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Contents
- Blake C. Clayton
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- Commodity Markets and the Global Economy
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- 05 October 2015
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- 14 October 2015, pp v-vi
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Frontmatter
- Blake C. Clayton
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- Commodity Markets and the Global Economy
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- 05 October 2015
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- 14 October 2015, pp i-iv
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5 - The Implications of Oil Prices for the U.S. Economy and Lessons Learned from the 2011 Strategic Petroleum Reserve Release
- Blake C. Clayton
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- Commodity Markets and the Global Economy
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- 05 October 2015
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- 14 October 2015, pp 119-165
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Summary
For the United States and other net importers of oil, the past two years have the dubious distinction of featuring the highest average annual crude oil prices, in both real and nominal terms, since the beginnings of the modern oil industry in the 1860s. Such elevated prices for oil, marked by extreme volatility at times, pose risks to the still-anemic U.S. and global economies, even though they have proven a boon to the domestic oil industry and the regions of the country where oil and gas are produced. Still, the U.S. economy is much less affected by changes in oil prices today than it was in the 1970s, for instance, when the first modern oil crises wreaked havoc on the national economy.
Understanding how oil prices affect the economy of the United States is crucial to sensible domestic policymaking. The consequences of the dramatic collapse in oil prices in 2014, for instance, vary tremendously across the country's geographic regions, economic sectors, and population segments. Pinpointing the exact dynamics at play, as well as measuring their magnitudes, is difficult to do with precision. But several decades of research have yielded critical insights. These findings can help inform policy decisions in realms as diverse as economic sanctions, strategic petroleum reserve releases, and gasoline taxes, limiting any negative implications their effects on oil prices might cause to the broader economy and maximizing their potential benefits.
One of the policy tools that many countries have at their disposal as a means of mitigating harmful spikes in oil prices is releasing oil from strategic reserves. The major oil release undertaken in 2011, coordinated by the IEA, provided policymakers with valuable lessons about three critical aspects of these emergency interventions: (1) their effect on oil prices and market perception, (2) their implications for international cooperation, and (3) the logistical issues they raise about the U.S. Strategic Petroleum Reserve (SPR). Energy officials in IEA countries should bear in mind those market-imposed constraints when structuring future releases, tailor their cooperation with influential oil-producing and -consuming countries to evolving geopolitical realities, and address potential operational impediments to the U.S. SPR, informed by the experience of the 2011 release.
HOW DO OIL PRICES AFFECT THE U.S. ECONOMY?
The primary channel through which higher oil prices reduce U.S. economic activity is by squeezing consumers, taking away discretionary income.
1 - The Revenge of the Old Economy
- Blake C. Clayton
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- Commodity Markets and the Global Economy
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- 05 October 2015
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- 14 October 2015, pp 1-16
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In an era defined by financial upheaval, few other markets have undergone as profound a transformation over the past decade as commodity markets. Part of the change, certainly, has been in price levels: Both futures prices and volatility levels have spiked to levels not seen since the 1970s, only for volatility to dip to the placid levels more typical of the mid-1990s, as of the time this book was written. For resource producers, whether nations or companies, such generally heady price environments have marked an era of almost unprecedented bounty, while their consumer counterparts have often languished as the cost of basic materials, including essentials like food and fuel, have soared. But prices are as much symptom as cause. Behind the price swings has been a range of factors spanning trends in economic development (an increasingly wealthy Asian consumer base), demographics (a restless rising generation in the Middle East), economics (declining real interest rates across the West), geology (massive disagreement over the hydrocarbon reserve base, coupled with technological advances that have challenged the Malthusian paradigm), and politics (an OPEC at turns emboldened and in disarray). Beyond these trends, the structure, players, and pricing dynamics that make up the landscape of modern commodity markets have also undergone a sea change, with vast new sources of liquidity and rapid securitization changing the way many of the world's oldest goods change hands.
Perhaps the most remarkable aspect of the mostly erstwhile commodities boom was the unexpectedness, at least for mainstream experts, of its arrival. This was a case of boom not merely following bust, but actually being borne – suddenly – of it. In the latter half of the 1990s, the market for hard assets was as soft as nearly any time in the hundred years prior. The relative geoeconomic stability that defined the second Clinton administration, coupled with its strong dollar policies, had depressed commodity prices in dollar-denominated terms. When the Asian financial crisis bit into economic growth in the emerging world in 1998, oil prices and commodity complex more broadly tanked. At $1.24, a gallon of retail gasoline in the United States was cheaper in real terms than it had been at any time since the Arab embargo of 1973.
6 - The Gold Standard as an Alternative Monetary Regime
- Blake C. Clayton
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- Commodity Markets and the Global Economy
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- 05 October 2015
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- 14 October 2015, pp 166-190
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Summary
Revived enthusiasm in some corners of U.S. politics for a return to the gold standard as a monetary system has renewed debate over the fitness of precious metals as a medium of exchange, highlighting the significance that these commodities have played at times in the global economy beyond their physical value. The Republican Party's 2012 platform suggested that the United States consider a return to a gold standard. Although it did not mention the standard by name, the statement noted that President Reagan, “shortly after his inauguration, established a commission to consider the feasibility of a metallic basis for U.S. currency.” It called for a similar taskforce in 2012 to “investigate possible ways to set a fixed value for the dollar.” The proposal hearkens back to the pan-Atlantic classical gold standard era that existed in the decades prior to World War I. Then, the leading industrial economies, as well as many smaller agrarian ones, defined the value of their currencies in terms of a specified amount of gold. Paper currency as well as other forms of money, such as bank deposits, could then be converted into gold at will (and vice versa) at the set price.
The gold standard as a monetary system has seen various iterations over the course of U.S. history. The last official vestige of the gold standard in the United States vanished in 1976, when the legal statute defining the dollar in terms of gold was eliminated. The Nixon administration had effectively put the nail in the coffin five years earlier by closing the so-called gold window, announcing that it would no longer freely convert dollars for bullion at the official exchange rate. Now, several decades later, enthusiasm for ditching fiat currency for commodity-backed money has begun to seep back into the conservative mainstream. “The international gold standard shimmers from the past like the memory of a lost paradise,” one historian has written of generational interest in gold-backed money. It “[embodies] all the nostalgia of the Victorian and Edwardian eras – stability, harmony, respectability.”
Yet the wisdom of returning gold to a position of privilege within the U.S. or global monetary system is controversial. Top American economists oppose the idea.
4 - Commodity Markets and Financial Speculation
- Blake C. Clayton
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- Commodity Markets and the Global Economy
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- 05 October 2015
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- 14 October 2015, pp 89-118
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The so-called financialization process that has occurred in commodities markets over the past three decades has given rise to intense public debate over whether the proliferation of commodity-backed securities and increasing presence of financial market participants has caused prices for these goods to rise and fall beyond their fair value, harming producers' and consumers' abilities to hedge their risks – the use for which forward grain markets were invented centuries ago – and hurting the businesses and consumers who would benefit from more stable, less unpredictable prices. The debate is a contentious one, and hardly new. For centuries, traders in commodity markets have raised suspicion among public officials and drawn the ire of consumers, who have questioned whether these market participants are playing a productive role or profiting at the expense of others. The launching of electronic futures trading and the proliferation of commodity-linked derivatives products over the past decade have intensified these concerns. It is true that broad, persistent increases in the prices of a host of commodities have occurred concurrently with a rise in commodity trading volumes and commodity holdings among investors. But is there a causal relationship between the two phenomena – in other words, are financial speculators pushing up prices? Or is the relationship between the two trends more nuanced and uncertain? The answer to these questions is critical for regulating energy markets and ensuring that market prices reflect fair value for producers and consumers alike.
A host of research explores the role and effect of financial speculators (that is, those who trade commodity-linked securities but do not produce, consume, or take delivery of the underlying good) on commodity prices. The lack of comprehensive, reliable data about the flow of goods and money within the world's commodity markets poses an enormous challenge to the ability of these studies to yield definitive conclusions. That said, some policy-relevant insights have emerged. There is little credible evidence that excessive financial speculation is systematically causing commodity prices to diverge significantly from what economic fundamentals would justify. Moreover, theoretical models and empirical data make clear the vital role that well-regulated speculation plays in commodity markets by enhancing price discovery, improving liquidity, allowing producers and consumers to hedge their market risk, and helping prices respond to fluctuations in supply, demand, and inventories.
2 - A Twenty-First-Century Supercycle? Long-Term Trends in Metal and Energy Prices
- Blake C. Clayton
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- Commodity Markets and the Global Economy
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- 05 October 2015
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- 14 October 2015, pp 17-53
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Summary
In the eyes of some market analysts, the tripling of commodity prices between 2003 and 2006 was more than simply another bull market – it was the upswing of a so-called commodity supercycle, a protracted boom driven by roaring Chinese demand growth. For some skeptics, the supercycle concept was theoretically underdeveloped, more marketing than substance. It is true that proponents of the idea, operating outside the realm of university economics departments, left its theoretical dimensions underspecified. But a closer examination of long-term price data for commodities, and the economic concepts that underlie them, suggest that prolonged periods of rising and falling prices are intrinsic to these markets, both phases of the cycle sowing the seeds of the other. The duration and magnitude of the bull market that began shortly after the year 2000 are not uncharacteristic of other booms that have taken place over the past century. In terms of short-term horizons, supply and demand behavior for many commodities helps account for the relatively high volatility of these markets. Over very long periods of time, however, the inflation-adjusted prices of primary commodities show a stagnating or slightly declining trajectory.
THE ORIGINS OF THE COMMODITY SUPERCYCLE IDEA
Alan Heap, a commodity strategist at Citigroup, published what became the most widely cited articulation of the commodity supercycle thesis in a March 2005 note, China: The Engine of a Commodities Super Cycle. Heap argued that a commodity supercycle was already underway. This boom was responsible for the postmillennial takeoff in natural resources. He defined a supercycle as a “prolonged (decade or more) trend in real commodity prices driven by urbanization and industrialization of a major economy.” The upswing portions of these cycles last between ten and thirty-five years, Heap argued, making the timing of a full cycle last as many as seventy years. In his view, two supercycles had occurred in the prior 150 years. The first one stretched from the late 1800s through the early twentieth century, fueled by the materials-intensive economic expansion of the United States, while the second cycle ran from roughly 1945 through 1957 in tandem with the postwar reconstruction of Europe and Japan. The third such cycle was just taking off, in his view.
Acknowledgments
- Blake C. Clayton
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- Commodity Markets and the Global Economy
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- 05 October 2015
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- 14 October 2015, pp xiii-xiv
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3 - Volatility in Global Food Markets
- Blake C. Clayton
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- Commodity Markets and the Global Economy
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- 05 October 2015
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- 14 October 2015, pp 54-88
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Summary
The four fault lines that define the commodity trade, outlined in Chapter 1, converge in the volatility seen in global foods markets over the past decade. Although in real terms still far below long-term historical averages, recent food prices, having trended higher over that period, constitute a reversal of the generally declining prices that had prevailed since the mid-1970s. The economic consequences for rich and poor countries, not to mention net exporting versus net importing countries, differ markedly. Among the world's poor, evidence suggests problematically high food costs can weigh on educational attainment in the rising generation with long-term negative consequences for economic productivity. Rising prices also present an acute inflationary threat in emerging economies, given that food represents a larger share of household expenditures, which can also weigh on economic growth. Many analysts have argued that severe food cost escalation can contribute to escalating political unrest, which they see as being a contributing factor in the ongoing upheaval in the Middle East and North Africa.
Yet the food market is another sphere in which a misdiagnosis of the problem can worsen it. Although financial market speculation is often cited as the root cause of high or unpredictable food prices, that explanation obscures more than it reveals. Fundamental forces of supply and demand in these markets, compounded by macroeconomic trends (secular trends in the U.S. dollar and a falling real interest rate environment in the G10), domestic price controls, and at times nationalistic trade policy by major exporters, are better supported by the econometric evidence as spurring the volatility. The food markets are an arena in which the structurally opposing interests of net importing and exporting countries can hinder cooperation among trade partners, pitting sovereign states and their national champions against private-sector enterprises and limiting the scope for international agreements that could increase the resiliency of these markets in times of severe market stress.
THE ONSET AND IMPLICATIONS OF THE GLOBAL FOOD CRISIS
Among the most dramatic storylines of the mid-2000s commodities boom was the sizeable leap in the price of food and agricultural products in the world market. “Across the World a Crisis is Unfolding at Alarming Speed,” read an April 2008 headline.
Index
- Blake C. Clayton
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- Book:
- Commodity Markets and the Global Economy
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- 05 October 2015
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- 14 October 2015, pp 193-199
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7 - Conclusion
- Blake C. Clayton
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- Commodity Markets and the Global Economy
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- 05 October 2015
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- 14 October 2015, pp 191-192
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Analyzing the future direction of the market requires understanding the four sets of opposing forces that define the global commodity trade: (1) net importing and net exporting countries, in search of economic gains; (2) sovereign states (and state-owned enterprises) and private-sector companies vying for competitive advantage; (3) international cooperation and nationalism as opposing means of addressing failures in resource markets; and (4) the physical and financial aspects of the modern commodity trade. These pairs of forces form the critical context in which the competition for relevancy among countries, companies, and consumers negotiate in the commodities marketplace for economic and political advantage will take place. They are the critical context in which the broad range of policy- and investment-related issues discussed in this book, from debates over speculators in commodities markets to mitigating harmful energy and food market volatility, will be settled.
The dive in crude oil prices in late 2014 underscores the potential for sudden reversals that are intrinsic to commodity markets – particularly to those like oil with long project lead-times – and their capacity for confounding even the best attempts by analysts to predict long-term price paths. Brent crude oil, trading at roughly $60 per barrel at year-end, appeared to many observers to be locked firmly in the $100 to $120 dollar range, where it had traded over the preceding three years, for the foreseeable future. And yet the suppositions that had formed the basis for such predictions – that the Saudis would put a floor under prices no lower than $90 per barrel to protect the fiscal feasibility of their social spending programs, that a still-recovering developed-world economy would sputter at prices above that range, and that an uptick in worldwide consumption should prices fall below that threshold would cause any dip below it to be short-lived and contain the seeds of its own undoing – now look feeble. Regardless of where one sits with regard to if and when prices will regain lost ground, it is clear that the relative tranquility that had marked commodities broadly since their rebound in 2009 to 2011 was a transitory state of affairs. We have not reached the end of oil market history. Volatility and structural shifts, difficult to detect far in advance, are still ahead, continue to define these markets.
Commodity Markets and the Global Economy
- Blake C. Clayton
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- Published online:
- 05 October 2015
- Print publication:
- 14 October 2015
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In an era defined by financial upheaval, few parts of the economy have witnessed the kind of volatility seen in commodities markets. In this book, Blake Clayton, a Wall Street analyst and adjunct fellow at the Council on Foreign Relations, draws on the latest thinking from academia and the private sector to deliver a clear-eyed analysis of pressing questions at the intersection of commodity markets, natural resource economics, and public policy. The result is a work that challenges the conventional wisdom about how these markets function and provides a fresh perspective on what public policy can do to improve them.