| It happened three times in the previous century and it appears to be happening again - an explosive rise in the prices of many commodity across the board. Crude oil prices are at their highest level since the first Persian Gulf war. Silver and soybeans are at their highest prices since 1988. Gold prices are the highest in eight years. Cattle prices are near their all-time highs and on Friday, the spot futures price for pork bellies closed at its highest level ever. Other multi-year highs can be seen in corn, wheat, copper, unleaded gasoline, and natural gas. What is causing all the excitement and will it last? The short answer is: many things and yes.
In the twentieth century, we saw this three times: in the 1910's, the 1940's, and the 1970's. The first two times coincided with World Wars I and II and are not too hard to understand. The war effort dominated everything. Government spending rose dramatically and private commerce suffered. Commodity shortages became common and the result was often a tripling in the prices of all kinds of goods.
The 1970's are a little more complicated. The decade started with the end of the Vietnam War, but wartime spending was not the dominant feature of the decade. The force behind the commodity price explosion in this decade had more to do with the economic theories of John Maynard Keynes. Observing the Great Depression, Keynes concluded that the way out of economic stagnation was for the federal government to increase public spending and keep interest rates low. The economic advisors of both political parties bought into this idea. Federal spending tripled in the 1970's, a big jump for a relatively peaceful decade. The economic gains were not impressive, but inflation sure was. By the end of the decade, it took the determination of Paul Volcker as the head of the Federal Reserve to allow interest rates to rise painfully high enough to shut off the inflation and bring back stability to the markets. When the dust cleared, many commodities had tripled in value or more. Spot silver was the big percentage winner, rising from under $2 to over $40 per ounce.
Understanding today's rise in commodity prices requires a little background. Thanks to the peace dividend that resulted in the downfall of communism and thanks to public pressure on both political parties to bring down the deficit, federal spending in the 1990's increased by only 43%. That was the smallest increase since the 1920's and the reduced governmental burden provided remarkable stimulus to the economy. The big winners for the second decade in a row were the financial assets - stocks and bonds. Commodity prices suffered, and more importantly, commodity producers suffered. Whether you look at mining or oil or the agricultural industry, commodity producers either left the business or were bought out by larger firms. The resulting concentration of producers set up today's bull market in commodities.
On the political side, today's war on terrorism is not as big as World War II, but it does take away the future outlook for a peace dividend and it requires an unexpected increase in federal spending. It is also fair to say that the President and Congress have lost the fiscal discipline that created the boom in the 1990's. Large increases in government spending hurt economic growth and favor tangible assets (commodities). The Federal Reserve is trying to help the economy by keeping the federal funds rate at 1.0%, but it cannot overcome the burden of increased federal spending. The result is a weaker U.S. dollar that revs up the market's appetite for commodities. As long as the consumer price index doesn't shoot up, the Fed is comfortable with this policy. The result is an opportunity for higher commodity prices that the market has not seen since the 1970's. In the 1980's and 1990's, financial assets ruled, but their day is over. This decade, the scale has tipped back and commodities are king.
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