Commodity surge could choke off recovery

by Ed Bowsher on 04 August 2009  |  2 comments
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Rising commodity prices aren’t good news. They mean that strong economic growth is even less likely in the next few years.

Commodity prices have surged this year. Back in February Brent crude oil was trading at $39 a barrel. Now it's at $73. Similarly, the price of copper has surged from $140 to $270 over the same period. Other commodities have followed a similar pattern.

So what's driving these rises?

I can think of two possible explanations:

1. Central banks have delivered too big a monetary stimulus through measures such as low interest rates and quantitative easing. Because the authorities have done too much, inflation is set to take off, and the rising price of commodities is an early warning sign for what lies ahead. 

2. We're in the middle of a massive structural change in the global economy. As India and China surge ahead, they need ever larger amounts of commodities. Yet, at the same time, we're not finding sufficient new deposits of some commodities such as oil. This trend means that commodity prices must rise and we saw that happen in the period before autumn 2008. The economic crisis triggered temporary price falls, but now the world economy is returning to some form of normality, commodity price rises are inevitable. 

So which explanation do I prefer?

Personally, I'm not convinced that we're about to see inflation take off.  Today's UK money supply numbers don't suggest prices are about to get out of hand. (If the money supply grows quickly, inflation is likely as there will be too much money chasing too few goods. But that doesn't seem to be happening at the moment.)

I think the structural change is the much more likely explanation. However, it's still a worrying development. Rising commodity prices will push up inflation in developed countries and that could force central banks to raise interest rates earlier than one might have hoped.

That means that any nascent economic recovery could be slowed down by higher interest rates, and that's not good news.

This just strengthens my belief that several years of slow, anaemic growth lie ahead. Not much fun....