Our discussion over commodity prices in today’s class really triggered my interest. As Professor Kimball said, the price of copper at time t is equal to the sum of extraction cost and its value at time t, while the present value is the real value at time t+1 discounted by the real interest rate at time t.
Relatively, John Taylor argued that:
There is yet another downside. Foreign central banks—whether they like it or not—tend to follow other central banks’ easy-money policies to prevent their currency from appreciating sharply, which would put their exporters at a disadvantage. The recent effort of the new Japanese government to force quantitative easing on the Bank of Japan and thus resist dollar depreciation against the yen vividly makes this point. This global increase in money risks commodity booms and busts as we saw in 2011 and 2012.
His argument certainly is unconvincing based on the calculation above, and I also disagree with him on the worldwide impact of the US quantitative easing. After the burst of the 2008 global financial crisis, major economies went into recession and therefore, it is absolutely reasonable for central banks around the global to conduct expansionary monetary policy to stimulate economic growth. So the increasing liquidity itself, as a growth momentum, is not a bad thing.
In particular, I think commodity prices have a lot more to do with global demand and economic growth in some particular countries instead of the monetary policy of central banks.
Copper prices fell to a seven-month low today on concerns about an economic slowdown and the health of financial system in China.
Last weekend, China reported that its exports fell 18% in February from a year earlier, which caused the decline in copper prices because the country is the top consumer of the medal and weakening exports might be a signal of slowing growth and modest consumption.
Furthermore, the so-called “Copper Financing” in the country has significantly affected the medal’s prices. Many investors claimed that the copper market’s problems go beyond the factory floor. The cracks appearing in China’s financial system likely are playing a bigger role. Much of the copper stored in China, the world’s biggest consumer of the metal, is used by companies and investors as collateral for loans from banks and other lenders. They then invest the money in higher-yielding assets. So the emerging concern is that the recent drop in copper prices might lead to a vicious circle in China’s copper demand as banks are becoming reluctant to accept copper as collateral.
So why can “Copper Financing” be a thing in China? It has to do with the shadow banking system in the country. As Professor Kimball said in today’s class, state-owned banks mainly make loans to state-owned enterprises in China, and therefore, many small and medium enterprises have confronted the financing problem. Consequently, they have to turn to some other channels for financing.
Nevertheless, I am still optimistic about the future demand of copper in China as the newly-established administration is determined to roll out structural reform initiatives and allows the market force to play a bigger role in the overall economy. In the financial sector, the Chinese central bank is trying to increase the flexibility of the yuan as it weakened the daily reference rate for its currency by the largest percentage in more than a year and a half on this Monday, which could stimulate the country’s exports and ensure financial stability in the long run. In addition, the government is expected to curb speculation and enhance credit quality by imposing stricter restriction on the shadow banking system.