Saturday, September 6, 2008

There are no such bubbles: An extension

At the end of Salvador’s post there is a policy transmission channel that left some ends untied. Maybe central banks’ around the world are leading the way answering them.

Assuming that the link between future markets and agricultural commodities is, at most, weak, assume also that the link between future oil prices and agricultural prices is strong. A downward trend of almost every commodity since last month surprised investors dragging down yields in commodities future markets’. Gold is down by 21 percent from January’s price, corn is down 29 percent, oil 26 percent, wheat, and soy are down too.

What has happened? There is an ever growing probability that U.S. GDP will stop growing at some point this year (maybe it already has as the economic growth is to be publish for the 3rd semester) Department of Commerce calculated a 3 percent rate of growth for the second quarter just last august 28th. This among other reasons helped to finish the very slow transition of the FED’s monetary policy stand from loose to neutral (adding more weight on inflation concerns).

The European Central Bank has not languished in its rough stand against inflation over any other threat. A growing number of central banks around the world are more focused on fighting increasing inflation expectations. Banco de Mexico shifted its primary rate three times this year, from 7.5 percent to 7.75 percent on June, then to 8 percent on July and finally to the current 8.25 percent.

There is a great number of voices claiming that restrictive monetary policy will not help to stimulate aggregate demand around the world. Moreover, they preach that economies will sink since there are fundamental factors that cause high prices of agriculture commodities.

Maybe its time to start considering that central banks are, indeed, fighting inflation with restrictive monetary policies. The thing is that they are not doing so through traditional channels. Consider the following argument: as central banks are increasing interest rates and in most cases pushing up sovereign bond yields, this un-coordinated action (think of it as it were coordinated without lost of generality) is bursting the bubble component of high commodity prices.

How is this possible? Just a coordinated action among central banks could burst a global bubble, thus shifting investors' money to sovereign bonds from future markets. So, unwillingly, restrictive world monetary policy is contributing to commodity prices’ slump.

Taking Salvador’s argument. High prices in commodities do not cause grain supply increases because of the nature of technology-lacking agricultural sector in many countries, then, again, how is it possible that corn lost around 29 percent in just 6 weeks? Or that oil had lost almost 26 percent in the same period? A plausible answer is that the “coordinated” monetary policy is bursting global bubbles.

Furthermore, if “coordinated” policy remains, its possible that the next bubble to be born after commodity’s will be stopped. The only loose end thus would be that a stronger dollar, pushed by low growth expectations in Europe and Asian economies, will not temper U.S.’ trade deficit, nor will help to the biggest economy in the world to grow. There are no such bubbles, thanks to restrictive monetary policy.

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