Thursday, November 11, 2010

Commodity prices point to ongoing recovery and rising inflation

Crude oil is now trading at a post-recession high of $88/bbl (first chart). Many non-energy industrial commodities (second chart) are now trading at all-time-high prices. With few exceptions, almost all commodity prices are rising: soybean prices, for example, have jumped 50% since last June. This is not the stuff of double-dip recessions, nor is there even a hint of deflation in these facts. The only legitimate question is whether the rise in commodity prices is being driven by accommodative monetary policy (i.e., too much money) or strong growth in global demand (i.e., the forces of recovery), or by some combination of the two.

I've been arguing for awhile—since early last year—that rising commodities are an excellent portent of recovery. We've seen lots of confirmation of recovery since then: strong growth in corporate profits, rising equity prices, rising federal revenues, rising auto sales, rising incomes, rising jobs, rebounding global trade, and declining swap and credit spreads, to name just a few.

I've also argued repeatedly that higher commodity prices are symptomatic of accommodative/inflationary monetary policy.

This next chart shows that the dollar has been highly inversely correlated with commodity prices since mid-2001 (-0.85). Not coincidentally, 2001 was the year in which the Fed started to ease after tightening so much in the late 1990s that the dollar soared and commodities collapsed in the early 2000s. Gold began rising in early 2001, at about the time the Fed first started easing, and commodities started rising by late 2001. The Fed kept interest rates exceptionally low from mid-2002 through mid-2004, during which time the dollar fell sharply and commodities rebounded strongly. I think this all makes the point that the Fed's monetary policy stance has played a strong role in the evolution of commodity prices for many years now, and that therefore the latest rise in commodity prices is due at least in part to easy money and thus a portent of rising inflation.

The rise in commodity prices which began early last year has not been nearly as well correlated to the dollar (-0.36) as it was in the mid-2001 to late 2008 era (-0.87), which in turn suggests that there have been other factors at work since early last year that have been more dominant, namely the forces of recovery.


septizoniom said...

would you ever concede that perhaps they portend as much as the rise in the market portends: federal reserve manipulation of asset prices?

Scott Grannis said...

I have no problem saying that accommodative monetary policy has contributed to higher commodity prices. But I don't think that's the same thing as saying that the Fed is manipulating commodity prices. Easy money tends to increase people's demand for tangible assets as it erodes their demand for financial assets, and that in turn tends to result in higher commodity prices. But it is a convoluted process.

On the other hand, I would say that there is now evidence that the Fed is manipulating bond prices, by artificially depressing yields on short- and intermediate-maturity bonds through its purchases of Treasury securities.

John said...


My brother-in-law is an engineering consultant in south Florida. He e-mailed me this evening that he is seeing several large projects he has been involved with that had been previously delayed re-starting. He is seeing a decided increase in his (very cyclical) workload. He also reports the restaurants in his area are very busy...even on weeknights.

All anecdotal but unmistakable.


No disrespect intended but are you now beginning to rationalize the obvious? And is it not the Fed's role, by law, to buffer the economic cycle?

Jim said...

What about the possibility that the rising prices have nothing to do with domestic demand and more for overseas - like China with 4 times our population?

Scott Grannis said...

China is certainly a major consumer of commodities, so it could be a significant factor determining commodity prices. But the U.S. is still the biggest economy by a long shot. What impresses me is the fact that just about every commodity under the sun has risen in price significantly. Whenever an entire asset class moves up or down, I think there must be a common denominator reason(s) that affects consumers and producers all over the world, and the easiest ones to find are monetary policy and global growth/recovery.

Benjamin Cole said...

With unit labor costs falling by 1.8 percent a year (third quarter y-o-y), and with commercial real estate of all kinds--warehouse, retail, office--giving away space, and aggregate demand weak, there is no inflation on the horizon.

Scott, how can we have inflation with unit labor costs going down (see DoL report 11/4)?

My roundhouse guess is that 80 percent of business costs (labor, rent) are down from last year. Health care is probably up.

Commodities are back to there they were before the great Bush Jr. Econo-Poisoning. They have reflated.

Would the same happen in real estate.

There is every indication that commodities are driven by emerging market demand, and speculation (NYMEX). US monetary policy is peripheral.

BTW, China is largest consumer of steel, and India the largest consumer of gold.

Scott--how far back was your first post predicting inflation? And what has happened since? We are running at 0.8 percent core CPI now, and that probably overstates inflation by one percent (Boskin). And, in 1990, did you predict 20 years of deflation for Japan?