Mo' Money, Mo' Problems

Mo' Money, Mo' Problems

Mini Teaser: A host of countries are making great economic strides, which means the burgeoning global middle class is demanding an ever-growing piece of the pie. That’s good news, but it’s also causing higher prices for just about everything you could want. Th

by Author(s): Daniel Altman

RISING PRICES in commodity markets have caused alarm, protests and even violence in places as diverse as Egypt and the Philippines. Even in wealthy nations, higher prices for fuels, foods and raw materials are squeezing consumers and businesses, at times painfully so. The cause of this problem is fairly obvious: higher demand from the world's emerging economies, coupled with the usual growth in mature markets. The effects-and the solutions-are more complex.

Inflation doesn't exist in a vacuum. It is the rise of one price in terms of something else, be that how much you earn, the time it takes to procure what you're buying or simply what other desirable things cost. If all prices and wages rose at the same time, you wouldn't feel much of a difference. But when the prices of a few key products rise without a corresponding increase in wages, you feel the strain on your budget.

In the past several years, prices for crops, metals, minerals and fossil fuels have been climbing steadily. A broad index maintained by the International Monetary Fund has jumped 75 percent since the turn of the millennium. Prices for several scarce materials, like platinum and oil, have more than tripled.

The most-basic explanation is that supply has not kept pace with demand. The higher demand has its roots in rich countries and the booms of the past couple of decades, as well as in the opening of new markets. At the same time as consumers in the West were piling up unprecedented wealth, governments in the East were expanding their willingness and their ability to export.

Demand for energy and raw materials first came from manufacturers in poor countries seeking to supply consumers and businesses in rich countries. Soon they were followed by service providers as well. And eventually, the people working in those factories and back-office operations became wealthier themselves. Then they, too, began to demand more commodities, and other products based on commodities, for their own use.

That process has accelerated recently, and supply has not yet adjusted. With many-more bidders for roughly the same supply of commodities, it was inevitable that prices would rise and some bidders would be left empty-handed.

Yet as any economist will tell you, there is no better inducement for a new producer than rising prices, as long as costs haven't risen quite as much. The current inflation is not an inescapable spiral that will end in ruin. Rather, it is the beginning of one cycle in a never-ending series of changes and adjustments.

 

THE CAUSE of this inflation is on display for anyone who cares to look. Since the early 1980s, China has created a new middle class of roughly 300 million people. India has added perhaps 100 million. In other words, the global economy has added as many middle-class consumers as there are in the entire European Union. Even if they don't yet have as much income as the Europeans, they have similar desires to consume.

Moreover, your income doesn't have to rise in order for you to demand more commodities. You simply have to consume more commodity-intensive goods, which are produced ever-more cheaply thanks to innovations in technology, organization and distribution-as well as low-cost labor. For the price of a flat-screen television a decade ago, today you can buy a flat-screen television, a DVD player, a video-game system and a surround-sound speaker set. Demand for commodities can rise even in countries where wages are largely stagnant, like the United States.

For some farm commodities, it's a double whammy: more demand for food from emerging economies, plus more demand for food-based fuel from wealthy countries. Senator Charles Grassley, the Republican from Iowa, has said that an ear of corn isn't dinner for an American family. Well, it is for many families in other countries.

For some fuels, it's a triple whammy. If you're manufacturing plastics, you need oil first for your raw materials, then for the electricity to run your plant, then for the gasoline to deliver your product.

All of this explains why prices for commodities are rising, but it doesn't quite explain why they have risen so quickly. Even with the intense demand for oil, for example, the jump from about $20 a barrel in early 2002 to $120 earlier this year has been stunning.

Part of the reason for the dramatic changes in commodity prices has to do with expectations. The price of a barrel of oil today is determined not just by people who want to use the oil today, but also by people who may be buying supplies for the future. They will want to balance the price of a barrel of oil today versus a barrel of oil a few weeks, months or years down the road. And the price of a barrel of oil a few years from now will, in turn, depend on expectations about supply and demand a few years after that.

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