Thomas Tooke

How to allocate money to different commodities in the face of monetary expansion? An answer coming from 1920.

In Commodities on May 5, 2012 at 3:52 pm

There are useful insights coming from Kemmerer, about the area of the economy and related commodities subjected to distortion in prices due to monetary expansion. The distortions are not uniform and this is where there is money to be made for the speculator, if he properly understands the area whose price “benefit” from the monetary expansion.


Our war and after war raise in prices has not taken place in the form of a great rise in the prices of a comparatively few important commodities needed for war and immediate reconstruction purposes accompanied by a decline in the prices of other kinds of commodities. On the other hand, price increases since 1913, like those of the greenback period, have covered almost every class of commodities — war commodities and peace commodities, “production goods” and “consumption goods,” absolute necessities and rank luxuries.


I will add a personal comment here. We had in 1913 a lose monetary policy to finance the war on an economy which was not over-levered pre-war, the result was a 7 years flash, broad based inflation. On the opposite, post 1929 and later after the devaluation of the dollar from 20 USD per ounce of Gold to 35 per ounce, there was a gradual and long period of reflation. I let the reader figure out if the 1913-1919 resembles more the Vietnam era than ours, or if ours resembles more the 30s and 40s.

It is extremely important to distinguish between the “production goods” and the “consumption goods”, because those show divergences in prices. The students of price history make very clear distinction between the price pattern of different group of goods, and the distinction between the production goods and the consumption goods is absolutely crucial. In other words the money multiplier is a nice concept once you aggregate prices in a single measure of inflation. The student of prices observe very different patterns of prices and hence reject the efficacy of this reasoning of the multiplier, while recognizing the impact of the monetary expansion on particular areas of the economy. There are periods where certain goods go up in prices and other go down, using a single multiplier results in a mathematical absurdity. One of those periods described in a great book called “The Great Wave” shows period of distress where food prices go up while manufactured goods (leather) go down. The multiplier equation fails miserably to explain the reality of palm oil up 10-20 a year in the last couple of years and home prices down at the same time. Proponents of this equation will try hard to keep it because it has some logical elegance but when some prices go consistently down and others up, you have to acknowledge the problem.

In other words, for the average price inflation to be at 2% there needs to be some prices moving above the average, and other prices moving below average. Clearly the commodities speculator will reflect on which area (consumption goods versus production goods)  and within that area, he will reflect upon which of those consumption goods have a pattern which of growth (in units) or non elastically stable (foods, leisure, discretionary and non discretionary etc…). In an environment where aggregate demand might be limited because of aggregated level of debt, maybe food and tobacco are going to show above average increase in prices while homes will show price declines.  In the case of 1913, the monetary expansion was on the back of an initially un-levered economy so the rise in prices was very broad based, but again certain commodities if measured as ratio of other commodities were going down in price. As Jevons explains, price is a ratio. From that point, one should start to consider how many bushel of corn for shares of Munich Re, whose balance sheet must include quite a bit of government bonds of return-free risk. (Jim Grant coined the expression)


Kemmerer continues


No one can make a study of price movements of recent years without being struck by the wide range of commodities affected and the similarity of the price curves, shown by widely different groups of commodities, both among themselves and with the “all commodities” group.  Of the 1437 commodities whose price movements were studied by the War Industries Board, only 41, or less than 0.29 of 1% were lower in 1918 than in 1913, and only 23, or 0.16 of 1% were more than 10% lower. Less than 0.22 of 1% of the total were 400% or more higher in 1918 than in 1913, and of these 31, 11 belong to one of the 50 classes of commodities studied — the small class labeled “coal tar crudes, intermediates, and dyes.”  Of the 1437 different commodities studied by Mitchell, 834 or 58% showed price increases in 1918, and compared with 1913, of from 50% to 150%, of which 431 showed increases of from 50 to 90%. Forty-two out of the 50 classes of commodities studied embracing 1260 out of 1437 commodities, or 88% of the total, showed average price increases of over 75% above the pre-war level.

The 50 charts summarizing these war-time price studies, made under the direction of Professor Mitchell of the War Industries Board and published in the Summary volume previously cited, are most illuminating. The similarity in the movement of these curves is striking, and forcibly suggests the conclusion that the dominant forces at work in causing the rise of prices in most classes, namely, all but a few like those of the “heavy chemicals”, “essential oils”, and “explosives” groups, have been forces acting on the money side of the price ratio, and not those acting on the commodity side, in other words, that, in the main, general prices have shown their phenomenal rise of recent years because money and credit have been becoming increasingly plentiful rather than because commodities have been becoming increasingly scarce.



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