Commodities surge may not spark 1970s stagflation

Surging food and energy prices are fanning global inflation pressures, but the 1970s scenario of anemic economic growth and sky-high prices is unlikely, with the commodities bubble expected to eventually burst.

Analysts at this week's Reuters Investment Outlook Summit in New York said that while much of the commodity price rise was being driven by supply and demand, speculative forces were also at play.

"The direction of commodities, the way they are moving, suggests there's another bubble in that market. Nothing ever goes to heaven," said Henry Kaufman, president of financial consulting firm Henry Kaufman & Co. Inc.

"I think there is a bubble, yes, in the commodity market. I can't evaluate what stage."
Demand from emerging markets such as India and China has pushed up food and energy costs, stoking inflation pressures and putting central banks on edge. That includes the Federal Reserve, which since September has slashed interest rates to shore up an economy battered by a housing sector downturn and a credit crisis.

The demand for commodities has proved insensitive to the price spike, with government subsidies cushioning the impact on consumers, the experts said.

The analysts argue that prices cannot continue their upward trend indefinitely, citing the U.S. house price collapse as an example, and say that combined with slower global growth should help curb demand and avoid stagflation.

WEAK STAGFLATION

"We had some really painful stagflation back in the '70s when we were looking at double-digit inflation rates and no growth," said Martin Feldstein, head of the Cambridge, Massachusetts-based National Bureau of Economic Research. "I don't see that happening now; that's not to say it couldn't happen again if the Fed misbehaved."

"Could we go over the next few years to a period in which prices or inflation remain at today's level, above what the Fed would like and above what the ECB would like, while we have at the same time slow growth? That could certainly happen. It will be more like weak stagflation."

The 1970s stagflation, which marked a period of double-digit inflation, slow economic growth and rising unemployment was triggered by an oil price shock and excessive monetary easing by central banks.

The European Central Bank has flagged an interest rate hike next month, while Fed officials, including Chairman Ben Bernanke, have signaled that the U.S. central bank's rate-lowering campaign is done and the next move in rates will be up.

"If we had 4 percent headline CPI (Consumer Price Index), together with very weak (U.S.) growth, you could call it stagflation, but it wouldn't be the kind of spiraling inflation that we had in the late '70s that eventually had to push the economy into a deep recession to get us out," Feldstein said.

"If the downturn continues and it gets deeper and more general, then the Fed is going to be reluctant to push up interest rates," he said. "How much imported inflation we get will be key in all this."

The headline CPI rose at an annual rate of 3.9 percent in April. The commodity price surge, also partially blamed on the dollar's unprecedented depreciation, had seen investors shifting from currencies into oil and gold, analysts said.

"There is obviously some diversification out of currencies in general into commodities, gold and energy. But I don't think you are going to see that much in grains or in industrial metals," said Roger Kubarych, chief U.S. economist at European investment bank Unicredit Group.

"This enormous boom in China is not going to last forever. They are going to have some slowing, particularly after the Olympics," Kubarych said.

Regarding global commodity prices, "We could probably see a situation where there isn't one-way direction from pure supply-and-demand considerations," he said.

The analysts cautioned against putting too much blame on the dollar for the jump in oil prices, saying the relationship between the two was rather weak.
"The oil and dollar connection is not the strongest one," said Alan Ruskin, New York-based chief international strategist at RBS Global Bank & Markets.

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Commodities surge may not spark 1970s stagflation