Dan Atkinson and Larry Elliott
When the Iraqi tanks of Saddam Hussein rumbled into Kuwait in August 1990, economic pundits declared that the oil price could hit $60 a barrel within months. Early this week, a barrel of Brent crude was changing hands at less than $16. It was not only oil that was tipped to go through the roof in those jittery days and nights of the Gulf crisis. Gold, after nine years in the doldrums, looked set to march back up to the peak of almost $1000 per Troy ounce hit in January 1980.
Today, after a further seven years’ disintegration, the price has dived to about $282 – in inflation-adjusted terms one of its lowest levels since it broke out of official price controls in the early 1970s.
Copper tells a similar tale. In London the price fell by 1,3% this week to a four-year low as the crisis in East Asia prompted a drop in global demand. A far cry indeed from the early 1970s, when the rising price of copper was an early warning of the inflationary storm clouds gathering over the West.
Commodity prices have a record of predicting economic and political trends. In the 1930s, the Great Depression in the United States, Australia, New Zealand and South America was presaged by crashing land values. Metal prices around the world fell sharply as industrial production was cut by 40%.
It is against this background that Federal Reserve chair Alan Greenspan made his cryptic remarks at the weekend about the need to guard against deflation. “Inflation has become so low that policy-makers need to consider at what point effective price stability has been reached,” he told the annual American Economic Association conference in Chicago.
Markets reacted predictably to his comments, with commodities marked down on the basis that the respected Fed chair must have some reason for mentioning the dreaded “D” word.
There are deeper reasons why commodity prices are sluggish. Many commodities come from the poorest nations in the world, which are struggling to pay off their enormous debts by increasing production. The West is also suffering from excess capacity, particularly of labour, with unemployment in Europe alone standing at 18-million.
But Greenspan’s fears go beyond this. Despite his reputation as an inflation hawk, he is the product of an economic and political culture for which depression is as much a nightmare as is inflation to the German establishment. For Americans, the memory of the 1930s, when at least a quarter of able-bodied men were on the dole, is as pivotal as 1923, when Germans trundled wheelbarrows full of worthless banknotes through the streets.
In other words, one would expect the US to be the first leading economic power to sound the alarm on deflation. For the rest of the world, the key question is whether the danger is real or imaginary.
Since the early 1970s, commodity price inflation has ebbed and flowed. Oil prices quadrupled in late 1973, after the Arab- Israel war, then fell back during the recession that followed. In the late 1970s, when demand was picking up in the West, prices of fuel, precious metals and raw materials roared ahead once more. Policy- makers responded by raising interest rates to combat inflation, but there was to be a further spike in prices in the boom of the late 1980s.
Little wonder, then, that the signs of rising commodity prices three years ago should have set alarm bells ringing in central banks. To conventional eyes, the message was clear: the slump of the early 1990s was over and another destabilising boom was in prospect unless early remedial action was taken.
Policy was tightened. In the US, interest rates were raised in 1994. In Europe, not only was monetary policy tough but taxes were increased, too, so that the Maastricht convergence criteria for membership of the single currency could be met.
This was the correct conventional response. But was it right? Looking at what has been happening to the price of Van Goghs and the more expensive red wines of Burgundy and Bordeaux, a neutral observer would say yes. But the nature of these commodities suggests the price rises may have more to do with widening social inequality than with a general increase in the price level.
Nevertheless, the optimistic scenario is that policy-makers acted promptly and prudently, ensuring continuation of the Goldilocks economy, one which is neither too hot (inflationary) nor too cool (deflationary), but just right.
Pessimists, and Greenspan may now be among them, would point to sliding commodity prices as proof that central banks and governments, by taking action in the mid- 1990s against a non-existent inflationary threat, may have pushed the world economy from benign disinflation into the vortex of deflation.
Trends in the price of farmland are not encouraging. The property consultancy Savills predicts that Britain’s agricultural land, having bounced back from the slump of the early 1990s, will fall in value by 20% by 1999.
It may be too early for a remake of The Grapes of Wrath but it may be worth keeping an eye on the most basic of all commodities: the soil.
BLURB: The key question is whether the danger is real or imaginary