Global Markets! The buzz word of modern finance has generated intense interest during the past few years. Yet it is a phrase often misconstrued to describe numerous separate, and interrelated activities in the world economy.
Global markets have come to be seen as the epitome of the information age, where the instantaneous transmission of data results in immediate transfer of capital, material, and other resources to wherever the yields seem most advantageous.
The extent to which the world economy has progressed towards efficient global markets depends upon how these markets are defined. Markets which have historically been tied to international trade are most readily identified as being global. Trade in primary raw materials and manufactures has been recorded throughout history, with goods produced in many regions and exchanged in markets around the globe.
Global markets in this context comprise a number of local exchanges, operating in tandem, and influencing market prices through the generally accepted interaction of supply and demand.
Market efficiency is often defined as equilibrium between supply and demand, where average prices equal average costs of production. If the world market price for a given commodity reflects the aggregate effects of all local exchanges, then local market prices are in equilibrium with world market prices.
Trends in world commodity prices often reflect a somewhat different picture, as shown in the attached diagrams:
These diagrams compare world market prices of coffee and maize to trade weighted market prices, calculated in proportion to total world imports. The two price trends are also compared with the trade weighted value of the US dollar, calculated according to the proportion of total world trade transacted by the G10 nations plus Switzerland.
Trade weighted coffee prices are shown to diverge from market prices during periods of large exchange rate movements, and to converge during relative exchange rate stability. The divergence in maize prices has also shown correlation to currency volatility, although any subsequent convergence is less clear. The examples shown here represent two limits for a spectrum of similar relations exhibited by other dollar market commodities.
The exchange rate impact on single currency commodity markets is external to the normal influence of production and demand. Fluctuating exchange rates, attributable to factors those specific to any individual market, introduce an exogenous risk to world trade in these products.
Commodities which are denominated in US dollars comprise over 20% of total world trade. Not surprisingly, the bulk of this trade (fluctuating around 15% of total world trade) is in petroleum and energy products. World trade in 15 other dollar market commodities increased from $76 billion in 1978 to $95 billion in 1987. The comparable proportion to total world trade of these products declined from 5.6% to 3.7% during the same period, due largely to the rapid expansion in trade of manufactured products.
The largest trading volumes for many primary commodities are exchanged in markets established in the United States, where trading occurs for domestic consumption, hedging, speculation, as well as international trade. These exchanges quote commodity prices in US dollars, prices which are widely used as a guideline from which other markets around the globe determine local trading prices.
Markets in other nations generally quote commodity prices in local currency, with notable exceptions such as sugar, cotton and petroleum. Local market prices tend to reflect the dollar values converted to local currency for those commodities which are predominantly traded in US markets.
An efficient global market would by definition reflect the aggregate demand of all local markets in determining the equilibrium price of a specific commodity. Its correlation with aggregate production would reflect the ability to supply every local market at the prevailing price.
Aggregate world supply, however, can be distinguished by two components; namely:
The extent to which a market for a given commodity is considered to be global is determined by the distribution between local and exported production. Roughly 90% of total world copper production is exported to the world market, as compared with only 9% of maize production. A quarter of cotton production is exported; and both coffee and sugar exports represent around 60% of respective production levels.
Copper, by this definition, would be considered as highly global while maize would be considered least global. World copper exchanges quote prices in Pound Sterling and US Dollars; maize is generally quoted in US Dollars.
Currencies, most notably the US dollar, have been shown to fluctuate widely during short periods. Exchange rate fluctuations are the result of many factors which are rarely related to world trade in dollar denominated commodities. Some local markets depend on international trade in commodities denominated in US Dollars for the majority of their imports and exports. The currency which is used for trading in specific products thus has an appreciable impact on the national balance of payments both for producers and consuming economies.
Despite the valuation of many commodities in US Dollars, only a small proportion of world trade in these products involves bilateral exchange with the United States. This phenomenon extends to commodities which are denominated in other currencies. The price observed by local markets shows significant divergence from nominal market prices during periods of exchange rate volatility and results in a spread between nominal market price indices and trade-weighted prices.
This spread is not uniform among all commodity markets. Convergence between trade weighted prices and nominal market prices is more significant where there is a greater proportion of international trade in a given commodity relative to total global production. Markets for commodities such as grains and cotton, where the proportion of international trade is lower relative to aggregate world production, show a greater divergence in relative prices due to the greater influence local market demand.
Most commodities have relatively inelastic demand curves, characterized by stable consumption levels and few substitutes. Major importing markets for these products comprise economies which use the commodities in a more diverse range of manufactured goods and capital products. Although primary raw materials are imported by most every local market, irrespective of their stage of industrialization, the major industrialized economies continue to represent the greatest demand for these products.
Variations in the market price for these products therefore have less impact on aggregate consumption levels. Their markets exhibit a higher degree of globalization, where a large proportion of total production is exported to the world economy.
Few exporters of primary commodities have sufficient levels of domestic demand to influence the world market price of their products. In many instances, exporters of primary raw materials are dependent on the revenues generated by commodity exports in order to finance imports of other commodities including energy and food products used to satisfy domestic consumption.
As such, the value of commodity imports into consuming markets represents a smaller proportion of total imports. Price fluctuations relating to the commodity imports has a less significant impact on the diversified importing economy than for the exporters which have greater reliance on fewer products as revenue sources.
Paradoxically, industrialized economies also exhibit a comparatively high income elasticity for imports, which applies to commodities as well as to manufactured goods. Discretionary trade in all goods increases as local income levels rise.
The implications of world market trading in primary commodities clearly go beyond the relation of price to volume. Rapid increases in trade of manufactured products increases demand for primary raw materials. As more local economies shift towards the export of manufactured goods, the dependence on exports of single currency trading diminishes.
Diversification of production by economies, which formerly depended on a few primary exports, results is a generalized increase in the world demand for the original commodity products. The result may lead to some demand curve inversion as the market for these products expands beyond any existing supply constraints.
New market structures are emerging in response to economic restructuring of many regions of the globe. This restructuring includes a broad diversification of production for export across the manufactures and capital goods sectors. Diversification of production reduces the proportion of single currency commodities relative to total world trade.
This trend is likely to mitigate price volatility due to exchange rates, across more products and more sources of production. Reduced price volatility results in more stable growth patterns across local markets when long term supply agreements become more assured. Equilibrium in world trade is achieved without impeding competitive pricing mechanisms when prices are determined by more endogenous market forces.