When commodities trade globally, events in one corner of the world can affect people profoundly in another corner. So the next time I am in one of the iron mining towns near Lake Superior, I might see people checking prices from the new iron ore exchange announced by China earlier this month.
I was struck by this phenomenon six years ago when, trying to file a column while traveling in Brazil, I found myself in an Internet cafe in a small city in the state of Goias, watching price quotes on soybean futures from the Chicago Board of Trade crawl across a display above the coffee machine.
Changes in Chicago Board soybean prices can have as large an effect on the farmers around Caldas Novas, Brazil, as around Decatur, Ill. And changes in spot prices for iron ore at Chinese ports can have as great an effect on Minnesota’s Iron Range as on mining areas of Brazil or Australia.
Whenever a relatively standardized commodity is traded internationally, it is overall global supply and demand that primarily determine prevailing prices anywhere and the quantities produced and used.
That is introductory microeconomics, but its implications seem to elude people who should know better.
Witness recent reports about political and military tensions in the Persian Gulf and the possibility of either an embargo on Iranian oil exports or the closing of the Straits of Hormuz to tanker traffic. Several such reports emphasized that the United States gets virtually no oil from Iran, and only a limited amount from the entire Gulf, but that larger fractions of Europe and China’s imports do come from there.
This is an interesting detail, but not a very important one when it comes to evaluating the effects of conflict in this region on gasoline prices or the U.S. economy. If conflict arises, prices will rise here about the same as in the rest of the world, even if few specific barrels of Persian Gulf oil come to our country.
There are limits to the “one world market” phenomenon. In case of a world war involving use of submarines, for example, the fact that nearly half of U.S. imports come from Canada, Mexico and Venezuela would be an advantage. China, much more dependent than the United States on imports through hard-to-defend sea lanes, would be very vulnerable.
Moreover, crude oil is not entirely fungible. Some refineries are set up to handle only certain grades of crude and might not be able to process oil from other-than-regular sources. And although global oil markets are highly efficient, adjustments never take place as instantaneously or as smoothly as in econ textbooks.
So price and availability reactions to supply disruptions can vary among different locations in the short run.
It is clear that Chinese officials don’t fully understand the implications of fungible commodities, either. The unstated purpose of their newly announced iron ore exchange is to reduce the pricing power of the three big mining companies, one Brazilian and two Australian, that dominate world trade in ore. They want a more open market.
Even so, the Chinese are very suspicious of futures and options in ore prices and stipulate that their new exchange will not allow such derivatives trading.
They cannot ban such trading worldwide, however, and if hedgers and speculators elsewhere want to enter into private forward or options contracts, there is no way the Chinese government can stop them.
To the extent that futures trading ever feeds back into spot prices, it might feed back into prices on their new exchange.
ED LOTTERMAN Economist who teaches and writes in St. Paul, Minn.
Write Edward Lotterman at ed@edlotterman.com.
