The Bernanke-bashing bubble

February 8, 2011, 4:36 PM UTC

If the Fed is out of ammunition, can Ben Bernanke really riddle the globe with inflationary slugs?

Practically every day we are told the central bank is powerless to right the staggering U.S. economy. The Fed’s bumbling oversight during the housing bubble, when trillions of dollars were wantonly misspent and worse, hardly undermines this view.

Don't blame the Fed. (Sources: NBEPA , Moody's via Beckworth)

Yet in one area, the Fed’s reputation for omnipotence remains strangely intact. Bernanke said a few months back he would try to get inflation rising modestly again to restore growth and jobs to the debt-addled U.S. economy – and now his critics are taking him at his word, and then some.

Fed doubters are all too happy to blame Bernanke for surging food and fuel prices — even though the evidence says the Fed plays at best a supporting role in this unhappy drama.

The true stars of the story of rising copper, corn and livestock prices are rising incomes and growing appetites in Asia and other emerging economies. That combination stokes robust demand for goods and raw materials that doesn’t fade with rising prices. Also making an appearance are foreign politicians crossing their fingers and hoping, as policymakers often do, that the party will wind down without anyone having to actually yank away the punch bowl.

This says higher food prices are the price of admission to the global growth game, and may persist no matter what we do in this country.  But hey, why sweat the details when a convenient punching bag is available in Washington?

“There is this presumption that the Fed is the god of everything,” said David Beckworth, who teaches economics at Texas State and writes a blog about what the central bank is up to. “But that betrays a perspective that the United States is more at the center of these developments than it really is.”

One story often told about commodity prices is that because they are priced in dollars, any sustained rise in the prices of things like oil, gold and flax seed reflects at least in part a decline in the value of the greenback. This dovetails nicely with the rise in commodity prices over the past decade or so of dollar weakness, and with the argument that the unstated goal of the Fed’s QE2 bond-buying program is to boost U.S. exports by cheapening the dollar against other currencies.

It dovetails less nicely, however, with the actual timing of the agricultural price shocks of the past year. The prices of wheat, sugar and cotton, to name three big gainers of 2010, took off well before Bernanke started talking up QE2, because of (among other things) bad weather. Meanwhile, the dollar index is actually up since QE2 started, and flat with its level three years ago.

Whose fault is it?

“You can’t blame Bernanke for the Russian drought or the cotton crop failures in Asia,” said Howard Simons, a strategist for Bianco Research in Chicago. “More money does create an inflationary environment, but rising commodity prices can’t be totally blamed on the creation of money.”

Bernanke blamers shoot back that there was no crop failure in copper, up 58% over the past year, or any weather-related disruptions tarnishing the market for silver, up 94%.

True enough. But Beckworth notes that dollar weakness is hardly the only investment trend that matches up with rising commodity prices – and recently, the massive flow of goods to China makes for a more compelling explanation.

A look at the year-over-year change in emerging markets industrial production, for instance, matches up rather well with the change in commodity prices since 2007 (see chart, right, above).

What’s more, economist João Marcus Marinho Nunes of Fundação Getúlio Vargas in Brazil points to a strong link between rising commodity prices and rising Chinese imports.

The link first became visible in 2001 (see chart, right, below), when China joined the World Trade Organization, and has gotten stronger since then, Nunes writes in a recent post.

Bulls in the China shop (source: Nunes)

He contends that commodity prices have tracked much more closely with Chinese economic activity in recent months than with the dollar. This makes sense, given that China last year accounted for half of global demand for iron ore, a third of world demand for aluminum and copper, and a fifth of demand for corn and soybeans, according to data compiled by UBS.

“Over the last 15 months the dollar has barely moved but commodity prices have shot up together with the resumption of growth in emerging markets industrial production and Chinese imports,” Nunes writes. “So maybe all the hoopla from people like the Brazilian Finance Minister about ‘currency wars’ induced by US monetary policy is misplaced.”

The China link also helps to clarify the action in commodities during the 2008 financial crisis. Global trade collapsed that fall, and Chinese imports fell essentially in lockstep with the CRB index of commodity prices (see second chart, right).

The dollar rose during that episode, in the classic flight to safety. But Beckworth, for one, doesn’t recall any accompanying shift in Fed policy. Could it be that the Fed isn’t the the only player in this game?

“People have been screaming bloody murder about the Fed being too easy,” he said. “Where were they in the fall of 2008?”