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Rising Commodity Prices - Are Negative Real Interest Rates to Blame?

By March 26, 2008

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I would have guessed that the major driver of lower commodity prices (when priced in U.S. dollars) is the sinking greenback. Note the use of the word major - because there are so many interrelated factors in the economy the problems of spurious relationships and confounding variables are ubiquitous. James Hamilton argues that we need to consider the role negative real interest rates are playing:
Nor do I agree with those who attribute the recent commodity price increases primarily to the falling value of the dollar. True, the dollar price of an internationally traded commodity should rise when the dollar falls. But the dollar only depreciated 7% against the euro between January 1 and March 17, while the average commodity included in the table at the right gained more than twice that. You paid more for your aluminum and coffee and wheat regardless of whether you tried to pay with dollars or euros or yen.

Instead I believe that Harvard Professor Jeff Frankel has the correct explanation-- commodity prices at the moment are being driven by interest rates, with a strongly negative real interest rate increasing the incentives for speculation in any storable commodity.
It makes sense - if interest rates are at 2% and inflation is at 6%, then you make real gains by buying and holding commodities - so long as the price of commodities rise at average or higher levels of inflation. And your profits don't get eaten up by transaction costs.

But do I really want to store 3000 lbs of copper in my garage? That's boring. I would much rather make my money by using baseball cards as my storable commodity. Of course there are far higher transaction costs with baseball cards than with "regular" commodities. Plus I have to hope someone else has my taste in cards. Does anyone other than me really want the 1973 Topps card of Terry Crowley about to get his leg broken by Thurman Munson?

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