Guoqing SONG: Terms of Trade, the Interest Rate and Exchange Rate


 date:2010-6-12 10:55:00 source:BiMBA         

Guoqing SONG
Professor of National School of Development


China's terms of trade have worsened for years since 2002. Only during the financial crisis did the terms of trade improve due to the precipitate drop in crude oil, iron ore and shipping prices. However, good times don't last long. Now the condition has worsened to a state comparable to 2008, and could continue worsening in the near future.

Compared with the situation with unchanged year-on-year growth in import and export prices, the worsening of terms of trade in Q1 caused a loss as large as 4.9% of the quarterly national income. The change in terms of trade was induced by China to a large extent. If China maintain its GDP growth at 7% instead of 12%, the national income growth might raise to 12%. The worsening terms of trade have partially turned into the relative rise in residents' consumption and investment price index. Households have swallowed most of the loss from the worsening terms of trade.

The interest rate is a crucial factor in determining the price of raw materials like crude oil. Under a high interest rate, oil producers would speed up oil-drilling to sell it for monetary saving. Under a low interest rate, they would keep oil underground in reserve to wait for price rise.

The interest rate also played a major role in metal prices' trend-reversing hike in recent years, besides shocks from China's urbanization. In the short run, the low interest rate affects the metal prices through inventory-building. The more important channel is, the low interest rate pushes up the real estate prices and stimulates investment in the residential buildings and the related areas.

Grain provides a good lesson in China's recent history. The inventory-induced price dynamics mean that the price will fall due to de-inventory exactly the way that it is pushed up by inventory- building.
 
 
 
 
 
 

 
 
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