As I have said before, the value of the dollar matters.
The value of the dollar matters in a grand sense because of purchasing power. The pertinent question being: Does my dollar buy more or less goods and services today than it did yesterday?
As consumers, it is natural that we would want the value of the dollar to increase. Having a more valuable dollar, year in and year out, is like getting an automatic raise every year. Last year we were able to afford a fictitious 20 units of goods and services – this year we are able to afford 25 units.
However, the perspective of the consumer is not my issue. My issue is the contradiction in the value of the dollar for cotton growers. Specifically: Should cotton growers prefer an increase in the value of the dollar or a decrease in the value of the dollar?
As consumers of nearly every good and service that the modern economy has to offer, as well as consuming ever expensive farm inputs – I would think that cotton growers should favor a higher value dollar. However, and I have this discussion with growers, both large and small, all the time;
In regards to their crop, American cotton growers should favor a lower value dollar.
The reason for this is that as the dollar is worth less, it takes more dollars to buy the same amount of cotton – i.e. prices rise. Also, the majority of cotton grown in the U.S is exported overseas. As late as the 2011/2012 growing season, when U.S. cotton growers produced approximately 15.6 million bales – about 11.6 million of those bales were exported.
This matters because foreign buyers must pay U.S. dollars for U.S. cotton. And when the value of the dollar is higher – relative to other currencies – it makes U.S. cotton more expensive to foreign buyers. And the more expensive it is for foreigners to buy U.S. cotton, the lower the dollar price of U.S. cotton must fall to compensate for this pecuniary difference so that U.S. cotton is price competitive with cotton grown in Brazil, India, China, or anywhere else.
That makes sense, a priori, but again, what does the data say?
Well, to find out I went back and correlated the ICE Dollar Index with the ICE Cotton Contract using weekly data from 16 February 2007 – 22 August 2012. Due to some indexing issues, I correlated their respective percent changes. There were 288 observations.
If our logic is correct, the data should confirm our prediction that: Overall, the higher the value of the dollar, the lower the value of cotton. And it does.
I found that the two variables have a correlation coefficient of: -.429, denoting a moderately negative relationship.
In relation to the coefficient of determination, it can be said that: “18.4 percent of the variation in the price of cotton can be explained by the change in the value of the dollar.”
Maybe most important however, is our final coefficient. Our rough back of the envelope model has a coefficient of -3.27.
This can be interpreted as: “On average, a 1 percent increase in the value of the dollar results in approximately a 3.3 percent decrease in the price of cotton.”
With respect to other currencies, in the first half of 2012 the value of the dollar was actually up. In fact going back from March 2011 (when we were at $2 cotton) – August 2012 the value of the dollar was up nearly 8 percent.
If our simple model’s coefficient is assumed to be close to the actual coefficient, this means that approximately 26 cents worth of the fall in the price of cotton from $2, to where it sat on August 2012, can be accounted for simply in the dollar’s increase in value.
Now, however, the story has turned around. From January of this year through nearly the end of September the US dollar is essentially flat. What happened you ask? QE3 happened.
QE3 is the abbreviation for the Federal Reserve’s third round of “quantitative easing,” which is just massive purchasing of financial assets with newly created money. Read: Inflation. QE1 and QE2 were ineffective. So why not try it a third time?
So, what should cotton producers prefer? A lower valued dollar and higher prices for their crop – with more expensive input costs (and goods and services) coming around the corner – or – a higher valued dollar and lower prices for their crop – with the prospect of cheaper input costs (and goods and services) nearby.
It is my sense, to the detriment of American consumers and savers everywhere, that the American cotton grower should prefer a lower value dollar. This is because, as we have seen, the lower the value of the dollar the higher the dollar price for cotton will be.
There is no doubt that with a lower value dollar, input prices and living costs will rise as well. However, this rise will most likely be tempered from the cotton producer’s perspective by the temporary (if only mildly temporary) stickiness of some consumer prices – a fact that is not an issue in commodity markets.
Never forget that cotton is a global market. Never forget that you are to a large extent an international exporter – and foreign nationals are your customers! Most importantly, never forget that both monetary and fiscal policy decisions both at home and abroad matter.
Be smart. Know your costs. Be the lowest cost producer around – and when the price works for you – don’t be afraid to hedge or sell!
First published by Cotton Grower Magazine under the title: Cotton Prices and the Value of a Dollar.