Tuesday, October 14, 2014

Guest Blog by Buck Klemkosky*: As the World Turns

Intro by Larry Davidson

I was in the process of writing something about recent global events when Buck beat me to it. I still have plans to write about the recent IMF World Economic Outlook report that was released last week. But in the meantime Buck brings up two very recent and potentially threatening global trends. The first one finds that the value of the dollar is rising lately and is creating new challenges for a still fragile US economy. Buck explains why dollar value changes are not that simple, however. The other interesting issue concerns global commodity prices. Most of us worry when prices of energy, steel, copper, aluminum, and various other commodities rise too much. But what happens when international prices of these items begin to decline?  I hope you enjoy Buck's take on these things.

The Dollar is Back

In the last year, the U.S. dollar has appreciated (strengthened) 10 percent against the euro and 15 percent against the Japanese yen. Most of the decline in the euro has been in the last six months, while the yen has fallen almost 40 percent in the last two years. It is not just the euro or yen either. The U.S. Dollar Index, which measures the value of the dollar again a basket of currencies, has climbed to its highest level in more than four years. Even the venerable Swiss franc has fallen 9 percent against the dollar since June, as well as emerging market currencies. About the only currency that hasn’t changed is the Chinese yuan, which is controlled by the government and unofficially pegged to the U.S. dollar.

Why do we care about the value of the dollar relative to other currencies? A strong dollar makes foreign goods cheaper and thus helps control inflation. However, a strong dollar also makes exports more costly and thus less competitive, resulting in slower economic growth. It has been estimated that a strengthening of the dollar by 10 percent reduces economic growth by 1 percent. It always pays to invest in a country with a strong currency, so a strong dollar had made U.S. financial assets more attractive to foreign investors; it has helped lower bond yields and other interest rates and supported stock prices.

Why is the dollar so strong? The U.S. has experienced better economic growth than either Europe or Japan. Both are on the verge of recession and have lower inflation or deflation and lower interest rates. The European Central Bank has initiated a bond purchase program, and Japan has an ongoing one just as the U.S. Fed will stop its program this month. Plus the Fed has already given guidance that U.S. interest rates will be increased in the future, while Europe and Japan have given no such guidance. In a broader context, the dollar remains the world’s primary reserve currency and a safe harbor in terms of crisis and geopolitical risks. The dollar will continue to anchor the world’s financial system in the foreseeable future. In the shorter term, one will not notice the effects of a stronger dollar unless traveling abroad; things will be cheaper.

Commodity Prices Tank

The closely watched Bloomberg Commodity Index, which tracks 20 commodity prices, has fallen in recent weeks to a four-year low. And the fall has been broad-based, including agricultural, energy and metal prices. How things have changed; between 2000 and 2011 commodity prices tripled, referred to as the commodity super-cycle, and there was talk of eventual shortages of almost all commodities. Since then commodity prices have fallen by about 25 percent, and 11 percent since June alone. The only commodities not to experience price declines have been cocoa, coffee, cattle and hogs.

Commodity prices are a function of supply and demand and both have had an impact this year. On the demand side, annual global economic growth has slowed from 5 percent to 3 percent this year. Global growth may not improve much in the short term as the Eurozone, Japan and other emerging countries are teetering on the brink of recession. China, the largest user of most commodities in recent year, is struggling to achieve annual growth of 7 percent. Christine Lagarde, head of the International Monetary Fund, recently declared that the global economic recovery was “brittle, uneven and beset by risks” and slow global growth may be the norm for a long time.

The supply side may be summarized by two words: “supply glut.” Agricultural commodities have benefited from good growing weather, record acreage planted and high yields, resulting in bumper crops and the lowest prices in seven years. The oversupply of most metals can be blamed on the huge investments made at peak prices to satisfy China’s appetite for raw materials and recovering global economic growth. Oil prices have fallen 16 percent since June and are at the lowest level since 2012. Much of this decline can be attributed to the shale boom in the U.S. as it replaces Saudi Arabia as the largest oil producer in the world. The U.S. imports less oil today – 3 million barrels daily – then it did two years ago. Oil prices would be lower if countries such as Libya, Iraq, Iran and Venezuela could produce at full capacity.

What are the positive and negatives of falling commodity prices? It depends on whether a country is a net importer of commodities or a net exporter. Producing countries that export suffer when prices drop and could be a drag on global economic growth. For the net importing countries, falling commodity prices are like a tax cut, leaving households with more disposable income. Since many commodities, such as oil, are priced in dollars, the stronger dollar helps the U.S. but hurts other countries where currencies have weakened again the dollar. In general, falling commodity prices are probably signaling slower global economic growth.

*Buck is Market Strategist at Wallington Asset Management.

1 comment:

  1. thank you very much. i am yet to write the last part of the series. i will write it as soon as possible so that the series would be complete and there are good information in this blog like global events , value of the dollar, global commodity prices.