Commodities, Global Growth, and Inflation
What to think.


Confirmation that the ongoing rise in commodity prices is of economic origin and not a worrisome monetary phenomenon comes from a Kudlow & Co. survey of 51 of the world’s larger economies, representing approximately 94 percent of global GDP. The data reveal a strong tandem relationship between the commodity price swings of recent years and the contraction and expansion of the global marketplace.

Nominal GDP for the economies surveyed ended 2005 at $41.6 trillion (in current U.S. dollars), up 0.4 percent from the prior quarter and 5.1 percent above its year-earlier level. More significant, since the global contraction of 2000-01, these economies have expanded by a cumulative 41.7 percent in nominal terms, averaging per annum growth of 9.3 percent. The Commodity Research Bureau (CRB) Index over the same period was on an almost identical track, rising 85.7 percent from its January 2002 trough.

Other commodity indices followed similar patterns, their movements coinciding with the ups and downs of world economic activity since the beginning of the new millennium. The Economist’s All Industrials Commodity Index, which gained 96 percent in the 2002-05 period, mirrored the rise in global capital spending over the same four years. Capital investment in the 41 countries that publish such data rose by 27.8 percent to $4.1 trillion (at current prices) as of year-end 2005.

The capital expenditures/GDP ratio, moreover, is usually indicative of future economic performance. When the ratio rises, it means the rate of capital spending is outpacing the growth in GDP — i.e., a sign of confidence in what the future has in store. The ratio hit bottom in the second quarter of 2002 at 0.1925:1. It then treaded water until the third quarter of 2003 when it commenced a rise to 0.2011:1 by mid-2004. It ended 2005 at 0.2052:1. While representing substantial improvement, the capex/GDP ratio is still below its recent peak of 0.2289:1, set in the third quarter of 1997.

In the absence of any resurgence in inflation, gold’s 125 percent appreciation since the start of 2001 must be interpreted as a sympathetic move. Gold’s initial upturn was little more than a response to prior price deflation, caused by a dollar liquidity shortage. Once it regained its luster by year-end 2003, gold began moving in synch with other commodities, such as copper.

Since the end of 2003, it’s safe to say that gold hasn’t led the commodities’ charge but rather has followed it. This again confirms that increased economic demand, not excess monetary liquidity, has been the principal cause of the continuing escalation in commodity prices.

– William P. Kucewicz is editor of and a former editorial board member of the Wall Street Journal.