Why do PIIGS matter to the price of corn in Indiana?

Philip Abbott

Euro Crisis• Unsustainable sovereign debt for

Portugal, Italy, Ireland, Greece , Spain (PIIGS)– 166% of GDP in Greece– High interest rates (risk premiums) for PIGS– European banks exposed to defaults

• Slow economic growth in Europe– Recession throughout Euro zone?

• Weak, volatile currency– Euro may not survive crisis

Debt, Interest Rates, GDP growth in PIGSDebt Interest rates Unemployment% of GDP 10 yr Govt bond** 2011 QIII 2011y/y Oct 2011

Greece 166 32.58 0.2* -5.5 18.3Italy 121 7.14 0.3* 0.1 8.5Spain 56 6.01 0.0 0.7 22.8Portugal 106 12.8 0.0* -0.3 12.9Ireland 109 -- 1.6* 1.1 14.3

Euro area 0.2 1.5 10.3Germany 83 2.06 0.5 2.9 5.5France 87 3.28 0.4 1.6 9.8UK 81 2.09 0.5 0.7 8.3

U.S. 100 2.01 0.5 1.5 9.0Japan 233 1.03 -0.4 4.1

GDP growth

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2.000 US $ Exchange Rates, 2000-2011

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Chinese Yuan

USDA Ag Index

Japanese Yen

Outline• Critical Issues of Euro crisis

– Exchange rates – Devaluation– Monetary Policy – The ECB is not the Fed– Interest rates – Foreign capital flows to a safe

haven, Investment– Fiscal Policy – Austerity– Financial Crisis – more severe than recession

• Does this matter to the US? to agriculture?• Solutions and consequences

Exchange rates – Devaluation

• Devaluation is the primary “cure” for a structural adjustment crisis– Improves export competitiveness– Inflates down debt in domestic currency– Greece can do neither of these

• Fixed exchange rate countries cannot implement independent monetary policy

• Weak dollar and commodity booms• Weak dollar from loose US monetary policy

Monetary Policy – The ECB is not the Fed

• ECB mandate is just to limit inflation– Fed’s includes unemployment

• No Euro bonds equivalent to treasury bills– Which country’s interest rates to control?– Buying government bonds by ECB is controversial

• Inflation and monetizing debt– Printing Euro’s or financing from Germany, France

• Politically unacceptable in Germany– Stabilization Fund

• Bank regulation – there are central banks in each Eurozone country

Interest rates – Foreign capital flows to a safe haven

• Historically, different interest rate policies by ECB versus Fed have been important to exchange rates– Influence investment, capital flows sooner than trade– ECB raised, but is now lowering short term rates

• Foreign capital flows as important as trade flows in transmitting economic shocks across borders– US dollar strength as safe haven– Low interest rates on US treasury bills also due to safe haven/

“risk off”• IMF and Europe

– IMF resources to increase stabilization fund, loans to Greece– European leaders asked for help from non-European nations

(China, Brazil, but not US)

Fiscal Policy – Austerity• Austerity also part of the IMF structural adjustment cure -

conditionality– Brought lost decade to Latin America, protests– Contradicts Keynesian prescription

• Confidence of investors versus stimulus of government spending• Severe austerity in Europe has evidently slowed economic growth

– Even US super committee fallback did a better job of timing deficit reduction

– Solution should be to stimulate growth in short term with a commitment to reduce spending in long run

• Tax revenue strongly related to business cycles– Austerity recession lower tax collections debt increases, deficit targets

not met• Euro zone does not have common fiscal policy

– Social protection varies across countries– Deficit targets and spending cuts

Financial Crisis – more severe than Recession

• Financial crisis and recession not the same thing– Recession without financial crisis, more severe

recession, or depression with financial crisis• Fed, US treasury policy motivated to avoid financial crisis• Euro rescue package – recapitalize European banks

– Bank failures with defaults on sovereign debt• US affected by CDS, Swaps – guarantees on debt

• Financial crisis in 2008/09 brought trade collapse– World trade in 2009 fell 23% relative to 2008– Short term effects more severe in 2008QIV and 2009QI

Does this matter to the U.S. economy? to agriculture?

• Exchange rates, inflation and agricultural prices– Historically a weak dollar and inflation have

brought higher agricultural prices, growing farm income

– Is inflation “contagious”• Recession spillovers?

– Exports to Europe – Worldwide recession– Food is income inelastic

• Financial crisis and trade collapse– CDS and US bank exposure– Agricultural trade not immune to crisis

Economic growth slowing worldwide - IMF

Corn versus Euro’s- stronger relationship recently, overshooting

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Prices Up in 2008 & 2011, but Export demand (volume)is Inelastic, at least in short run

Fiscal year 2008 2009 2010 2011 (Oct-May) 2011V Q V Q V Q V Q V Q

Corn 57% 12% -34% -21% -2% 4% 44% -4% 42% -9%Soybeans 71% 2% -5% 14% 22% 19% 23% -1% 20% -3%Wheat 87% 11% -51% -31% -2% 14% 130% 57% 96% 34%Pork 49% 52% -7% -9% 8% 3% 22% 11% 25% 15%Cotton 11% -5% -26% -7% 35% -2% 149% 49% 86% 13%Total 40% 10% -16% -14% 13% 14% 29% 6% 27% 2%

Price does affect trade value significantly, and Dec 2008 corn futures fell from nearly $8 in July to almost $3 in December,With much of that fall after Lehman Brothers failed.

GDP has influenced trade volume, including agricultural trade, more so than prices

World total exports:

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U.S. Agriculture somewhat more resilient to recession than overall trade – inelastic demand

• From 2008III to 2009II, US trade declines were– Imports 35% Ag Imports 11% Oil imports 57%

(6% in Q)– Exports 26% Ag Exports 19%– Ag trade back to peaks in 2011

www.bea.gov

Quarterly US exports – Total, Ag, Corn and Soybeans – 2005 to 2011:II

2005 2006 2007 2008 2009 2010 2011

Agricultural productsCornSoybeansMeat and poultryExports

Some solutions?• Disorderly break-up of Eurozone

– Export competitiveness with devaluations– Recapitalizing PIGS banks – Debts remain in Euros– Financial crisis likely

• Monetizing PIGS debt– ECB buys PIGS bonds – prints Euros

• Inflation in Germany– Stabilization Fund -- is it big enough, will it substitute for ECB bond purchases?

• Severe austerity– Budget limits in EU treaty

• Do differences in social protection persist?– Recession more likely, more severe– Tax collections fall with recession– Social Unrest

• Rescuing European banks– Voluntary “Haircuts” on Greek bonds – why doesn’t this trigger CDS?– Liquidity, loans from Fed to ECB– Increased capital requirements

Closing Thoughts• U.S. stimulus measures should have meant weak dollar

– Would have brought higher commodity prices– Weak Euro due to crisis counteracted this– Euro austerity more likely to bring recession

• European countries have not delayed budget cuts• Euro crisis has already influenced corn, soybean prices

– Exchange rates, recession, financial crisis– Longstanding problem, but actual crisis would have dramatic effects

• Biggest risk is European financial crisis– Severe austerity means worldwide recession?– But bank failures and financial collapse may again have big effects

on trade, including agriculture• ECB/ Fed moves to provide banks liquidity had most dramatic effects on markets• Fed policy to rescue banks based on fear of financial crisis