Transcript Slide 1

Consultation on Financial Crisis and Trade:
Towards an Integrated Response in the Latin
America-Caribbean Region
Dates: September 1-2, 2009,
Venue: SELA (Caracas)
Draft of Remarks Prepared by Dr. Jan Kregel,
Professor, Levy Economic Institute, Bard College
For SESSION II (1:30 – 3:20): FINANCIAL MARKETS AND SPECIALIZATION
IN INTERNATIONAL TRADE: THE CASE OF COMMODITIES
Introduction: Trade and Finance are
Inseparable in Theory and Practice
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Adam Smith, increasing returns
Dynamic comparative advantage
Getting prices wrong
Supporting investment and large size
Developed Countries’ policies
• Thus the proscriptions on the production of manufactures that
could be produced in the colonies that were proposed by Adam
Smith not only provided protection and foreign demand for English
manufacturers, this dynamic commercial policy also created the
specialization of developing countries in raw materials noted by
Prebisch and other theorists as providing the basic constraint on
their development.
• It is thus somewhat paradoxical that it was foreign financial flows
financing investments that created the monocommodity
specialization in developing countries and created the constraints
on development in the form of financing the external deficit.
• It had virtually nothing to do with static comparative advantage. It
might better be called imposed comparative advantage.
Reacting to Monocommodity
comparative advantage
• Financing development by increasing exports was thus a
"Sisyphean task". The solution could only be found in
stabilizing commodity prices –
– thus the proposals for commodity stabilisation funds, moving
into the production of goods with higher rates of technical
progress –
– thus the proposals to support industrialisation where
economies of scale were higher – and the need to borrow
external funds to finance the import of capital goods to build up
manufacturing.
– While these positions eventually came to be known as
structuralist or supporting import substitution they were far
from either position. Indeed, as Alice Amsden has recently
noted, they look much like a blueprint for the Asian
development model as practiced in countries like Korea.
The Impact of Globalisation on the Relation Between
Trade and Finance
• Since the 1950s when this discussion about market structure was
going on there have been substantial changes.
• Most importantly, international commodity markets are no long as
purely competitive as they once were, and are now dominated by a
small number of large monopsonistic oligopolists.
• This has tended to increase the final prices of commodities to
consumers, but has had little impact in increasing prices for
producers.
• Rather, the increase in real incomes that was transferred from the
developing country producer to the developed country consumer
by the competitive mechanism has now been captured by the
intermediaries, to the benefit of either party.
• This tendency has been noted in the Report of the UN Expert
Commission on Commodities in its Report presented to the General
Assembly in 2003
Other Non-competitive impacts
• Other non-competitive measures have also had a negative impact
on prices paid to producers.
• Price supports practiced by many developed countries for their own
producers who sell to protected domestic markets have increased
outputs above domestic absorption levels.
• This not only decreases global demand, but also increases supply as
the excess is sold or better dumped on world markets, causing
further price declines.
• The case of cotton is exemplary – the global price of cotton is below
the cost of production of the cheapest developing country
producers, who are driven to poverty, while their developed
country counterparts receive hefty subsidies that allow them to
increase capital investments and productivity.
• Thus, while market structure is clearly a problem, changing it does
not seem to provide a solution
Globalisation and Commodity Price
Movements
• The outbreak of the oil crisis in the early 1970s, along with the
warnings of the Club of Rome, created the last reversal of the trend
decline in commodity prices. It created the basis for the aspirations
for a New Economic Order in which developing countries would
play a more important role in global trade, finance and most
importantly is global politics. However this dream was short-lived
and evaporated with the eventual collapse of petroleum prices in
the 1980s. This ushered in another sustained trend decline in
commodity prices.
• The New Millennium has seen a similar reversal of the downward
trend in commodity prices, although they never reached the levels
of the 1970s in real terms. While most of the attention was again
on petroleum prices, it was widespread across energy substitutes,
metals and foods.
Commodity Index Funds and Commodity Prices
• There has been a good deal of discussion concerning the
impact of investments in commodity index funds on
commodity prices. No one would deny that the size of
these funds has grown dramatically, as shown the chart.
• Nor would anyone deny that this growth has been
accompanied by the rise in prices and by an associated
increase in volatility as shown below.
• Some of the arguments in this section were presented to
the Tercer panel: Temas sistémicos, Consulta Regional
Preparatoria de la Conferencia Internacional de
Seguimiento Sobre la Financiación para el Desarrollo
Encargada de Examinar la Aplicación del Consenso de
Monterrey, Santo Domingo, Republica Dominicana,12 de
junio de 2008.
1400
Palm Oil; Malaysia and Indonesian, cif NW Europe
1200
Rice; 5 percent broken, nominal price quote, fob Bangkok
Soybean; U.S., cif Rotterdam
1000
Wheat; U.S. number 1 HRW, fob Gulf of Mexico
Maize; U.S. number 2 yellow, fob Gulf of Mexico
800
Average Petroleum Spot index of UK Brent, Dubai, amd West
Texas
Coffee, Robusta, Uganda and Cote dIvoire, ex-dock New York
600
Cotton, Liverpool Index A, cif Liverpool
400
200
2009M7
2009M4
2009M1
2008M7
2008M10
2008M4
2008M1
2007M10
2007M7
2007M4
2007M1
2006M10
2006M7
2006M4
2006M1
2005M10
2005M7
2005M4
2005M1
2004M10
2004M7
2004M4
2004M1
2003M10
2003M7
2003M4
2003M1
2002M10
2002M7
2002M4
2002M1
2001M10
2001M7
2001M4
2001M1
2000M10
2000M7
2000M4
2000M1
0
350
Maize; U.S. number 2 yellow, fob Gulf of Mexico
300
Rice; 5 percent broken, nominal price quote, fob
Bangkok
250
200
Standard Deviation
12 mo trailing 1980-2009
Soybean; U.S., cif Rotterdam
Wheat; U.S. number 1 HRW, fob Gulf of Mexico
Palm Oil; Malaysia and Indonesian, cif NW Europe
150
100
50
0
2008M1
2007M5
2006M9
2006M1
2005M5
2004M9
2004M1
2003M5
2002M9
2002M1
2001M5
2000M9
2000M1
1999M5
1998M9
1998M1
1997M5
1996M9
1996M1
1995M5
1994M9
1994M1
1993M5
1992M9
1992M1
1991M5
1990M9
1990M1
1989M5
1988M9
1988M1
1987M5
1986M9
1986M1
1985M5
1984M9
1984M1
1983M5
1982M9
1982M1
1981M5
1980M9
1980M1
How Commodity Funds Affect Both Future and
Spot Commodity Prices
• However, a commodity index fund has no interest in ever
taking physical delivery of the commodity, indeed has no
interest in the behaviour of the physical market conditions
that determine the price of commodities at all. This is
because one of the basic justifications for the sale of
commodities as an asset class is that they are uncorrelated
with other asset classes used as investments. The absolute
direction of the change in price is not important, as long as
it does not change in the same direction as equities, or
bond or real estate or foreign exchange. Thus a commodity
index fund, investing in futures has a permanent
unquenchable demand for futures, irrespective of the price
of the cash or the futures contract.
How Commodity Funds Affect Both Future and
Spot Commodity Prices
• Since there is no such thing as a perpetual future, this means that a
commodity fund must buy contracts with an expiration date. Since
they are trying to track the physical price, this usually means the
shortest, or near contract. It also means that it has to sell the
contract before expiration, to avoid taking delivery of the physical
commodity. Thus, before expiration commodity funds will be
selling the current holdings of futures and buying new ones. If the
funds to be invested are increasing, the funds will always be buying
more contracts than they are selling. This has meant in general that
not only has there been no convergence of the future with the spot
contract, but that for most commodity markets since the turn of the
century they have been characterized by a condition called
“contango”. That is, the future price is above the spot price.
How Commodity Funds Affect Both Future and
Spot Commodity Prices
• This is a market condition that Keynes characterized as representing
conditions in which speculators dominated commercial hedgers, or
in the present case in which commodity fund speculators dominate
commercial traders.
• The opposite, condition, called “backwardation” Keynes considered
to be normal. Normal because there are usually more producers
seeking to hedge their selling prices, than speculators will to risk a
decline in price, so to give the speculator a remuneration for his risk
the future price has to be below the spot, so that after convergence
of the future rising to meet the spot price at the future date the
speculator has a profit equal to the difference for his trouble. As
noted above, this difference has a limit in the costs that would be
incurred to buy and store the commodity until the future date since
this is the only way that the speculator could absolutely cover his
risk. The point about the spread determining who holds the stocks
of commodities thus returns.
How Commodity Funds Affect Both Future and
Spot Commodity Prices
• But the important point here is that the emergence of the
commodity funds had converted the market into a virtually
permanent contango market, in which convergence became
uncertain. As noted above, convergence is necessary to provide the
incentive to use the futures market. In a contango market, the
producer is selling at a price that is above the current spot price and
will converge to the future spot price. To extinguish the contract he
thus relies on the price convergence, that is to be able to buy the
contract back at spot, for a profit. If the futures price does not
converge, then he has to buy back at a higher price than the market
cash price, reducing his hedge coverage. Further, as prices rise
during the contract period, sellers of futures will be facing higher
margins that must be paid to the clearing house or the contracts
will be closed out. This raises the costs of using futures for
producers.
How Commodity Funds Affect Both Future and
Spot Commodity Prices
• Finally, in many markets, not only has convergence
failed at expiry, the size of the contango in the market
has exceeded the fair price of the future contract as
given by the spot price plus carrying costs. As noted
above, the cost of the future determines how much
and who stores commodity stocks over the contract
period. When the contango exceeds this fair price
(called the full carry) then it pays for producers to keep
commodities in storage. That is, instead of selling a
future at the beginning of the period and covering it
through sale or delivery just before expiry, it is more
profitable to keep the commodity in storage and roll
over the future contract, waiting for a higher price.
How Commodity Funds Affect Both Future and
Spot Commodity Prices
• All of these factors will lead producers and other holders of physical
commodities to favour a holding strategy of paying the carrying costs. This
will induce storage and reduce supply, and exert an upward push to spot
prices. Thus, there is a very clear reason why the emergence of commodity
funds has led to a breakdown in the efficiency of futures markets and a
sustained rise in prices at the same time as recorded stocks (not to mention
those not recorded) have been observed. What seems illogical in a normal
physical market, higher production relative to demand with rising prices,
becomes normal when the market becomes dominated by speculative
futures traders.
• Again, it is not clear whether producers actually benefit from this positive
impact of commodity index funds on market prices. The large wholesalers
have increasingly become full service financial centers in which they engage
in the storage of the physical commodities, so that much of the increase
accrues to these large multinationals rather than to the producers. There is
clearly little benefit to the final consumer. Indeed, the world has been faced
with the paradox of higher primary product prices which should be good for
developing countries, and a food emergency in developing countries, as the
retail prices full reflect the rising futures prices.
•
How Commodity Funds Affect Both Future and
Spot Commodity Prices
• Although the US Commodities Futures Exchange
Commission originally argued that there was no evidence
of any impact of Commodity Fund trading on the
efficiency of futures markets prices, it has now changed
its position and a recent Staff report of the Majority and
Minority Staff of the Permanent Subcommittee on
Investigations Committee on Homeland Security and
Governmental Affairs, entitled “Excessive Speculation In
The Wheat Market” June 24, 2009 finds “substantial and
persuasive evidence that the large presence of
commodity index traders in the Chicago wheat futures
market is a major reason for the breakdown in the
relationship between the Chicago futures market and the
cashprices for wheat.” P. 113.
•
How Commodity Price Boom has
impacted Developing Countries
• Lifted External Constraints
• Increased Reserves
• Changed relative prices
– Internal and external
– Soya
• Impact of biofuels
20
Terms of Trade: Goods
Emerging and developing economies
15
Africa
Africa: Sub-Sahara
10
Developing Asia
Western Hemisphere
5
0
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
-5
-10
Current Account Balance % GDP
8
Emerging and developing economies
Africa
6
Africa: Sub-Sahara
4
Western Hemisphere
Developing Asia
2
0
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
-6
1994
-4
1993
1992
-2
External Financing for Emerging Market Economies
1,000,000
800,000
Private flows, net
Commercial banks, net
US$ billion
600,000
400,000
200,000
0
2003
-200,000
2004
2005
2006
2007
2008e
2009f
The Danger of “Financial” Commodity Prices on
Development Plans
• However, the recent improvements in commodity prices appear to have
an impact that is very similar to the commodity lottery that dominated
Latin American exports in the 19th century. The price improvements in a
range of primary commodities brought an increase in the terms of trade,
but which was just a quickly reversed when the financial bubble in
developed country markets imploded.
• . Irrespective of the reasons for these changes in relative prices, the
impact that they have had on export performance is clear. And the
reversal in this position for many countries has been equally rapid and
extreme.
• The improvement in trade and current account balances has been
accompanied by increased capital inflows from international investors
seeking to participate in the improved conditions. But, also it has brought
a return of capital reversals seen in the 1990s.