Today’s loose monetary policy, which is helping the economy recover, will bring tomorrow’s next big economic disaster–a commodity crisis, with spiking oil prices, writes Francisco Blanch in the Financial Times.
Blanch, head of global commodities research at BofA/Merrill says, “The largest rise yet in global commodity prices and the most pronounced credit collapse in history occurred in the same quarter, in that precise order, for a reason.”
In the last 10 years, money flowed to sectors like the housing market, rather than expanding commodity production. The global economy grew, but it was on tenuous footing because we live in a world with a limited amount of natural resources. Demand for oil, and other commodities grew, but at some point there had to be a push back:
Simply put, limited quantities of energy, grains and metals just could not sustain strong global gross domestic product growth for ever. The rise in energy prices in the third quarter of 2008 and subsequent collapse in credit markets ultimately forced world economic growth into negative territory, pushing down industrial activity and driving up unemployment. Central banks then rushed to avoid deflationary pressures by producing as much money as they saw fit.
The divergence between oil and money has never been so apparent. For decades, the expansion of global oil consumption closely followed the expansion in global economic activity and global money supply. This relationship between the economy, oil and money started to change in 2005, owing to serious physical oil supply bottlenecks. Unlike oil, the supply of money and credit grew unconstrained from 2005 to 2008 as the global economy expanded, pushing up asset values worldwide. In their effort to bring the good times back, most central bankers have conveniently chosen to ignore the second-round effects of exceptionally loose monetary policy.
Blanch says we’re going to see this happen all over again.
What will happen next? This recovery is ultimately about a sustained expansion of domestic demand in emerging markets. Thus, EM central bank responses matter more to oil prices than US Federal Reserve policy. Our economics team believes that severe monetary policy tightening in EMs such as China is unlikely in the near term. Inevitably, the gap between money and oil supply will grow again.
For developed nations, he says, “there is nowhere to hide.” The price of oil will stay below $80 until 2010, as the global economy gets back on its feet. Once the world economy is in recovery mode by the end of 2010, expect the price of oil to move above $80, and stay there permanently. The higher oil prices will “act as an important drain on disposable income for most of the developed world.”
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