Are commodity prices heading down?

And if so, is that a good thing?

Free exchange

THE Wall Street Journalreports that some high-flying commodities have gone into retreat in recent weeks:




What to make of this? Paul Krugman notes that real commodity prices were near historical highs and writes:

Some of this probably represents a long-term upward trend, as emerging economies place pressure on limited resources, but even so, you wouldn't expect continued rapid rises, and in fact you should expect some regression toward normal levels as supplies and to some extent demand respond.

The only reason to believe that commodity prices would continue to soar would be if you thought that they were the harbinger of runaway inflation. But they aren't.

Well, if we're talking about real prices, then higher inflation wouldn't necessarily lead to continued increases, unless one assumes that commodities are rising in real terms as a hedge. In that case, you'd also expect to see other signs of expected runaway inflation, like a runaway increase in inflation expectations. Obviously, that hasn't yet appeared.

If we're looking at moderating increases as a sign of supply responses, we'd expect to see big differences across categories. Supply is more elastic for some commodities than others.

In last week's Fed press conferences, Ben Bernanke argued that most of the recent increase in headline inflation has been due to rising energy costs, and most of that is atttributable to rapid emerging market growth. I've generally been looking at commodities as a loose, volatile gauge of expected emerging market economic performance. If commodities as a category are plateauing, then says to me that markets are indicating a slowdown in emerging market expansions.

That's a reasonable expectation, as far as I can tell. The IMF is projecting a slower growth performance across Asia in 2011 relative to 2010. Brazilian growth is also expected to slow. Governments across the emerging world are tightening policy in the face of rapid inflation. There is no doubt some concern in these countries that the link between emerging market growth and commodity prices has become too tight, such that the only way to limit a damaging increase in inflation is to limit growth. This isn't an unreasonable fear. Sure, historical prices have rarely been higher. But China and India are in the process of moving hundreds of millions of people toward developed nation living standards. Given that China and India have not invented a new, resource-lean means of becoming rich, this can't help but quickly push up commodity demand. By 2013, world output is expected to be double what it was in 2000. Energy intensity hasn't fallen 50% in that time. Not even close.

So to the extent that commodity prices have leveled off in recent months, I'm tempted to view the development as evidence of the commodity constraint on growth in a world of rapid emerging market expansion. Until wealth becomes less resource-intense, rising prices and the policy reaction to rising prices may place an upper bound on growth that's lower than we've come to expect.

Reuse this contentThe Trust Project
The Economist Today

Hand-picked stories, in your inbox

A daily email with the best of our journalism