Commodity prices and global growth

COMMODITIES are partying like it is 2008. The oil price stands at its highest since October of that year, just shy of $100 per barrel. World food prices—as measured by The Economist’s index—are back at their peak of July 2008. Copper prices, which have jumped by 17% since the start of November, are at an all-time high. The recent gains reflect reduced concern about global economic prospects, helped along by the Federal Reserve, which announced a second dose of quantitative easing in November last year.

The worry is that rampant commodity prices may cause another wobble in the world economy. Higher commodity prices act like a consumption tax, transferring income from households and companies which use the resources to companies and countries that produce them. As the producers tend to save more of their income than the consumers, more expensive commodities bear down on global demand.

The oil price has pushed the world into recession in the past, most obviously in the 1970s. Blame for the recent great recession is typically laid at the door of the financial crisis, but it is often forgotten that America’s economy was shrinking for nearly a year before the collapse of the investment bank Lehman Brothers.

James Hamilton, an academic at the University of California, points the finger at oil. He reckons that the rise in the oil price from early 2007 largely explains the downturn between the end of 2007 and the third quarter of 2008. Households tightened their purse-strings as they found themselves devoting almost 7% of their spending to energy. That share had fallen back to 5.5%, before the latest surge in oil prices began.

Outside America, food has a bigger share than energy in consumers’ shopping baskets—and thus in inflation too (see chart). In developing countries, rising food prices can be a human as well as an economic disaster. In Asia in early 2008 a spike in the price of rice led to widespread unrest and desperate attempts by governments to secure more supplies. In December in India, for example, food prices rose at an annual rate of 14%, and there has been a run on onions, a dietary staple.

As well as taxing consumers, or worse, dearer commodities push up overall inflation, as the latest numbers from the euro area and Britain show. Although textbooks suggest central banks should “look through” a one-off increase in commodity prices, which provides only a temporary boost to inflation, monetary policymakers fret about second-round effects.

With inflation now above the European Central Bank’s comfort zone and almost double the Bank of England’s target, pressure to raise interest rates is growing. So far, these central banks have held back, in view of the big cuts to public spending taking place, sluggish growth and idle resources. Unlike some emerging economies, where rates have been raised, these rich economies are far from overheating. But higher commodity prices may tip the balance of risks, causing policymakers to lose their nerve. Tightening policy would act as a further drag on growth, possibly threatening the recovery.

Some comfort can be taken from the fact that, although some commodity prices are above 2008 levels, inflation rates of commodities are still below what they were then. For instance, agricultural food prices are up 37% on a year ago, whereas in 2008 the rate of increase peaked at 75%. Jonathan Anderson, an economist at UBS, a bank, reckons that global food prices would have to rise by another 50% from current levels for headline food-price inflation to reach the heights of 2008. And he thinks that is unlikely: there is no sign of the massive energy and fertiliser price increases seen in 2008. That is partly because annual oil-price inflation is running at 17%, compared with 100% at its peak in 2008.

But the balance between oil supply and demand is a concern. Whereas recent increases in many food prices reflect temporary supply disruptions (such as droughts and flooding), the rise in the oil price is due to strong demand and stagnating production. Lutz Kilian, at the University of Michigan, suggests that unless energy consumption is reduced or new supplies found a full recovery from the financial crisis will push the oil price back to its highs of mid-2008.

Furthermore, commodity prices are rising at an early stage in the economic cycle. Jeffrey Currie of Goldman Sachs worries that, as American oil demand recovers, it will “bump up against” China, which is consuming 23% more oil than it did in 2007—as well as 63% more copper, 18% more cotton and soybeans and a few more cases of wine too (see next article). With the global recovery fragile and unbalanced, higher commodity prices are the last thing the world needs right now.