Our Life in a tough new world of higher commodity prices

SOARING commodity prices, rising headline inflation and weakening economic growth: for those whose memories stretch back to the 1970s, this combination brings painful memories. It reminds them of the mistakes made by the central banks that accommodated the upsurge in inflationary expectations rather than contained them. Inflation was finally brought back under control in the early 1980s. But the costs of letting it escape were huge. Could we be making the same mistakes again?

In the US, headline consumer price inflation was 4.3 per cent in the year to January. In the eurozone, it was 3.1 per cent in the year to December 2007. In both cases, there was a gap - in the case of the US, a huge gap - between the headline rate and the "core" rate, which strips out volatile prices of energy and food.
If this were a temporary deviation, one would ignore it. But it has been continuing for years, particularly in the US. A cynical observer might well conclude that the Federal Reserve threw caution to the wind years ago. That is what Arthur Burns, then Fed chairman, did in the early 1970s, under pressure from Richard Nixon, then president. Has that been happening again in recent years? The question is surely a fair one.

The proximate cause of the surge in headline inflation is the global rise in commodity prices. Over the six years to February 2008, the Goldman Sachs broad commodity index jumped by 288 per cent, the energy price index by 358 per cent, the non-energy index by 178 per cent, the industrial metals index by 263 per cent and the agricultural index by 220 per cent. This, then, has been a broad surge in commodity prices, albeit after more than two decades of, first, falling and then stagnant prices.

A rise in the relative prices of commodities may reflect inflationary pressures. It may also cause inflation. But it is not itself inflation. Such a rise is also precisely what we are seeing. If one deflates the rise in commodity prices given above by the increase in the unit value of exports of manufactures from high-income countries, one obtains the following increases in real prices: 147 per cent for all commodities, 192 per cent for energy, 77 per cent for non-energy, 131 per cent for industrial metals and 104 per cent for agricultural commodities