Why Are Commodity Prices Falling?

In spite of falling oil prices, he brought this country up here.

But, though inflation is very low, and even negative in a few countries, something more must be going on, because commodity prices are falling relative to the overall price level. In other words, real commodity prices are falling.

Until now, the consensus view has been that this would be bad for output and employment. Keynes gave the reason in 1923 the fact of falling prices, he wrote, injures entrepreneurs consequently the fear of falling prices causes them to protect themselves by curtailing their operations.

But the macroeconomic weakness in the US now goes beyond the decreased supply of credit. Falling house prices reduce household wealth and therefore consumer spending. Falling employment lowers wage and salary incomes.

Deflation is potentially a very serious problem, because falling prices and the expectation that prices will continue to fall would make the current economic downturn worse in three distinct ways.

With prices of finite fossil fuels rising and cereal prices falling to record world market levels, it is becoming economically interesting to use cereals, in addition to straw, for energy production.

The prospect of falling prices reflects the collapse of industrial production, the resulting high level of unemployment, and the dramatic decline in commodity prices. Industrial production is falling at double digit rates in the negative inflation countries, and the price index for all commodities is down more than 30 over the past year.

The scrap market, traditionally the most volatile, has maintained its unsteadiness, with prices increasing almost threefold in some countries in 2004 before falling again.

Now, exports to the US are falling while the yen has strengthened. Moreover, high oil prices in a country that imports all of its oil needs, together with falling business profitability and confidence, are pushing Japan into a recession.

Therefore, in the 2000 2003 period, despite falling prices of agricultural products in the world market, Vietnam's agriculture enjoyed continuous growth at 4 per annum.

This recalls a familiar historical pattern. Falling real (inflation adjusted) interest rates in the 1970s, 2002 2004, and 2007 2008 were accompanied by rising real commodity prices sharp increases in US real interest rates in the 1980s sent dollar commodity prices tumbling.

Falling prices mean a rise in the real value of existing debts and an increase in the debt service burden, owing to higher real interest rates. As a result, defaults, bankruptcies, and economic decline become more likely, putting further downward pressures on prices.

Buying foreign gold did succeed in driving down the dollar s value in terms of gold. But domestic prices continued falling throughout the three months of the gold buying spree.

If anything, inflation is now falling further globally as commodity prices adjust downward in response to weak global growth. And gold is following the fall in actual and expected inflation.

Global output is probably falling faster than at any rate since World War II, except perhaps for 1974 1975. Under these circumstances, large excess capacity develops and commodity prices fall.

These risks are already exacerbating the economic slowdown equity markets are falling everywhere, leading to negative wealth effects on consumption and capital spending. Borrowing costs are rising for highly indebted sovereigns, credit rationing is undermining small and medium size companies, and falling commodity prices are reducing exporting countries income.

Third, in countries running current account deficits, consumers need to cut spending and save much more for many years. Shopped out, savings less, and debt burdened consumers have been hit by a wealth shock (falling home prices and stock markets), rising debt service ratios, and falling incomes and employment.

In November, annual inflation in the euro area fell to a cyclical low of 0.3 , largely owing to the sharp fall in oil prices since the end of the summer. But falling core inflation (which excludes volatile energy and food prices) also points to weak aggregate demand.

When deflationary expectations are entrenched, as they are in Europe today, consumers and investors delay spending on the ground that prices and costs will be lower tomorrow. Those expectations become self fulfilling, because less spending means even less inflation and, in the worst case, falling prices.

Today s environment of falling oil prices enables the world to take that step. It should be modest, so that it is politically feasible flexible, so that it helps stabilize user prices and it should increase over time, to place the global economy on a more sustainable path.

Because many contracts are sticky (that is, not easily revised) in monetary terms, inflation and deflation would both inflict damage on the economy. Rising prices reduce the value of savings and pensions, while falling prices reduce profit expectations, encourage hoarding, and increase the real burden of debt.

Accordingly, the general tenor and direction of the market is expected to change, with prices remaining at present levels or falling further and excess capacity possibly again emerging as a concern.

Currently, since property prices in the UK are falling and outflow of capital starts occurring, keeping domestic economy and market system stable has been the top priority of the UK's new government.

The host, Chávez s successor Nicolás Maduro, confronts a collapsing economy and tensions within his own party. Despite relatively high oil prices, Venezuela has a large fiscal deficit and falling foreign exchange reserves.

Falling oil prices may provide cheaper energy for manufacturers and households, but they hurt energy exporters and their spending. And, while increased supply particularly from North American shale resources has put downward pressure on prices, so has weaker demand in the eurozone, Japan, China, and many emerging markets.

The predictive significance of oil prices is indeed impressive, but only as a contrary indicator Falling oil prices have never correctly predicted an economic downturn. On all recent occasions when the price of oil was halved 1982 1983, 1985 1986, 1992 1993, 1997 1998, and 2001 2002 faster global growth followed.

Another problem, at least from the point of view of the rest of the eurozone, is that inflation in Germany remains too low. With German prices rising at less than 1 annually, the eurozone periphery needs falling prices in order to regain the competitiveness lost during the pre 2008 boom years.

Second, because most exporters also import intermediate inputs that are priced in dollars, exchange rate fluctuations have a limited impact on their costs and thus on their incentive to change dollar prices. And, third, exporters who wish to preserve their share in world markets where prices are largely denominated in dollars choose to keep their dollar prices stable, to avoid falling victim to idiosyncratic exchange rate movements.

Such homeowners knew that with rising prices they would be able to realize a gain by either selling their homes or increasing their debt, while in the case of falling prices they could simply hand over the keys to their banks. Given the uncertainty about future house prices, they could reasonably expect gains, which induced them to pay even more in the first place.

Falling Stars

It is no coincidence that this new kind of bank run originated in the US, which is the clearest example of falling home prices in the world today. When home prices stop rising, recent homebuyers may lose the enthusiasm to continue paying their mortgages and investors lose faith in mortgage backed securities.

The point is simple When energy prices stop falling, the overall price index will rise close to 2 . And the FOMC members own median forecast puts inflation at 1.8 in 2017 and 2 in 2018.

All eyes are on households. Thanks to falling unemployment, rising home values, and record stock prices, an emerging consensus of forecasters, market participants, and policymakers has now concluded that the American consumer is finally back.

Of course, upward pressure on commodity prices also stems from supply side challenges. It is not just that global supplies of resources are increasingly scarce, but also that supplies are increasingly falling into inefficient hands.

Benign disinflation means rising real incomes for lenders, pensioners, and workers, and falling energy prices for industry. All sectors of the economy will spend more, pushing up output and employment (and sustaining the price level, too).

Falling Blocks Game

Falling for Germany

Weakening electricity demand has tipped China s coal industry into severe distress, with many mines effectively bankrupt. Falling house prices are another classic indicator of a vulnerable economy, though the exact pace of decline is difficult to assess.

In the first four months of 2014, housing sales dropped by nearly 7 year on year, with construction of new floor area falling by more than 22 . As a result, downward pressure on property prices is mounting.

While it persisted, expenditures swelled but were manageable until, suddenly, energy prices collapsed. The Kremlin, devoted to its key fetish Putin s approval ratings proved completely unprepared to curtail public spending in the wake of falling state revenues.

Then the Bush administration s reckless fiscal policy pushed it lower. Falling interest rates in recent years pushed up real estate prices and allowed America s upper middle class to treat their houses as enormous ATM s, lowering savings still more.

Of course, given the ongoing recession, it may not be so easy for central banks to achieve any inflation at all right now. Indeed, it seems like avoiding sustained deflation , or falling prices, is all they can manage.

Fit falling blocks together

Falling blocks puzzle game