About those falling oil and commodity prices…

0

TWO of the most commonly cited culprits for the apparent general downturn of the world economy are falling oil and commodity prices, particularly for coal and industrial metals. Yet despite the importance given to these two key indicators, clear explanations of exactly why they are bad for the economy are almost impossible to find.

Advertisements

The reason for that, of course, is that low oil and commodity prices are an effect rather than a cause. A low price for oil, or coal, or copper ore, or aluminum, or a processed rare-earth metal is not by itself a bad thing; on the contrary, it should encourage more economic activity. But the prices are low because of a dearth of demand; that condition creates circumstances in which low prices have an aggravating effect on an already flagging economy, an effect that can easily be given more importance than it should.

Let’s look at two indicators in particular: The price of Brent crude (which is one of the oil price benchmarks, and is traded in London), and a good yardstick of global coal prices, the Market Vectors Coal exchange-traded fund (which aggregates the share prices of all the world’s larger coal-related companies). The most recent peak for oil prices was on June 20 of last year, when the price reached $113.41 per barrel. Through Wednesday, when Brent crude closed at $31.36 per barrel in London, oil has declined by about 72 percent.
Over roughly the same period, coal prices have also dropped, which is reflected in the price of the MVC ETF. On June 19 of last year, its price stood at $11.87 per share; on Monday (January 25), it closed at $5.44, a decline of a bit more than 54 percent.

Oil and coal are good general indicators of economic activity. About 84 percent of petroleum is used for fuel, with most of the rest being used for the production of plastics and other chemicals; more than 90 percent of coal is burned in power plants, with the remaining 9 percent or so more or less is equally divided between steel and cement production. An oversupply of oil indicates fuel demand is shrinking, or at best not growing fast enough to soak up new supplies; people and products are not being transported from place to place, and demand for petroleum for other uses—making plastics, asphalt for roads, various chemicals, etc.—if it has increased at all, has not done so on a large enough scale to boost demand and cause oil prices to rise.

Declining demand for coal is really falling demand for electricity, which is a very obvious indicator of economic activity on both the consumption and production sides of the economy. For consumers, the fall in prices is a benefit, or at least should be: Lower prices on fuel and energy theoretically boost disposable income by reducing household expenses.
Consumers, however, are not spending as tidy economic theory suggests they ought to be; even where consumer spending has increased, it has not done so to a degree equal to the decline in commodity prices, and thus demand continues to shrink.

Although the somewhat paradoxical weakness of consumer demand is a result of many factors and thus, defies a tidy explanation, one major contributing factor is the stagnation of wages. In the US, for example, a study by Pew Research based on Bureau of Labor Statistics data found that in over a 50-year period from 1964 to 2014, real wages (in constant 2014 dollars) only increased by about 7.2 percent, which averages out to a barely noticeable 0.14 percent per year. The specific figures vary from country to country, but apart from a few local and short-duration exceptions, the trend is similar all over the world. Without a substantial gain in wages from year to year—on the order of a percent or two at a minimum—the cost savings from lower fuel and energy prices is apparently not enough on its own to encourage a significant increase in consumption.

And of course, with the downturn in demand, pressure is put on the production side of the economy. Lower costs of energy and materials are reflected in lower prices of goods. What businesses try to avoid, however, is a reduction in revenues, so if the increase in sales brought on by cheaper goods does not compensate for the lower selling prices, the price reductions are moderated. But there are limits to how long a producer can hold back on cutting the price of goods; if demand remains basically unchanged even at the lower price, then in order to make any headway and prevent or reduce the negative impact on margins, lowering prices further is essentially the only option.

All the factors taken together paint a picture of a global economy caught in a death spiral.

Consumer demand isn’t rising, because it takes more jobs and higher wages to feed demand; but jobs aren’t being created and wages aren’t increasing because overall demand remains depressed. Somehow, the world’s economic minds have to figure out how to solve both problems at the same time, and that is something which has so far proved impossible.

ben.kritz@manilatimes.net

Share.
loading...
Loading...

Please follow our commenting guidelines.

Comments are closed.