Surge in Commodity Prices Points to Overheating U.S. Economy


A recent surge in record-high prices for commodities such as coffee and copper can be linked to a common cause: an overheating U.S. economy.

The spike in commodity prices may indicate that the Federal Reserve is not successfully managing inflation, economists revealed. In simpler terms, these record prices could suggest that monetary policy remains too loose, despite several Fed rate hikes.

At first glance, the Fed might not seem responsible for the rise in commodity prices.

It might appear that various random factors have driven up the prices of different commodities.

For example, cocoa prices hit record highs this spring due to aging tree stock and disease in Ivory Coast and Ghana.

Coffee prices also reached new heights mainly because of drought in Vietnam.

Last month, copper prices soared to unprecedented levels. Copper has long been considered an economic barometer due to its extensive use in construction, appliances, and more. This time, however, traders blamed a short squeeze for the spike.

Other commodities like gold have also recently hit record levels.

Overall, except for oil and natural gas, commodity prices have been climbing in recent months, approaching their highest levels in a decade, apart from the surge seen after Russia’s invasion of Ukraine.

While various supply-side factors have pushed up different commodity prices, one key demand-side factor might be responsible for the overall rise: the persistent strength of the U.S. economy.

U.S. gross domestic product has been growing rapidly, at annual rates of 8.3%, 5.1%, and 4.3% in recent quarters. These numbers, unadjusted for inflation, indicate strong demand for goods and services from governments, businesses, and consumers. The low unemployment rate of 4% in May reflects this demand.

Both low unemployment and high commodities prices could suggest that the Fed’s monetary policy is too loose, meaning there’s too much money chasing too few goods and services.

This idea might surprise those who know the Fed has raised its target interest rate to its highest level in decades. However, high rates do not automatically mean tight money, as shown during the Great Inflation of the 1960s and 1970s when rates were even higher.

Decisions by Chairman Jerome Powell and other Fed officials can influence commodities in multiple ways.

Higher interest rates can encourage investors to sell commodities stored away to purchase higher-interest-paying bonds.

Monetary policy changes that suggest stronger growth also lead investors to anticipate higher demand for commodities. Economic growth means more use of metals for construction, wood for homebuilding, and so forth.

Finally, Fed decisions impact the dollar, which in turn affects commodities prices since most are traded internationally using dollars. For example, the dollar rose over 20% from mid-2014 to early 2016 as the Fed increased rates from near-zero levels post-financial crisis. During this period, West Texas Intermediate crude oil prices fell from around $100 a barrel to under $40, disrupting the shale boom and causing massive oil field layoffs.

Economic studies have shown the Fed’s decisions affect commodities prices. An IMF paper published last October found that a 0.10 percentage point rise in the Fed’s target rate can reduce commodity prices by 0.5% to 2.5% within weeks.

Some economists interpret high commodities prices as indicating that the Fed is keeping money too loose.

David Jacks, the J.Y. Pillay Professor of Social Sciences at Yale-NUS College and professor of economics at the National University of Singapore, stated in an email that commodities market activities reflect “remarkably loose fiscal policy.”

Jacks pointed out the U.S. government’s large fiscal deficits, indicating more spending than income, which pressures inflation. “That the US is running a deficit over 5% outside of a recession is unprecedented recently, and it naturally affects asset markets and inflation expectations,” he said.

However, other economists view high commodity prices as a sign of a robust economy but not necessarily that the Fed’s monetary stance is fueling more inflation.

Jeffrey Frankel, an economist at the Harvard Kennedy School who has studied the link between monetary policy and inflation, noted that real interest rates have risen and the dollar has strengthened. These developments often suggest tighter, not looser, monetary policy.

“I would suggest that strong US economic growth is the driving force behind high commodity prices, high real interest rates, and a high dollar,” he wrote.

Another consideration is that global growth, not just in the U.S., is unexpectedly robust, pushing up commodity prices.

Economists at BMO Capital Markets recently noted that the “backdrop for non-oil commodities is firming amid new Chinese economic support measures and disinflation progress, setting the stage for central bank rate cuts.” They expect prices to rise further in the coming year.

Joseph Lawler
Joseph Lawler
Policy Editor & Economics Reporter. Previously, Joseph worked for RealClearPolicy. He is a native of Massachusetts and a graduate of the University of Notre Dame.

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