Monday, May 16, 2011

The Downturn in Commodity Prices

So here is an opportunity for a lesson in observing the economy. In the last few days some commodity prices that have risen significantly in the last couple years, including oil prices, have backed off their highs. I have seen several articles claiming that this price drop proves that the Fed and other inflationary forces are not to blame for the price rises.

Now anyone who has read this blog may remember that I am not convinced that the the Fed's activities  the primary cause of the rise in oil and other commodities’ prices. I see real, actual economic causes at work. But I can not allow my analysis to then infer that recent lowering of those prices proves me right, or proves anything particularly at all. Short-term changes in prices offer little evidence of anything.

Frankly, I think that looking at short-term events is an indication of a lack of thought. It is a knee-jerk reaction. It is a sign that the source has little understanding of actual economic processes and is instead seeking to support his own predetermined ideological position.

Of course, the recent downturn could become something more than short-term, meaning that it is too early to tell if the drop in prices means anything.  If the declines continue, then we have something to consider.

Suppose the drop in prices becomes a trend. We would need to ask why the drop is taking place. The first thing to do is to look at production. If production has increased, then we can regard that as a significant element of the price drop. As government actions, especially money creation, haven’t changed much, changes in production would be the major factor.

If there has been no change in either production or government activity, then we are faced with a weakness in the actual demand for the product. That is, economic activity is lessoning, and we may be seeing the first steps toward a downturn in the world economy.

What changes in commodity prices, prices that are more responsive to market changes than most, means depends upon the details. We should never accept knee-jerk reactions that look solely toward the government.

1 comment:

  1. Astute observations C.W. Too often do politicians use short-term economic activity for short-term political gain. However, the sounds of politicians scrapping the bottom of the barrel sometimes drowns out honest and pragmatic analysis such as yours.

    Thanks for your thoughts.