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Could The Cotton Crash of 2022 Signify The Next Recession?

Worried about the economic outlook? Then, buckle up because the cotton market has called the next recession, which may already be upon us. Let me explain.

So, I was in a bar last week. Had too much to drink and collapsed on the floor. Struggled to get up. Fortunately, some patrons helped me to my feet. I've been woozy ever since.

This describes cotton since late June. Soaring prices that defined the market for much of this year showed that cotton had imbibed too much. Weightless intoxication turned into a physics lesson on gravity, as cotton lost practically a third of its value on June 24th. The question remains, though, if there are any patrons to help the market recover -- let alone get off the floor? Let's see.

Gradually, then suddenly

No one saw the crash coming, and that's perplexing. For sure, analysts anticipate market fluctuations all the time. But crashes are a different thing entirely. Indeed, market crashes are a little like what the character Mike Campbell said in Ernest Hemingway's novel, The Sun Also Rises. When asked about bankruptcy, Mike answers, "Two ways: gradually, then suddenly."

So, cotton is suddenly worth about a third less than it was the day before. But wait! Hasn't the world economy entered a period of high inflation? Of course, it has, but there's more to the cotton story, and it's a bit complicated. So, let's begin with market fundamentals, assess what we see in the farm-side supply situation and then examine the demand side of the cotton market equation.

Down on the farm

Here's what we know about the current crop globally:

1. There's a prolonged drought in Texas.

2. According to a government mandate, raw cotton cannot be exported from India.

3. According to government laws and regulations, the use of Xinjiang cotton is restricted in many countries.

4. World inventories of cotton are down thanks to pandemic-induced pent-up demand.

Together, these add up to higher cotton prices: restricted supply struggling to keep up with accelerating demand. What's puzzling, though, is we still had the crash.

All things being equal, it's not surprising that cotton prices rose this year. But these days, things are no longer equal: We have a pandemic, war in Europe, geopolitical tensions, stress on international supply chains -- and inflation. Uncertainty is the net result, which typically results in higher commodity prices. But we just witnessed a crash in cotton prices.

Cotton, however, is a leading indicator of downstream demand, as it is sensitive to changes in the textile and clothing businesses. Moreover, if retail sales weaken, lessened demand for inputs ripples back upstream — like during an economic recession. We may not technically be in one, but I fear the cotton market is telling us to get ready.

The demand equation: inventory is a problem

Many of my friends in the clothing business complain about elevated inventories. It's a sign of waning demand for clothes. These inventories comprise a mix of older products that couldn't make it to store shelves on time during the pandemic, along with new products.

Yet these higher inventories come after a period when consumer demand outstripped the ability of global supply chains to fulfill consumer appetite for new clothes. It was a rebound from the economic doldrums of the pandemic; only now consumers have moved on to buy other things.

We've all heard about the problems at the ports, disrupted supply chains, product shortages, and so forth. It seems that supply has managed to meet demand just in time to find demand dissipating. An irony, I suppose. But it's also the effect of inflation on consumer purchasing.

Other products and services, like travel, have edged out clothing as must-have items for many consumers, particularly those on limited budgets. It's a question of priorities. Moreover, we now have consumers of clothing less willing to pay more because of inflated prices. Hence, their purchasing moves down market; they trade down. Cheaper products will do when, for many consumers, that was never previously acceptable.

Bottom line for brands and retailers: Get used to a changing consumer environment while inflation remains high along with higher inventories. Like raw materials, stocks will reflect higher costs on a brand's balance sheet. But this is an example of the distorting effects of inflation. Even though it will be harder to sell products to skittish consumers because of rising prices, the raw materials, and the push from the supply chain to make more stuff will squeeze retail sellers, even more, creating a cycle that may prove hard to break.

Will central banks overdo it?

There are signs that central banks -- such as the Federal Reserve and European Central Bank -- may go too far to control inflation and trigger a recession. No one really knows what the breakpoint is for higher interest rates. Nevertheless, the waiting game creates a climate of uncertainty.

Look at the stock markets lately. Gosh, talk about volatility. Indeed, market uncertainty encourages investors to cash in their positions to lock in whatever profits they can, pull into port, and wait out the storm. In the case of the cotton market on June 24th, that's what happened. Uncertainty leads to fear -- which in this case is fear that future demand for cotton will be sharply lower because of a weaker overall economy or a recession. So, folks dumped their positions and called it a day.

But if you're a textile mill, you may ask: Do we care? After all, lower cotton prices are better for us, right? Maybe, until they're not. But it's too early to rejoice. The cotton market is forecasting an economic slowdown, a recession. It doesn't matter how cheap cotton gets (or competing polyester, for that matter) if consumer demand crumbles -- along with your textile sales.

Yet, here's something else to consider (as a consolation): if inflation-induced prices result in lower demand, central banks may not have to take draconian steps to control inflation. Instead, the market will take on that load, a "soft landing" in economics-speak. A place where production and sales continue, albeit at a slower pace, but prices moderate due to easing product demand avoiding the need to impose stiff interest rates to knock down the market, literally choking the breath out of the economy and, in so doing, cripple consumer-facing industries like apparel.

So now what?

During the pandemic, cotton prices fell for a time when the cost of textiles and apparel soared. It appeared to be a puzzling disconnect, but it was more of a measure of the coming supply chain snags downstream than raw material related, as imported products reflected prices from orders placed months earlier.

And then, there was the surge in shipping costs and then delayed consumer demand as the effects of the pandemic sorted out. Demand then outstripped supply, so the industry went from canceled orders to failing to meet enormous consumer demand. Stuck in the middle was cotton, which simply fell back in the face of uncertain demand.

In time prices will moderate but only after a period of economic pain as the supply chain readjusts and demand falls back in line with supply. But which will also result in lower product prices and an economic recession.

How deep such a recession could go will affect employment, sales, etc. Indeed, the wage gains seen over the last few years are not keeping up with inflation, so perhaps we're at the cusp of a recession already.

And there remains the worry of stagflation. Welcome to the 1970s. Gosh, will bellbottoms return? Let's hope we can not only avoid lousy fashion but, more importantly, avoid low economic growth coupled with high inflation.

We'll need more data before we know whether inflation will be tamed simply with a few taps on the brakes or if more aggressive actions are required. All we know is that volatility is with us, and there's no sign yet that price volatility has moderated. Supply and demand remain out of alignment. Inflation remains a central economic problem. So choppy water metaphors are appropriate.

A last comment

But there is a point of consideration when analyzing the demand side of the market for cotton: Consumers are trading down from department-store-grade clothing to discount goods because of inflated prices.

Yep, cheap, fast fashion survives and thrives. And now there's hyper-fast fashion. From out of the ashes of the pandemic economy, we now have fast fashion on steroids. Yikes. It won't do the planet any good, that's for sure.

Inflation plays a role in this perversion. So, prices get too high? Then figure out a way to sell products faster and cheaper to grab all those consumers trading down on their purchasing.

The odd thing is if we end up in a recession, or worse, then low prices won't matter as much as demand for products and services will dry up except for essentials.

Too bad we don't know if there's anyone around to help us up from the bar room floor.

Originally published in on July 8, 2022.

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