How severe will the international slowdown be – the story from commodity prices?

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Commodity prices are a particularly sensitive indicator for the world economy due to their strong and pro-cyclical price fluctuations. These in turn are linked to supply inelasticities – the obstacles to and pronounced time delays in changing the supply of many commodities.

Agricultural commodities frequently require a minimum of a year to increase output due to seasonal factors, and many minerals require very heavy investment, needing time to implement, before output can be increased. Once such heavy fixed costs have been undertaken it is prohibitively expensive to reduce production. Therefore whereas in manufacturing and services a large part of fluctuations in supply and demand is absorbed by changes in volume, in commodities a much higher part has to be absorbed by changes in price – hence extreme price fluctuations.

In that light Figure 1 shows a sensitive indicator for the world economy – the daily Dow Jones-UBS spot commodity price index for the last 20 years. The story is clear. The first gradual and then rapid surge in commodity price inflation in 2000-2008 is evident, as is the price crash during the international financial crisis. Price recovery occurred during 2009 up to spring 2011, taking commodity prices to higher levels than in 2008. This lay behind the consumer price inflation in India, China and other developing economies.

The peak of commodity prices was reached on 29 April 2011 – the subsequent decline itself being an excellent indicator of a slowing world economy. The subsequent fall, of 17.7 per cent to 21 December, may be seen in Figure 1.

Figure 1

11 12 22 DJUBS all

The year on year fluctuation in prices, which is what is reflected in the annual consumer price and producer price index figures, is even more violent. In 2011 the peak annual increase was reached at 46.6 per cent on 7 June and by 21 December it had fallen to minus 6.3 per cent. This largely explained the falling consumer price inflation in first China and now India. This inflation drop gives to gives room to loosen economic policy which is why China, for example, will not have a hard landing.

The present fall in commodity prices is clearly not yet nearly as severe as in 2008. Neither, however, has the decline halted. As they are available on a daily basis monitoring the course of commodity price indexes is a key early warning tool for gauging how severe the international economic slowdown will be.