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Explaining Metals Prices.

By Paul MacAvoy, The Netherlands: Kluwer Academic Publishers Group, 1988, pp. 145, $47.50.

AS ITS TITLE suggests, this book will be of particular interest to those who follow the markets in metals, especially aluminum, copper, lead, zinc, nickel, molybdenum and steel. It is also of general interest to the readers of Business Economics as a good example of the kind of studies consulting economists are asked to prepare.

MacAvoy's research focused on the behavior of annual average prices for those metals during the period of 1970-86 to determine the reasons behind their sharp downturn in the early 1980s. During the 1970s, metals prices had risen as fast as, and sometimes faster than, the general price level. From 1980 through 1986, however, these prices declined relative to the general price level in all cases and in absolute terms for most of them. The relationship between the business cycle and metals prices was also broken, since from 1982, there was a sustained increase in the level of world economic activity.

In studying the sources for the downturn, he presents two analytical approaches. In one, the assumption is that markets were moving toward equilibrium. Changes in supply and demand caused prices to adjust to new, lower, equilibrium levels. In the other approach, the collapse was the result of continuing market disequilibrium. Changes in supply and demand caused an ever-increasing gap between them, pushing the prices down. The disequilibrium scenario was as follows: With the decline in inflation in the early 1980s, manufacturers reduced their inventories. As the general price level stabilized, the prospective gains from holding these inventories fell further, causing more reductions in inventories resulting in another decline in demand. Meanwhile supply was increasing as new, government-owned producers in less developed countries expanded output even as prices fell. This was attributed to an effort by them to maintain gross cash receipts in order to meet fixed, politically determined payrolls.

Because these prices tend to move together, he was able to develop a metals index, thus simplifing the analysis. Supply and demand functions were constructed and then each variable was tested for its sign and level of significance. The four variables were: the level of industrial production, the general price level, the volume of inventories, and the relative strength of the dollar. He found that they had the signs predicted by the equilibrium model and all the coefficients were significantly different from zero. However, the level of industrial production had a much smaller impact than the other variables. As expected, an increase in the inflation rate resulted in higher metals prices. On the other hand, the larger the beginning of the year stocks or the greater the relative value of the dollar, the lower metals prices would be. The price equation based on market equilibrium explained most of the behavior of prices during the period. The runup in the 1970s conformed to the era's demand expansion. The decline in the 1980s coincided with a decline in demand due to the slowing in economic activity in the early 1980s, but it was aggravated by what appears to be a permanent increase in the use of nonmetal substitutes in some manufacturing processes. Of greater importance were the increases in inventories and the additions to capacity in the third world. That expansion was encouraged by the strengthening of the dollar, because it added to their profit margins. The collapse of metals prices was an adjustment to a new, lower equilibrium price level. The markets were not dominated by inventory speculation and politically determined levels of supply as postulated by the disequilibrium model.

While the equilibrium model explains more than two-thirds of the year-to-year variations in prices, it does not adequately interpret the very sharp decline suffered by aluminum, nickel and molybdenum in the early 1980s. Those markets were special cases because they experienced competitive shock. Previously they had been dominated by a few large, North American producers. Encouraged by the high dollar, third world, low cost producers gained market share by selling in dealer markets at whatever terms were available. The broke up the oligopolies pushing prices for those metals to lower, competitive levels.

In general, MacAvoy contends that the prices of all seven metals will not soon rebound to their 1970 heights because structural changes affecting supply and demand are permanent, and he expects no sharp increase in inflation. He predicts that any price runup in one metal would be of limited extent and duration.

This book can be read on two levels: for a general understanding of those markets and as a road map for the future by a market participant. The arguments are clearly developed making the reading easier than expected, a definite plus when such a study is destined for noneconomists. In part, this is due to the extensive footnotes that are used to refer to situations in specific markets or to flesh out an argument. Although they could be ignored by the casual reader, placing them at the bottom of the page greatly facilitates their inclusion into the general understanding of the material. The liberal use of tables and the nontechnical explanation of the econometric methods help make the analysis readily understandable.

Considerable space is devoted to government controlled output in less-developed countries but not to the output of second-world countries with centrally planned economies. Some of that production finds its way into world markets and it would be of interest to determine their ability to disrupt any of these markets should their need for hard currency cause them to dump supplies. Except for some passing references in footnotes, one is left to infer that neither the USSR nor China could have a discernable impact on these markets. A short section in the body of the book explicitly spelling out their positions would have been a useful addition. Other than that, this book is a comprehensive and comprehensible treatment of the subject.
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Author:Landry, Carolyn K.
Publication:Business Economics
Article Type:Book Review
Date:Jan 1, 1990
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