Category: Essentials of Economics: Ch 15

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Precious metals getting even more precious

In the past few weeks, the prices of gold and silver have been soaring and have hit all-time (nominal) highs. Over the past 12 months, gold has risen by 31%, while silver has risen by 149% and 64% since the start of February. Part of this reflects the general rise in commodity prices (see also). Oil is trading at around $125 per barrel, up 43% on a year ago; wheat is up 66%, maize by 114%, coffee (Arabica) by 118% and cotton by 122%.

Part of the reason for the rise in the price of precious metals, however, has been the weakness of the dollar. In such times, gold and silver are often seen as a ‘safe haven’ for investors.

So why have commodity prices been rising and why has the dollar been falling? What is likely to happen to the prices of gold and silver in the coming weeks and months? Is their meteoric rise set to continue? Will the ratio of the gold price to the silver price continue to fall? The following articles investigate.

Articles
Gold and silver prices jump to new record highs BBC News (25/4/11)
Gold rises 7% in April as US dollar continues to weaken BBC News (29/4/11)
Gold and silver set new highs after S&P move Financial Times, Jack Farchy (22/4/11)
Real Interest Rates Explain the Gold Price Perfectly…Too Perfectly? The Market Oracle, Andrew Butter (25/4/11)
Silver, platinum to outshine gold Toronto Sun, Sharon Singleton (25/4/11)
Gold Bugs Beware Of Fed Extermination Forbes blogs: Great Speculations, Mark Sunshine (25/4/11)
Shock and Au: Hedging Against Fear EconomyWatch, Alice Briggs (26/4/11)
Keeping an Eye on the Gold/Silver Ratio Seeking Alpha, Evariste Lefeuvre (25/4/11)

Data
Commodity Prices Index Mundi
Commodities Financial Times
Commodities BBC Market Data

Questions

  1. Why have the prices of gold and silver risen so much recently?
  2. Why has silver risen more than gold?
  3. Why may higher rates of world inflation make investors turn to precious metals for investment?
  4. How are future decisions by the Fed likely to affect the price of gold?
  5. According to the efficient capital markets theory (strong version), the current price of a commodity should already reflect all knowable factors that are likely to affect the price? Does this mean that speculative buying (or selling) is pointless?
  6. How is the price elasticity of supply of silver and gold relevant in explaining the magnitude of their price movements?
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The world economy

Periodically, the BBC hosts debates on major global topics. The following links are to the January 2011 debate on the state of the world economy and on what policies governments and central banks should pursue.

Should governments be boosting aggregate demand by raising government expenditure and cutting taxes in order to stimulate growth and plan to bring down deficits over the long term once growth is established? Or should they embark on tough fiscal consolidation now by cutting government expenditure and/or raising taxes in order to stimulate confidence by international financiers, thereby keeping long-term interest rates down and creating the foundations for sustainable economic growth? The debate considers these two very different policy approaches.

The participants in the debate are Joseph Stiglitz (Professor of Economics, Columbia University), Christina Romer (Professor of Economics, University of California, Berkeley and Adviser to Barack Obama (2009–10)), George Papaconstantinou (Finance Minister of Greece), Dominique Strauss-Khan (Managing Director, IMF) and Zhou Xiaochuan (Governor, Chinese Central Bank). The debate is in five separate webcasts.

Webcasts

World debate on the global economy BBC World Service (20/1/11)
Part 1
Part 2
Part 3
Part 4
Part 5

Questions

  1. What are the arguments for maintaining economic stimulus, at least for the time being? What are the relative merits of fiscal and monetary stimulus? Explain whether such policies are consistent with Keynesian polcies.
  2. What are the arguments for tough fiscal consolidation? Explain whether such policies are consistent with new classical policies.
  3. How successful have US policies been in stimulating the US economy?
  4. What role can China play in the recovery and long-term growth of the global economy and are there any imbalances that need correcting?
  5. Why might countries’ domestic policies result in currency wars? Is currency realignment necessary for sustained global growth?
  6. How important are consumer and business confidence to short-term recovery and long-term growth and to what extent do government policies respond to swings in confidence?
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A financial health check

Every six months the Bank of England publishes its Financial Stability Report. “It aims to identify the major downside risks to the UK financial system and thereby help financial firms, authorities and the wider public in managing and preparing for these risks.”

In the latest report, published on 17 December 2010, the Bank expresses concern about the UK’s exposure to problems overseas. The two most important problems are the continuing weaknesses of a number of banks and the difficulties of certain EU countries in repaying government bonds as they fall due and borrowing more capital at acceptable interest rates. As the report says:

Sovereign and banking system concerns have re-emerged in parts of Europe. The IMF and European authorities proposed a substantial package of support for Ireland. But market concerns spilled over to several other European countries. At the time of writing, contagion to the largest European banking systems has been limited. In this environment, it is important that resilience among UK banks has improved over the past year, including progress on refinancing debt and on raising capital buffers. But the United Kingdom is only partially insulated given the interconnectedness of European financial systems and the importance of their stability to global capital markets.

The Bank identifies a number of specific risks to the UK and global financial systems and examines various policy options for tackling them. The following articles consider the report.

Articles
Bank warns of eurozone risks to UK as EU leaders meet Independent, Sean O’Grady (17/12/10)
Deep potholes on the road to recovery Guardian, Nils Pratley (17/12/10)
It’s reassuring that regulators are still worried about financial stability The Telegraph, Tracy Corrigan (17/12/10)
Europe is still searching for stability and the UK must find it too Independent, Hamish McRae (17/12/10)
Shafts of light between the storm clouds The Economist blogs: ‘Blighty’ (17/12/10)

Report
Financial Stability Report, December 2010: Overview Bank of England
Financial Stability Report, December 2010: Links to rest of report Bank of England

Questions

  1. What are the most important financial risks facing (a) the UK; (b) eurozone countries?
  2. What is the significance of the rise in banks’ tier-1 capital ratios since 2007?
  3. Which is likely to be more serious over the coming months: banking weaknesses or sovereign debt? Explain.
  4. What is being done to reduce the risks of sovereign default?
  5. Why might the weaker EU countries struggle to achieve economic growth over the next two or three years?
  6. How do interest rates on government debt, as expressed by bond yields, compare with historical levels? What conclusions can you draw from this?
  7. What is likely to happen to bond yields in the USA, the UK and Germany over the coming months?
  8. What has been the effect of the extra £200 billion that the Bank of England injected into the banking system through its policy of quantitative easing?
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Paris Club relief

The Paris Club is the name given to the grouping of 19 rich countries which meets in Paris monthly to consider the cancellation or rescheduling of official loans to poor countries (see Sloman Economics 7th edition, pages 784–5). For many of the 40 heavily indebted poor countries (HIPCs), this debt relief has been substantial, with 36 of the HIPCs receiving full or partial cancellation of their debts (see Sloman Economics7th edition, pages 788–90).

On 17 November it was the turn of the Democratic Republic of the Congo. The Paris Club cancelled 97.6% of the debt owed to its members by the DRC – $7.35 billion. As the Paris Club press statement says:

The representatives of the Paris Club creditor countries and Brazil met with the representatives of the Government of the Democratic Republic of the Congo (DRC) on 17 November 2010 and agreed on a reduction of the debt following the DRC having reached its Completion Point under the enhanced initiative for the Heavily Indebted Poor Countries (enhanced HIPC Initiative) on 1 July 2010.

As a contribution to restoring the DRC’s debt sustainability, the Paris Club creditors will provide a cancellation of USD 7350 million, fulfilling all their commitments under the enhanced HIPC initiative.

However, the Paris Club did have some reservations. These are explored in the articles below.

Articles
Paris Club cancels more than half of DR Congo’s debt International Business Times, Palash R. Ghosh (19/11/10)
Creditors agree Congo debt write-off, flag worries Reuters, Brian Love and Katrina Manson (18/11/10)
Paris Club and Brazil Cancel $7.35 Billion of Congo’s Debt Bloomberg Businessweek, Michael J. Kavanagh (18/11/10)
DR Congo gets US$ 7bn debt cancellation afrol News (18/11/10)

Paris Club Press Release
DRC Paris Club (17/11/10)

Questions

  1. Explain the process whereby HIPCs receive debt relief.
  2. What were the reservations expressed by the Paris Club in granting debt relief to the DRC?
  3. To what extent is there a moral hazard in granting debt relief? Explain.
  4. What can Paris Club members do to reduce the moral hazard?
  5. Find out what other debt relief has been given by the Paris Club to HIPCs over the past few months and whether concerns were expressed in those cases.