Monday Commodities Price Blogging

In the 1970s, commodities prices went way way up and then eventually went way down again. Today, they're going up again. Will they go down again? Paul Krugman's not counting on it:

For one thing, I don’t expect growth in China to slow sharply anytime soon. That’s a big contrast with what happened in the 1970s, when growth in Japan and Europe, the emerging economies of the time, downshifted — and thereby took a lot of pressure off the world’s resources.

That doesn't sound right to me. Surely the supply shocks from the commodities markets contributed to the slowdown in growth growth rates. Similarly, isn't a big increase in basic commodities exactly the sort of thing we would expect to slow down growth in China?

UPDATE: Why I'm wrong -- "China’s also growing at around 10 percent per year, a rate deemed too fast by the country’s own leaders. Expansion in China could slow considerably and still be greater than 4 percent–sufficient to place a lot of pressure on food and energy stocks."

Comments

One of the things you are looking at in both cases is a broader dollar devaluation.

When viewed as a whole, commodity prices in a given currency tend to more or less represent the value of that currency relative to a weighted summation of all the currencies in the world. So if commodity prices in dollars are going up mostly across the board, and not just in a limited subset of particular commodities, then what you are looking at is likely more a dollar devaluation than something internal to the commodity markets.

Of course in the 1970s, this dollar devaluation was largely brought about by the collapse of Bretton Woods. These days, it has been a combination of things like rapid increases in federal spending and Federal Reserve policies that favored low rates.

Anyway, I don't know when, or if, the ongoing devaluation of the dollar will halt or reverse. So for an individual, my advice is to try to have unhedged non-dollar income or investments.

Posted by DTM | April 21, 2008 1:08 PM

Oh, and although the main proximate cause of dollar devaluation in the 1970s was the collapse of Bretton Woods, the more basic causes included things like a President from Texas spending a lot of new money on a war and expanded social programs without raising taxes to pay for that new spending. So, as they say, the more things change ...

Posted by DTM | April 21, 2008 1:13 PM

Indeed, just because China is big doesn't mean all of it will expand indefinitely. Thus far growth has been confined to major cities and their suburbs that have about half the population of China. It remains to be seen whether rural areas will really pick up.

Posted by Shock Mouse | April 21, 2008 1:16 PM

Oh wow, major props for this post!!

Krugman is obviously applying partial equilibrium analysis (thinking China will keep on growing regardless of developments in the wider world) to a general equilibrium problem.

Yglesias is totally right.

Posted by Mr. Noah | April 21, 2008 1:19 PM

It is relatively easy to ramp up productivity to match already existing productivity in other countries. As you approach productivity in the state of the art I would expect gains in productivity to slow (it is easier to copy than innovate).

How far were Japan and Europe behind the US in the relative period compared to where China is now? I think that would go a long way towards ansewering your question.

Posted by theCoach | April 21, 2008 1:22 PM

No, Krugman is right, almost. If he qualified his statement about China to say that he doesn't expect growth there to slow, except in response to commodity prices, he'd be right.

Japan did not stop its rapid growth because of high commodity prices. It hit a point where its customers could not borrow enough to buy its manufactured goods anymore. Commodity prices fell as a result of lower than expected demand.

China, on the other hand, may work the other way around. Growth will decline, but as a result of high commodity prices, not reduced demand for finished goods. Commodity prices will not fall as a result. Growth will be curtailed only to such an extent that it keeps commodity prices high.

Posted by Njorl | April 21, 2008 1:40 PM

I think the real answer is a combination of all three Krugman explanations (how's that for political courage).

You don't have to be freak to believe in peak oil anymore; extend that explanation to other commodities and the story of harder to find/harder to exploit raw commodities is quite feasible.

The secular growth story is real. China and India are producing bigger domestic economies, right now there is no other way to do it without oil, copper etc. Other countries that have been net exporters will also begin to consume more of their raw materials (export land theory). Inventories are consumed at point of origin.

Speculation is an offshoot/derivative of the peak commodity explanation. The speculation without inventory can be explained by the mine-owners and oil field developers having misgivings about investing more in their operations. It wasn't that long ago (in corporate institutional memory space) that many resource companies were losing their shirts -- there is always extreme risk-aversion from the survivors in this industry. This is where the speculation-without-inventory explanation comes to the fore -- they are keeping the raw materials in the ground.

The complete explanation appears to be more complicated than this (take dollar devaluation and growth of speculative vehicles/ETFs as two major complicators) but it is the best I can do without hand-waving too much.

I could also characterize commodities as being in a long-term secular uptrend with current prices temporarily above that trend line. I won't bet against Soros (except for his political bets).

Posted by mike c | April 21, 2008 2:01 PM

just for the record, krugman didn't say that growth in china would not or could not "slow." he said he didn't expect it to "slow sharply any time soon."

there is tremendous momentum in the chinese economy that isn't going to stop overnight no matter what realistic set of circumstances emerges (yes, they'd be in trouble if we were hit by an asteroid).

after all, the slowing mechanism in china would go something like this: china allows for a strengthening of its currency, which reduces the input cost (imported commodities) while raising the output cost (export goods). eventually, those raised output costs reduce external demand, and insofar as internal demand doesn't organically grow to replace it (which is, after all, a possibility), the chinese trend growth rate slows.

that's not "anytime soon."

Posted by howard | April 21, 2008 2:10 PM

One of the problem with newspapers is that they have word limits. One would hope that if Krugman were operating without a 900 word limit, he could, you know, provide some facts to back up his assertions. Like actual commodity prices, adjusted for inflation.

The fact that he doesn't provide any - aside from pointing to oil - kind of makes me think he's full of crap.

Also are food prices higher because of a problem with that commodity, or just a higher oil prices.

One of the things you are looking at in both cases is a broader dollar devaluation.

Uhh, that's the same thing as saying "inflation". We've inflated our currency, which helps Bear Stearns and friends unload debt at lower cost, but screws the rest of us.

Remember, inflation is just another word for "tax".

Posted by Joe Strummer | April 21, 2008 2:13 PM

mike c,

Just an aside, but I would note ETFs have basically made diversified unhedged commodity investments much cheaper for small individual investors, which is generally a good thing (obviously they can be misused for speculative purposes, but what can't?).

Joe Strummer,

A dollar devaluation will tend to show up as inflation, but of course at least moderate inflation can have other causes as well--it is only if you have sustained high inflation that the cause is almost certainly your currency devaluing. In fact, one way of stating my point would just be that when almost all commodity prices are inflating in dollar terms, that suggests the primary cause is dollar devaluation, as opposed to one of the other possible causes of inflation.

And generally, that is true because commodity prices rarely march in lockstep, but rather are mostly their own markets subject to all sorts of very commodity-specific dynamics. And frankly, that is why I am highly skeptical of Krugman's analysis, at least without seeing more evidence of a bonafide across-the-board commodity price increase once currency effects have been eliminated.

And actually, you should never see a currency-neutral inflationary effect in something like gold (now that its price is free-floating), since gold's industrial value is only a trivial component of its overall value. Rather, primarily gold is valued as a store of value--which is a bit circular, but that is why it is more or less a natural currency. And that is also why it shouldn't matter what is going on economically in China when it comes to gold prices, once you have controlled for currency effects, since increased economic activity in China has nothing in particular to do with the demand for gold.

Posted by DTM | April 21, 2008 2:33 PM

I don't understand how the supply aspect of the equation is not being considered here.

You know what happened in the 70's as commodity prices skyrocketed? Well the World Bank went around to all the barely newly indepedent former colonies in Africa and Asia and told them what they needed to do was borrow huge somes of money to promote development in this sector so that they could develop through the game of import substitution.

Well what happened once all of these countries started producing large quantities of cocoa, copper, bauxite, etc, etc? What happened is exactly what one would expect what would happen in these cases. Commodity prices plummeted which left there countries stranded in vast sums of debt without the capacity to repay it. Which led to the debt crisis of the 80's.

The value of those assets declined and they many, perhaps even most were sold off to large multinationals, if they were not in their hands already and in the intervening years since the debt crisis, commodity prices have slowly edged up. However now with high demand from China in the past decade, they have skyrocketed.

The only way for commodity prices to fall again like they did in the 70's if there was a similar huge supply stimulus. However, unfortunately there is nowhere else left on the planet to exploit.

Welcome to the age of scarcity.

Posted by Bubba | April 21, 2008 2:37 PM

Sorry Krugman is completely clueless and DTM is right.

I watched the gold price go from around $400 in 2004 to around $1000 today.

A gallon of gas has gone from around $1.50 to over $3.30 today.

The rise in prices is entirely monetary inflation and the responsibility for that is the Fed's. The same thing happened in the 70s. That's where the movie "Soylent Green" came from. I wouldn't listen to Krugman for a second on this issue, he's out to lunch.

With the floating dollar, there is no way for him to tell what is happening with China's prices because the Chinese currency is pegged to the dollar. Because he will not watch gold, he (an economist) cannot predict inflation as well as I (an internet comment writer) can.

Posted by wellbasically | April 21, 2008 2:58 PM

Bubba,

Lots of commodity industries could increase production if there really was excess demand. Even with oil, it is just a matter of price (meaning extraction of various reserves of oil will only become feasible when the real price of oil hits a certain level).

By the way, what happened in many third-world commodity-producing countries in the 1980s was also partly a matter of currency effects. For example, the dollar had become relatively devalued by the early 1980s, and third-world countries borrowing in dollars to increase their production of certain commodities might have reasonably thought they were getting a good deal. But as the dollar generally increased in value over the next 20 or so years, those debts denominated in dollars could no longer be paid using the resulting revenues from commodities.

Now, some overproduction of certain commodities might have happened as well. But the bottomline is that if you are looking at price effects cutting across a lot of different commodities at once, you are probably not looking at a duplicated supply/demand dynamic in each individual commodity market, but rather you are looking at a dynamic which is affecting the common element in all those charts, namely the currency.

Posted by DTM | April 21, 2008 3:06 PM

the more basic causes included things like a President from Texas spending a lot of new money on a war and expanded social programs without raising taxes to pay for that new spending. So, as they say, the more things change

Don't rewrite history - Johnson requested (several times) and received a 10% income tax surcharge specifically to pay for the Vietnam War ("The Revenue and Expenditure Control Act of 1968, signed by Johnson on June 28, 1968, imposed a 10 percent surcharge on individual and corporate income taxes"), which was also accompanied by a 10% decrease in domestic discetionary spending ("Egged on by his economic advisers, Johnson acceded to Mills and his conservative cadre on the Ways and Means Committee. The president swallowed a 10 percent reduction in discretionary spending, and Mills gave him the tax surcharge"). source

Posted by Ethel-to-Tilly | April 21, 2008 3:17 PM

Of course it is all about oil, and we have seen the end of cheap oil. I bet Krugman is right; only a severe worldwide recession would delay things--but only delay them.

Posted by Chris Dornan | April 21, 2008 3:57 PM

And that is also why it shouldn't matter what is going on economically in China when it comes to gold prices, once you have controlled for currency effects, since increased economic activity in China has nothing in particular to do with the demand for gold.

Not quite, as increased economic activity in China makes for wealthier Chinese who will in turn want more gold jewelery, wedding bands, watches, etc. which will increase the demand for gold.

Posted by Stefan | April 21, 2008 4:05 PM

The stock of gold is so high compared to the yearly demand that the price of gold barely changes. It is the price of the dollar that has changed.

Posted by wellbasically | April 21, 2008 4:20 PM

RE:the Update

With the floating dollar, and inflation under-represented in government statistics, it is very difficult to tell what the "real" growth rate is.

This is what has happened since the collapse of Bretton Woods. The government reported growth statistics which have told us that we should be feeling better, while in actuality living standards were decimated in the 70s and never caught up to 1970s levels until the late 90s.

China is probably still managing its money under the idea that fast growth causes inflation. This is the same reason Greenspan/Bernanke raised rates to high in 2005-2006 and I would say, caused the current recession.

What really happens with the floating dollar is that weak growth (relative to the money supply) causes inflation. An unexpectedly low amount of business activity means that there is more cash sloshing around that needed by the economy. That's monetary inflation and the result is high gold prices first, then high everything else prices.

This is really what is happening, I can't stress enough that it has little to do with the end of the planet, that's a pet issue of liberals like Krugman that shows up in times of inflation (see movie Soylent Green). Our friend Karl Marx said that the upper classes would find ways to limit the growth of the underclass to preserve their relative position. That's why rich liberals think SUVs are gauche.

Posted by wellbasically | April 21, 2008 4:31 PM

Ethel-to-Tilly,

The Revenue and Expenditure Control Act of 1968 was temporary (expiring in mid-1969). The revenues it raised were about 1/10th of the cost of the Vietnam War, and in fact did not come close to offsetting the revenues lost from the tax cuts at the beginning of Johnson's Administration. Similarly, Johnson's temporary cuts in discretionary spending did not come close to offsetting the increases in entitlement spending from his Great Society programs. Of course we haven't even done that much, but overall I think it would indeed be rewriting history to say that Johnson's lack of fiscal discipline did not contribute greatly to the oversupply of dollars which in turn led to the collapse of Bretton Woods and dollar devaluation.

Stefan,

The ornamental uses of gold are also a trivial component of its value. Most gold is sitting around vaults and safes in coin or ingot form, and even a lot of gold jewelry is stored and rarely or ever seen.

That said, if the supply of gold was kept constant, it retained its status as a natural currency, and the world economy grew, one might expect the value of a given quantity of gold to gradually increase in proportion to the world economy. So the Chinese economy is not completely irrelevant to the real price of gold, just not in the sense of the Chinese economy creating a nontrivial amount of extra demand for gold which would be put to actual use.

Posted by DTM | April 21, 2008 4:35 PM

wellbasically would have us believe that commodity prices aren't really going up: it's just that the dollar is going down.

which would be fine if there were an actual inverse relationship, but there isn't: commodity prices are up considerably more than the dollar is down.

meanwhile, i'd take wellbasically more seriously if there were evidence that he or she had actually, you know, read what krugman said: there is increasing demand, which is real. either supply will adjust to the increasing demand and prices will fall back off or it won't - these are the options that krugman paints. it has nothing to do with soylent green or whatever other misunderstanding of inflation occupies valuable real estate in wellbasically's brain.

Posted by howard | April 21, 2008 4:46 PM

howard,

You write: "[C]ommodity prices are up considerably more than the dollar is down."

What measure are you using for dollar valuation? Note, for example, that while the dollar is down versus the Euro, the Euro is also down versus gold, and the dollar is down more versus gold than the Euro. All of that is consistent with the increase in the dollar-price of gold largely being the result of dollar devaluation, with the Euro having also devalued, just not as much as the dollar.

By the way, Krugman doesn't cite any specific facts directly backing up his view that the recent runup of commodity prices is the result of the same supply/demand dynamics affecting all of the various relevant commodity markets. Indeed, he doesn't even show there has been a runup in commodity prices when you control for currency effects. Rather, he basically just asserts all this, and then argues that maybe supply will not be able to increase to keep up with demand.

Posted by DTM | April 21, 2008 5:09 PM

So I just checked, and on 4/15/08, the AGI published this:

http://www.agiweb.org/workforce/Currents-007-OilByCurrency.pdf

What it shows is that while the price of oil in dollars has run up since 2001, and run up a bit less in Euros, it has basically not run up at all when compared to gold.

That sort of pattern is inconsistent with the theory that the runup in oil prices is being driven by some sort of supply/demand imbalance. However, it is consistent with the runup in oil prices being driven by dollar devaluation.

Posted by DTM | April 21, 2008 5:17 PM

introducing facts about gold (END-POINT BIAS ALERT)
since 11/2004 (start of gold etf: GLD) return expressed in different currencies:
USD +100.38%
EUR +68.30%
JPY +94.11%
CAD +73.26%
CHF +74.47%

"reserve currency"? flight to safety? fungible proxy for unhedged or unhedgeable industrial commodities?

I don't have time today to get a longer history but this provides some basic inference of the magnitude of the dollar devaluation effect.

Posted by mike c | April 21, 2008 5:31 PM

I assume you Peak Oil folks have put your money where your mouths are? $116 oil has been great for the oil stocks I own, but I'm starting to think the fundamentals don't justify these oil prices. A significant chunk of the demand is speculative (maybe 20%?). And to the extent that the weak dollar has been driving oil prices higher, that support factor will fall away once the Fed's tightening cycle starts (sometime after the November elections).

Posted by Fred | April 21, 2008 11:24 PM

DTM hits it again. The European Central Bank can't sit there and do nothing while the dollar collapses. I have heard several stories about inflation rising worldwide. The other currencies have to devalue, either because they are pegged to the dollar or they are getting political pressure from their exporters.

to the extent that the weak dollar has been driving oil prices higher, that support factor will fall away once the Fed's tightening cycle starts (sometime after the November elections).

The fiscal factor is also an issue, and the security factor. But it comes down to this: because of the floating dollar, and expanding economy actually puts deflationary pressure on the dollar. If the economy is expanding beyond the Fed's willingness to supply money, then the dollar will deflate and oil prices will go down.

Posted by wellbasically | April 22, 2008 12:00 PM

Just one last note:

Of course with something like the prices of commodities produced and marketed worldwide, that is where you will see the strongest dollar devaluation effect. In contrast, at the other end of the spectrum would be a differentiated good or service with an entirely U.S. supply chain and entirely U.S. market. Of course that is basically a purely theoretical construct (almost all products have some sort of connection to global markets), but the more a product's total value-added is in the U.S., and the more of its market is restricted to the U.S., the less it should be affected by dollar devaluation.

So, the inflationary effects of dollar devaluation will not be uniform. Hence, it is possible overall inflation could be moderate even while commodity prices in particular are inflating relatively quickly. And I actually think that is a reasonable bet for the near term--for example, I think there is a good chance that oil and gasoline prices in dollars will remain relatively high as compared to the overall CPI, and indeed that oil and gas prices may continue to appreciate more rapidly than the CPI for a while longer. In contrast, something like the price of land in the U.S. (as reflected in home prices and rents) may well appreciate slower than the CPI.

Posted by DTM | April 22, 2008 1:09 PM

Not really, if the price of wheat goes up worldwide, your bread will cost more in the USA even if the bread is entirely produced in the USA.

What you're seeing is the different amounts of time it takes to settle contracts for different things. Commodity prices are settled in futures contracts and reflect the value of the dollar almost immediately. At the other end of the scale, house contracts are settled over a period of 15-30 years. So it will take longer for them to reflect the new value of the dollar. Assuming the dollar stays stable at the new level for 30 years. Intellectual production can fall somewhere in between.

This is why during an inflation, the farmers and miners do well -- while for the rest of us, it takes longer for our salaries to catch up to the new value of the dollar. During the 1970s the arab oil sheiks, the Texas oil men, and the subsidized farmer were all cultural bad guys, because they were making out like bandits, the stuff they bought went up in price slower than the stuff they sold.

Posted by wellbasically | April 22, 2008 3:59 PM

So you can see how the traditional affection of Democrats for an inflationary monetary policy goes back to William Jennings Bryan and his support in the farm states. Most of the farmers were in debt and paying off their debt by growing stuff that was falling in value.

Commodity prices fell because Lincoln took the dollar off gold during the civil war. By the end of it the dollar was basically at $40/oz when it had been $20/oz before. Instead of just leaving it though they tied the dollar back at $20, causing deflation. If you bought land at $40 you were screwed.

There was a lot of farm failure in the late 90s because of a similar increase in dollar strength against gold.

Posted by wellbasically | April 22, 2008 4:07 PM