Commodity prices and real world trade volume tend to move in lockstep. Something different happened during the past year, when non-fuel commodity prices rose much farther than the modest recovery in world trade volume would have indicated. The discrepancy between a tepid recovery in trade (compared with the 2009 snapback) and an unprecedented jump in commodity prices can be put down to the Federal Reserve’s tsunami of a monetary stimulus and the US federal government’s never-before-seen-in-peacetime deficits. Practically, that means we are facing prolonged, nasty and persistent inflation driven by monetary policy, rather than “transitory” inflation due to real economic factors. The real factors contribute to price pressures, to be sure. But the irresistible force of multi-trillion-dollar US budget deficits financed by
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Commodity prices and real world trade volume tend to move in lockstep. Something different happened during the past year, when non-fuel commodity prices rose much farther than the modest recovery in world trade volume would have indicated.

The discrepancy between a tepid recovery in trade (compared with the 2009 snapback) and an unprecedented jump in commodity prices can be put down to the Federal Reserve’s tsunami of a monetary stimulus and the US federal government’s never-before-seen-in-peacetime deficits.

Practically, that means we are facing prolonged, nasty and persistent inflation driven by monetary policy, rather than “transitory” inflation due to real economic factors.

The real factors contribute to price pressures, to be sure. But the irresistible force of multi-trillion-dollar US budget deficits financed by $5 trillion of Federal Reserve asset purchases during the past year has hit the immovable object of sclerotic supply chains and a labor force reluctant to trade in souped-up unemployment benefits for a salary.

The International Monetary Fund’s economic blog acknowledges that cheap money is a factor, noting that “lower interest rates reduce the ‘cost of carry,’ which also includes cost of storage, insurance, and other expenses, and, thus, tend to support commodity prices.”

It isn’t just low interest rates, but the combination of cheap money and $5 trillion of fiscal stimulus that sent commodity prices into the stratosphere.

The explosive combination of fiscal and monetary policy both are captured by one variable: The Federal Reserve’s $5 trillion balance sheet expansion since the Covid recession began in March 2020.

If we add the size of the Fed’s balance sheet and the US dollar exchange rate to changes in world trade volume, we obtain a very good explanation of the past year’s jump in commodities prices (and the model stands up to rigorous statistical tests).

The only “transitory” thing in this environment of hyperventilating monetary policy is the Federal Reserve’s credibility. As we noted yesterday, former New York Fed President Bill Dudley warned in his weekly Bloomberg column that inflation might run out of control.

Retired Federal Reserve Governor Donald Kohn warned at a June 8 seiminar, “There are risks to the upside for inflation,” adding that the Fed has “a framework that’s not designed to deal with the upside risks to inflation. That’s the worrisome piece.”

You should be worried, too.