Are we heading for ‘perfect storm’ in commodity production and prices? Certainly the prices of many commodities have soared in recent months. These include the prices of foodstuffs such as dairy products, cooking oils and cereals, crude oil, cotton, metals and many other raw materials. The overall world commodity price index has risen by 28% in the past 12 months. The following are some examples of specific commodities:
Price rises in the 12 months to February 2011
• Wheat 62%
• Maize 59%
• Coffee 70%
• Beef 39%
• Sugar 46%
• Palm kernal oil 142%
• Soybean oil 50%
• All food price index 32%
• Crude oil 20%
• Cotton 132%
• Fine wool 55%
• Softwood timber 25%
• Iron ore 78%
• Copper 29%
• Tin 55%
• All metals index 58%
• Rubber 79%.
The problems are both short term and long term, and on both the demand and supply sides; and the effects will be at micro, macro and global levels. Some hard choices lie ahead.
The following webcast, articles and reports explore both the current position and look into the future to ask whether rising commodity prices are likely to continue or even accelerate.
The first link is to a BBC World Debate which considers the following issues: “Is scarcity of natural resources a serious challenge for developing and advanced economies? How great is the risk that scarcity might lead to conflict, both within and between nations? Might a scramble for resources lead to a retreat from globalisation and to greater protectionism?”
Webcast
World Debate: Resources BBC World Debate, Louise Arbour, President and CEO, International Crisis Group; James Cameron, Global Agenda Council on Climate Change; He Yafei, Ambassador and Permanent Representative of China to the UN; Malini Mehra, Founder and CEO, Centre for Social Markets; Kevin Rudd, Minister of Foreign Affairs, Australia (19/1/11)
Articles
Global Food Prices Continue to Rise Reuters, Steve Savage (7/3/11)
The 2011 oil shock The Economist (3/3/11)
Global Food Prices Will Probably Be Sustained at Record This Year, UN Says Bloomberg, Supunnabul Suwannaki (9/3/11)
Food prices to stay high as oil costs, weather weigh livemint.com, Apornrath Phoonphongphiphat (9/3/11)
‘Perfect storm’ threatens agriculture in developing nations Manila Bulletin, Lilybeth G. Ison (9/3/11)
IMF sees no immediate respite from high food prices Commodity Online (7/3/11)
Drought, supply, speculation drive world food prices to record high NZ Catholic (8/3/11)
The Factors Affecting Global Food Prices Seeking Alpha, David Hunkar (7/3/11)
World food prices climb to record as UN sounds alarm on further shortages FnBnews (India), Rudy Ruitenberg (9/3/11)
Food crisis: It’s a moral issue for all of us New Straits Times (Malaysia), Rueben Dudley (8/3/11)
Oil prices: Green light from the black stuff Guardian (5/3/11)
Cotton hits $2 a pound Guardian, Terry Macalister (17/2/11)
Supermarkets are raising prices faster than inflation, says UBS The Telegraph, Philip Aldrick (1/3/11)
What next for commodity prices? BBC News, Jamie Robertson (5/5/11)
Reports
FAO Cereal Supply and Demand BriefFood & Agriculture Organization, United Nations (March 2011)
Rising Prices on the Menu Finance & Development (IMF), Thomas Helbling and Shaun Roache (March 2011)
Data
Commodity prices Index Mundi
Commodities Financial Times, market data
Questions
- Identify the various factors that are causing rises in commodity prices. In each case state whether they are supply-side or demand-side factors.
- How can the price elasticity of demand and supply, the income elasticity of demand and the cross-price elasticity of demand be used to analyse the magnitude of the price rises?
- To what extent are rising food prices the result of (a) short-term (i.e. reversible) factors; (b) long-term trends?
- Why are food prices in the shops rising faster in the UK than in many other countries?
- To what extent is the future of food security and prices and moral issues?
- Why may current oil price rises become an opportunity for the future?
- What might be the respective roles be of government, business and consumers in responding to natural resource constraints?
In March 2009, the Bank of England’s base rate was slashed to 0.5% in a bid to boost aggregate demand and stimulate the UK economy. And there it has remained for almost 2 years and as yet, no change is in sight. In the February 2011 meeting of the Monetary Policy Committee (who are responsible for setting interest rates to keep inflation on target), the decision was to keep interest rates at 0.5% rather than raise them to tackle high and rising UK inflation. Those in favour of keeping interest rates at this record low argue that any increase could damage the UK’s ability to recover and may lead to the dreaded double-dip recession. This is of particular concern given the economy’s performance in the last quarter of 2010.
However, one group that will certainly not be happy is the savers. With instant-access savings accounts paying on average just 0.84% before tax and with inflation at 3.7%, savers aren’t just not gaining much interest, but are actually seeing the value of their money in real terms fall. Howard Archer of HIS Global Insight said:
“For now, we retain our view that the Bank of England will hold off from raising interest rates until the latter months of the year. Even if interest rates do rise in the near term, the likelihood is still that they will rise only gradually and remain very low compared to past norms.
Monetary policy will need to stay loose for an extended period to offset the impact of the major, sustained fiscal squeeze. Consequently, we retain the view that interest rates will only rise to 2pc by the end of 2012.”
Following some speculation that the Bank of England may succumb to the pressure of inflation and hike up interest rates (markets had priced in a 20% chance of a rate rise), sterling did take a hit, but after the decision to keep rates at 0.5%, sterling recovered against the dollar. There is a belief amongst some traders that rates will rise in May, but others believe rates may remain at 0.5% until much later in 2011, as the country aims to avoid plunging back into recession. Of 49 economists that responsed to a poll by Reuters, three quarters of them said that rates would rise by the end of 2011, with median forecasts predicting a rise around November. This is certainly a space to watch, as it has implications for everyone in the UK and for many in countries around the world.
BOE leaves bank rate unchanged at 0.5% at Feb meeting Automated Trader (10/2/11)
Economists predict interest rates will rise in November Telegraph, Szu Ping Chan (11/2/11)
UK May rate hike view holds firm after BOE Reuters, Kirsten Donovan (10/2/11)
Interest rates: What the economists say Guardian (10/2/11)
Fixed rate mortgages becoming more expensive BBC News (10/2/11)
Bank rate: savers’ celebrations on hold Telegraph, Richard Evans (10/2/11)
Inflation fears turn up heat ahead of bank rate decision City AM, Julian Harris (10/2/11)
Sterling takes BOE in its stride, higher rate talk aids Reuters, Anirban Nag (10/2/11)
Bank of England holds interest rates of 0.5% Telegraph, Emma Rowley (10/2/11)
Questions
- Why are interest rates such an important tool of monetary policy? Think about which variables of aggregate demand will be affected by the Bank of England’s decision.
- What is the relationship between interest rates and inflation?
- What explanation is there for the fall in the value of sterling following speculation that interest rates may rise? Why did sterling recover after the Bank of England’s decision?
- How has the recent speculation affected fixed rate mortgages?
- What does the Telegraph article about “savers’ celebrations on hold” mean about the ‘real value’ of money and savings?
- What are (a) the arguments for keeping interest rates at 0.5% and (b) the arguments for raising interest rates? Who wins and loses in each case?
- Are there any other government policies that could be used to combat inflation, without creating the possibility of a double-dip recession? Why haven’t they been used?
Here’s an interesting example of oligopoly – one you probably haven’t considered before. It’s the art market. And it’s not just one market, but a whole pyramid of markets. At the bottom are the ‘yearning masses’ of penny-poor artists, from students to those struggling to make a living from their art, with studios in their attic, garden shed or kitchen table. At the top of the pyramid are those very few artists that can earn fantastic sums of money by selling to collectors or top galleries. Then there are all the layers of markets in between, where artists can earn everything from a modest to a reasonable income.
The pyramid is itself depicted as a work of art, which you can see in the linked article below. It’s worth studying this piece of art carefully as well as reading the article.
A guide to the market oligopoly system Reuters, Felix Salmon (28/12/10)
Questions
- Identify the increasing barriers to entry as you work up the art market pyramid.
- Are there any other market imperfections in the art market that you can identify from the diagram?
- What are the key differences between the ‘primary market, tier 1’, the ‘primary market, tier 2’ and ‘the secondary market’?
- Are artists ‘rational maximisers’? If so, what is it they are trying to maximise? If not, why not?
- How would you set about determining the ‘worth’ of a piece of art? How do possible future value of a piece of art determine its present value?
The price of gold has hit a record high of over $1282 per ounce. By contrast, in 2007 it was trading at under $700 per ounce and in 2001 at under $300 per ounce. Various uncertainties in the world economy have led to large rises in the demand for gold by both central banks and investors in general.
But why has the gold price risen so dramatically and what is likely to happen to the price in the coming days and months? Some commentators are saying that the gold price has further to rise. Others are saying that it is already over priced! The following articles look at the explanations and the arguments.
Articles
Monetary easing fears lift gold to record high Financial Times, Javier Blas (17/9/10)
Five-fold rise in gold price ‘is not a bubble’, claims industry body Independent on Sunday, Mark Leftly (19/9/10)
Gold Prices Today Are Increasing to Record Levels Business and Finance News, Aidan Lamar (18/9/10)
Gold hits new peak of $1,283 Telegraph, Richard Evans (17/9/10)
Gold hits new record high Guardian, Julia Kollewe (17/9/10)
Gold prices – the highs and lows since 1971 Guardian, Julia Kollewe (17/9/10)
Gold is overpriced, so be wary of those ads to buy it Idaho Statesman, Peter Crabb (17/9/10)
Data
Gold prices World Gold Council
Commodity price data (including gold) BBC Business: Commodities
Questions
- Why has the price of gold risen? Illustrate your arguments with a demand and supply diagram.
- How are these demand and supply factors likely to change in the near future?
- What is the role of speculation in the determination of the gold price? What particular factors are speculators taking into account at the moment?
- Why have actions by the Bank of Japan (see A Japanese yen for recovery) influenced the gold price?
- Why have possible future actions by the US Federal Reserve Bank influenced the gold price?
For the past three years the Japanese yen has been appreciating against the US dollar and many other currencies. From the end of June 2007 to 14 September 2010, the yen appreciated from ¥100 = $0.81 to ¥100 = $1.20 (a 48% appreciation). Over the same period the yen exchange rate index rose from 113.3 to 172.4 (a 52% appreciation). The rising yen has been impeding Japan’s recovery as it has made its exports more expensive, while, at the same time, making imports cheaper and thus making it harder for domestic firms to compete.
Until 14 September 2010, the yen was freely floating. But on 15 September, the Japanese central bank decided to intervene by selling yen and buying dollars and other currencies.
But why had the yen risen so strongly? There are four main reasons.
The first is the persistent Japanese trade surpluses, partly stimulated by falling costs of production in Japan.
The second is the unwinding of the carry trade. Before the banking crisis of 2007/8, many banks and other financial institutions borrowed yen, given the low interest rates in Japan, and used the yen to purchase dollars and pounds, given the much higher interest rates in the USA and the UK. The effect of this ‘carry trade’, as it was known, was to drive up the exchange rates of the dollar and sterling and drive down the value of the yen. This encouraged further speculation as people sold yen in anticipation of further depreciation and purchased dollars and sterling in anticipation of further appreciation. With the banking crisis, however, short-term financial flows decreased and the current account became more important in determining exchange rates. The carry trade began to unwind and people began selling dollars and sterling and buying yen. What is more, towards the end of 2008, interest rates were reduced substantially in the USA and the UK in order to stimulate aggregate demand. The interest rate differential between Japan and the USA and UK virtually disappeared. This further encouraged the purchase of yen and the sale of dollars and sterling as carry trade investors began paying back their loans to Japan.The third reason for the appreciation of the yen is the actions of the Chinese who have used their surpluses to buy other currencies: originally mainly dollars, but increasingly yen.
The fourth reason is speculation. As the yen has risen, so increasingly people have bought yen in anticipation of further appreciation. But, of course, this speculation has brought about the very effect the speculators anticipated. Such speculation can be very powerful, given that some $4 trillion goes across the foreign exchange markets every day (see The inexorable growth of FOREX).
So will the intervention by the Bank of Japan be successful in causing the yen to depreciate? Or will the forces that drove up the yen prove impossible to resist? The following articles consider this question and also look at the factors that caused the yen to appreciate and its effects on the Japanese economy.
Articles
Japan’s $21b move to weaken yen may be futile Sydney Morning Herald (16/9/10)
Japan acts to weaken surging yen Guardian, Larry Elliott and Graeme Wearden (15/9/10)
Q+A: How is Japan judging success in yen intervention? Reuters, Hideyuki Sano and Charlotte Cooper (17/9/10)
Tokyo action puts brake on yen Financial Times, Peter Garnham (17/9/10)
It’s hard to keep a strong yen down CTV, Canada, Brian Milner (16/9/10)
Firm stance on yen stressed / Govt, BOJ strike decisive pose, but drastic action still required Daily Yomiuri, Japan, Tadashi Isozumi and Yomiuri Shimbun (16/9/10)
Bernanke Shadow of Easing Limits BOJ Success With Yen Weakness Bloomberg, Ron Harui and Joshua Zumbrun (17/9/10)
The Bank Of Japan Is Spitting In The Wind Wall Street Journal blogs: The Source, Nicholas Hastings (16/9/10)
Japan intervenes in markets to combat rising yen BBC News, Mariko Oi (15/9/10)
Q&A: What’s moving the Japanese yen? BBC News (15/9/10)
Currency intervention’s mixed record of success BBC News, Russell Hotten (16/9/10)
Yen intervention: Because I Kan The Economist (16/9/10)
Beggar, then sneakily enrich, thy neighbour The Economist (15/9/10)
The yen and gold The Economist, Buttonwood (15/9/10)
Data
Dollar/yen exchange rate X-rates.com
Statistical Interactive Database – interest and exchange rates data Bank of England
Currencies BBC News
Currency converter Yahoo Finance
Questions
- Why has the Japanese yen appreciated so much over the past three years?
- What will be the effect of the Bank of Japan’s exchange market intervention on Japanese money supply? What will determine the size of this effect?
- Why might the Bank of Japan’s actions have been influenced by the anticipation of further quantitative easing by the US Federal Reserve Bank?
- What factors determine the likely success of foreign exchange market intervention by central banks?
- What will determine how speculators will react to the Bank of Japan’s actions?
- Discuss the following quote from the second The Economist article above: “A bit of inflation in Japan wouldn’t just be a good thing. It would be a really, really great thing. And if other countries react to Japan’s intervention by attempting to print and sell their own currencies in order to toss the deflationary potato to someone else, well then so much the better.”
- If all countries seek to achieve export-led growth, is this a zero-sum game?
- Why has the price of gold been rising?