Earlier Posting

Up or down? 0700 3 August 2009 Inflation or deflation? This is possibly the biggest question in global macro-economics today. If you watch the commodity index, as I do, the charts are not yielding an easy answer. Since May of this year, the Reuters/CRB commodity Index of 17 major commodities has fluctuated between 200 and 260 - and is now towards the upper end of that band. Whenever it seems that the various government fixes are bringing recession to an end, the commodity index soars, and when indicators like unemployment or consumer spending show continued weakness, commodity prices drop. I like to distil my view on commodities down to three basic thoughts: - The US Fed and Treasury are doing everything they can to avoid deflation in the US. Trillions have already gone into the fight, so they are committed to the cause. They are not going to give up in a hurry. - The money they throw at the problem will cause increasing deficits in the US, as tax revenue is not going up any time soon. The US government will need to keep borrowing money to fund these deficits; at some point, the over-supply of dollar assets will mean that external investors will be willing to pay less for them, leading to continuing weakness in the dollar. - The mirror image of this dollar weakness will be strength in currencies of nations which have surplus savings to invest - the yen, and the yuan, notably. Other things being equal, the dollar price of commodity prices will tend to go up, while countries with excess savings will see commodity prices in their currencies go down. In other words, the issue is not of general deflation or inflation, but of the relative costs of commodities in different currencies. In this line of reasoning, India is likely to be in the same boat as the US, since we have a chronic export deficit, AND a government with increased borrowing needs. Which is why I believe that in the medium-term (of one to three years), we are in for commodity price inflation. How does one protect oneself against such a scenario? The best hedge I know is gold.
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