Hoarding ham and cornering corn

By Jim Leaviss
I wrote recently about the impact of banking crises on inflation (read comment here). In short, banking crises are significantly disinflationary at best – and at worse, in the cases of the 1930s Great Depression and the bursting of the Japanese bubble in the 1990s, actually deflationary. There is still a lot of reluctance to accept this evidence though, and the most common objection is the strength of commodity prices. After all, how can inflationary pressures subside if oil is $108 per barrel and wheat has doubled in price over the past year? I think there are a couple of reasons why we shouldn’t worry too much about commodity prices – at least for our western economies where food and energy prices are a relatively small portion of our expenditure (below 20%), but for developing countries these higher costs are already causing political and societal tensions.

Firstly there’s evidence that there is a lot of speculation in commodity markets, with hot money having flooded into the asset class. In contrast with speculation in paper assets like shares and bonds however, if you’ve bought a million pork bellies for delivery in June, you better have a plan for getting them out to people who actually want to eat them. You can’t hoard ham for long. Secondly there’s good evidence that commodity prices are a lagging indicator of past economic growth. Goldman Sachs have looked at their own commodity index (the GSCI) over the past couple of recessions and found that once growth slows, prices fall significantly. In the 1990-91 recession the index fell by 28%, and in the 2001 recession by 37%. The slowing global growth picture is what concerns central banks the most – the recent elevated commodity prices will not prevent them from cutting rates aggressively in 2008.

The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. Past performance is not a guide to future performance.

Jim Leaviss

Job Title: CIO Public Fixed Income

Specialist Subjects: Macro economics and fixed interest asset allocation

Likes: Cycling, factory records, dim sum

Heroes: Brian Clough, Morrissey, Neil Armstrong

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