously, but also for roads, shopping centers and other modern suburban paraphernalia, all of which is highly physical and requires substantial commodity inputs to satisfy.

It therefore follows that the Internet/communications revolution, by spreading purchasing power from a small group of rich country inhabitants to a much larger group of emerging markets citizens, has reversed the trend so clear in 1950-90 of shrinking commodity intensity in Gross World Product. As well as providing rich Westerners with ever more complicated gadgets of minute size, this new economy is also providing a numerically much larger group with the chunkier products (think furniture, for example) for which Western demand was already more or less saturated.

In services too, the trend is by no means wholly towards resource downsizing. While hedge funds consume directly no more of the world’s resources than the merchant banks and mutual funds they replaced (though being more expensive, they create product demand among their overpaid staff) that’s not true of other services, especially air travel and vacation expenses, which tend to expand more rapidly than GDP. When characters on the down-market Yorkshire farming soap opera Emmerdale Farm vacation in Antigua, huge social change has occurred. Their journey to Antigua uses far more of the world’s commodity resources than their grandparents’ 1957 week in Blackpool. The transition of wealth to emerging market countries will only increase this resource-intensive demand further. However much environmentalists may wish to create a world in which the entire population stays home and plays video games, watches satellite television or surfs the Internet, that’s not globally where we are heading.

Thus the commodity boom we have seen over the last 5 years is probably not simply a cyclical phenomenon, but a long term trend. Oil in particular will be scarce again in 2008, according to the International Energy Administration, with prices likely to rise further. Commodity prices will dip once the world’s central bankers come to their senses and stop creating excess money, but the dip, not the recent rise, is likely to prove temporary.

For oil and most minerals, increasing production will cause demand to move towards the more costly sources, and those in the less reliable countries. This will provide a bonanza for the likes of Russia’s Vladimir Putin, Venezuela’s Hugo Chavez and Iran’s Mahmoud Ahmedinejad. It will also cause a secular rising trend in inflation (when measured properly) which will prove as impervious to monetary policy as has the deflation caused by the Internet/communications bonanza.

Since Alcan produces a commodity, aluminum, that is basic to modern civilization, and sources much of its power needs from cheap Canadian hydro-electricity, it may be exceptionally well placed to take advantage of a secular rising trend in commodity demand and prices. Far from overpaying, Rio Tinto may be buying intelligently early into a trend that will shape the long term future. Oil companies that appear prepared to abase themselves more or less ad infinitum before the grand larceny of Putin and Chavez may also be seeing the future more clearly than the rest of us.

However, if Rio Tinto and the oil majors are right, most of the acquirers at premium prices in non-commodity fields are wrong. A world of high commodity prices is one in which the US, the EU and other “advanced” powers have a lower share of the world’s economic strength, with lower growth, lower living standards and much higher inflation than in the recent past. Far from rising 283 points to close to 14,000 to celebrate the Rio Tinto deal therefore, the Dow should have plummeted to a level more in line with the 5,000 that would reflect its long term historical trend – or even somewhat lower, reflecting the secular deterioration in US economic prospects.

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(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)