There are more and more signs that the global economy is tanking.
For example, the International Monetary Fund (IMF) just released its October reports, “World Economic Outlook” and “Global Financial Stability Report.” In these texts, the IMF paints a picture where the engines of global growth have stalled. And the economic plane is on its way down. In turn, the responses of central banks, in particular those of the U.S. Federal Reserve, have taken the air out of the plane’s tires—almost ensuring a crash.
Many people will blame the Fed’s tight monetary policy for causing the trouble. In reality, though, the Fed’s restrictive money policy is simply a reaction to inflationary pressures. Indeed, higher interest rates are the standard treatment for deflating inflation. We need to look elsewhere for the causes of inflation.
Cause and Effect
Everyone in the business knows this too well. Pandemic-induced supply chain disruptions, a war in Ukraine, and stepped-up government spending have all combined to create the inflationary times in which we live. Yet, looking back, the Fed was slow to respond to the threat of inflation until they had little choice but to raise interest rates in a draconian manner. And in so doing, risk stalling the economy.
We see the direct effects of the policy and slowing economy in the industry’s excessive inventories. Up and down the supply chain, warehouses are stocked high, a carryover from the explosive economic recovery from the pandemic. Further, a tight labor market and pent-up consumer demand pulled prices upwards as supply chains struggled to meet demand. In response, inventories were replenished. Only now, demand has waned, a combination of satiated consumer desires and inflated prices.
However, as the world is far more interconnected than when inflation last reared its ugly head (the 1970s-1980s), Fed actions have global consequences. Need a handy measure? Check out the value of the dollar against foreign currencies. When the dollar gains value against other currencies, products purchased in dollars become more expensive. Moreover, so much of the developing world’s debt is priced in dollars. As the dollar goes up, so do many countries’ debt payments.
As a result, for much of the world, the costs associated with importing products or raw materials and debt repayments are rising at a time of weakening global demand. No wonder the IMF is worried. They should be. But all the economic chatter may seem abstract, so let’s look at a practical example from our industry, Pakistan.
A Look at Pakistan’s Spinning Industry
Rahim Khimani, a colleague at Gherzi Textil Organisation, shared a statistical analysis with me of Pakistan’s cotton and textile situation. It tells a dire story.
Remember, Pakistan lost more than half of its cotton crop to flooding. Its textile and garment industries were also affected. Nevertheless, undamaged Pakistani mills still need cotton. If domestic sources are impossible to locate, then the only alternative is to import cotton. Contracts for imported cotton are typically priced in dollars. Pakistan has always been a significant importer of U.S. cotton. However, cotton has become more expensive as the dollar has gained against the Pakistani rupee this year.
And there’s another consideration: The U.S. crop was also damaged by drought in Texas. Therefore, there’s not as much U.S. cotton to go around. That will also contribute to higher prices, assuming mills can find available cotton to import.
Let’s look at the cotton and cotton yarn situation in Pakistan: cotton prices rose steadily in 2021—in line with cotton futures—only to lose steam in 2022. Moreover, the rupee has steadily lost value to a strengthening U.S. dollar. The exchange rate, in turn, has helped to make prices for Pakistani yarn more expensive.
New York cotton futures, as listed on the ICE exchange, rose sharply in 2022, building on previous gains in 2021. However, since mid-2022, cotton futures have slumped despite a spike around the time of the flood in Pakistan. Generally, severe weather events, such as those witnessed in Pakistan, translate into higher prices—although that’s not the case according to the futures market as prices have declined.
Spot prices for Pakistani cotton have also followed the general price trends of the futures market. But, we’re left to ponder the question, why?
This brings us to exchange rates. A strong dollar equates to higher input costs for local spinners. As cotton contracts are typically priced in U.S. dollars, prices are magnified when converted to rupees. Indeed, the weaker rupee only accentuates higher input costs for spinners.
But there’s more to consider. As input costs rise for spinners, they pass on those increases to their customers. For 20/1, 40/1, and 60/1 cotton yarn, prices rose in 2021 and jumped significantly in 2022—in line with the stronger U.S. dollar. However, the broader question remains for Pakistani spinners: how much longer will they be able to pass on these costs before the market pushes back?
So here we see the implications of a strong dollar. What’s more, there are implications well beyond the U.S. economy when monetary policy is tightened by the Fed. Today’s world is so much more integrated than it once was. And as the U.S. dollar is used in many raw material transactions, there are implications for textile suppliers worldwide.
Beyond cotton prices per se, we need to consider broader factors. Let’s assume the IMF is correct and the global economy is slowing down, then recession-induced demand will hit suppliers throughout our supply chain. When the significant inventory accumulation we’re witnessing at retail is considered, we face the double whammy of high inventories and waning consumer demand. At the same time, inflationary pressures have many suppliers anxious to pass on higher input costs at a time when downstream demand hits the skids. It’s a tough situation.
Industries—like those in Pakistan—find themselves caught in the middle. And, of course, in the case of Pakistan, we have the terrible humanitarian cost of the floods: loss of life, property destroyed, and livelihoods upended. But, again, a human tragedy suffering from open wounds is only salted by inflation and a weakening global economy. Real-world consequences. Real-world pain.