Tuesday, May 12, 2009

Commodity recap: strong price gains

With few exceptions (e.g., wheat, corn, cattle), commodity prices have risen significantly this year. I think this reflects a fundamental improvement in the global economic outlook. Demand collapsed briefly in the fourth quarter of last year as the banking crisis sowed general panic, but it has now firmed and is likely picking up as economic life slowly returns to normal. It also reflects, as is strongly suggested by gold prices, that monetary policy is quite accommodative. Money is plentiful, and as demand and confidence returns, we are seeing some renewed interest in commodity speculation and stockpiling.

The rise in commodity prices is thus a reflection of renewed economic growth, as well as a precursor of higher inflation. Gasoline prices at the pump have jumped almost 10% this month, and since gasoline is about 5% of the CPI, that alone could give the CPI a boost of 0.5%.

I think it is very hard, in the face of this price action, for the Fed to argue that policy needs to be super-accommodative for a prolonged period in order to ensure that the economy avoids deflation and/or depression. If the Fed were following a commodity standard, they would already be taking steps to withdraw the liquidity they have injected in the past 6-8 months. By ignoring the signal of market-driven prices, and instead worrying about the supposed fragility of the recovery, they are making yet another monetary mistake.

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