WTF is going on with the Economy?!

WTF is going on with the Economy #122 - Spain and Chocolate

WTF Economy Editors April 02 2024 · 6 min read

Spain’s Bullish Economy

This decade hasn’t been too kind to the European economy. Since early 2020, it’s gone through generation-defining disruption, ranging from the COVID chaos, to the abrupt reshuffling of energy supplies, and the acute threat of deindustrialization.  As it stands right now, the continent’s economy is listless, neither growing nor shrinking. However, not all countries in the old world are living the same story, and in Spain’s telling, the economy is the bull of Europe (olé).

Over the past year, the Spanish economy has been one of the fastest-growing ones in Europe, clocking in at 2.0% annual GDP growth in the last quarter of 2023, far above the 0.0% annual growth rate of the EU.

Spain’s economic success goes down to a few different factors:

  • Less exposure to the heavy manufacturing contraction that is plaguing Germany and other European economies.
  • Digitization policies to build or develop tech and startup ecosystems
  • Higher job growth and creation compared to its peers
  • Increasing real estate value which boosts the wealth of homeowners

These factors compelled ratings agency Moody’s to upgrade Spain’s outlook to positive for the year, while maintaining its overall rating at Baa1, which is right below their investment-grade tier.

Spain’s story is encouraging, particularly as it represents a model for other European economies to follow to stay competitive in a changing world.  There are some caveats to Spain’s current bull run.*

For one, inflation still remains higher than GDP growth. Even if inflation continues to fall, upward price pressure can spell uneven returns for society as a whole. Second, the 4.2% increase in home prices comes from sustained demand that supply can’t keep up with, whether it be due to geographical constraints, politicians not encouraging development and a functioning market, or a combination of both. 

Consumers are incredibly sensitive to housing prices and if those costs don’t go down through increased supply and reduced market inefficiencies, then they won’t believe the economy is doing well, even if the numbers say otherwise. That disconnect can spell bad news all around, particularly for Spanish politicians banking on economic growth to carry their mandate.

* The market bull run, not the physical one held in Pamplona each year. Also, we totally took advantage of the whole “toro” thing to make some puns because we could. 🐂

Cocoa prices are up, and that's bad news for the chocolate industry

Easter just came and went, and if you celebrate the holiday by scarfing down chocolate eggs*, you might have noticed that prices for the delectable treat are up compared to years past.  Unfortunately, we’ll be paying more for chocolate for the foreseeable future.  Here’s why.

Chocolate comes from the refinement of cocoa, a commodity with a global market value of 26.709 billion USD in 2023.  This year’s growing season is particularly brutal for cocoa farmers. West Africa — which produces most of the world’s cocoa harvest — experienced periods of extended droughts then record flooding, leading to the spread of cocoa tree-killing diseases.  These whipsaw conditions created historically poor yields for farmers, and some of the lowest supply situations on record. At the same time, chocolate demand continues to grow, with revenue up 30% since 2020.

These forces are driving prices for the delicious bean to historic levels. However, since cocoa is also a traded commodity, the futures market is adding fuel to the fire. In short, futures or “future contracts” are agreements between commodity producers and buyers to lock in a price today for delivery in the future. The logic goes like this:

  • Buyers of commodities want to have price certainty in the future so they can control their costs. For example, if I make chocolate Easter eggs, I want to have my cocoa prices fixed for next January when my production season starts.
  • Commodities producers and inventory holders want to insure themselves against price falls in the future by creating a contract at a fixed price with a buyer (i.e. writing or selling a contract).
  • If the market price drops below that price the seller will make a bigger profit since they’ll get more money for the commodity in the contract than they would selling it on the spot (aka “spot price.”)
  • To make trading easier, futures contracts are for multiples of the underlying commodity. In cocoa, for example, one contract is for 10 metric tons of cocoa beans.

This above is the gist of how futures work for producers and buyers, although in practice it gets far more complex. For one, neither producers nor buyers hedge 100% of their activity as doing so means they could miss out on potential price gains. (For example, if the spot price of cocoa is higher than what’s in the contract, the producer misses out on a market gain. If the price is lower, then the buyer has to pay above-market prices for their beans).

The sellers of the futures contract take what’s called a ‘short position’ in the futures market as they are long (aka they hold) the physical product. Since a futures contract is for a multiple of the commodity, the seller will need to put up collateral or margin in case they can’t deliver the underlying good; and here is where we’re seeing the market going crazy right now.

As the price of cocoa climbs, future sellers need to add more collateral to meet their margin requirements. Under normal market conditions, this wouldn’t be an issue, since they know they’ll have the cash to cover their obligations when they sell the physical cocoa. 

Right now, though, prices are rising too fast, forcing the sellers to add more and more cash. In many cases, the sellers don’t have that money on hand, forcing them to sell their futures contracts to someone else to cover their costs.  This rapid selling of futures contracts is exacerbating the market, causing prices to rise even higher in what’s known as a ‘short squeeze.’

This isn’t the first time we’ve seen future markets go into such chaos. In 2022, nickel futures went into a rapid upward ascent, taking down a major Chinese commodities producer.  Right now, no chocolate manufacturer or producer has succumbed to market forces, and it’s not clear if one or more will. What is certain is that chocolate is going to get more expensive for the foreseeable future. Good news for dieters, bad news for the upcoming holiday seasons.

* Editor’s note: That’s how it happens in our house.