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Commodities take a 40-yr round trip





The top chart is the nominal version of the CRB Spot Commodity Index, while the bottom chart is the real, inflation-adjusted version of the same index. According to the PCE deflator, inflation has totaled 385% since the beginning of 1970, and according to this commodity index (which includes no energy), commodity prices have risen a total of 370%. That means that in real terms, commodity prices today have just about returned to where they started in 1970. (For the record: during the 1960s, inflation was about 25%, but commodity prices rose only 15%, so real commodity prices today are about 10% below where they were in 1960.)

To make things more interesting, on the second chart I have added some colored backgrounds to highlight how different monetary policy regimes have impacted real commodity prices. Monetary policy was notoriously easy in the 1970s. Money was cheap to borrow (real interest rates were generally low), so speculators had a field day buying and hoarding commodities, and selling the dollar. Beginning in late 1979, when Paul Volcker took over the Fed, monetary policy shifted to inflation-fighting mode and ignored any signs of economic weakness. Real interest rates were generally high for the next two decades, and inflation fell from double digits to a mere 2%. Speculators had a hard time surviving those years, since commodity prices went nowhere but borrowing costs were high. Unable to speculate on inflation-fueled price rises, investors were forced to make money the old-fashioned way by buying and creating productive assets. Since 2002 we have seen the Fed shift to an overtly accommodative monetary policy stance. Real borrowing costs have been generally low, speculators have thrived, the dollar has again collapsed, and commodity prices have soared.

The parallels between the 1970s and the past 8 years are many: a weak dollar, soaring commodity, gold, and energy prices, real interest rates that are generally low, and a Fed pays more attention to the economy than it does to sensitive asset prices. The only thing that makes the period since 2002 different from the 1970s is that inflation hasn't risen in recent years (although the CPI did rise to 5.6% in mid-2008). Will we continue to see very low inflation? I sincerely doubt it. History may not repeat itself exactly, but there is sure a lot of rhymin' going on.

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