Although I have mentioned this TED talk on a previous post – The Fear Index – I thought it deserves a separate post for people to view the presentation.
Kevin Slavin argues that we’re living in a world designed for — and increasingly controlled by — algorithms. In this riveting talk from TEDGlobal, he shows how these complex computer programs determine: espionage tactics, stock prices, movie scripts, and architecture. And he warns that we are writing code we can’t understand, with implications we can’t control.
The 1983 movie ‘Trading Places’, staring Eddie Murphy and Dan Aykroyd tells the story of an upper class commodities broker Louis Winthorpe III (Aykroyd) and a homeless street hustler Billy Ray Valentine (Murphy) whose lives cross paths when they are unknowingly made part of an elaborate bet.
There is a great part in the movie when they are on the commodities trading floor that explains price and scarcity. Winthorpe and Valentine are up against the Duke Brothers in the Frozen Concentrated Orange Juice (FCOJ) futures market.
How a futures market works
As opposed to traditional stock/shares futures contracts can be sold even when the seller doesn’t hold any of the commodity. For instance a contract of $1.30 per pound for a 1000 pounds of FCOJ in February indicates that the seller is compelled to provide the produce at that time and the buyer is compelled to buy the produce.
Here’s how it worked in the movie
The Duke Brothers believe they have inside knowledge about the crop report for the orange harvest over the coming year. They are under the impression that the report will state the harvest will be down on expectations which will necessitate greater demand for stockpiling FCOJ – this will mean more demand and a higher price. Therefore at the start of trading the Dukes representative keeps buying FCOJ futures. Others saw they were only buying and wanted in on the action, those that had futures were not willing to sell so the price kept rising. However the report was fake and Winthorpe and Valentine had access to the genuine report which stated that the orange harvest had not been affected by adverse weather conditions. Knowing this they wait till the the price of FCOJ reaches $1.42 and start to sell future contracts.
Then when the crop report is announced and it indiates a good harvest investors sell their contracts and the price drops very quickly. The Dukes are unable to sell their overpriced contracts and are therefore obliged to buy millions of units of FCOJ at a price which exceeds greatly the price which they can sell them for. In the meantime Winthorpe and Valentine for every unit they sold at $1.42 they only have to pay $0.29 to buy it back to fulfill their obligation. This results in a profit of $1.13 per pound.
Well, I didn’t get sunburnt after 3 weeks at the beach, however it was good to get away.
Below is a chart from a series that The Economist produced entitled Charting 2011. It shows the correlation between google searches in the US for the “Gold Price” and the “S&P 500 Volatility Index”.
Often referred to as the fear index or the fear gauge, the S&P 500 Volatility Index (VIX) represents one measure of the market’s expectation of stock market volatility over the next 30 day period. It is quoted in percentage points and translates, roughly, to the expected movement in the S&P 500 index over the next 30-day period, which is then annualized. Wikipedia
However it is interesting to relate the above chart to that of the actual gold price for 2011 – see below. Here we can see that there is a reasonable correlation between the actual gold price and the google searches and the VIX. Gold prices rose once again from the turbulence on world markets and recorded its 11th straight gain. Will gold prices continue to rise? The fundamentals that have pushed up the price of gold are still evident, namely:
- the problems of debt within the eurozone
- the concern of a double dip recession in a lot of the larger economies
- the increasing demand for gold jewelry amongst the developing economies such as India and China.
Here is a great graphic that shows how banks and other financial speculators are betting food prices in financial markets, causing dramatic spikes in the cost of food. This infographic done with the World Development Movement, looks at how higher prices for staple foods, such as wheat and maize, mean poor people around the world are going hungry and millions are being forced into deeper poverty. Click here to go the infographic site.
In teaching my AS level class Unit 4 -Trade – of the CIE course I have often used the Black Gold DVD which shows some good examples of barriers to trade. The part of the DVD that is particularly relevant is at the World Trade Organisation (WTO) talks in Cancun, Mexico in 2003.
In countries such as Ethiopia, small coffee producers have suffered as a result of the WTO. The International Monetary Fund (IMF) and the World Bank, established to facilitate global trade and regulate an international monetary system, have privatised public businesses and removed restrictions on foreign ownership in many developing countries who sign the IMF agreements in order to prevent default on international loans. Black Gold – The Economics of Coffee
Furthermore, as the farming sector in developed countries continues to get government subsidies – $300bn pre year – the IMF insisted that those developing countries receiving IMF aid had to stop any assistance to their own farmers. One wonders how these countries are going to achieve any sort of growth as subsidies wipes out the ability of developing countries competing on the international market. At the WTO in Cancun, ministers from across Africa packed out the conference centre calling for an end to subsidies. As Sam Mpsau the Minister of Commerce and Industry in Malawi stated:
“we would like the world trading system to be able to help us stand on our own two feet. Trade is more important to us than aid. We cannot live on aid forever”.
A 1% increase in the continent’s share of world trade would in itself generate $70 billion per year – five times more than what the continent now receives in aid.
Below is a trailer to the movie. Well worth getting.
With the terrible events overnight in Japan one wonders how the Japanese economy is going to be affected. However it was interesting to notice what has happened to the Yen against the US$ and the price of oil.
The US$ dropped against the Yen – was ¥82.8 but now is ¥81.8. Reasons for this:
1. The flow of insurance pay-outs that will no doubt follow the earthquake/tsunami.
2. Companies repatriating funds as happened after the Kobe earthquake in 1995
Benchmark Brent crude oil contracts fell 1.1 per cent to $114.16. Reasons for this:
1. The closure of Japan’s refineries damped immediate demand for crude oil.
2. Considering Japan’s huge oil consumption, around 4.4 million barrels a day, investors feared the demand would fall after the disaster at least temporarily, triggering large scale of sell-offs across markets.
According to the FT in London:
Natural disasters can actually be positive for growth because governments spend to repair the damage. After the Kobe earthquake in 1995, the Nikkei fell about 8 per cent in the following five days, then recovered 5 per cent in the next two weeks.
In a broader sense this earthquake is probably the last thing that the Japanese economy needed – namely its ability to pay in order to get the country back to a growing level of economic activity. However, although Japan’s government is highly indebted its people are very wealthy and there are many ways that you can tap into this wealth.
It seems that oil prices will be downward until the damage in Japan is fully assessed. But there always remains the threat of further political turmoil (sorry about the pun) in the Middle Eastern countries.
In 2008, at the height of the financial crisis, a barrel of oil reached $147 and amidst the turmoil in the Middle East there are concerns that this figure will reach over $200 a barrel. If this transpires there is a real risk of a double-dib recession especially in the US and Europe – if not New Zealand. In Libya, as rebels took control of the port of Tripoli its critical oil supplies remained squeezed, production from most of Libya’s oil fields was down to very low levels. The country’s wealth largely comes from oil and whoever controls the oil fields will ulitmately control the country.
Libya in the Global Oil Market
The Economist website has some good statistics about the oil industry. Libya sends 1.4m barrels/day to global markets which is around 2% of global demand. This makes Libya the thirteenth largest oil exporter. Saudi Arabia the worlds biggest exporter, and country with significant spare capacity, is already pumping an extra 600,000 barrels per day to make up for the shortage on world markets.
A recovering global economy had convinced traders that demand for oil was going to rise by about 2 percent in 2011. Some industry experts and Wall Street visionaries were predicting a gradual return to $120 and even $150. The thinking was that investors would pour money into the commodity markets. This was due to the huge increase in demand from developing countries which was threatening to obliterate OPEC’s spare capacity – see graph below.
If prices keep climbing, consumers will in all likelihood tighten their belts. If prices stay high for long, the impact could be severe: every oil shock of the past 40 years has helped push the global economy into recession. Nariman Behravesh, senior economist at IHS Global Insight, said that every $10 increase in the price of a barrel of oil reduces economic growth by two-tenths of a percentage point after one year and a full percentage point over two years - New York Times.
However, as the world is so dependent on oil there is little room for supply disruptions. Spare capacity is at 5 million barrels a day which is approximately 6% of what the world consumes every day. Although this is 4% higher than in 2008 it is still worringly low when one considers the demand pressures coming from developing countries like China and India. However that is not even taking into account the loss of about one million barrels a day exported from Libya. If Libyan oil was to be removed from the oil market it would represent the 8th largest oil shock in history – see graph below.
Much now hinges on what happens next in the Middle East. The price spikes that accompanied the two Persian Gulf wars did not have deep impacts because of they did not last long enough. But several oil price increases have preceded economic downturns. The biggest shock followed the 1973-74 OPEC embargo, which quadrupled oil prices and helped produce stagflation, a period of slow growth, high unemployment and inflation. The 1979 Iranian revolution caused another shortage, and again American motorists were forced to wait in long lines for gasoline. Oil prices surged, but they did not stay elevated for long, as Mexico, Nigeria and Venezuela expanded production and OPEC lost its unity. Oil prices remained low for years, and the economy through the later half of the 1980s and most of the 1990s was generally strong. New York Times
Demand for copper and other industrial metals is outstripping supply, as industrial output by the emerging markets economies surges ahead of their pre-recession levels. China’s unrelenting demand being an important factor.
Global copper inventories are down by about a third this year, and traders say that with supplies so tight, the risk is that prices could rise more rapidly if the recovery gathers pace. The major exception to this trend is China, which is sitting on a large stockpile that it built up during 2009, but is expected to be used up during the coming months. Prices in dollars have also been supported by the relative weakness of the US currency, compared with the euro and particularly the Chinese yuan.
Copper prices record high $9,660 a tonne on the London Metal Exchange and near all-time peak of $4.44520 per lb on New York’s COMEX market.
A festive hat tip to colleague David Parr for this excellent podcast from the BBC Worldservice Documentaries. If you had told me 20 years ago that bottled water would be a billion dollar industry I wouldn’t have taken you seriously. However, bottled water is the most revealing substance for showing us how the global capitalist market works today – it actually represents a kind of caricature of the global economy in that it provides people in the developed world with 20 or 30 varieties of something for which there is no actual variety. With a mark-up of over 3,000% it raises questions as to the power of branding, multi-nationals, and the power of the globalised market itself. Well worth a listen as you sit on the beach having that bottle of water. Click the link below to go to the BBC Documentary Archive:
Currently in Western Australia for a family wedding and notice that the workforce here is undergoing a significant change. The numbers employed in the manufiacturing sector is likely to be elcipsed by the number employed in the mining industry. Have a look at these figures:
2008 – Manufacturing 105,000 – 70,000 mining
2010 (Aug) – Manufacturing 87,700 – 86,900 mining
The commodity boom has simply led to resources flowing from one part of the economy to another. The labour market is allocating its resources in a more efficient and wealth maximising manner. However with the continued rise of the AUS$ the manufacturing sector is finding it increasingly hard to compete and it is difficult to make things when a nation’s capital, labour force and financial resources are focused on the resources sector to capitalise on high prices. It sounds very like a case of ‘The Resource Curse’ - click here to see earlier post on this topic. The Reserve Bank of Australia (RBA) worried about another commodities boom are suggesting a rise in interest rates. This might not impact the mining sector but it will definitely affect manufacturing.
Once again there is concern about wheat prices being overstated, even with the Russians fires and the extended export ban, so what has been causing prices to rise? Like when oil prices hit US$147/barrel on 18th July 2008 (today US$73) analysts are suggesting that investors are to blame. They are buying wheat on world commodity markets in the anticipation that prices will rise further and are thus overriding the fundamentals of supply and demand. The fact is, the world market remains very well supplied with wheat.
However if this price rise in wheat is due to the Russian fires and its exports ban, one should be aware of the long-term picture for prices – overall global food prices have risen by an average 83% in the past 10 years, according to the Food & Agriculture Organisation of the United Nations. The United Nations’ food agency has called a special meeting of policy makers to discuss the recent rise in global food prices – click here for further information from the BBC. The photo shows traders in the wheat pit at the Chicago Board of Trade Exchange.
Russia’s fires and drought have had adverse affects on the agricultural sector. The harvest is now expected to be 65 million tonnes, but could be as low as 60 million tonnes – it was previously predicted to be 75 million tonnes. Because of the pressure on domestic supply President Putin has put a stop to all exports of grain in 2010 and may look to extend this date. This anouncement by Putin pushed up the price of wheat on the Chicago Board of Trade – $7.26 a bushel. Critics of the ban on exports have said that trade barriers further distort wheat markets by making it harder for supplies to move from areas of surplus to areas of deficit, and by preventing price signals from reaching wheat farmers. With this ban on Russian exports it is believed that speculators have been artificially driving up the price of wheat for their own advantage. However the forces of supply and demand don’t necessarily support the increase in prices to date.