The Other Side of Fed Policy
April 16th, 2008 by Chris KinnanThe dramatic loosening of monetary policy is spiking dollar-based commodity prices worldwide. While there are many factors driving higher commodity prices, including U.S. biofuels mandates, I believe Fed policy is a major cause. Banks and homeowners and some exporters are helped by the Fed’s actions, but consumers are taking it on the chin. As Milton Friedman once said, there’s no such thing as a free lunch.
(ht for the underlying graph to “Anonymous” commenter at Calculated Risk, Fed timeline from various news reports)
April 16th, 2008 at 5:36 pm
Can you expand on your point here Chris? I’m trying to understand what exactly I supposed to glean from the graph.
April 16th, 2008 at 5:52 pm
Hi Sickle, I’m just trying to show the connection between Fed monetary policy and the increase in commodity prices. It’s been a dramatic run since August.
April 16th, 2008 at 6:37 pm
Okay, I see what you’re getting at. What’s the mechanism by which these fed actions affected the commodity prices, though? I think that’s the part I’m missing.
April 16th, 2008 at 7:21 pm
When the Fed cuts interest rates, it puts more dollars into the economy. The law of supply and demand works for currencies, too. So commodities that we need to buy in the global marketplace (oil, food, etc) become more expensive, in dollar terms, because every dollar we hold is worth a little bit less now.
Of course, Fed “loose” monetary policy doesn’t explain the commodities run-up completely, as there are many other factors in play, especially in food markets. But I think Fed policy is a major factor…as is the response to Fed policy, as investors pump money into assets (like commodities) that will hold their value as the dollar crashes.
April 17th, 2008 at 11:50 am
Thanks, Chris, for explaining that to me. Appreciated.