7/14/22
There used to be, and there still may be, a school of
thought, of which yours truly was an admittedly not-at-all prominent member,
that held that commodity prices should be the guide to monetary policy. If commodity prices were rising, money was
too loose and the Fed should tighten.
If commodity prices were falling, money was too tight and the Fed should
loosen. For a number of reasons, this
perfectly logical line of thinking was derided. Among those reasons were
·
This approach was an updated approach to the
gold standard, and adherents of the gold standard are generally thrust into
the same category as those who consult pig entrails. That the commodity- based approach was effectively
an acknowledgement of the shortcomings of the gold standard didn’t matter; its
proponents had to be kooks because there remained a tenuous connection to that
ancient object of kingly desire (i.e., gold, not the late and beautiful Grace
Kelly).
·
The commodities-based approach to monetary
policy was simple. Economists don’t
like simple, even though the “science” to which they have devoted their
professional lives is little more than common sense put to numbers.
·
The approach got politicized, as has just
about everything else in economics over the last 40 or so years. It would appear that the modern economist
is a generally bright person who really wanted to be a political scientist but who
figured out that eating was preferable to starvation and hence decided, about
halfway through undergrad school, to drop his or her poly-sci major in favor of
economics, a field in which there are actual jobs. But I digress.
·
The prices of the commodities contained in the
products we buy are not substantial components of the price we pay for those
products; labor and transportation costs are usually more substantial. This is a decent argument, but commodities
are bought and sold as hedges by users, suppliers, and speculators and hence
give an idea of where the market thinks prices are going. Their role in the cost structure is, in this
sense, irrelevant.
At any rate, despite the derision commodities based
monetary policy suffered from some quarters and the near deification in which
it basked from other quarters, as an objective way of looking at monetary
policy, it seemed to work. Such an
approach to monetary policy probably would have achieved far better results than
the “do whatever the Administration wants so we can keep our really nice
jobs” (See SOON
THE FED WILL LEARN TO SIT UP AND BEG from May of this year.) approach the
Fed and many of its fellow central banks have pursued for most of my
professional lifetime. Certainly, a
commodity aware Fed would have tightened monetary policy much sooner in this
go-around (probably at least in mid-2021) and would have avoided many of the
inflationary travails that threaten to run our economy off the rails.
I bring this up to point out that, despite the orthodoxy
that seems to prevail everywhere, perhaps the Fed should be less gung-ho about
continuing to raise rates and shrink its balance sheet. Note that commodity prices have been
taking a beating of late. Here are
the price changes of the most active futures contracts on the following
commodities and commodity indices since their highs, just about all of which
were hit in early June, except for the agricultural commodities, the highs for
which were reached in the Spring:
West Texas crude -23%
Gasoline -24%
Copper -33%
Corn -26%
Wheat -35%
Lumber -47%
Soybeans -22%
Gold -14%
Silver -30%
CRB -15%
S&P GSCI -16%
For those of us who think commodity prices are
important, this doesn’t seem to be a good time to be tightening money. Yes, that 9.1% June CPI number was
bone-chilling, and the 11.3% PPI number was even more angina-inducing. However, much of the aforementioned drop in
commodity prices has taken place since the end of June. And, yes, commodity prices, except for the
metals, are still up as much from their lows as they are down from their highs. However, in economics, as in much of life,
it is what happened most recently that matters most, i.e., life takes place
at the margin.
There is another good reason that Fed should re-examine
the course into which it has apparently locked itself, and I am not talking
about avoidance of recession. Yours
truly, being of a certain age, has never understood the horror with which the
markets, much of the economics profession, and apparently the world recoils at
the notion of a recession. As I wrote
long ago in a post I can no longer locate, recessions are part of the economic
cycle and have a salubrious effect on the long-term economy by squeezing out
excesses and laying a firmer foundation for further growth. Efforts to avoid these normal economics
phases have led to many of the excesses, bubbles, and the like that have done
grave damage to our economy. Perhaps
this utter terror at the very notion of recession results from the perspective of
most practicing economists and market participants. The only recessions that these youngsters
remember are real doozies, like 2008.
They don’t remember the mild, and ultimately eupeptic, recessions yours
truly, and most of you, have experienced.
So maybe one can’t blame them for cowering under their proverbial desks
at the very thought of a recession. The
rest of us suffer from their resultant policy prescriptions, but that is life. At any rate, if we are headed toward a
recession, and the Fed seems bound and determined to induce one if we are not,
this will be one of the strangest recessions in yours truly’s lifetime, with
tight labor markets, continuing spending on the usual frivolous baubles and
other silliness by the wealthy or those who want to appear to be wealthy, and
the only recently developing, and halting, resistance to outrageous prices for
things that we could easily do without with only a little bit of effort. But I digress.
No, it is not recession that I fear. I fear the strength of the dollar. Here are the increases in the value of the
dollar against the following currencies year to date:
Euro 13%
Canadian dollar
2%
Yen 19%
British pound 14%
Mexican peso
1%
Note that the peso is a commodity-based currency and may
hence be receiving a shellacking in the near future. The Canadian dollar is perceived to
be a commodity-based currency and hence may be in for the same fate. But I digress. The important thing is that the value of the
dollar has gone through the proverbial roof and now trades, for the first time
since the dawn of this millennium, at greater than one euro.
Why is the strong dollar a bad thing? Not for the reasons involving “terms of
trade” that you were taught in economics class.
A strong dollar, combined with increasing interest rates, makes
servicing dollar denominated debts onerous, and in some cases impossible, for
“emerging market” countries. This debilitating
debt service burden, along with the increases in the price of food in these
countries born largely of Mr. Putin’s barbarism in Ukraine (Yes, the
aforementioned drops in commodity prices will help here, but they haven’t yet
and may take some time to do so.), are making life miserable in much of the
developing world. Sri Lanka, in
which rioters occupied the homes of both the President and Prime Minister, may
be only the first in a series of manifestations of unrest overseas born of the
increasingly onerous burdens of debt service and food prices. This has human consequences, of course, but
also has financial consequences. An
outbreak of effective bankruptcies overseas would not be good for the world’s
financial system. Should the Fed be
making developing countries’ debt burdens worse directly by increasing interest
rates and indirectly by increasing the value of the currency in which these
debts are settled?
I will write something here I rarely wrote, or said, when
I was younger and obviously far smarter than I am now: I could be wrong. Maybe we are seeing, at best, a temporary
reprieve in inflation. Maybe commodity
prices don’t matter and are only so much nonsense as more enlightened thinkers
tell us. But if I were in charge at
the Fed right now, I might be a little less gung-ho about bearing down on the
money supply in an environment characterized by crashing commodity prices and a
dollar so strong that it could lead to a worldwide financial crisis.
