Development & commodity chains

Travels of a T-Shirt illustrates various aspects of the development dilemma: where do t-shirts come from? First stop: subsidized cotton growing in Texan Panhandle Second stop: weaving fabric & cutting pieces in Shanghai Third stop: sewing pieces together in a Mexican maquiladora Fourth stop: final assembly in New York City (“Made in USA”) Fifth stop: purchase from a retail outlet in Florida Sixth stop: second-hand donation to Goodwill where it is sorted Seventh stop: low value t-shirts sold in markets in Africa Eight stop: rag makers where turned into cleaning rags

What is the difference between a $5 & $90 t-shirt? How revenue from a $40 sweatshirt is distributed What is the difference between a $5 & $90 t-shirt?

Money! http://www.youtube.com/watch?v=rkRIbUT6u7Q

What is “money?” Medium of exchange Store of value More efficient than barter Easy to move Widely accepted Store of value Useful today or tomorrow Can be accumulated Can increase via interest What is money worth (for what can it be exchanged)? What is the value of money (what prevents its decay or depreciation)?

What is money worth? Whatever it can buy “Exchange value” quantity of money for goods “Use value” is utility of specific goods “Fungibility” in range of goods for which it can be exchanged We assume money’s worth remains constant Increase in supply of money needed for growth As supply grows, value of money decreases But too much decpreciates its worth & value

What is the value of money? Wealth is accumulated as money or things with exchange value How can wealth be maintained or increased? Precious metals or jewels have been one store of value But value increases only in relation to demand & inflation Money can be invested to make more money—”rate of return” “Interest rate” is the return on money for deferring use today Investors seek high rates of return—higher than bank rate They are always looking for such speculative investments More on this Monday

Growth in the money supply facilitates economic growth Constant money supply limits economic growth High interest rates, low investment, fewer jobs Some inflation fosters economic growth Too much money chasing too few goods inflation Then value of debts & money decrease Saving too much leads to less money, deflation & recession Borrow & spend today rather than saving for the future This means borrowing against future income & resources

Growth in wealth is said to be good… Adam Smith: production & exchange generates wealth—better than mining or theft Goods are made at one cost & sold at a higher price--profit Remember that buyers must have money to buy goods & transfer it to sellers. Therefore, buyer needs reliable supply of funds to acquire goods Labor sold for wages in the most common way this happens Labor receives less in wages than it pays for the goods it buys The difference is profit, which is reinvested in production of goods And such circulation of money fosters growth in the economy

All of this takes place within countries What about exchange among countries There must be a common unit or medium of exchange, valued in terms of domestic currencies Medium of exchange is also used as a unit of account Trade & exchange undertaken on basis of this unit Gold played this role for much of recorded history Trade took place in gold or gold-backed currencies or in silver World supply of gold is limited, and silver is cheap Global money supply was limited by quantity of gold Bretton Woods currency system sought to increase global money supply U.S. dollar backed by gold became medium of global exchange US has “seigniorage”: it can create $$

To trade, countries need dollars After WWII, U.S. injected gold-backed dollars into international circulation Global economic growth depended on growing supply of dollars But too little gold in Fort Knox to sustain dollar supply In early 70s, dollar “went off gold,” with market setting exchange value Since then, exchange value of dollar has depreciated But dollar remains unit of exchange, value & account

Int’l commodity prices mostly set in dollars “Hard currency” countries exchange for dollars “Soft currency” countries must earn dollars via trade Earnings are related to world price for their goods Dollars are used to buy hard currency goods & commodities Shortage of dollars means fewer such goods are available If prices rise, producers earn more; if they fallearn less This can cause domestic recession What if countries earn more dollars than they need? Tend to put them in Northern banks or “sovereign wealth funds” to invest outside of home country

This is where finance & speculation come in Money should earn as much money as possible Any surplus is put into high-return instruments These return regular interest payments Higher interest implies greater risk speculation Related bonds & securities may rise in price if investors seek high returns Both underlying assets and paper rise in value But this creates “asset bubbles,” which can burst & vaporize funds

“Real” economy vs. “speculative” economy “Real” economy involves exchange in goods & services “Speculative” economy involves investment in stocks, securities, bonds, paper “Paper” is linked to future earnings of underlying “real” assets As real economy grows, so should future earnings, and value of paper should also increase This is much like a Ponzi Scheme But it may also divert excess money away from real economy & limit inflationary tendencies If economy stops growing, this implies static future earnings and lower returns Then, holders of paper may seek to exit speculative markets, causing value of both assets & paper to collapse So, why is the stock market doing so well?

Relationship of “real” to “speculative” economy