Commodities, inflation and finance:
The risks of 21st century stagflation
Jayati Ghosh
Dramatic volatility in global commodity
prices.
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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.
These recent price changes did not and do not
reflect real demand and supply imbalances
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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.
Recent data indicate a new price surge
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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.
Negative impact on developing countries
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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.
Past stagflation
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Past stagflation (1970s) was associated with costpush 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.
New form of stagflation today
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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.
Global output recovery weak and likely to be
reversed
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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.
Dealing with the new stagflation
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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.
Inflation is still all about income
distribution
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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.