More Food for Thought
Bill Fleckenstein was back talking to Dylan Ratigan about the source of rising oil prices. (See the last Fleckenstein video here). Clearly, supply constraints and increased demand in emerging markets play the central role in creating a supply demand imbalance for a commodity where demand is price inelastic. I am not just talking about natural disasters and riots, I am also talking about peak oil, of course. That means prices for oil soar until we hit a recession and the resulting demand destruction.
However, at the margin there are other factors at play, one of which is pro-inflationary central bank policy. I have mentioned this a couple of times in the past. For example, regarding food price inflation, I wrote in November:
[Morgan Stanley Chief Economist Richard] Berner sees four forces at play, pushing up food prices: strong global demand, weather, energy costs, low food stock inventories. You can read the full note at the link below.
My take is a bit different. The rise in food and energy prices should be taken into consideration by government officials conducting pro-inflationary policies. What should be of concern regarding commodity price inflation is how it represents a regressive tax on lower income workers and consumers in emerging markets and developing countries. Lower income consumers spend a much greater percentage of income on food and energy. So when commodity prices increase, it has a disproportionate effect on them. One reason we saw food riots in emerging markets in 2008 has much to do with this.
In January I wrote:
Excess liquidity in the developed economies is not only being pumped into emerging markets but also into other alternative investments like commodities. With the speculative flow increasing and prices higher across the commodity spectrum, animal spirits are certainly a factor in the commodity markets. You can see why Brazil is still talking about a so-called ‘currency war’ and why the Chileans too are now fixing for capital controls.
There are other places this wall of liquidity is re-surfacing. In my view, the IPO fever in the US suggested by the frenzy over Facebook and Twitter, the trading in hot pre-IPO shares and the mergers amongst pre-IPO technology companies all point to mid-cycle excesses driven by accommodative monetary policy aka quantitative easing. If Bernanke thinks QE has been a success because it has revived animal spirits and underpinned the technical recovery, he is probably right – but at what cost down the line?
There are lots of people denying the connection between high food, oil and commodity prices and easy money at the Fed and other central banks. Those same people are also saying that Fed policy is creating jobs. If the Fed is creating jobs by lifting asset prices, then how is it not also lifting commodity prices? This makes no sense. The reality is that quantitative easing does not create jobs because it has no impact on the real economy. Banks are not reserve constrained, so the Fed’s printing money and adding reserves doesn’t ‘create’ loans for capital investment that ostensibly add these jobs. What the Federal Reserve does is boost asset prices, including commodity prices, by changing private portfolio preferences. It fosters a risk-on investing environment by keeping interest rates artificially low and signalling that there is a Bernanke put for investors who want to lever up. How does this create jobs?
Here’s a thought. If the Fed wants to print money, why does it buy up assets from the primary dealers which are financial institutions? QE is merely an asset swap whereby the Fed credits checking accounts of financial institutions in exchange for some asset like a Treasury bond. Couldn’t we just as easily credit consumer bank accounts? I’m not saying I want to do this, but it is certainly a more direct and efficient way of boosting spending and creating jobs – if that’s actually what the Fed cares about.
My take: Quantitative easing is dangerous policy. It gives one the illusion that the debt deflation dynamics in the US have receded when in fact QE has provided the pre-conditions for asset bubbles and a future bust that will precipitate more vigorous debt deflation dynamics. You can’t print your way to prosperity.
Bill Fleckenstein gives his take in the video below.