International Nonferrous Scrap Flow and Currency Considerations

May/June 1988

The final 1987 data on ferrous and nonferrous scrap exports are in and are prompting many questions. Of major concern are the international scrap flow, the role of the U.S. dollar, and the 1988 outlook for scrap exporters and brokers.

A look at the exchange rates reveals there is more here than meets the eye. For example, is there a consistent relationship between the relative strength of the dollar over time and the amount of metallic scrap that is shipped abroad annually? Why were nonferrous scrap exports expanding fastest between 1984 and 1985, when the dollar was strongest? And, now that the dollar has weakened, what--if anything--does this portend for scrap exports in general?

Scrap Metals Defy Foreign Exchange Logic

Conventional foreign exchange logic states that a strong dollar, relative to other currencies, should inhibit U.S. exports of goods and services. Fewer goods would be exported because foreigners would have to give up more of their currency to purchase "expensive" American-made goods. Conversely, with a weaker or weakening U.S. dollar, American-made goods should seem less expensive to those same offshore buyers; hence, U.S. exports should expand.

But the facts about nonferrous scrap do not fit perfectly with the theoretical scenario. Over the past several years, almost the opposite has occurred. A period of relatively strong dollars from 1983 through 1985 coincided with large yearly increases in scrap exports for most nonferrous scrap metals. In 1987, after the dollar's strength diminished considerably worldwide, most scrap exports, but all nonferrous exports, lost their earlier vitality.

That is not necessarily bad news for the domestic scrap industry since rising prices and solid domestic demand for scrap were recorded in 1987. But what was happening abroad when the dollar was gaining strength?

What a Strong Dollar Means: Setting the Stage

Published reports describe the period from 1983 through early 1985 as one characterized by strong U.S. economic growth, coupled with a sharp reduction in inflation and inflation expectations. The dollar responded by moving higher in value, buoyed by large inflows of private capital from abroad. From a trough in the third quarter of 1980, the dollar appreciated 56 percent in real terms (inflation adjusted) by the first quarter of 1985. Economists believe that this rise in the value of the U.S. dollar was chiefly responsible for world commodity price weakness.

In examining what this period of dollar appreciation did to overseas commodity supply and demand, economists explain that if a metal is quoted in dollars (either on a producer price or free market basis), and if the dollar appreciates sharply (meaning that local currency depreciates), any given increase in the dollar price of a commodity will result in higher prices converted in local currency. The effect of this local currency depreciation results, in theory, in a decline in the terms of trade. Overall purchasing power and, hence, demand for commodities, goes down--industrial input materials, including scrap metals, apparently being the exception.

On the supply side, the effect of dollar appreciation has its greatest impact on the cash costs of producing a raw material. Again, studies show that a depreciation of the local currency in real terms can vastly improve the international competitiveness of the producer of a dollar-denominated commodity--for example, fabricated metal products. In short, foreign production costs depreciate as export selling prices appreciate.

Assuming there is a viable offshore market for the product, the foreign producer can easily justify importing "expensive" raw materials--scrap, coal, ores, and other industrial input materials, for example. The "cost-saving" supply side was thus partially responsible for the increased demand for U.S. scrap during the mid-1980s, despite the seemingly negative effects of local currency depreciation. The logical destination for offshore producers' finished goods was any importing country paying for dollar-denominated products in dollars.

Internationally traded dollar-denominated commodities do respond to government exchange rate policies as well as inherent problems associated with floating exchange rates. What governments do about policies that enhance exchange rate stabilization is quite another matter. It is the view of some that U.S. authorities have shown little desire to actively pursue international exchange rate stabilization. Rather, both monetary and fiscal policies have been geared more to domestic objectives, e.g., reducing inflation. If this is true, this may help in understanding periods of dollar strength (1983-1985) and dollar weakness (1978-1979, and current).

U.S. Markets Hit Hard by Imports

In the mid-1980s, the U.S. economy exhibited impressive growth rates and a substantial rise in import penetration of refined metals, including semis and fabricated products. Imports began taking an increasing share of the American market.

According to research published by Commodities Research Unit in London, copper and aluminum imports to the U.S. as metal nearly doubled between 1973 and 1983. Much of the recorded growth in actual worldwide metal consumption was accounted for by the U.S. In 1984, world refined copper consumption grew by about 620,000 metric tons (mt). The U.S. accounted for over 40 percent of that growth, and Western Europe for only 21 percent, although Europe is actually a larger market for refined copper. Additional aluminum imports in 1984 accounted for almost 50 percent of the U.S. growth in consumption.

U.S. growth rates for aluminum semis and brass mill products were very impressive in the past several years, exceeding the growth rates even in refined metals consumption. The European markets were less buoyant and, as their currencies depreciated, new export opportunities to the U.S. opened. From 1984 to 1985, U.S. brass mills lost a substantial share of their markets to imports from Germany, France, and Italy in commodity products such as brass rod. Nonferrous scrap, which looked relatively expensive given the strong dollar, was being exported at a record rate. European producers of dollar-denominated output found a significant margin buying nonferrous scrap and turning it into value-added products to be shipped where dollars could be obtained in payment.

Effects of a Slumping Dollar; Exceptions Noted

However, since the mid-1980s, most reports on economic growth point to a marked slowdown as dollar appreciation led to unprecedented import penetration and generally stagnant U.S. exports. The dollar has depreciated rather sharply since the first quarter of 1985 and, with the demise of the dollar, export opportunities for the European producers of nonferrous semis subsequently have diminished. Further, European domestic demand for nonferrous metals might not be strong enough to succeed the U.S. as the driving force behind the growth in world metal consumption. Judging by the changes in overseas nonferrous scrap shipments, this observation is proving correct.

An exception to floating exchange rates are those countries (mostly Asian) that have currencies directly tied to the U.S. dollar rate and, accordingly, value their product in those competitive terms. The Korean won and the Taiwanese dollar are linked closely to the U.S. dollar; the Koreans and Taiwanese therefore have an advantage over Europeans in terms of export-led sales of products. Consequently, they are less concerned about exchange rate fluctuations and thus, at times, are more competitive for raw materials, such as scrap. This may help explain the amazing growth in zinc scrap exports over the past five years (see table). Since 1985, Taiwan's share of the U.S. export market for scrap zinc has grown from 45 percent in 1985 to 75 percent in 1986, to approximately 85 percent in 1987. For the Taiwanese, currency considerations are not the only determining factor in purchasing scrap zinc. In point of fact, the Taiwanese also look for higher valued aluminum and copper found in the scrap being imported.

Domestic Demand for Scrap Picks Up

As noted earlier, reductions in the export markets for scrap are not necessarily worrisome--as long as domestic demand for scrap remains strong and steady. Scrap exports were an important safety valve for scrap processors and brokers during the past several years. But today, at least, rising domestic demand for scrap is absorbing tonnages earlier earmarked for export.

The most recent measures of the U.S. economy indicate significant increases in industrial production and capacity utilization rates compared to early 1987. The nation's factories operated at over 80 percent in February 1988, unchanged from December 1987. According to government statistics, the February figure was the highest for that month in almost eight years. Makers of steel and other primary metals saw their operating rates dip slightly to 89.6 percent in January from 91.2 percent in December, but rates are still well above the average for all manufacturing industries. Factory output is clearly leading the economy, and forecasters believe that this is the key to avoiding a recession in 1988.

Considerable attention has focused on the growth in exports of finished goods since last year. While most forecasts point to only "modest" 1988 growth, they also acknowledge that exports are compensating for apparent weakness in consumer spending, particularly in the housing and automotive sectors. Companies are not only finding new overseas opportunities but, equally important, those that once relied on foreign sources are now looking to domestic suppliers. The dollar drop has also encouraged many Japanese and European companies to choose the U.S. for locations.

Outlook for 1988 Scrap Exports