While milk production in New Zealand is lower this summer the global milk supply over the last year is strong with a 2.2% growth in Europe and 1.2% in the USA. This strong supply growth and the reduction in demand from China has led to downward pressure on prices.
New Zealand Federated Farmers Dairy chairman Andrew Hoggard said the disappointingly weak GDT result would put more pressure on Fonterra’s “poor” forecast payout of $4.60 a kilogram of milksolids.
“With another poor result I expect various people might try to jump on the bandwagon and try to the lay the blame somewhere, this is simply economics 101, supply is too high and demand is weak. … If we want to look at anything to blame, then the answer lies offshore with subsidised production in other countries hiding economic realities from farmers offshore who keep increasing production despite the market telling them the opposite.”
These prices are generated by the GlobalDairyTrade which is an auction platform for internationally traded commodity dairy products. How does it work?
GlobalDairyTrade trading events are conducted as ascending-price clock auctions run over several bidding rounds. In each auction a specified maximum quantity of each product is offered for sale at a pre-announced starting price. Bidders bid the quantity of each product that they wish to purchase at the announced price. If the price of a product increases between rounds, to ensure their desired quantity a bidder must bid their desired quantity at the new, higher price. Generally, as the price of a product increases, the quantity of bids received for that product decreases. The trading event runs over several rounds with the prices increasing round to round until the quantity of bids received for each product on offer matches the quantity on offer for the product (as shown in the diagram below). Each trading event typically lasts approximately 2 hours.
Bidders cannot join a trading event part way through: they must participate in round 1 and can only maintain or decrease their total bid quantities from that point. Products can be purchased over different delivery time periods, known as contract periods.
Click below for more information.
China’s outlook in 2016 looks to be more complicated than ever. Consider the following:
1. The data out of China is difficult to measure and the economy remains soft like 2015
2. The Chinese authorities are unlikely to support any further credit stimulus as the corporate sector is already one of the highest leveraged in the world – see graph. However they have allowed the Yuan to devalue (1.5% this year so far) in order to help the export market
3. China’s foreign reserves have decreased significantly as locals and foreign investors take money out of China – the Yuan would have fallen further is it wasn’t for foreign exchange intervention.
4. Investors are wanting to exit the stockmarket – 12% down in 2016. This figure would have been higher if authorities didn’t curb the trading and buying of stocks. Although the stockmarket is down 40% from its mid 2015 high it is basically unchanged from a year ago.
The Chinese economy needs more stimulus and that the currency and stockmarket should fall further – a lower currency would also support growth. On a positive side low Government debt and vast foreign exchange reserves are the ammunition to tackle the downside economic risks.
Source: NAB – Australian Markets Weekly – 11th January 2016
A lot of attention has been paid to the drop in oil prices to $28 per barrel as of today which is indicative of the increase in supply from US shale producers and the fall in global demand especially from China. However there is another indicator that shows the global economy is in pause mode and that is the Baltic Dry Index which measures the cost of shipping raw materials – iron ore, coal, metal etc.
In mid January this year the index fell below 400 (see graph) for the first time since records began in1985. In June 2015 the index was comfortably above the 1000 mark and in 2010 approximately 4000, therefore transport costs are at a very low level.
Why are shipping costs at such low levels?
It comes down to simple supply and demand. On the supply side shipping companies have increased their dry bulk capacity as the cost of borrowing money is at very low levels. On the demand side it was assumed that global trade would keep expanding but according to a World Bank report global trade has slowed down sharply in recent years to around 3% and it predicted to slow further.
Cost for ship owners
Owners of the largest container ships (known as capsize vessels) reckon it costs $8,000 per day for running costs. However in today’s market, users of these ships only pay around $5,000 in fees which makes it uneconomical for ship owners to offer their service. With this is mind shipping bankruptcies are bound to feature this year and unless China produces a new growth spurt the Baltic Dry Index will keep heading south.
Baltic Dry Index – Jan 2009- Jan 2016
Obesity it turns out is actually good for the economy. More consumption of food, particularly processed food, contributes to more economic growth. Poor health, strangely enough, can be considered an economic bonus. Bad food, too much food and drink, might be tragic in health terms but when it comes to the economy it would seem that obesity pays. But obesity doesn’t pay when it comes to the natural capital of the planet. Some economists have seen this obesity issue as indicative of wider economic, environmental and social problems. They take the economic argument one step further and link obesity to greenhouse gas emissions. Unnecessary over consumption of food is putting pressure on the environment through farming and manufacturing processes and hence contributing to its degradation.
There is proof to support the belief that while economic development is for the most part undoubtedly associated with human health, this is not always the case. The measure of economic growth – GDP – the value of the output of goods and services, does not consider the negative contributions that it might make to an economy. Ten percent of the developed world is made up of drug alcohol and cigarette sales and dealing with all these, medically of course, adds to the GDP and it is ironic that some cigarette manufacturers also produce surgical equipment and therefore making and doubling the benefit for GDP from smoking.
However growth is related to people living longer and this has been apparent with the improvements in healthcare in developed countries over the last century. In the developing world there has been a change from a high presence of infectious diseases to that of persistent illnesses including heart disease, strokes etc and is reflected, in some cases, in a disability for life. According to Garry Egger and Boyd Swinborne obesity is not a disease but a signal. It’s the canary in the coalmine, which should alert us to bigger structural problems in society. There are a number of areas where humans have achieved a peak of success, a sweet spot, but now that very success is turning on us and threatening to unravel centuries of achievement.
On the one hand, economic growth has over centuries led to a steadily improving standard of living, better levels of health and ever increasing life spans. In economic terms this reflects the start of a point of diminishing marginal rates of return from continued investment in the growth model.
Diminishing rates of return for the growth model
Mortality and economic growth data collected on the Swedish economy between 1800 to 2000 has shown the commencement of a diminishing rate of return on economic growth in relation to mortality rates. This coincides, not unexpectedly, with the leveling of improvements in health made from the decrease in infectious diseases associated with development, but with the consequent increase in chronic diseases associated with modern lifestyles, driven as they are by the modern environment. It is this switch, from predominantly infectious disease, to lifestyle-related chronic disease, and the consequent breakdown in the human immune system that differentiates the early from late stages of economic development. Several developing countries, such as China and India, appear to be experiencing this issue of chronic disease and at a more rapid pace because of their levels of GDP. In China for instance more than a quarter of the adult population are overweight or obese, as people add more meat and dairy products to their diet, causing chronic disease. According to a study in the Journal of Health Affairs “we need to find the right investments and regulations to encourage people to adopt a healthy lifestyle, or we risk facing higher rates of death, disease, and disability and the related costs.”
The reverse applies to Cuba where they experienced improved health conditions with the withdrawal of the Soviets in 1989. Over the next decade there was a significant improvement in health:
• Decrease in food intake of 1000 kcal/day average
• Mortality rate decrease by 20%
• Obesity reduced by approximately 50%
• Deaths from heart disease reduced by 35%
• Deaths from stroke reduced by 18%
It seems to be apparent that the current economic growth system cannot keep going in perpetuity. As developed economies grow there comes a point where there is a diminishing marginal rate of return on investment in terms of climate change and in particular human health. As Keynes indicated at the Bretton Woods conference in 1944 this current model of economics, ie. growth driven, will need to change in the next 100 years.
Obesity, Chronic Disease, and Economic Growth: A Case for “Big Picture” Prevention by Garry Egger http://www.sage-hindawi.com/journals/apm/2011/149158/
Radio New Zealand – 30-1-11 Interview with Garry Egger
The December 2015 edition of the New Internationalist discussed 10 Economic Myths that need to be addressed especially after the GFC. Below is the list and the NI goes through each in detail – click here to go to the NI website.
Myth 1: Austerity will lead to ‘jobs and growth – ‘
It’s wrong to sell austerity as a cure for economic woes
Myth 2: Deficit reduction is the only way out of a slump - Don’t rely on those who caused the crash to resolve it
Myth 3: Taxing the rich scares off investors and stalls economic performance – Taxation creates prosperity just as much as private enterprise
Myth 4: Economic migrants are a drain on rich world economies – Migration follows a demand for labour and benefits the receiving country
Myth 5: The private sector is more efficient than the public sector – There is no evidence of greater efficiency
Myth 6: Fossil fuels are more economically viable than renewables – Not if you look at the environmental costs
Myth 7: Financial regulation will destroy a profitable banking sector – Why should financial markets be accountable only to themselves?
Myth 8: Organized labour is regressive – It can be argued that the opposite is actually true.
Myth 9: Everyone has to pay their debts – We need debt management not reduction
Myth 10: Growth is the only way – why we need to find another way, fast.
Although it is repetitive in places especially when they talk of debt and austerity it does provide some valid arguments. I think that the last myth ‘Growth is the only way’ is of particular importance in that GDP growth at all costs has led to wasteful resource use, particularly by the wealthier countries, on an unparalleled scale and without a backward glance. It is often noted that the economy is a subset of the ecological system, but equally there seems to be a belief that nature can cope with anything we throw at it. However, an assessment by the Global Footprint Network indicates we are running a dangerous ecological debt. Currently the global use of resources and amounts of waste generated per year would require one and a half planet Earths to be sustainable (see graph below). The price to be paid for this overshoot is ecological crises (think forests, fisheries, freshwater and the climatic system), a price that is again paid disproportionately by the poor.
Ken Rogoff (Harvard University) recently wrote a very informative piece on the Project Syndicate website. He discussed the relationship between the drop in oil prices and its impact on economic growth. The price of oil has dropped from US$114 in June 2014 to $45 in December 2015 but the global GDP increase has only been around 0.5%. Over the last 20 years there have been a number of rapid fall in oil prices.
1985-86 – OPEC members decided to ignore quotas in the hope of regaining market share
2008-09 – The GFC saw a demand shock which shouldn’t have a significant impact as in the past the supply has adjusted to the reduced demand.
2014-2015 – the reduction in the price of oil has both demand and supply factors. A slowing Chinese economy has seen a downward movement in commodity prices – less demand for oil. This has been accompanied by increasing oil supply mainly from the fracking industry in the USA:
2008 – 5 million barrels a day.
2015 – 9.3 million barrels a day
Lower prices = more disposable income.
With lower prices consumers should have greater disposable income but it hasn’t stimulated a significant amount of extra demand. However Rogoff does mention that the emerging-market importers have a much larger global economic footprint than they did in the 1980’s, and their approach to oil markets is much more interventionist than the advanced countries.
China and India subsidise retail energy markets to keep prices lower for consumers but the drop in oil prices has meant that lower subsidies are now required and what government’s have saved has gone towards other areas of spending.
Oil is now seen to be less of a driver of global business cycles and even with investment in exploration falling by $150 billion in 2015 futures market have oil prices rising to $60 a barrel only by 2020.
2016 brings its challenges to oil producers with a forecast of tightening monetary conditions.
Although Norway is a capitalist country, it is state-owned enterprises that seem to be most prevalent in business circles. Oil revenues have been at the forefront of Norway’s development and it is, behind Luxembourg, the richest country in Europe. Ultimately the economic welfare of the country is heavily influenced by the price of oil and the peak of $150 a barrel in 2008 had huge benefits for the government purse. Oil and gas now account for about 25% of Norway’s GDP and almost 50% of its exports. However with the recent fall in oil prices to below $50 a barrel, oil companies have had to lay off workers – estimated to be 30%. According to The Economist the falling oil price has exposed two weaknesses in the Norwegian economy.
- Bureaucracy is a problem in Norway with the government owning about 40% of the stockmarket. Furthermore, as the vast majority of the country’s top executives attend the Norwegian School of Economics there is an unhealthy cultural uniformity which is not a catalyst to change.
- The welfare state has been too generous. The public sector employs 33% of the workforce (compared to 19% for the OECD countries) and as people enjoy a 37 hour week and sometimes a 3 day weekend there is a concern that the state is undermining the work ethic. In 2011 Norway spent 3.9% of GDP on incapacity benefits and early retirement, compared with an OECD average of 2.2%.
However, the government has been very prudent with its saving in that it now has the biggest sovereign-wealth fund in the world at $873 billion. The country also has a fish industry which is worth $10 billion a year.
Where to from here?
Are we seeing a classic resource curse where an economy has become reliant on a particular resource? Does Norway have a real alternative to oil to generate revenue for its economy?
Norway needs to allow the entrepreneurial spirit more room to grow and also apply some free market reforms to the welfare state. Shrinking the role of the state will help as the private sector cold start to be more involved in the running of schools, hospitals, and surgeries. So far the country’s reaction to the oil price drop is to be become even more left wing especially in the cities of Bergen and Oslo.
Source: The Economist – Norwegian Blues – October 10th 2015