Something important happened yesterday, whilst UK politicians were preoccupied with arguments over marginal changes to Council budgets. Commodity prices experienced sharp falls. Silver is down by around one third in a few days, and oil fell 10% in a day. Metals and agricultural commodities have also weakened.
These price falls will take some of the inflationary pressure out of the world economy. They are both bad news and good news. The bad news is they show that markets fear the world economy will slow again. The ending of US money printing next month, allied with the monetary squeezes the emerging market countries have had to impose to tackle dollar led inflation, are very likely to lead to slower growth in 20112. The US economy may be strong in the second half of 2011 on the back of this year’s printed dollars and tax cuts, but may slow next year. China, India and the rest should slow next year as their higher interest rates and bank controls have their impact.
So what is the good news? The good news is that inflation should come down. This could start to relieve the squeeze on real incomes in the UK and elsewhere. It could also mean that China and other leading emerging economies could be closer to ending their monetary squeeze, as the impact of higher food and commodity prices on their own inflation starts to abate.
May 6, 2011
Bernanke said there would be no QE3 but whilst the Fed remains a major buyer of US T-bills it is hard to see how this is not inflationary. I suspect the pull-backs in commodity prices reflect some profit taking rather than a long term trend since US and European budget deficits remain and there were the fundamental causes of QE.
May 6, 2011
Very cogent observation Mr. F.
Any fall in commodity prices is likely to be transient and the upward curve will resume shortly. Oil prices seem to be in the hands of children who are all excited and actually believing what is coming out of the White House at the moment; this, too, will pass.
If Bernanke has said that there will be no QE3 I am taking it as read that there will be. As the economic ordure enters the long-suffering air-conditioning once again here in GB, we may be sure that futher debauching of the currency will ensue. Oh – I am so sorry, that last should have read, ” further judicious quantative easing may be carefully applied by the financial giants of the BoE”.
May 6, 2011
Write out one hundred times “Bank of England Monetary policy committee members are our omniscient betters, Bank of England Monetary policy committee members are our omniscient betters…”
I think it’s the old Yes Minister thing from Sir Humphrey, the more politicians talk about something (in this case debt reduction and driving economic growth) the less will actually happen.
May 6, 2011
Lower oil and commodity prices is indeed good news the UK cannot tax this governments inflationary anti growth policies and higher commodity prices.
Can someone now, post this pointless referendum, please explain, forcefully, to the Liberals and Cameron that electoral success (in the next general election in particular) will come from sensible government policies and a decent economic recovery. The Liberal policies of pro EU, more pointless regulation, fairness, tax, borrow and waste and an ever bigger state are a total disaster.
Chris Huhne must go if he is unable to stand up and change completely by 180 degrees the direction of his idiotic energy policy. It flies in the face of physics, engineering and economics as many involved in the department must know only too well.
May 6, 2011
Sorry I meant “UK cannot take” not tax.
On energy the new promising Shale gas technology (see report by Matt Ridley http://thegwpf.org/images/stories/gwpf-reports/Shale-Gas_4_May_11.pdf
shows huge promise and will (with New Nuclear and existing fossil fuels and other sensible technologies in insulation, heat pumps, combined heat and power and the rest) take us through comfortably to nuclear fusion or other to be perfected technologies.
Can we now please stop the pointless, tax and waste house “Bling” and wind farms so loved by Huhne and his department at least until the technology actually works.
Four years is just about enough time for Cameron and Clegg to embrace real world, small government, economics and real world engineering. Will they now finally do this or are they both just looking for a nice EU job and pension after loosing the next election?
May 6, 2011
David Cameron said he will ‘fight with every fibre in his body to maintain the union”.
Why would he want to do this when the clear logic of his (and the Liberal) pro EU stance (and the very clear aim of the EU) is to break England up into regions plus Scotland and Wales and relieve Westminster of all but regional powers.
Perhaps it is time for him finally to decide which way he actually wants to go he clearly cannot do both without looking totally absurd.
May 6, 2011
I was busy yesterday because of this a the hedge fund, we called it right a couple of months ago. I would disagree with your view that inflation will fall – the drop in commodities was due to a slow down in China, the US,UK and EU. But it was the increasing interest rates in China – due to the housing bubble – that led to the fall in commodity prices. I now see a sharp correction in house prices in China comming – which is what the Chinese Government wants. This is however just a blip. The UK now remains one of the last economies where house prices will fall – and they will. The only question is how far below the long term average.
Perhaps the most depressing news of the day is that Government department increased their spending to use up their budgets. Some may see this as a last hurrah, my view is the Osborne still has no control over spending. I’ve posted several tales on this site about how departments waste money to use up budget. The increase in spending tells me that Osborne has decided (or forced) to use a slege hammer rather than a scaple to reign in Government spending. The fiscal correction is going to be deep and bloody – but that is the civil servants choice.
Reply: The government’s plan is to cut the deficit by extra tax revenue, not by cuts to cash levels of spending.
May 6, 2011
Javelin “The only question is how far below the long term average.”
When you talk about long term average of houseprices what time frame do you mean ; the past 30 years , the postwar period to 1975 , something else ?
And what measure , multiples of average earnings , pound sterling ?
Do you think the English will ever be cured of their property obsession ?
What do you think the future is for commodity prices over the next 5 years , have China secured what they need for the medium term ?
May 6, 2011
I’d expect the answer to be measured in real terms – a fall to something like 50% below 2007 peak values. In nominal terms, that probably means 30% off nationally – but much more in overheated London and commuterland. Of course, in Northern Ireland prices have already halved in sympathy with Eire.
May 6, 2011
That will not happen. Prices are well supported in London by rents at about 5 % and good rental demand increasing population and little land supply. Building costs are also high and many people coming in with outside overseas cash made in counties without absurd tax rates. If you have cash you can put it on deposit and watch it devalue with inflation or buy a property and earn 5% rents and it is likely to increase in the long term with general increasing wealth when Cameron or someone finally start to more the right way and the bank lending position settles back and confidence returns. True Cameron could inspire more confidence but he will get round to it soon eventually won’t he?
May 7, 2011
I suggest you check out what happened to London property prices and rents between 1989 and 1992. In nominal terms they fell by 28.5% (Halifax London quarterly sub index) in an era of relatively high inflation, and rental yields were much higher than today’s.
May 8, 2011
Not really the same this was during Major’s absurd ERM and mad economic management and absurd interest rates closing businesses all over the place. Long term interest rates & swaps are still fairly low now and the bank lending will slowly come back a little.
House prices will reflect supply and demand. London has an international demand and limited supply. True Cameron could help by taking a few decisions in the right direction for a change.
May 9, 2011
“It’s different this time”
Check out what happened to Tokyo property prices despite decades of ZIRP. 90% falls. A bubble is a bubble is a bubble. Even the super rich foreigners can lose money playing spoof with London property – and they will again this time. I can recall a top price paid in 1975 of £25mby a rich foreigner being resold in the 1990s for just £5m (with very high inflation, remember).
May 6, 2011
It didn’t occur to me that Ulster would have been affected by the drop in Eire but it makes sense .
A graphic illustration of what can happen when you have open borders .
The UK housing bubble which can’t be allowed to deflate because of the banks exposure is proving one of the disasters of our generation .
May 6, 2011
Commodities dropped because the US Dollar rose against the Euro, three cents after ECB said Euro rate hikes may be delayed. There were a lot of currency “short” selling positions that had to be reversed. So were the positions that traders had gone “long” on; commodities and precious metals.
May 6, 2011
Just to add add what I wrote earlier, interest rate rises in China are to dampen domestic demand for house prices. I dont think the fall in commodity prices are due to a demand from China – but a fall in demand from the US and EU. China is dependent on Western economies – and Western debt. China’s interest rate rises are designed to bring down domestic consumption before it is brought down sharply by a drop in Western consumption. As I said before I think we are due for 5-8 years falling demand and house prices, and slow growth (below inflation).
May 6, 2011
I think the Chinese are smarter than that. They have realised a massive housing price bubble has problems irrespective of external events. But i think the logic is spot on.
Now QE2 is nearly where will the hot money run to or is debt deflation likely to reassert.
How much China is dependant on EU/US trade or if it has reached a self sustaining internal demand within Asia.
At what time do you predict the markets will force UK/US interest rates up. Or is it more likely we will see a further sterling/dollar collapse with resultant import inflation. Considering our imbalances continue to increase.
May 6, 2011
Answer to reply : I dont believe taxes (80:20) will increase enough to cover the deficit. I think falling real incomes will not match inflationary rise in public sector, so the ratio will be (60:40) and cuts will need to be a lot deeper. I’m not convinced that George Osborne is getting on top of the civil service spending addiction OR that the UK will become more competitive in the global market. I cant see the relative downward productivity of UK labour being turned around any time in the next 5 years.
May 6, 2011
Well said Javelin – I am in your camp on this topic. The government is wrong to expect extra tax revenue to pay down the deficit, or more importantly teh total amount of outstanding government debt, and John I know understandibly you do not want to be drawn into the issue of real tax cuts being necessary but sadly they are. The official economic orthdoxy a la Labour, Anthony Hilton & Chris Blackhurst (of Standard fame) is that you cannot reduce ( or cut is not the right word) public expendure too quickly or you will increase the potential of a recession is simply wrong. We waste so much money and one thing that life has always taught me is to take control of those things you can control and in this case it means what we spend ! The government should cut taxes and cut expenditure aggressively as the markets will eventually turn on the UK when the growth in tax revenue fails to reduce the total level of our government debt as the government hopes, despite the fact that the government continues to devalue sterling massively with all that implies.
Reply: I have urged the government to adopt lower tax rates as part of its growth strategy
May 6, 2011
JR, in his 22 June 2010 “emergency budget” George Osborne claimed he was splitting the “pain” 23% tax rises and 77% spending cuts. In his most recent budget spending increased by about 2% in cash terms, and taxation by approx 7% in cash terms, thus moving the “pain” more to the tax side. Is the policy now to maintain spending forever more and deal with the deficit entirely through extra taxation? If yes, then I’d just like to say, ouch!
Reply: the strategy was always to increase spending in cash terms overall and to raise tax revenue to cut the deficit. The 77/23 figures were by way of comparison to previous government plans for future years
May 6, 2011
“Reply: The government’s plan is to cut the deficit by extra tax revenue, not by cuts to cash levels of spending.”
Yet the likes of Nick Robinson get away with quotes such as “Cameron’s savage cuts”
May 7, 2011
I’ve found myself asking why they get away with it .
– Many Labour supporters allow their hatred of the Tories stemming back to the mid eighties (some justified even) to blind them – they want to believe the Tories are being nasty again .
– Labour want to claim that the Coalition is cutting harder than neccessary .
– The coalition wants to be portrayed as tough .
The myth of savage cuts suits everyone . You never hear the figures being discussed on BBC , only rhetorric . Pravda gave up their claim to being a serious new channel years ago .
Their current reporting has about as much factual truth in it as their reporting of the Lancaster Bomber raids in the 1940’s .
What chance is there for a democracy with such a poor media ?
May 7, 2011
“What chance is there for a democracy with such a poor media ?”
Indeed – the BBC staff seem incapable of thinking outside the Poly Toynbee/Guardian think big state box on any issue. Not much chance of change with Cameron’s appointment of Lord Patton to head the trustees either.
Look like we are to be stuck with big state, big green exageration, pro EU tosh from the BBC for some time to come.
May 7, 2011
If you had called it right a couple of months ago (and placed bets) you wouldn’t be up on shorting silver or oil yet surely?
My view is that the US still looks on a sticky wicket, but then again they can get away with throwing useless folk on the scrapheap more than any other western nation.
I reckon that on a macro level they would love a good bout of price/wage inflation over the pond but don’t seem to know how to get it started. On the other hand p/w inflation would wipe out a lot of their retiring baby boomers.
And this is the crux – demographics – older folk are net repayers of debt and that is deflationary. Paradoxically they also need their governments to issue more debt to sort their annuities. As the consumer deleverages in the ageing western nations their respective governments will leverage even more, both to pay their pensions and mitigate the effects of a reducing money supply.
The big question is whether the ROTW de-couples from US/the west and gets along nicely against this backdrop, and if BRIC workers keep getting pay rises. That is where the price inflation/debt deflation long term stagnation and decline will com from.
On that basis I’d say swapping western banknotes for commodities backed assets ould be a good move long term. If however, the ROTW does not decouple from US hedgemony then you could easily see an entirely different scenario play out.
That’s where I am anyway.
May 6, 2011
What’s your view on the B of E again holding short term interest rates at 0.5%?
Reply: I will write about this at some length shortly.
May 6, 2011
Please could you comment also on yesterdays poor PMI data. There is a smell of Merv King printing another £50 billion. We have the US with loose monetary and fiscal policy. The ECB tight (currently) on both. The UK loose on money and tight fiscally. 2012 is starting to look like a possible Annus Horribilis.
May 6, 2011
i have not looked widely at the newsbut was surprised by the pull back today. i thought ‘bubble’ over the weekend when i saw 3X articles in the sunday press about how silver ‘was a great investment’
my Q is – if you have come out of commodities yestreday – where did you go? equities? not the FTSE. cash? not the dollar. oil?
May 6, 2011
If my chartist mate is to be believed, back into gold when the spot hits $1435 sometime in the next three weeks. He does like his charts, but has traded +18% or better for the last three years. Then again monkeys get lucky sometimes…
Reply: This site does not offer investment advice and reminds people of the regulations that require any investment offer or advice to be made in the regulated manner.
May 6, 2011
I had hoped the “monkeys get lucky sometimes” may have been a sufficient caveat, but if you think it necessary, neither SF nor his Simian pal offer financial advice, do so at your own risk etc
May 6, 2011
There were probably people saying things like that about gold all through 1980 and 1981.
May 7, 2011
Yes, but in 1981 we had a strong prime minister with a grasp of economics committed to controlling the money supply tackling inflation and interest rates touching 15% and inflation around 12% (so real rates +3%) and later actual public sector debt repayment (and if memory serves, a Welsh office minister who spendidly did not spend all his budget, who cares about the bloody anthem), whereas today we have recently had a bout of debauchment, every likelihood of more, BoE gilt purchases(!) interest rates of 0.5% and inflation around 5% (so real rates -4.5%) and worldwide currency races to the bottom, thus making serious inflation probable and no possibility of actual debt repayment just a vague aspiration to go into more debt more slowly and much of our gold sold off at the bottom. Oh and a current prime minister who is to put it mildy, something less than Lady Thatcher.
May 9, 2011
Those are all fundamentals, not technicals. You don’t know who will be president in 2012 either.
May 6, 2011
Commodities are mostly traded on margin on futures markets. That is to say if you buy 100,000bbl of oil today at 100 $/bbl for delivery in three months time, you put down a deposit of say 10 $/bbl (or $1m today). That deposit is known as “initial margin”, and is designed to guard against the risk of default. Its size depends on how volatile markets are from day to day. So long as prices only move say up to 5 $/bbl up or down from one day to the next, the $10 margin covers the risk. If prices move against you, you have to deposit a further “maintenance margin” to cover that loss: this accounting is typically done on a daily basis. If you fail to provide the maintenance margin your position can be liquidated, with losses covered from your initial margin deposit. If the market moves in your favour, you may withdraw your profits (which are funded by the maintenance margins of those who lose, since futures markets are zero sum games) even though you haven’t sold your position.
When prices start to make more volatile daily moves, futures exchanges rapidly increase initial margin requirements to cover the increased risk of loss. That requires investors to divert funds from other investments (potentially causing a selloff in other markets), or to liquidate their positions so that their deposits cover any remaining position. However, that can lead to a stampede effect. The consequence is that prices move down very sharply, with large profits for those who sold to you, corresponding to your losses.
It is most likely to be the specialised commodity trading operations of certain commodity traders, large banks and perhaps a handful of the most sophisticated industry companies who are on the right side of this kind of move. The money most probably went into the coffers of a bank, since banks are now the dominant traders. At least it is profits to offset all their ongoing losses on mortgages and loans to uncreditworthy EU governments.
May 6, 2011
I don’t believe there are any tax cuts in the US. Obama agreed to extend the ‘Bush tax cuts’, which were due to expire, by another two years (until after the presidential election) so tax rates stayed the same. On the negative side of this if he wins re-election and you’re a US taxpayer you can be pretty certain that they won’t be extended after that.
Reply: I had in mind the tax cuts on business investment for this year
May 6, 2011
Commodities market traders behave a bit like sheep – when one runs away, they all do. This is a blip. The sharpest fall was in silver, largely due to higher cash margin requirements, and it dragged down the rest of the precious metals market. Other commodities fell on short-term panic about possible losses on futures ahead of expected poor world economic growth figures. Now they’ve got the figures, they aren’t panicking any more. The long-term trend is still up. I expect prices in all commodities to rise again shortly. Sadly that means this drop will have little or no effect on inflation, and I still think Bernanke will go ahead with QE3. Expect more inflation misery to come.
I really do think governments have got it wrong about the need to tighten. The clear message from this blip for me is that the markets are beginning to worry about falling demand in the world economy. You don’t stimulate demand by fiscal and monetary tightening. It’s the wrong medicine.
May 6, 2011
The drop in commodity prices is good news. It helps prick a few speculative bubbles.
Another interesting piece of news was the Shale Gas Report written by Matt Ridley for the Global Warming Policy Foundation. If this energy source delivers what its promoters hope it will, it too will have a significant impact on global energy politics. I am unclear just where the UK government stands on this. Is its head still stuck in sand of its green energy policy or has it actually noticed what is going on in the rest of the world?
May 6, 2011
When the largest global credit bubble in history bursts, it collapses in a large deflation. The size and speed of this will probably swamp all the central banks’ ability to reflate timeously. History is littered with these events, this time is no different, just bigger. We may be on the cusp of the Kondratieff winter.
May 6, 2011
How much of this is a correction of speculative bubbles in commodities? As we keep being told that our stubbornly high inflation is, at least in part, a result of high commodity prices I welcome yesterday’s news.
May 6, 2011
High commodity prices are a consequence, not a cause of inflation. Inflation is a monetary phenomena. Prices are just the side show.
May 6, 2011
Are you suggesting that commodity bubbles cannot exist? I thought speculators piled into commodities when they tired of sythetic CDOs etc? How exactly in the short term can you distinguish between the consequences of demand for raw materials and for speculative gain? In particular, the behaviour of silver suggests a speculators’ tug-of-war which probably does interest the Chinese much. Commodities have been appreciating faster than Bernanke can stamp tokens.
May 6, 2011
If commodities do indeed fall but CPI remains stubbornly high, it will be very interesting to see what new “one-off factor” excuse the MPC dredges up.
May 7, 2011
The ‘(multinational-ed) effect’ will probably work both ways, they’ll cushion you on the way up in prices but cling onto their extra profits on the way down.
May 7, 2011
Supermarket oligopoly? Is that better?
May 6, 2011
The drop in silver was mainly accounted for by small traders taking profit of the 175 per cent increase in its value over the past year. The other commodity price drops including corn, oil are a response to the global outlook of a slow recovery with persistent high levels of unemployment in Europe and the US. China while still growing strong is pressing down hard on its inflation and this tightening will be felt around the world.
We can now appreciate that the MPC has been wise in not raising rates prematurely and this is now supported by the ECB statements in the past couple of days and in the US. Its really too early to pencil in any beneficial impact on long term inflation because inevitably falling oil and other commodity prices rarely get passed onto the UK consumer.
Other people have commented about the house price correction seen around the world but not nearly to the same extent in UK. This presents a significant risk to the UK economy and the banks who have not made provision for further mortgage delinquency and default.
The banks seem to be playing a game of ‘extend and pretend’ for borrowers who are in arrears. The housing market should be allowed to correct itself . Contrary to the propaganda there is an over supply of housing and the cheap money is encouraging builders to keep adding to the stock. The last budget gave the builders another £250m so that they can build AND provide lending to buyers to pay for those over priced new homes. I can recall when previous governments distorted the market with taxpayer bailouts and they always ended with the taxpayer losing out.
May 6, 2011
I should add that if the government has £250m of taxpayers money to give to private developers then why not instead cut the amount of stamp duty taxpayers pay?
After watching last nights question time I am coming to the conclusion that the LibDems are forcing though socialist policies and this is impeding the progress of addressing the deficit. The ratings agencies have been patient with the UK unlike what we are seeing with the PIIGS but that could change if the promised economic reforms are not implemented to plan.
The LibDems have been significantly weakened by last nights results and I take this as a rejection of their policies and an endorsement for the PM and Chancellor to push ahead .
May 7, 2011
The interesting one with corn is the whole biofuel agricultural subsidy thing – elections in 2012 over there!
May 6, 2011
should we be waiting to see which speculators have their hands burnt?
Hopefully they weren’t “our” banks
May 6, 2011
I think that commodities are offering a way for banks to rip wealth off jejune punters by sucking them in and then margining them back out. The open interest figures suggest a lot of Johnny-come-lately investors who have bought close to the peak. Expect big profits for those banks with larger commodities trading operations. Once these investors have been flushed out and their wealth captured, the effects of money supply inflation will once again fuel the next surge in nominal commodity prices.
May 6, 2011
We may yet see individual bankers in the dock. Greece prosecutors are filing criminal charges against individuals in the investment banks who were involved in the crime of selling bonds and then betting that those bonds failed. We now have a virtuous coincidence where the Germans are pressing for Greek default and prosecuting their own investment banks because Germany’s exports are faultering and a Greek default would weaken the euro again vs dollar helping German exporteres. Germany’s own banks may now be sacrificed because their costs to the taxpayers are outweighing the falling exports. This could start a chain reaction among all the PIIGS.
May 6, 2011
As Julian Simon proved, in winning his bet with eco-alarmist Paul Ehrlich, the trend, so long as Luddism is not rigorously enforced, must be for a fall in commodity prices as human ingenuity becomes am ever greater part of wealth.
Simon is, of course, ignored by media, “N”GO’s and other representatives of the Big Brother state while Ehrlich, who has been absolutely wrong on every single well publicised prediction of doom he has ever made, is lauded by them.
Those countries which embrace progress are growing incredibly fast. Those whose government’s embrace Luddism, as our own does, are failing. We could get out of recession and into fast growth any time our government truly wanted to.
May 6, 2011
Simon said that prices in commodities would not increase due to scarcity as Ehrlich thought. They won’t, BUT the ongoing debasement of various fiat currencies and central bank bond purchases will cause price increases due to an inflated money supply.
I entirely agree with your sentiments on Ehrlich and wholly agree, we could end the stagnation and have growth around 10% within 24 months if any front bench politician really wanted to, the methods are well known. We can only conclude, they really dont want it, preferring the crisis to make them feel relevant.
May 6, 2011
Lower oil prices mean that it will be a lot easier for the English to vote for independence from the Scots. I presume when the referendum is held the English will get to vote as to whether they want independence from the Scots.
May 6, 2011
As we’ll all soon be oblasts of the EU we may as well ask every member state to vote as to Scotland’s leaving one Union to leap into bed with another.
In short, it makes no difference whether or not Scotland is part of the UK, smoke and mirrors to distract the proles, the real game is being played in Brussels.
May 6, 2011
Chocolate bars will now revert to their previous size and price and petrol will get cheaper? The mistake is in thinking there is some relationship to price/profit/quantity/profits and wages for the average person.
May 7, 2011
The US slow down will come in the middle of Barrack Obama’s re-election year. Admittedely, he is a more impressive man than Jimmy Carter, but the same fate may await him. It serves him right in a way; nobody chose his economic policy for him.
May 7, 2011
The natural trend in a free market is for ALL prices to fall gently over time as technological and productive gains are made. It is in a debt based fractional reserve fiat system that inflation is baked into the cake(until we periodically crash in vicious reversions to the mean and beyond), for without it the banks die.