Pearson - Always learning

All your resources for Economics

RSS icon Subscribe | Text size

Posts Tagged ‘speculation’

Brexit fears

On 20 February, the UK Prime Minister, David Cameron, announced the date for the referendum on whether the UK should remain in or leave the EU. It will be on 23 June. The announcement followed a deal with EU leaders over terms of UK membership of the EU. He will argue strongly in favour of staying in the EU, supported by many in his cabinet – but not all.

Two days later, Boris Johnson, the Mayor of London, said that he would be campaigning for the UK to leave the EU.

In the meantime, Mr Johnson’s announcement, the stance of various politicians and predictions of the outcome of the referendum are having effects on markets.

One such effect is on the foreign exchange market. As the Telegraph article below states:

The pound suffered its biggest drop against the dollar in seven years after London Mayor Boris Johnson said he will campaign for Britain to leave the European Union ['Brexit'].

Sterling fell by as much as 2.12pc to $1.4101 against the dollar on Monday afternoon, putting it on course for the biggest one day drop since February 2009. Experts said the influential Mayor’s decision made a British exit from the bloc more likely.

The pound also fell by as much as 1.2pc to €1.2786 against the euro and hit a two-year low against Japan’s yen.

This follows depreciation that has already taken place this year as predictions of possible Brexit have grown. The chart shows that from the start of the year to 23 February the sterling trade weighted index fell by 5.3% (click here for a PowerPoint).

But why has sterling depreciated so rapidly? How does this reflect people’s concerns about the effect of Brexit on the balance of payments and business more generally? Read the articles and try answering the questions below.

Articles
Pound in Worst Day Since Banking Crisis as `Brexit’ Fears Bite Bloomberg, Eshe Nelson (21/2/16)
Pound hits 7-year low on Brexit fears Finiancial Times, Michael Hunter and Peter Wells (22/2/16)
Pound in freefall as Boris Johnson sparks Brexit fears The Telegraph, Szu Ping Chan (22/2/16)
Pound falls below $1.39 as economists warn Brexit could hammer households The Telegraph, Peter Spence (24/2/16)
Why is the pound falling and what does it mean for households and businesses? The Telegraph, Szu Ping Chan (23/2/16)
Pound heading for biggest one-day fall since 2009 on Brexit fears BBC News (22/2/16)
Cameron tries to sell EU deal after London mayor backs Brexit Euronews, Guy Faulconbridge and Michael Holden (22/2/16)
EU referendum: Sterling suffers biggest fall since 2010 after Boris Johnson backs Brexit International Business Times, Dan Cancian (22/2/16)

Exchange rate data
Spot exchange rates against £ sterling Bank of England

Questions

  1. What are the details of the deal negotiated by David Cameron over the UK’s membership of the EU?
  2. Why did sterling depreciate in (a) the run-up to the deal on UK EU membership and (b) after the announcement of the date of the referendum?
  3. Why did the FTSE100 rise on the first trading day after the Prime Minister’s announcement?
  4. What is the relationship between the balance of trade and the exchange rate?
  5. What are meant by the ‘six-month implied volatility in sterling/dollar’ and the ‘six-month risk reversals’?
  6. Why is it difficult to estimate the effect of leaving the EU on the UK’s balance of trade?
Share in top social networks!

When pessimism takes over

Over 2015 quarter 3, stock markets around the world have seen their biggest falls for four years. As the BBC article states: ‘the numbers for the major markets from July to September make for sobering reading’.

  US Dow Jones: –7.9%
  UK FTSE 100: –7.04%
  Germany Dax: –11.74%
  Japan Nikkei: –14.47%
  Shanghai Composite: –24.69%

So can these falls be fully explained by the underlying economic situation or is there an element of over-correction, driven by pessimism? And, if so, will markets bounce back somewhat? Indeed, from 30 September to 2 October, markets did experience a rally. For example, the FTSE 100 rose from a low of 5877 on 29 September to close at 6130 on 3 October (a rise of 4.3%). But is this what is known as a ‘dead cat bounce’, which will see markets fall back again as pessimism once more takes hold?

As far as the global economic scenario is concerned, things have definitely darkened in the past few months. As Christine Lagarde, Managing Director of the IMF, said in an address in Washington ahead of the release of the IMF’s 6-monthly, World Economic Outlook:

I am concerned about the state of global affairs. The refugee influx into Europe is the latest symptom of sharp political and economic tensions in North Africa and the Middle East. While this refugee crisis captures media attention in the advanced economies, it is by no means an isolated event. Conflicts are raging in many other parts of the world, too, and there are close to 60 million displaced people worldwide.

Let us also not forget that the year 2015 is on course to be the hottest year on record, with an extremely strong El Niño that has spawned weather-related calamities in the Pacific.

On the economic front, there is also reason to be concerned. The prospect of rising interest rates in the United States and China’s slowdown are contributing to uncertainty and higher market volatility. There has been a sharp deceleration in the growth of global trade. And the rapid drop in commodity prices is posing problems for resource-based economies.

Words such as these are bound to fuel an atmosphere of pessimism. Emerging economies are expected to see slowing economic growth for the fifth year in succession. And financial stability is still not yet assured despite efforts to repair balance sheets following the financial crash of 2008/9.

But as far as stock markets are concerned, the ECB is in the process of a massive quantitative easing programme, which will boost asset prices, and Japan looks as if it too will embark on a further round of QE. Interest rates remain very low, and, as we discussed in the blog Down down deeper and down, or a new Status Quo?, some central banks now have negative rates of interest. This makes shares relatively attractive for savers, so long as it is believed that they will rise over the medium term.

Then there is the question of speculation. The falls were partly due to people anticipating that share prices would fall. But has this led to overshooting, with prices set to rise again? Or, will pessimism set in once more as people become even gloomier about the world economy? If only I had a crystal ball!

Articles
Markets see their worst quarter in four years BBC News (1/10/15)
Weak Jobs Data Can’t Keep U.S. Stocks Down Wall Street Journal, Corrie Driebusch (2/10/15)
What the 3rd Quarter Tells Us About The Stock Market In October EFT Trends, Gary Gordon (2/10/15)
The bull market ahead: Why shares should make 6.7pc a year until 2025 The Telegraph, Kyle Caldwell (5/9/15)
Is the FTSE 100′s six year run at an end? The bull and bear points The Telegraph, Kyle Caldwell (24/8/15)

Webcasts
The stock market bull may not be dead yet CNNMoney (29/9/15)
IMF’s Lagarde: More volatility likely for emerging markets CNBC, Everett Rosenfeld (30/9/15)
What’s next for stocks after worst quarter in four year CNBC, Patti Domm (30/9/15)
Global markets to log worst quarter since 2011 CNBC, Nyshka Chandran (30/9/15)

Speech
Managing the Transition to a Healthier Global Economy IMF, Christine Lagarde (30/9/15)

Questions

  1. Distinguish between stabilising and destabilising speculation. Is it typical over a period of time that you will get both? Explain.
  2. What is meant by a ‘dead cat bounce’? How would you set about identifying whether a given rally was such a phenomenon?
  3. Examine the relationship between the state (and anticipated state) of the global economy and share prices.
  4. What is meant by (a) the dividend yield on a share; (b) the price/earnings ratio of a share? Investigate what has been happening to dividend yields and price/earnings ratios over the past few months. What is the relationship between dividend yields and share prices?
  5. Distinguish between bull and bear markets.
  6. What factors are likely to drive share prices (a) higher; (b) lower?
  7. Is now the time for investors to buy shares?
Share in top social networks!

A chill wind from the east

The mood has changed in international markets. Investors are becoming more pessimistic about recovery in the world economy and of the likely direction of share prices. Concern has centred on the Chinese economy. Forecasts are for slower Chinese growth (but still around 5 to 7 per cent) and worries centre on the impact of this on the demand for other countries’ exports.

The Chinese stock market has been undergoing turmoil over the past few weeks, and this has added to jitters on other stock markets around the world. Between the 5th and 24th of August, the FTSE 100 fell by 12.6%, from 6752 to 5898; the German DAX fell by 17.1% from 11,636 to 9648 and the US DOW Jones by 10.7% from 17,546 to 15,666. Although markets have recovered somewhat since, they are very volatile and well below their peaks earlier this year.

But are investors right to be worried? Will a ‘contagion’ spread from China to the rest of the world, and especially to its major suppliers of raw materials, such as Australia, and manufactured exports, such as the USA and Germany? Will other south-east Asian countries continue to slow? Will worries lead to continued falls in stock markets as pessimism becomes more entrenched? Will this then impact on the real economy and lead then to even further falls in share prices and further falls in aggregate demand?

Or will the mood of pessimism evaporate as the Chinese economy continues to grow, albeit at a slightly slower rate? Indeed, will the Chinese authorities introduce further stimulus measures (see the News items What a devalued yuan means to the rest of the world and The Shanghai Stock Exchange: a burst bubble?), such as significant quantitative easing (QE)? Has the current slowing in China been caused, at least in part, by a lack of expansion of the monetary base – an issue that the Chinese central bank may well address?

Will other central banks, such as the Fed and the Bank of England, delay interest rate rises? Will the huge QE programme by the ECB, which is scheduled to continue at €60 billion until at least September 2016, give a significant boost to recovery in Europe and beyond?

The following articles explore these questions.

Articles
The Guardian view on China’s meltdown: the end of a flawed globalisation The Guardian, Editorial (1/9/15)
Central banks can do nothing more to insulate us from the Asian winter The Guardian, Business leader (6/9/15)
Where are Asia’s economies heading BBC News, Karishma Vaswani (4/9/15)
How China’s cash injections add up to quantitative squeezing The Economist (7/9/14)
Nouriel Roubini dismisses China scare as false alarm, stuns with optimism The Telegraph, Ambrose Evans-Pritchard (4/9/15)
Markets Are Too Pessimistic About Chinese Growth Bloomberg, Nouriel Roubini (4/9/15)

Data
World Economic Outlook databases IMF: see, for example, data on China, including GDP growth forecasts.
Market Data Yahoo: see, for example, FTSE 100 data.

Questions

  1. How do open-market operations work? Why may QE be described as an extreme form of open-market operations?
  2. Examine whether or not the Chinese authorities have been engaging in monetary expansion or monetary tightening.
  3. Is an expansion of the monetary base necessary for there to be a growth in broad money?
  4. Why might the process of globalisation over the past 20 or so years be described a ‘flawed’?
  5. Why have Chinese stock markets been so volatile in recent weeks? How seriously should investors elsewhere take the large falls in share prices on the Chinese markets?
  6. Would it be fair to describe the Chinese economy as ‘unstable, unbalanced, uncoordinated and unsustainable’?
  7. What is the outlook over the next couple of years for Asian economies? Explain.
  8. For what reasons might stock markets have overshot in a downward direction?
Share in top social networks!

The Shanghai Stock Exchange: a burst bubble?

Many Chinese people have taken to investing on the Chinese stock market, seeing it as a way of making a lot of money quickly. From October 2014 to June this year the market soared, rising by 126% from 2290 to 5166.

More and more people used their savings to buy stocks and China now has over 90 million individual investors. And it was not just savings that were invested. Increasingly people have been borrowing money to invest, seeing it as an easy way of making money. Unlike stock markets in developed countries, where the majority of shares are held by financial organisations, such as pension funds, holdings by individuals account for about 80% of stocks on the Chinese market.

But since mid-June, share prices have plummeted by 32% (see chart). People have thus seen a huge fall in the value of their savings, while many others have found their shareholdings worth less than their debts. The fall, like the rise that preceded it, has been driven by speculation, fuelled by first optimism and then pessimism.

The Chinese government is worried that the fall might dampen investment and economic growth. It has thus has been supplying liquidity to various institutions to buy shares, but this has had little effect and is dismissed by many as meddling. What is more it could expose companies which take advantage of the liquidity to greater risk.

So serious has been the rout, that over 50% of listed companies have halted trading on the mainland Chinese stock exchanges.

So just why has there been this bubble and why has it burst? What implications will it have for (a) China and (b) the rest of the world? The following articles explore the issues.

China’s stock market fall hits small investors BBC News Magazine, John Sudworth (7/7/15)
China Stocks Plunge as State Support Fails to Revive Confidence Bloomberg (8/7/15)
Chinese stocks are crashing Business Insider UK, Myles Udland, David Scutt (8/7/15)
Shanghai stocks plunge, over 1,200 Chinese companies halt trading Economic Times of India (8/7/15)
Everyone freaking out about China’s stock-market crash is missing one thing Business Insider UK, Elena Holodny (7/7/15)
China’s stock market has lost nearly a third of its value in a month Vox, Timothy B. Lee (8/7/15)
Chinese leaders may be undermined as investors suffer stock market slide The Guardian, Emma Graham-Harrison (8/7/15)
Opinion: China’s stock-market crash is just beginning MarketWatch, Howard Gold (8/7/15)
What does China’s stock market crash tell us? BBC News (22/7/15)

Questions

  1. What is meant by a ‘bubble’? Has the recent performance of the Shanghai Stock Market been an example of a bubble?
  2. Is the current fall in share prices in China an example of overshooting? Explain how you would decide.
  3. Distinguish between stabilising and destabilising speculation. Why does destabilising speculation not go on for ever?
  4. What is meant by the ‘stock market wealth effect’? How is the fall in the Chinese stock market likely to affect consumption and investment in China? How does the proportion of assets held in the form of shares affect the magnitude of the effect?
  5. What are the likely implications of the fall in the Chinese stock market for the rest of the world?
  6. Why has the Hong Kong stock market not behaved in the same way as the Shanghai market?
  7. What have the Chinese authorities been doing to arrest the fall in share prices? How likely are they to succeed?
Share in top social networks!

Predicting the stock market: it’s normally too late

With worries about Greek exit from the eurozone, with the unlikelihood of further quantitative easing in the USA and the UK, with interest rates likely to rise in the medium term, and with Chinese growth predicted to be more moderate, many market analysts are forecasting that stock markets are likely to fall in the near future. Indeed, markets are already down over the past few weeks. Since late April/early May, the FTSE is down 4.5%; the German DAX index is down 7.0%; the French CAC40 index is down 6.9%; and the US Dow Jones index is down 2.3%. But does this give us an indication of what is likely to happen over the coming months?

If stock markets were perfectly efficient, then all possible information about the future will already have been taken into account and will all be reflected in current share prices. It would be impossible to ‘get ahead of the game’.

It is only if market participants have imperfect information and if you have better information than other people that you can are likely to predict correctly what will happen. Even then, the markets might be buffeted by random and hence unpredictable shocks.

Some people correctly predicted things in the past: such as crashes or booms. But in many cases, this was luck and their subsequent predictions have proved to be wrong. When financial advisers or newspaper columnists give advice, they are often wrong. If they were reliably right, then people would follow their advice and markets would rapidly adjust to their predictions.

If Greece were definitely to exit the euro, if interest rates were definitely to rise in the near future, if it became generally believed that stock markets were overvalued, then stock markets would probably fall. But these things may not happen. After all, people have been predicting a rise in interest rates from their ultra-low levels for many months – and it hasn’t happened yet, and may not happen for some time to come – but it may!

If you want to buy shares, you might just as well buy them at random – or randomly sell any you already have. As Tetlock says, quoted in the Nasdaq article:

“Even the most astute observers will fail to outperform random prediction generators – the functional equivalent of dart-throwing chimps.”

And yet, people do believe that they can predict what is going to happen to stock markets – if not precisely, then at least roughly. Are they deluded, or can looking calmly at likely political and economic events put them one step ahead of other people who perhaps behave more reactively and emotionally?

Bond rout spells disaster for stock markets as global credit kraken awakens The Telegraph, John Ficenec (14/6/15)
Comment: Many imponderables for markets The Scotsman, Bill Jamieson (14/6/15)
How Ignoring Stock Market Forecasts Will make you a better investor Forbes, Ky Trang Ho (6/6/15)
The Predictions Racket Nasdaq, AdviceIQ, Jason Lina (21/5/15)

Questions

  1. Why may a return of rising interest rates lead to a ‘meltdown in equity prices’? Why might it not?
  2. Why have bond yields fallen dramatically since 2008?
  3. Why are bond yields rising again now and what significance might this have (or have had) for equity markets?
  4. Why may following the crowd often lead to buying high and selling low?
  5. Is there an asymmetry between buying and selling behaviour in stock markets?
  6. Will ignoring stock market forecasts make people better investors?
  7. “The stock market prices suggest that investors believe both the Federal Reserve and the Bank of England are bluffing about raising interest rates. That may be so, but it is an extremely risky game of chicken for investors to play.” Explain and discuss.
Share in top social networks!

Getting out the crystal ball

The New Year is a time for reflection and prediction. What will the New Year bring? What does the longer-term future hold? Here are two articles from The Guardian that look into the future.

The first, by Larry Elliott, considers a number of scenarios and policy options. Although not totally doom laden, the article is not exactly cheery in its predictions. Perhaps ‘life will go on’ and the global economy will muddle through. But perhaps a new recession is around the corner or, even worse, the world is at a tipping point when things are fundamentally changing. Unless policy-makers are careful, clever and co-ordinated, perhaps a new dark age may be looming. But who knows?

Which brings us to the second article, by Gaby Hinsliff. This argues that people are pretty hopeless at predicting. “History is littered with supposed dead certs that didn’t happen – Greece leaving the euro, the premature collapse of the coalition – and wholly unimagined events that came to pass.” And economists and financial experts are little better.

Two years ago, The Observer challenged a panel of City investors to pick a portfolio of stocks and rated their performance against that of Orlando, a ginger cat who selected his portfolio by tossing a toy mouse at a sheet of paper. Inevitably, the cat triumphed.

But is this fair? If capital markets are relatively efficient, stock prices today already reflect knowable information about the future, but clearly not unknowable information.

It’s the same with economies. When information is already to hand, such as a pre-announced tax change, then its effects, ceteris paribus, can be estimated – at least roughly.

But it’s the ‘ceteris paribus‘ assumption that’s the problem. Other things are not equal. The world is constantly changing and there are all sorts of unpredictable events that will influence the outcomes of economic policy and of economic decisions more generally. And central to the problem are people’s attitudes and confidence. Mood can swing quite dramatically, from irrational exuberance to deep pessimism. And such mood changes – often triggered by some exogenous factor, such as an international dispute, an election or unexpected economic news – can rapidly gather momentum and have significant effects.

Predicting the long-term future is both easier and more difficult: easier, in that short-term cyclical effects are less relevant; more difficult in that changes that have not yet happened, such as technological changes or changes in working practices, may themselves be key determinants of the future global economy.

One of the most salutary lessons is to look at predictions made in the past about the world today and at just how wrong they have proved to be. Perhaps we need to call on Orlando more frequently.

Why ‘life will go on’ thesis about global economy might not pass muster in 2015 The Guardian, Larry Elliott (28/12/14)
Who knows what the new year holds? Certainly none of us The Guardian, Gaby Hinsliff (26/12/14)

Questions

  1. Give some examples of factors that could have a major influence on the global economy, but which are unpredictable.
  2. Is economic forecasting still worthwhile? Explain.
  3. Look at some macroeconomic forecasts made in the past about the world today. You might want to look at forecasts of agencies such as the IMF, the OECD, the World Bank and the European Commission. You can find links in the Economics Network’s Economic Data freely available online. Explain why such forecasts have differed from the actual outcome.
  4. Why, if capital markets were perfect, might Orlando be just as good as a top investment manager at predicting the future course of share prices?
  5. In what ways is economic forecasting similar to and different from weather forecasting in its methods, its use of data and its reliability?
Share in top social networks!

A crude indicator of the economy (Part 2)

As we saw in Part 1 of this blog, oil prices have fallen by some 46% in the past five months. In that blog we looked at the implications for fuel prices. Here we look at the broader implications for the global economy? Is it good or bad news – or both?

First we’ll look at the oil-importing countries. To some extent the lower oil price is a reflection of weak global demand as many countries still struggle to recover from recession. If the lower price boosts demand, this may then cause the oil price to rise again. At first sight, this might seem merely to return the world economy to the position before the oil price started falling: a leftward shift in the demand for oil curve, followed by a rightward shift back to where it was. However, the boost to demand in the short term may act as a ‘pump primer’. The higher aggregate demand may result in a multiplier effect and cause a sustained increase in output, especially if it stimulates a rise in investment through rising confidence and the accelerator, and thereby increases capacity and hence potential GDP.

But the fall in the oil price is only partly the result of weak demand. It is mainly the result of increased supply as new sources of oil come on stream, and especially shale oil from the USA. Given that OPEC has stated that it will not cut its production, even if the crude price falls to $40 per barrel, the effect has been a shift in the oil supply curve to the right that will remain for some time.

So even if the leftward shift in demand is soon reversed so that there is then some rise in oil prices again, it is unlikely that prices will rise back to where they were. Perhaps, as the diagram illustrates, the price will rise to around $70 per barrel. It could be higher if world demand grows very rapidly, or if some sources of supply go off stream because at such prices they are unprofitable.

The effect on oil exporting countries has been negative. The most extreme case is Russia, where for each $10 fall in the price of oil, its growth rate falls by around 1.4 percentage points (see). Although the overall effect on global growth is still likely to be positive, the lower oil price could lead to a significant cut in investment in new oil wells. North sea producers are predicting a substantial cut in investment. Even shale oil producers in the USA, where the marginal cost of extracting oil from existing sources is only around $10 to £20 per barrel, need a price of around $70 or more to make investment in new sources profitable. What is more, typical shale wells have a life of only two or three years and so lack of investment would relatively quickly lead to shale oil production drying up.

The implication of this is that although there has been a rightward shift in the short-run supply curve, if price remains low the curve could shift back again, meaning that the long-run supply curve is much more elastic. This could push prices back up towards $100 if global demand continues to expand.

This can be illustrated in the diagram. The starting point is mid-2014. Global demand and supply are D1 and S1; price is $112 per barrel and output is Q1. Demand now shifts to the left and supply to the right to D2 and S2 respectively. Price falls to $60 per barrel and, given the bigger shift in supply than demand, output rises to Q2. At $60 per barrel, however, output of Q2 cannot be sustained. Thus at $60, long-run supply (shown by SL) is only Q4.

But assuming the global economy grows over the coming months, demand shifts to the right: say, to D3. Assume that it pushes price up to $100 per barrel. This gives a short-run output of Q3, but at that price it is likely that supply will be sustainable in the long run as it makes investment sufficiently profitable. Thus curve D3 intersects with both S2 and SL at this price and quantity.

The articles below look at the gainers and losers and at the longer-term effects.

Articles
Where will the oil price settle? BBC News, Robert Peston (22/12/14)
Falling oil prices: Who are the winners and losers? BBC News, Tim Bowler (16/12/14)
Why the oil price is falling The Economist (8/12/14)
The new economics of oil: Sheikhs v shale The Economist (6/12/14)
Shale oil: In a bind The Economist (6/12/14)
Falling Oil Price slows US Fracking Oil-price.net, Steve Austin (8/12/14)
Oil Price Drop Highlights Need for Diversity in Gulf Economies IMF Survey (23/12/14)
Lower oil prices boosting global economy: IMF Argus Media (23/12/14)
Collapse in oil prices: producers howl, consumers cheer, economists fret The Guardian (16/12/14)
North Sea oilfields ‘near collapse’ after price nosedive The Telegraph, Andrew Critchlow (18/12/14)
How oil price fall will affect crude exporters – and the rest of us The Observer, Phillip Inman (21/12/14)
Cheaper oil could damage renewable energies, says Richard Branson The Guardian,
Richard Branson: ‘Governments are going to have to think hard how to adapt to low oil prices.’ John Vidal (16/12/14)

Data
Brent crude prices U.S. Energy Information Administration (select daily, weekly, monthly or annual data and then download to Excel)
Brent Oil Historical Data Investing.com (select daily, weekly, or monthly data and time period)

Questions

  1. What would determine the size of the global multiplier effect from the cut in oil prices?
  2. Where is the oil price likely to settle in (a) six months’ time; (b) two years’ time? What factors are you taking into account in deciding your answer?
  3. Why, if the average cost of producing oil from a given well is $70, might it still be worth pumping oil and selling it at a price of $30?
  4. How does speculation affect oil prices?
  5. Why has OPEC decided not to cut oil production even though this is likely to drive the price lower?
  6. With Brent crude at around $60 per barrel, what should North Sea oil producers do?
  7. If falling oil prices lead some oil-importing countries into deflation, what will be the likely macroeconomic impacts?
Share in top social networks!

Commodity prices fall to four-year low

Commodity prices have been falling for the past three years and have reached a four-year low. Since early 2011, the IMF overall commodity price index (based on 2005 prices) has fallen by 16.5%: from 210.1 in April 2011 to 175.4 in August 2014. The last time it was this low was December 2010.

Some commodity prices have fallen by greater percentages, and in other cases the fall has been only slight. But in the past few months the falls have been more pronounced across most commodities. The chart below illustrates these falls in the case of three commodity groups: (a) food and beverages, (b) agricultural raw materials and (c) metals, ores and minerals. (Click here for a PowerPoint of the chart.)

Commodity prices are determined by demand and supply, and factors on both the demand and supply sides have contributed to the falls.

With growth slowing in China and with zero growth in the eurozone, demand for commodities has shown little growth and in some cases has fallen as stockpiles have been reduced.

On the supply side, investment in mining has boosted the supply of minerals and good harvests in various parts of the world have boosted the supply of many agricultural commodities.

But in historical terms, prices are still relatively high. There was a huge surge in commodity prices in the period up to the financial crisis of 2008 and then another surge as the world economy began to recover from 2009–11. Nevertheless, taking a longer-term perspective still, commodity prices have risen in real terms since the 1960s, but with considerable fluctuations around this trend, reflecting demand and supply at the time.

Articles
Commodities Fall to 5-Year Low With Plenty of Supplies Bloomberg Businessweek, Chanyaporn Chanjaroen (11/9/14)
Commodity ETFs at Multi-Year Lows on Supply Glut ETF Trends, Tom Lydon (11/9/14)
What dropping commodity prices mean CNBC, Art Cashin (11/9/14)
Goldman sees demand hitting commodity price DMM FX (12/9/14)
Commodity price slump is a matter of perspective Sydney Morning Herald, Stephen Cauchi (11/9/14)
Commodities index tumbles to five-year low Financial Times, Neil Hume (12/9/14)
Commodities: More super, less cycle HSBC Global Research, Paul Bloxham (8/1/13)
Commodity prices in the (very) long run The Economist (12/3/13)

Data
IMF Primary Commodity Prices IMF
UNCTADstat UNCTAD (Select: Commodities > Commodity price long-term trends)
Commodity prices Index Mundi

Questions

  1. Identify specific demand-and supply-side factors that have affected prices of (a) grains; (b) meat; (c) metal prices; (d) oil.
  2. Why is the demand for commodities likely to be relatively inelastic with respect to price, at least in the short term? What are the implications of this for price responses to changes in supply?
  3. Why may there currently be a ‘buying opportunity’ for potential commodity purchasers?
  4. What is meant by the ‘futures market’ and future prices? Why may the 6-month future price quoted today not necessarily be the same as the spot price (i.e. the actual price for immediate trading) in 6 months’ time?
  5. How does speculation affect commodity prices?
  6. How does a strong US dollar affect commodity prices (which are expressed in dollars)?
  7. How may changes in stockpiles give an indication of likely changes in commodity prices over the coming months?
  8. Distinguish between real and nominal commodity prices. Which have risen more and why?
  9. How do real commodity prices today compare with those in previous decades?
Share in top social networks!

Cleaning up the foreign exchanges

According to latest evidence from the Bank for International Settlements, in April 2013 some £3.2 trillion ($5.3 trillion) of foreign exchange was traded daily on global foreign exchange (forex) markets. About 40% of forex dealing goes through trading rooms in London. This market is highly profitable for the UK economy. But all is not well with the way people trade. There is a scandal about rate fixing.

Exchange rates on the forex market are freely determined by demand and supply and fluctuate second by second, 24 hours a day, except for weekends. Nevertheless, once a day rates are fixed for certain trades. At 4pm GMT a set of reference rates is set for corporate customers by banks and other traders. The rates are set at the free market average over the one minute from 16:00 to 16:01. The allegation is that banks have been colluding, through text messaging and chat rooms, to manipulate the market over that one minute.

Since the early summer of 2013, the Financial Conduct Authority (FCA) in the UK, along with counterparts in the USA, Switzerland, Hong Kong and elsewhere, has been looking into these allegations. Last week (4/3/14), the Bank of England suspended a member of its staff as part of its own investigation into potential rigging of the foreign exchange market. The allegation is not that the staff member(s) were involved in the rigging but that they might have known about it.The Bank said that, “An oversight committee will lead further investigations into whether bank officials were involved in forex market manipulation or were aware of manipulation, or at least the potential for such manipulation.”

Meanwhile, the House of Commons Treasury Select Committee has been questioning Bank of England staff, including the governor, Mark Carney, about the scandal. Speaking to the Committee, Martin Wheatley, head of the FCA said that the investigation over rigging had been extended to 10 banks and that the allegations are every bit as bad as they have been with Libor.

Forex rigging ‘as serious as’ Libor scandal: Carney Yahoo News, Roland Jackson (11/2/14)
Forex manipulation: How it worked HITC (Here Is The City), Catherine Boyle (11/3/14)
Bank of England Chief Grilled Over Forex Scandal ABC News, Danica Kirka (11/3/14)
Carney Faces Grilling as Currency Scandal Snares BOE Bloomberg, Scott Hamilton and Suzi Ring (10/3/14)
UK financial body urges quick action over foreign exchange ‘fixing’ Reuters, Huw Jones (11/3/14)
Timeline -The FX “fixing” scandal Reuters, Jamie McGeever (11/3/14)
Forex in the spotlight Financial Times (16/2/14)
Forex scandal: What is that all about? BBC News (11/3/14)
Bank of England in shake-up after rate manipulation criticism BBC News (11/3/14)
Mark Carney faces Forex questions from MPs BBC News, Hugh Pym (11/3/14)
Bank of England’s Paul Fisher: ‘It’s not our job to go hunting for market wrongdoing’ Independent, Russell Lynch , Ben Chu (11/3/14)

Questions

  1. For what reasons would sterling appreciate against the dollar?
  2. Most of forex trading is for speculative purposes, rather than for financing trade or investment. Why is this and does it benefit international trade?
  3. If foreign exchange rates fluctuate, is it not a good thing that banks collude to agree the 4pm fixed rate? Explain.
  4. What was the Libor scandal? Why are some people arguing that the current forex scandal is worse?
  5. What can the FCA do to prevent collusion over exchange rates?
Share in top social networks!

Dramatic rise in Turkish interest rates

World markets were taken by surprise by a large rise in Turkish interest rates on 28/1/14. In an attempt to combat a falling lira and rising inflation, the Turkish central bank raised its overnight lending rate from 7.75% to 12%. Following the decision, the lira appreciated by over 3%.

Since the start of this year, the Turkish lira had depreciated by 7.1% and since the start of 2013 by 22.8%. Along with the currencies of several other emerging economies, such as India and Brazil, speculators had been selling the Turkish currency. This has been triggered by worries that the Fed’s tapering off its quantitative easing programme would lead to a fall, and perhaps reversal, of the inflow of finance into these countries; in the worst-case scenario it could lead to substantial capital flight.

Consumer price inflation in Turkey is currently 7.4%, up from 6.2% a year ago. The central bank, in a statement issued alongside the interest rate rise, said that it would continue with a tight monetary policy until the inflation outlook showed a clear improvement.

The Turkish Prime Minister, Tayyip Erdogan, has been opposed to rises in interest rates, fearing that the dampening effect on aggregate demand would reduce economic growth, which, as the chart shows, has been recovering recently (click here for a PowerPoint of the chart). A slowing of growth could damage his prospects in forthcoming elections.

World stock markets, however, rallied on the news, seeing the rise in interest rates as a symbolic step in emerging countries stemming outflows of capital.

Articles
Turkey raises interest from 7.75pc to 12pc The Telegraph (28/1/14)
Emerging markets forced to tighten by US and Chinese monetary superpowers The Telegraph, Ambrose Evans-Pritchard (28/1/14)
Turkey Gets Aggressive on Rates The Wall Street Journal, Joe Parkinson (28/1/14)
Turkish central bank raises lending rate to 12% BBC News (28/1/14)
Asian stock markets stage relief rally after Turkey rate rise BBC news (29/1/14)
Turkey raises rates to halt lira’s slide Financial Times, Daniel Dombey (29/1/14)
Turkey Rate Increase Stems Lira Drop as Basci Defies Erdogan Bloomberg Businessweek, Onur Ant and Taylan Bilgic (29/1/14)
Fragile economies under pressure as recovery prompts capital flight The Observer, Angela Monaghan (2/2/14)

Data
Main Economic Indicators (including Turkish data) OECD
Data on Turkey, World Economic Outlook database IMF
Turkey price indices Central Bank of the Republic of Turkey

Questions

  1. Why did the Turkish central bank decide to raise interest rates by such a large amount?
  2. Why has the Turkish lira been depreciating so much over the past few months? How has this been linked to changes in Turkey’s balance of payments and what parts of the balance of payments account have been affected?
  3. Why did global stock markets rally on the news from Turkey?
  4. What will be the impact of the central bank’s actions on (a) inflation; (b) economic growth?
  5. How has the USA’s quantitative easing programme affected developing countries?
Share in top social networks!