Bernanke and higher food (commodity) prices

In his speech at the National Press Club, Bernanke said several things:

  • Supply and demand abroad for commodities, not U.S. monetary policy, are causing higher food and energy prices rattling much of the world..
  • The most important development globally is that the world is growing more quickly, particularly in emerging markets
  • As economies in Asia grapple with high inflation, constraints on supply — such as bad weather — along with increased demand are to blame for pushing up prices for food commodities.
  • Strong growth in emerging economies is moving millions of people from poverty to the middle class, changing their eating habits — more beef and less grains and so on.
  • The Fed’s policies are aimed at growing the domestic economy and to address stability in the United States. For some foreign countries facing high inflation, their policies have not been such to keep growth and capacity in balance.
  • I think it’s entirely unfair to attribute excess demand in emerging markets to U.S. monetary policy, Those nations can use their own monetary policy and adjust exchange rates to deal with their inflation problems. It’s really up to emerging markets to find appropriate tools to balance their own growth.

David Beckworth did a post showing evidence supporting Bernanke´s view. The evidence comes in the form of a strong correlation between commodity price increases and growth in emerging markets industrial production.

The figure below extends back in time the graph of emerging markets industrial production growth and commodity price change. A couple of points:

ü  The correlation becomes somewhat tighter after 2001 (there´s a lull in the correlation in late 04 and 05. More on that below)

ü  After 2001 emerging markets industrial production growth goes higher and becomes more systematic 

The next figure shows the behavior of commodity prices since the 1970s. Noticeable is the fact that for decades commodity prices behaved in a cyclical pattern. The up trend that began in 2002 is temporarily interrupted in 2004-05 before shooting up again. The cyclical pattern is broken. Why did this happen?

The following picture provides a compelling explanation. There we see that after gaining access to the World Trade Organization (WTO) in late 2001, Chinese imports increase by a factor of 7 over the next 8 years. To put this in perspective, over the previous 8 years it had gone by a factor of “only” 2.8. This helps to explain the behavior of commodity prices and the fact that industrial production growth in emerging markets is so much higher and systematic following “China in the WTO”. I believe this was the “economic event” of the decade.

The best explanation I could come up with for the weakening of the correlation in 2004-05, despite the continued growth of industrial production (and Chinese imports) is that, given the history of commodity prices, the “300 level” was perceived by traders as a “resistance level”. But the pressure on commodity prices was intense and the “resistance” was quickly broken with commodity prices “shooting up”.

During the crisis, NGDP tanked in the US and in most developed countries, falling less severely in emerging markets. Nevertheless in 2008 emerging markets industrial production growth fell considerably and grew only 1.5% in 2009.In 2009 Chinese imports dropped by 11%. No t surprisingly, commodity prices went down. In 2010 Chinese imports grew by 39% and emerging markets industrial production went up by 10%.

One of the reasons many blame US monetary policy for the “rise in food prices” is related to the effect of monetary policy on dollar depreciation and the negative correlation between the dollar exchange rate and commodity prices. The next figure depicts the exchange rate of a broad basket of currencies to the dollar and commodity prices.

Before the Asia crisis, the correlation was mostly positive, becoming negative thereafter. I couldn´t think of a compelling causal story for the perceived negative correlation between the dollar exchange rate and commodity prices. The Asian crisis had a deflationary impact (Asian countries experienced a steep fall in growth) which had a strong negative impact on commodity prices. At the same time there was a “flight to quality” towards the dollar (which continued following the Russian crisis of 1998). By 2001 the US trade deficit had increased significantly and the US economy experienced a period of low growth. Simultaneously, China´s trade drive began upon becoming a member of the “Club of Nations”. Chinese imports propelled commodity prices, with the dollar exchange rate depreciating for other (likely unrelated) reasons.

Starting in mid 2005, Chinese exchange rate policy changed to a controlled appreciation of the yuan against the dollar. For the next couple of years the dollar moved little but commodity prices went up significantly. It may not be coincidental that the “300 level resistance” of commodity prices was “breached” when the yuan appreciated. More recently, over the last 15 months the dollar has barely moved but commodity prices have shot up together with the resumption of growth in emerging markets industrial production and Chinese imports. So maybe all the hoopla from people like the Brazilian Finance Minister about “currency wars” induced by US monetary policy is misplaced.

Commodity exporting countries like Australia and Brazil are subjected to terms of trade shocks from commodity prices. The causal story in those cases is clear: A rise in commodity prices appreciates the real (and nominal) exchange rates of these countries!

So who´s “responsible” for higher food (or commodities in general) prices? In a one word answer: China. And beware; if the yuan appreciates the effect could increase!

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17 thoughts on “Bernanke and higher food (commodity) prices

  1. The Brazilian Finance Minister should be advised: trying to stem the appreciation of the BRL will only cause inflation to rise even more. The link between commodities prices and our currency is clear, a rise in commodities prices might well be DEflationary.

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  4. I partially agree ; yes, China weighs on commodity prices ; but it is also clear that with the announcement of quantitative easing rounds in the US, commodity prices received a boost. Bernanke is exporting the problems with investors & speculators buying into commodities, hard assets and gold as a hedging device against USD debasement. Printing USD @ 0%-0,25% = printing problems abroad ; the carry trade intensifies and EM countries face problems : hiking rates to stem inflation but making the carry even more attractive. Or not responding by interest rates with inflation lifting off. I still consider it obscene from Bernanke when he claims that the EM countries only have to blame themselves for the current (food)inflation problems

    • Steve & Christof I know that (always) there are complex reasons involved. I didn´t want to speculate on speculative activities but was trying to pull-out, so to speak, what I felt confortable was THE major factor. More generally, the economic history of the last 20 years is rich and still unappreciated, and in this context 2008 was a defining moment and is characterized by a major monetary policy error in the US. The events that followed are a consequence of attempts to “correct” that mistake. I´m sure the next few years are not going to be easy!

  5. I liked the analysis I guess there could be a lot of other factors involved but for sure some of the points Bernanke made and some of the points you made are a big part of the reason.

    I still think QE1 and e have an impact though. Basically the commodity trading sphere has become increasingly speculative. QE1 and 2 goes in part to a lot of financial players who use the cash to speculate. i.e. instead of buying treasuries they buy something elsse and commodities is part of their investment universe.

    I’d also guess it happens indirectly.

    Firstly, through speculative demand for commodites as assets. QE is thought to equal more inflation so speculators bet on things that are inflation hedges and the price rises – i.e commodities up. There are any numbers of different commodites that have seen a significant increase in speulative holding.

    Secondly, through demand for commodities for consumption. To the extent QE impacts on real demand in the US and elsewhere that means more demand for commodities for consumption.

    The other side of the story is the supply side. If supply is not that price elastic at the time being. i.e. for food – lack of new areas for cultivation, water shortages, slower increase in productivity etc. then increase in demand is going to be hit by a higher increase in price.

    But anyway China can blame the US and the US will presumably say it’s nothing to do with us and the truth probably lies somewhere in between but certainly not soley on QE.

    Having lived in poorer countries I wouldn’t underestimate the impact that higher food prices has on a large propertion of the population and the social/political disruption and change this can bring. This partiularly applies to the urban poor who aren’t growing there own food. The third world is much more urbansied now than it was 10-20 years ago. A lot of poor, angry people on mass in centres of politcal and economic power makes things volatile. I’d say for the average poor urban person in Egypt the price of food would be extremly high on their list of priorites.

  6. US monetary policy has no influence on prices. Huh! what a surprise. Actually it is bunk.

    US monetary policy is now at an Uber level of ease. We have ZIRP, QE1, QE2 and the top off of QE1. We have these policies in place for two years now.There is no end to the the madness in sight.

    How could one possibly conclude that s reasonable portion of global commodity inflation can’t be traced back to Bernanke and the insanity game that he is playing?

    You can go to sleep blaming China for all the problems. But in the next six months you will wake up and see things for what they are. The US monetary policy is driving this, not China.

    • Bruce
      During the fixed Exchange rate era (Bretton Woods), US inflation was transmitted to other countries. US monetary policy affects China inflation due to the “fixed” yuan/dollar rate. But that´s something China chooses to do. The specific rise in commodity prices is closely tied with Chinese economic growth and the fantastic increase in imports (although people only talk about Chinese exports) after 2001. The Fed made a major monetary policy mistake in 2008, letting nominal spending drop for the first time since the 1930´s. Now it´s trying to “make things up”. Fiscal stimulus didn´t help and probably made things worse.

  7. Jeffery Frankel has done some work on effect of monetary policy on commodity prices. To me the monetary policy chart is as convincing if not more as the story about Chinese imports. What is Bernanke going to claim next? Beef prices are going up because the Indians have started eating a lot of beef?

    • Jeffrey Frankel´s work is fine. But leaves out an explanation of why the pattern of commodity prices, cyclical for ages, suddenly dissapears? This dissapearence coincides with rising chinese demand (proxying for emerging markets).

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  10. Particularly for the post 2003 period, I would place additional weight on ‘speculative’ factors such as the expansion in number and size of index funds, remembering these tend to operate through swap dealers, be long-only and, thanks to the 2000 CFMA, have beeen able to avoid exchange-based .position limits.

    Of course, as Alan Heap made clear, there had been the somewhat earlier move in metals’ prices ‘beyond fundamentals’ driven largely by the expanded hedge fund community, pools, et cetera.

    Certainly much more and just as certainly cannot be reduced to global fundamentals or U.S. policies.

    Regards

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