It is hard to remember now, but mineral and agricultural commodities were considered passé less than ten years ago. Anyone who talked about sectors where the product was as clunky and mundane as copper, corn, and crude petroleum, was considered behind the times. In Alan Greenspan’s phrase, GDP had gotten “lighter;” the economy was becoming weightless, ”dematerializing.” Agriculture and mining no longer constituted a large share of the New Economy, and did not matter much in an age dominated by ethereal digital communication, evanescent dotcoms, and externally outsourced services. The Economist magazine in a 1999 cover story forecast that oil might be headed for a price of $5 a barrel.
Since then, of course, we have seen tremendous increases in the prices of most mineral and agricultural commodities, many of them hitting records in nominal and even real terms (see graph). Oil is now well above $100 a barrel, and gold has just crossed the $1000 an ounce line.
The question is why.
There could well be merit to many of the explanations that have been offered for the rise in the price of oil. One is the “peak oil hypothesis,” and another is geopolitical uncertainty in Russia, Nigeria, Venezuela and – above all – the Gulf. Corn prices have been impacted by American subsidies for biofuel. And other special microeconomic factors are relevant in other specific sectors. But it cannot be a coincidence that mineral and agricultural prices have risen virtually across the board. Some macroeconomic explanation is called for.
The popular explanation since 2004 has been rapid growth in the world economy. The strongest growth has of course been coming from China and other recently minted manufacturing powerhouses in Asia, but the expansion has been unusually broad-based – including up to last year the United States and even a reinvigorated Europe. So growth has pushed up demand for energy, minerals, farm products, and other industrial inputs, right?
This reigning explanation now looks suspect. Since last summer the US economy has slowed down noticeably, and is probably entering a recession. Despite talk of decoupling, it is clear that other countries are also slowing down at least to some extent. In its most recent forecast, the IMF World Economic Outlook revised downward the growth rate for virtually every region, including China. The overall global growth rate for 2008 has been marked down by 1.1% (from 5.2 % in July 2007, just before the sub-prime mortgage crisis hit, to 4.1 % as of January 29, 2008). And prospects continue to deteriorate. Yet commodity prices have found their second wind over precisely this period! Up some 25% or more since August 2007, by a number of indices. So much for the growth explanation.
How to explain commodity prices up while the economy turns down? I will offer my answer in my next posting, tomorrow.
one word http://www.morganstanley.com/views/gef/archive/2008/20080303-Mon.html - numeraire
If you look at the M3 statistic for the money supply, you can see that the Fed and banking system dilute the currency at a rate of about 10% a year. The only way to protect your money is to put it into assets - ie - stocks, real estate, or commodities. The problem with putting your money into assets to protect from dilution is that it triggers over production. Once over production set in, the value of the asset starts to collapse, and people move their money onto the next asset. Technology stocks overheated in the 90’s, real estate in the past couple of years, so now the herd has moved on to commodities.
The core problem is that when the Fed inflates the currency, is does not do so by throwing money of a helicopter. It inflates via complicated risk subsidization schemes. This distorts the economy. We will continue to see asset bubbles as long as the fed maintains this practice.
The high gold prices have a different explanation. People are effectively hedging against the complete collapse of the dollar. In such an occurrence, there would be a flight to use gold as a currency, driving its price upwards of $10,000 an ounce. A 10% dilution rate might not be enough to trigger this collapse, but it definitely approaches the danger zone.
[...] World Growth Can No Longer Explain Soaring Commodity Prices. …global growth rate for 2008 has been marked down by 1.1% (from 5.2 % in July 2007, just before the sub-prime mortgage crisis hit, to 4.1 % as… [...]
[...] Jeff Frankel questions why commodity prices continue to rise despite the world economic growth slowing down? The answer [...]
Jeff, I will have to read your post on what your answer is to the “why” The cost of gas and basic commodities has really increased. I can’t believe how expensive groceries are lately and I have been hearing the cost of basic commodities is going to increase even more! You make such a good point in this post.
I was raised on a large row crop farm in Idaho and I can say that farm commodity prices remained nearly stagnant for nearly 3 decades through most of the 90’s. The only reason commodity prices have gotten so much attention is because the increase was so sudden, instead of a steady increase over the years. If commodity prices had risen over the past decades at least commensurate with the CPI, commodities would likely cost more that they do today. Many don’t realize how good this country had it for so many years with the cheapest food in the world. The demand of grain and specifically corn for ethanol production has been the reason grain prices have risen so much so quickly. The largest oil field in the world has not been tapped and either have the oil reserves of this country. There are obviously some very powefull people and companies that are keeping oil prices at the levels they are at because they know they can.
The High Commodity Prices and INFLATION - FOOD/OIL CRISES:
is directly link to commodity exchanges having LOWER MARGIN
REQUIREMENT on LONG PURCHASE POSITION around the world.
If MARGINS are increased to 100% of Value of Commodities..
Oil, Wheat, Corn, Gold, Metals, Rice……..
the PRICE will certainly come down to the levels where they were before 3-5 years.
MARGIN MONEY OF 8-10% can BUY full Value of commidity
on this Exchanges with LONG POSITION of 3-12month !!
While in REAL LIFE we need to pay Full 100% value.