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)
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!