Commodities and the dollar

Each commodity market has its own story to tell: oil prices are falling because OPEC can’t agree production cuts, steel faces a glut from overcapacity, and even the price of maize has fallen, presumably because of good harvests.

In local currencies this is not so much the case. Of course, the difference between prices in local currencies and prices in US dollars is reflected in the weakness of most currencies against the dollar in the foreign exchange markets. This tells us that whatever is happening in each individual commodity and in each individual currency the common factor is the US dollar.

Macro-economists, who are Keynesian or monetarist by definition, are beginning to interpret falling commodity prices and a rising dollar as evidence of insufficient aggregate demand, which left unchecked will lead to deflation, increasing unemployment, bankruptcies, falling asset prices, and bank insolvencies. It is, they say, an outcome to be avoided at all costs by ensuring that aggregate demand is stimulated so that none of this happens.

Whether or not they are right in this assessment is not the point. They neglect to allow that some of the move in commodity prices is due to the currency itself as the numéraire of all prices.

For evidence of this we need look no further than the attitude of the Fed and every other central bank that targets price inflation as part of their monetary policy. In forming monetary policy there is no allowance for the possibility, nay likelihood, that in future there will be a change in preferences against the dollar, or any other currency for that matter, and in favour of anything else. The tragedy of this lack of market comprehension is that it’s a fair bet that monetary policy will not only succeed in limiting the rise of the dollar as it is designed to do, but end up undermining it when preferences shift the other way.

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