Figments of imagination
30-10-2008 | Other news
Rabobank Economist Hans Stegeman searches the economic 'house of horrors' and finds consolation in eased commodity markets.
A couple of months ago it looked like the worst of the turmoil in the financial world had subsided. So it seemed that the time had come for us to prepare to become reacquainted with a ghost of the past: inflation. After all, oil and a range of other commodity and food prices had been rising for a prolonged period. Some people predicted these prices could continue to climb for years. And others even referred to a food and fuel crisis.
Haunted house of economic threats
Under these conditions, inflation would not be the result of an overheating economy; inflation would be a driving force that would drag the economy down. This ghost is called stagflation and has not reared its head since the 1970s.
We are now a couple of months further down the road. It has become clear that we signed the financial crisis’ death certificate prematurely. Nobody is forecasting years of high inflation anymore. The oil price has been cut in half and the prices of most other commodities are also coming back down. Inflation is no longer being mentioned. Instead the same people, who until now have been talking about stagflation, are currently discussing the possibility of deflation. Another dweller in the haunted house of economic threats.
One positive side effect
And while we are making our way through the 'house of horrors' of the economy, we can in any case draw reassurance from the fact that the financial crisis has produced at least one positive side-effect: easing commodity markets. This is particularly true in the case of oil. And that’s good news, particularly for developing countries that import large amounts of commodities and in which commodities represent a much larger share of total consumption than in the Netherlands.
Was there ever a crisis?
But what is the real story? Was there ever a commodity price crisis or a food crisis? Should we genuinely fear deflation? In retrospect, you can say with certainty that there was a prolonged period of price rises. The price increases that persisted until the middle of this year were the greatest in modern history and were comparable to the increases seen in the late 1970s. A similar feature between the commodity price increases then and now is that both took place during a period of strong worldwide economic growth.
In addition to economic expansion, a diverse range of other causes, some of which were also structural, led to rising commodity prices. It started with relatively low inventories and limited reserve capacity. The recent price increases were reinforced by the rise of biofuels and increased demand from emerging economies. It is a clear fact that the prices for most commodities, especially fossil fuels, are at a structurally higher level than in the past.
Correction process
But, it now appears less likely that prices will continue to rise for a number of years. It is, after all, important to remember that there is such a thing as correction processes within the economy. High prices can attract extra supply, but they can also result in a lower supply through the rise of alternatives. This is most clearly evident in the field of energy.
Figments of imagination
And what about deflation? Deflation may certainly come into play in the year ahead, especially in countries in which commodity price rises have contributed heavily to inflation. Examples include developing countries and the United States. However, underlying inflation (the component that is not affected by volatile factors such as food and fuel prices) is not expected to fall rapidly. It is also important to note that we did not see a period of deflation following the last period of high inflation. This all means that long-term deflation, stagflation and sky-high inflation will for now remain… figments of the imagination.
