Commodities, inflation and finance: The risks of 21st century stagflation

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Commodities, inflation and financeThe risks of
21st century stagflation

• Jayati Ghosh

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Dramatic volatility in global commodity prices.

• Unprecedented volatility of global commodity
  prices in 2007-08, first rising then falling.
• Widely predicted that global economic crisis
  would dampen such prices.
• But recent revival of prices especially in some
  commodities.
• These price increases are most marked in food and
  fuel.

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These recent price changes did not and do not
reflect real demand and supply imbalances

• Financial activity (index investors) mostly
  responsible for these dramatic price movements.
• Commodities emerged as an attractive alternate
  investment avenue for financial investors from
  2003 and especially 2006, when the US housing
  market showed the initial signs of its ultimate
  collapse.
• This was aided by financial deregulation that
  allowed purely financial agents to enter such
  markets without requirements of holding physical
  commodities.
• This generated a bubble, beginning in futures
  markets that transmitted to spot markets as well.
  

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Recent data indicate a new price surge

• From mid 2008 commodity prices started falling as
  index investors started to withdraw.
• Another bubble now Most important commodity
  prices have been rising from early 2009.
• Price increase between Dec 2008 and Dec 2009 16
  for all food (sugar 105), 96 for metals, 110
  for oil.
• But global demand and supply for most commodities
  remains broadly in balance for some, both output
  and stock holding have increased.
• However, longer term supply issues are important
  for food and other agricultural commodities
  because of policy neglect and persistent agrarian
  crisis.

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Negative impact on developing countries

• Because they are the result of financial
  activity, such price increases typically do not
  benefit the direct producers resident in the
  developing world.
• But they cause huge damage to consumers of food
  and other essential items, as the prices of
  necessities increase even as employment and wages
  continue to languish.
• They can also generate cost-push inflation even
  in a context of slow economic activity.
• Food prices especially adverse they did not fall
  in most developing countries even when global
  food prices were falling.

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Past stagflation

• Past stagflation (1970s) was associated with
  cost-push inflation related to oil price shock
  and wage increases, within context of low
  interest rate policy in the wake of recession.
• The underlying processes were national and global
  conflicts over income shares.
• This was eventually resolved by monetarist
  policies that suppressed real wages and led to
  falls in primary commodity prices.

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New form of stagflation today

• Arguments about the threat of stagnation that are
  based on excessive government deficits and loose
  monetary policy are wrong.
• But the threat comes from another quarter the
  continuing involvement of financial speculators
  in commodity markets, who drive up futures and
  (indirectly) spot prices.
• This continues because commodities are seen as
  safe havens, and because inflationary
  expectations about some commodities persist.
• This can generate sharp commodity price rises
  even with weak global recovery, and generate cost
  push pressures even with large excess capacity in
  manufacturing.

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Global output recovery weak and likely to be
reversed

• Basic problems in financial sector still not
  addressed (and now real estate, sovereign debt
  issues) and increased risky behaviour because of
  moral hazard of bailouts.
• Policy response has been to encourage renewed
  bubbles based on earlier growth model.
• US cannot be engine of global growth in the
  immediate future.
• Weak employment recovery so sources of new demand
  constrained.
• Sever procyclical policies still being imposed on
  BOP constrained economies by IMF and other
  international agencies.

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Dealing with the new stagflation

• Because this is different in nature, broad macro
  policies like raising interest rates will be
  counterproductive.
• Instead the focus has to be on specific actions
  to control commodity prices.
• The most important immediate action is regulation
  of finance with respect to commodity markets.
• Strategies include banning financial players from
  involvement in commodity futures markets and
  ensuring cheaper access of developing countries
  to supplies of such commodities.
• Commodity boards, buffer holdings and other
  measures to stabilise prices also important.

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Inflation is still all about income distribution

• This projected stagflation would reflect the
  attempt of the global financial class to increase
  its share of global income, even in the wake of
  financial crisis.
• Most of the declining share would be of wage
  incomes especially in the developing world.
• Therefore attempts to resolve this also require a
  reduction of the political power of finance but
  this may not occur without even more extensive
  crisis.