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loose monetary policy and commodity prices

Page history last edited by PBworks 15 years, 4 months ago

 

 

One interesting theory (hotly debated) is that the US Federal Reserve is causing the commodities bubble by keeping interest rates so low, effectively a negative real interest rate (after you consider inflation).  The theory is nicely outlined here.   In summary;  the negative real interest rates cause mean that its not wise to invest in treasuries because they are a bad "storage" of value, but commodities that can be held till later, are.  Jeff Frankel, a Harvard economist, has long argued that negative real interest rates lead to higher commodity price.  When real interest rates fall, there is an incentive to keep the commodity in the ground rather than sell it today.  This, presumably, leads to lower supply.  The uptick in price also leads speculators (and amateurs) to believe that the upward trend is sustainable, and they jump at the chance to make a quick buck...driving the price even higher.  Read here for more.  

 

More reasons to blame the fed:

 

Monetary easing in the US, while it may be necessary to spur growth in the US, is one of the main culprits that is causing worldwide inflation in the commodities markets.  The problem is not just a simple matter of commodities being priced in US dollars, because then the relative value of the commodes would not really be going up at all.  

 

In fact, the trouble is a bit deeper than that. 

 

What is happening is that many emerging market countries have currencies that they fight desperately to keep undervalued vs the dollar so as to spur export growth.  Even in Latin America, countries such as Argentina have policies in place to keep downward pressure on the value of the currency to stimulate exports.  But, due to the fundamentals of the "Mundell trilemma", we know that in order for a country to keep the currency controlled, they must give up monetary policy control in the local market. 

 

In other words, each time the US cuts interest rates, these other countries must also cut interest rates, or else risk a rise in the value of their local currency.  So, because they are cutting rates, it is having the impact of increasing the availability of money.  And, loose monetary policy leads to inflation.   By this mechanism, every country in the world that has been trying to keep competitive in export markets (as the US dollar has depreciation), have also been forced to cut interest rates along with the US, and that has led to inflation globally.  Its not the Fed's fault, but it is a reality that their actions are largely to blame for the increase in inflation around the globe...driving up commodity prices in the process. 

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