Commodities
Global unease, from commerce to currencies, rattles raw materials
Are the worst fears now priced in?
THEY make an intriguing posse: about 160 “scouts” in jeans and muddy boots, jumping out of cars with ropes in hand, plunging deep into corn (maize) and soyabean fields across the American Midwest. They are not just farmers. They include commodity traders and hedge-fund managers. Their quest: to predict this year’s harvest by using ropes as a measure and counting, to the last ear of corn and soyabean pod, the yield in a given area. “We have a really beautiful crop. I think this is going to be a record,” says Ted Seifried, a market strategist at Zaner Group, a commodities brokerage in Chicago, during a stop in Nebraska on August 21st. The mud on his boots is a reassuring sign of ample moisture in the soil.
But when he gets back into the car with others on the Pro Farmer Midwest Crop Tour, the talk turns to darker subjects, such as trade tensions, collapsing currencies and what he calls the start of an “economic cold war” between America and China. “While we’re driving the 15-25 miles from field to field, we certainly have a lot to talk about. By and large the American producer thinks the fight with China is just. But it’s very much affecting the pocketbook.”
From the midwestern farm belt to the commodity markets of Chicago, New York, London and Shanghai, this is a tricky time to be producing and trading commodities. Americans may relish their stockmarkets soaring. But a rising dollar, higher American interest rates, sliding emerging-market currencies and fears of a tariff-induced blow to exports to China have taken a toll on commodity prices in recent months (see chart 1).
In the background lurks climate change, fears of which have grown with the heat and drought battering Europe’s wheat crop this summer. European grain prices have surged as a result. But those of many other commodities are sagging. On August 22nd a pound of arabica coffee fell below $1, less than the cost of a takeaway brew and the lowest in 12 years. Raw sugar was also at ten-year lows. Both have been hit by oversupply in Brazil, as well as a slide in the value of the real, the Brazilian currency, which makes it more compelling to sell crops, priced in dollars, rather than store them.
The previous week, prices of copper fell into bear-market territory, down by more than 20% since June, on fears that protectionism would dampen global growth, especially in China, whose efforts to crack down on financial leverage are another drag on expansion. Oil prices have dipped for seven straight weeks, also because of concerns about lacklustre demand in emerging markets and because a strong dollar makes it dearer for those with weak currencies to buy crude. Gold has developed a strange habit of sliding in sync with the Chinese yuan.
American corn and soyabean prices, meanwhile, continue a long streak of weakness caused mainly by harvests that get more bountiful by the year. The Department of Agriculture is forecasting a record corn yield this year and the biggest harvest of soyabeans ever, something the crop tour is likely to validate, Mr Seifried says. But that is lousy timing, given that China, which was America’s biggest buyer of soyabeans, raised retaliatory tariffs on the crop in July. Farmers hope to sell more in Europe, where soyameal for animal feed is in high demand because of the high cost of wheat. But the slide in the real also makes Brazilian soyabeans more competitive.
Optimism flickers from time to time. Many commodities rallied in the run-up to the latest trade talks between American and Chinese officials, which were due to end after The Economist went to press. The dollar fell, bolstering some commodities, after President Donald Trump said in an interview with Reuters on August 20th that he was “not thrilled” with the Federal Reserve’s policy of raising American interest rates. Progress in talks on the North American Free-Trade Agreement would also be good news (see article).
But BHP, the world’s biggest miner, issued a blunt assessment of the longer-term dangers to its products during its otherwise promising year-end results on August 21st. It said protectionism was “exceedingly unhelpful” for broad-based global growth, adding that Sino-American trade tensions could weaken both countries’ GDP growth by a quarter to three-quarters of a percentage point, absent counter-measures. Both America and China imposed another tranche of tariffs, on a further $16bn-worth of each other’s goods, on August 23rd.
Analysts point to two main ways in which these tensions hurt commodity prices. The first is because of the rising importance of emerging markets to demand. In a report in June, the World Bank calculated that almost all the growth in the past 20 years in global metal consumption, two-thirds of the increase in energy demand and two-fifths of the rise in food consumption came from seven countries: Brazil, China, India, Indonesia, Mexico, Russia and Turkey. This group now exceeds the Group of Seven industrial nations in consumption of coal and all base and precious metals, as well as of rice, wheat and soyabeans. Commodity prices are therefore far more sensitive to these countries’ fortunes than they used to be. Hence their walloping last week when the plunging Turkish lira gave a shock to other fragile currencies.
The second is speculation. Ole Hansen, head of commodities strategy at Saxo Bank, says that fears of a trade war have clobbered prices of the most globally traded commodities, notably copper, as short positions by speculators have surged (see chart 2). China accounts for half the world’s demand for copper, the same share as its consumption of steel. Yet steel prices have fared much better because the most liquid steel contract is in China, which is much more affected by domestic supply and demand factors than big global bets. A steel-futures contract in Shanghai touched a seven-year high on August 22nd.
As ever, demand from China remains the biggest swing factor for commodities. BHP reckons China will use fiscal and monetary expansion to help offset the impact to its exports from the trade conflict, which could benefit commodities. But even if the worst is now priced in, plenty of volatility lies ahead. As Mr Seifried quips from the cornfields of Nebraska, “predicting the future is a son of a bitch”.
You walk into a casino and try to figure out whether or not it is rigged. You notice that 1% of the people are winning 20% of all the money. Does this mean that the casino is rigged? It might seem a little suspicious but, then again, talent is not distributed equally, and some people are always luckier than others, so it is not necessarily surprising that a small fraction of the people get most of the winnings.
While looking at the casino’s record books you find that 40 years ago the top 1% were only winning 10% of all the money. This seems more suspicious. Are they that much more talented now or does luck matter that much more? You might also notice that in other casinos in Europe and elsewhere the top 1% is taking more like 9-14% of all the money.
In an attempt to strain the metaphor of the American economy well beyond where it should go, you come back to the casino a generation later and find that the children of the bottom 20% of winners in the previous generation have only a 7% chance of being in the top 20% today, again suspiciously less than in many other countries.
If this casino had a roulette wheel and the house was winning more than about 10% of the money you would infer it was rigged even if you could not observe exactly how it was rigged or who was doing the rigging. Similarly, the outcomes in the American economy are prima facie evidence that it is tilted towards societal elites.
We can, however, observe many of the ways the economy systematically favours the wealthy and powerful. For most people inequality begins at birth. In America one-fifth of four- and five-year-old children do not go to school, putting us 29th in the OECD in this regard—below much poorer countries like Mexico. When the child does eventually enter school, the amount spent per pupil varies from over $28,000 per pupil in rich areas to less than $8,000 per pupil in poorer ones because America has chosen to primarily fund schools at the local level and thus further perpetuate local inequality. A game where the participants have purposefully been given radically different amounts of preparation could be fairly described as rigged.
Then there is the fact that, as Adam Smith observed nearly 250 years ago, “People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.” The fewer businesses engaged in the same trade, the easier it is to collude, either tacitly or explicitly and illegally.
And in most trades there are many fewer businesses today: hospitals, beer, railroads, trucking, retail, technology, airlines, and most other categories of the economy. In certain industries this may have been a natural outgrowth of economies of scale, but it is hard to not also see that increased government-sponsored monopolies, through stronger intellectual-property protections, and reduced antitrust enforcement have also played an important role.
The result can be higher prices or worse service for consumers. Witness the cases of air travel and broadband internet. Or it can be lower wages for workers. Witness the illegal collusion that has taken place to lower the wages of nurses and software workers or much more extensive but legal practices, such as non-compete agreements, which help to keep those wages down.
The less cited second half of Smith’s quote is no less important: “[the law] ought to do nothing to facilitate such assemblies; much less to render them necessary. A regulation which obliges all those of the same trade in a particular town to enter their names and places of abode in a public register, facilitates such assemblies…” The regulations that facilitate collusion and the perpetuation of economic rents do not just come from nowhere. They come from the beneficiaries of those gains.
These regulations manifest themselves as overly strong intellectual-property protections, occupational licensing that requires a florist to undertake extensive certification work, or land-use restrictions that keep housing prices high and make it more difficult for more people to move to areas with better jobs, schools and amenities.
Capitalism does not exist in a vacuum. It requires laws that establish property rights, adjudicate disputes, fund public infrastructure and finance all of these inputs. If you look at how elites currently shape the operational rules of capitalism, the outcome of these rules in terms of inequality and low levels of intergenerational mobility, or observe the many specific policies that establish and perpetuate inequality. It is clear that capitalism today could fairly be described as rigged in favour of elites.
While looking at the casino’s record books you find that 40 years ago the top 1% were only winning 10% of all the money. This seems more suspicious. Are they that much more talented now or does luck matter that much more? You might also notice that in other casinos in Europe and elsewhere the top 1% is taking more like 9-14% of all the money.
In an attempt to strain the metaphor of the American economy well beyond where it should go, you come back to the casino a generation later and find that the children of the bottom 20% of winners in the previous generation have only a 7% chance of being in the top 20% today, again suspiciously less than in many other countries.
If this casino had a roulette wheel and the house was winning more than about 10% of the money you would infer it was rigged even if you could not observe exactly how it was rigged or who was doing the rigging. Similarly, the outcomes in the American economy are prima facie evidence that it is tilted towards societal elites.
We can, however, observe many of the ways the economy systematically favours the wealthy and powerful. For most people inequality begins at birth. In America one-fifth of four- and five-year-old children do not go to school, putting us 29th in the OECD in this regard—below much poorer countries like Mexico. When the child does eventually enter school, the amount spent per pupil varies from over $28,000 per pupil in rich areas to less than $8,000 per pupil in poorer ones because America has chosen to primarily fund schools at the local level and thus further perpetuate local inequality. A game where the participants have purposefully been given radically different amounts of preparation could be fairly described as rigged.
Then there is the fact that, as Adam Smith observed nearly 250 years ago, “People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.” The fewer businesses engaged in the same trade, the easier it is to collude, either tacitly or explicitly and illegally.
And in most trades there are many fewer businesses today: hospitals, beer, railroads, trucking, retail, technology, airlines, and most other categories of the economy. In certain industries this may have been a natural outgrowth of economies of scale, but it is hard to not also see that increased government-sponsored monopolies, through stronger intellectual-property protections, and reduced antitrust enforcement have also played an important role.
The result can be higher prices or worse service for consumers. Witness the cases of air travel and broadband internet. Or it can be lower wages for workers. Witness the illegal collusion that has taken place to lower the wages of nurses and software workers or much more extensive but legal practices, such as non-compete agreements, which help to keep those wages down.
The less cited second half of Smith’s quote is no less important: “[the law] ought to do nothing to facilitate such assemblies; much less to render them necessary. A regulation which obliges all those of the same trade in a particular town to enter their names and places of abode in a public register, facilitates such assemblies…” The regulations that facilitate collusion and the perpetuation of economic rents do not just come from nowhere. They come from the beneficiaries of those gains.
These regulations manifest themselves as overly strong intellectual-property protections, occupational licensing that requires a florist to undertake extensive certification work, or land-use restrictions that keep housing prices high and make it more difficult for more people to move to areas with better jobs, schools and amenities.
Capitalism does not exist in a vacuum. It requires laws that establish property rights, adjudicate disputes, fund public infrastructure and finance all of these inputs. If you look at how elites currently shape the operational rules of capitalism, the outcome of these rules in terms of inequality and low levels of intergenerational mobility, or observe the many specific policies that establish and perpetuate inequality. It is clear that capitalism today could fairly be described as rigged in favour of elites.
