Tuesday, January 5, 2010

Commodities update



Here's a long-term look at spot commodity prices. They have risen 38% from their lows of early last year, and are only 10% below their all-time high in mid-2008. Note the huge gain in prices which occurred in the inflationary 1970s, followed by the flat trading range that lasted from 1980 through 2006, a period characterized by relative low and stable inflation. Commodities now appear to be moving in a new, higher trading range, which in turn was ushered in by the Fed's accommodative monetary policy which began in the mid-2000s. The apparently permanent rise in virtually all commodity prices that began in 2007 is one of the reasons I look for inflation to continue to rise in coming years.

5 comments:

septizoniom said...

isn't a future of higher inflation exactly what we don't want?

Scott Grannis said...

Yes, unfortunately. As a supply-sider, I believe that low and stable inflation is a key ingredient to a healthy and dynamic economy. Many, if not all, of the problems the economy has experienced in the past decade can be traced back to erratic monetary policy. Monetary policy has been too easy for too long, and so we are likely to see rising inflation and perhaps another asset bubble in coming years. This is very unfortunate and one reason we are likely to see sub-par growth (but still a V-shaped recovery) in coming years.

septizoniom said...

thank you for that elaboration.
please explain if you can your view on why the gov/fed pursues such a poor policy.

Scott Grannis said...

I've commented at length over the past year or so on this issue. You can do a search of the blog for the words "Phillips Curve" to find most of the related posts, but here is one that lays out the basic themes:

http://scottgrannis.blogspot.com/2009/09/why-bond-market-is-so-complacent.html

Short answer: the Fed keeps making mistakes because their theory of how inflation works is flawed. They believe in the Phillips Curve theory of inflation, and that gives them a bias to be too tight when the economy is strong, and too easy when the economy is weak. Instead of trying to fine tune the economy, the Fed should instead be paying attention to market-based indicators of inflation, such as gold, the value of the dollar, the yield curve, the breakeven spread on TIPS, and credit spreads.

I would add that the Fed faces great politicial pressures to "do something" when the economy is weak, and this only adds to the problem. Monetary policy should be limited to targeting inflation, because it is a very poor tool for fine tuning economic growth. Trying to target inflation and economic growth simultaneously is not only impossible for mere mortals, but also highly likely to produce unintended consequences.

An Old Guy in MD said...

"...the Fed faces great politicial pressures to "do something" when the economy is weak..."

Wow! Wouldn't it be sooo much better if we did away with the "independent" Fed and let our politicans manage our money?