In the last five years, the price of commodities like rubber, corn, and cotton have doubled, crashed, and then quadrupled. Is this a typical tango between limited supply and growing demand? Or have central banks and investors pumped the commodities markets with extra juice that makes their gyrations more violent?
In July, the St. Louis Fed looked at this very question. This synchronization of price waves across many commodities (see above) might suggest that our commodity price boom is "a bubble driven primarily by near-zero interest rates and excessive speculation in commodity futures markets." But it's more likely that market fundamentals are driving the high price of agricultural products and other resources, for at least three reasons:
1) Supply shocks: The 47 percent increase in wheat prices last year was largely attributable to "drought in Russia and China and to floods in Canada and Australia," the Fed reported. High cotton prices stemmed from floods in China, the world's largest producer, and Pakistan, its fourth-largest.
2) The Rise of China/India, whose share of the aluminum and copper market has quadrupled since 1995.
3) The Rise of Biofuels: The growth of ethanol and biodiesel demand means energy demands are eating what would have formerly been surplus of corn and soy. This has the effect of "placing a floor" beneath food prices, since there will always be a base of demand for these crops.
At the same time, there is a less understood relationship between historically low U.S. interest rates, financial speculation, and high food prices. This sounds impossibly convoluted, but it's not.
The Federal Reserve wants banks to lend more money. So it lowers interest rates and buys risky assets off the banks in exchange for something liquid, like cash. Flush with cash now, these investment funds go out looking for higher returns. What offers high returns? Something where the fundamentals suggests rising prices in the near future. Hey, that sounds a lot like some commodities we've been talking about! Seeing the imbalance in the crops, metals and commodities markets due to rampant demand and questionable supply, they bet up the price of corn, cotton, oil, and so forth, with the expectation that these prices will keep rising ... at least before they can sell off the investments and make some money along the way.
This infographic from the World Development Movement makes just that case.