Summary:
Guillermo Calvo (Columbia) argues that the high commodity prices are not the result of speculation, but of fundamentals. Disagrees with Krugman however on the nature of these fundamentals, and instead believes it is due to a portfolio shift against liquid assets by sovereign wealth funds, partly triggered by lax monetary policy, especially in the US. This could be a harbinger of higher CPI inflation if interest rates stay low. An effective anti-inflationary battle will involve a sharp rise in interest rates, which will enhance the risk of deepening recession. Policy makers should start worrying about inflation and stop chasing imaginary destabilising speculators. (Published: 20/06/08)
Notes:
- rise in oil, metals and food prices
- hard to rationalise on the basis of world output growth
- not even on the basis of China's and India's fast growth, let alone the expected global slowdown
- phenomenon has been accompanied by much higher transaction volumes in the forward markets
- analyst and policy makers pointing accusing finger at speculators
- Calvo's thrust:
- we are not going through another self-fulfilling bubble
- today's explosion of commodity prices is the result of a very real financial storm associated with large excess liquidity in several non-G7 countries and nourished by low G7 central banks' interest rates
- this price explosion could be a leading indicator of future inflation driven by fundamentals
- Wolf, Krugman: absence of substantial increase in physical commodity inventories is evidence of absence of speculative activity
- incentives to stockpile commodities stem from the combination of low central bank interest rates (esp. in the US) and the growth in sovereign wealth funds
- SWFs have been created partly with the intent of switching the composition of government wealth from highly liquid but low-return assets to more risky but much more profitable investment projects
- Fed's rate has been sharply lowered and market does not expect expect that it will be raised with equal impetus within a year
- must add to SWF's determination to switch away from US treasury bills
- portfolio switch implies higher prices
- not all prices have same degree of flexibility
- commodity prices are at the high end of the flexibility spectrum
- wages at the low end
- i.e. price rise phenomenon will bring about a change in relative prices in favour of commodities
- however: eventually the slow-moving prices will catch up and these sharp differences across prices will disappear
- a much more uniform price rise phenomenon will materialise
- when analysed from the perspective of some future time, this whole episode will look very much like a bubble in the commodity market, even though what is behind it is a fundamental factor
- i.e. lower demand for liquid assets by sovereigns like China, Chile or Dubai
- conclusion
- high commodity prices are not the result of speculation, but of fundamentals
- namely a portfolio shift against liquid assets by sovereign wealth funds,
- partly triggered by lax monetary policy, especially in the US.
- this could be a harbinger of higher CPI inflation if interest rates stay low
- an effective anti-inflationary battle will involve a sharp rise in interest rates, which will enhance the risk of deepening recession.
- Policy makers should start worrying about inflation and stop chasing imaginary destabilising speculators
