2. Literature Review
2.4. Equipment Prices and Other Financial Market Indices
However, just because the US equipment industry is not a monopoly, it could be the case that this targeted increase in supply which does not meet true equilibrium is collusion (technically still a limit on supply, but just in the change of supply). Therefore, it could still be argued that taking time and the change in time, there is still a decrease in the supply since firms are failing to increase supply sufficiently enough to meet demand. Since this is the case, it must still be considered that the US equipment industry is still suffering from oligopolistic conditions.
2.4. Equipment Prices and Other Financial Market Indices
It could be the case that machinery prices are also heavily impacted by commodity input costs such the cost of fuel (Cartwright et al., 1989, pg. 79). Most manufacturing plants require fossil fuel-based energy in order to power these plants, even in the advanced economy of the United States (Ram et al., 2017). Additionally, Equipment prices in the power sector were using data from January 1996 until December 2003 and data from January 2004 through December 2007 found that price increases were primarily due to the increase in the demand for oil (Pauschert, 2009, pg. 3). This increase in oil peaked during the bubble of global asset prices commonly referred to as the 2008 GFC. These financial trends also happened to coincide with an overall rise in US CEPs (Federal Reserve Bank of St. Louis, 2019) which suggests that commodity prices are much more reactionary in the short-term to financial conditions than equipment prices. However, research has found that there is only a two percent increase in prices of construction machinery from oil shocks which, compared to other asset shocks, was substantively insignificant (Lee and Ni, 2002). Since the results of the data provides different results over different periods of time, it is difficult to determine the degree to which petroleum products or the trade weighted dollar (DXY) – impacts CEPs.
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equipment and other machinery are primarily made out of steel and iron which have in the past decade suffered from dramatic volatility in spot prices (Dwyer et al., 2011, pg. 49). Furthermore, commodity prices such as steel have also been found to be related to machinery prices in the power industry (Pauschert, 2009). This may therefore also be the case as well in the construction equipment market. Without a doubt though, the price is steel is strongly significant in the overall cost of construction (Masur et al., 2016). Steel is undoubtedly a major input in the building of roads, bridges, buildings, and other structures. Because of this, it would not be surprising to find that the price of steel is correlated with CEPs from construction spillover effects.There may also be an impact on CEPs related to the exchange rate. While the production of construction equipment itself is not necessarily subject to exchange rates, the price of inputs which are imported into the US and implemented or used in the production of construction equipment are of course impacted by the exchange rate. Goods and the cost of inputs on the international market are subject to foreign exchange costs. When the US dollar is strong relative to its trading partners currencies, then the cost of imports is lower and conversely these costs are higher when the dollar is weaker. As a general rule of thumb though, a strong DXY is a reflection that investors or potential investors (regardless of what industry they are in) prefer to hold onto those dollars as opposed to spending them. Furthermore, there is a long-standing inverse relationship between the DXY and commodity prices (Bai and Koong, 2018). Moreover, when the DXY is stronger, then international goods may be more competitive to import against domestically produced goods. Undoubtedly, US imports have incurred the cost of foreign exchange for several decades and the relationship between nominal imports and the exchange rate is strong and statistically significant (Hooper and Mann, 1989). Additionally, it has been found that before the
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Considering these implications in the literature, it may be the case that this variable could be a determinant of CEPs.
Even though the empirical record is relatively clear on its relationship between capital inflation or deflation and financial markets, the reason as to why this is remains murky. The relationship between capital inflation or deflation and equity markets is clearer as it there are more direct components to the influx of money into firms which allows for them to invest more into capital. However, why would there then be strong relationships between other financial markets and these prices? It seems to be the case that many financial markets are correlated with one another. As previously mentioned, the DXY and diesel or oil are highly negatively correlated.
Many other correlations exist as well though.
Probably the most notable correlation in financial markets is that between currencies and equities which could impact equipment prices. Without a doubt, the strength of the currency is a reflection of the demand for that currency. However generally speaking, two main competing theories provide a framework through which to analyze the relationship between equity markets and foreign exchange markets. The first is the goods market hypothesis (Dornbusch and Fischer, 1980) which asserts that exchange rate fluctuations have a significant impact on the competitiveness of firms which conduct business internationally (most larger firms in today’s world) which in turn impacts their equity prices. If a local currency is weakened, then its goods are more enticing for foreign buyers which leads to higher sales. Naturally then, the value of these exporting firms increases. Exporters also are affected by price fluctuations of exchange rates in terms of their future payables that are denominated in foreign currencies. This is also how the
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The second main explanatory ideation on the relationship between foreign exchange and equity markets is relatively contrary to the first ideation. That is to say, those of the ‘portfolio balance approach’ (Branson 1980; Frankel and Dickens, 1983) reminds us that money itself is an asset with an intrinsic value and is used as a portion of a portfolio. Because of this, foreign exchange rates are also determined by market forces. As can be simply understood through the basic framework of supply and demand, a currency’s nominal rate can fundamentally be determined by capital inflows and outflows. When a currency is more sought after for the use of purchasing stocks, bonds, or for conducting business in the country, the value of the local currency strengthens. In contrast, when foreign capital flows out of international equity or bond markets and convert the local currency back to their foreign currency or into another currency, the value of the local currency is weakened. Foreign investment tends to increase over time through the model of portfolio diversification as well which has led to the in general weakening of the dominant global currency, the US dollar since the 1980s. In sum, equities lead currencies.
It may also be the case that both equities lead currencies at some points in time and then the correlation changes for the currency to lead equities. Mok (1993) uncovered a dual directional relationship between causal relationship between global currencies and equities in Hong Kong, a city with one of the most advanced and liquid financial markets in the world. Moreover, this relationship between equities and currencies is not always constant. Adding onto this initial finding, a causal relationship between stocks and currencies was found to be present in the short run, but not the long run (Bahmani-Oskooee and Sohrabian, 1992; Nieh and Lee, 2001).
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Regardless of whether currencies lead equities or whether equities lead currencies, it can be generally surmised that when the demand in a particular currency rises its strength rises which is in turn likely the manifestation of the desire for investors to either invest into that economy whether it be in equities (the most common financial investment), that country’s bonds, or capital in that country in order for business to establish infrastructure. Spillovers of volatility between both markets may increase the international portfolio risk faced by international investors. This reduces the opportunities from international diversification and disturbs the asset allocation decisions. Rapidly increasing international equity investments creates a higher supply and demand for currencies, leading to some degree of interdependence between both markets.