Prices of just about everything have been rising precipitously in recent months – from cotton and corn to copper, and, of course, oil. Generally speaking, high prices for commodities are bad for growth, for two reasons. First, they spark inflationary pressures that can force central banks to hike interest rates, thus slowing down economies. Secondly, they cause consumers and companies to spend more on food, raw materials and energy. That eats into their ability to spend on other stuff and dampens economic growth as well. With oil at $100, you’d think the world’s economists would be in a frenzy of dire predictions and growth downgrades.
But they’re not. I’ve noticed that the reaction from economists to high commodity prices – generally speaking – has been muted. Sure, they are taking note of the potential risks. But overall they’ve stuck to their position that the global economic recovery is proceeding along nicely and are taking something of a wait-and-see approach to recalculating where the global economy will head in 2011.
However, I’m getting a sinking feeling in my gut that the rising prices could have a bigger, more painful and more protracted impact than many economists now expect. Granted, I’m engaging in a bit of speculation here, but hear me out.
There are good reasons to be optimistic that the commodity price increases won’t tank the global recovery. Prices for commodities have been on the upswing for months, yet the recovery has been gaining, not losing, steam – a sign that the world is better able to absorb high food and energy prices than in the past. And there is some hope that the recent price spikes are a result of temporary phenomenon and their effect therefore won’t be lasting or severe. Oil prices might roll back once the crisis in Libya is resolved, or a few strong harvests in 2011 could tame food-price inflation.
Yet on the other hand, there are sound reasons to believe that high prices for many basic commodities are here to stay. Yes, oil has jumped recently because of the uprisings in Egypt and Libya. But the price of oil has been increasing steadily for two years now. So when the Middle East crises eventually resolve themselves, how much can we expect oil prices to decline? Ditto on food. The USDA recently warned that even though farmers were planting larger crops, markets for wheat, corn and soybeans would remain tight, keeping upward pressure on prices. In other words, don’t expect any better deals at your local supermarket any time soon.
So that means a generally high level of food and oil prices will continue to weigh on the incomes of families everywhere, dampening consumption globally. The impact of high commodity prices is hardest on the poor, who devote a large share of their daily income to food, but the richer people of the West will see their wallets strained as well. In the U.S., where families are already under duress from joblessness and the housing crisis, higher prices for food and gasoline could make American consumers even less able or more reluctant to spend. In an economy so dependent on private consumption for growth, that can’t be good.
Meanwhile, high commodity prices have already contributed to inflation in emerging markets, and that’s causing governments across the developing world to take steps to fight rising prices by slowing down their economies. China has hiked interest rates three times in four months and continually raised the reserve ratio for the banking sector – which forces bankers to hold back more money for each loan they make, constraining credit growth. In India, where inflation is running at more than 8%, analysts expect more rate hikes. Higher interest rates in emerging markets mean slower growth for all of us, since they have been playing a bigger and bigger role in world economic growth. The World Bank figures that nearly half of global GDP growth in 2010 came from low- and middle-income countries.
If prices of commodities level off or decline, some of the inflationary pressure in emerging economies will be alleviated. But not all of it. High oil and food prices are not the only factors creating inflation in the developing world. Rapid growth has sparked inflation of its own; so have easy money policies. In China, concerns persist that raging credit growth has fueled escalating property prices. It’s hard to say, of course, if China’s real estate is actually in a bubble, but with prices soaring by 20% or more in some major cities over the past year, according to private data, there is good reason to fear it is. Chinese officials obviously are worried, and they keep issuing edicts, warnings and regulations to try to cool the market down. They’ve even started experimenting with a new property tax. The point here is that policymakers in emerging economies are contending with inflation caused by a bunch of factors, not just high commodity prices, and those pressures are pushing them to tighten money and slow their economies as well.
We also have to start worrying about inflation creeping up in the developed economies, even though growth in many of them remains weak. Look at the U.K… Inflation has reached 4%, in part due to high oil prices, putting pressure on the Bank of England to hike rates, even though growth contracted in the fourth quarter of 2010. If inflation does force the central bank to raise rates, that will lead to even slower growth.
So you can see what I’m getting at here. A combination of persistently high commodity prices and inflation-busting measures in the developing (and possibly the developed) world could very easily translate into slower global growth. I’m not saying that the entire recovery will be derailed, but I am worried that we’ve so far been underestimating the hit global growth could take from rising prices