Fed Exonerated in Commodity Price Surge

I can't help but read Fed Chief Ben Bernanke's speech yesterday – in which he absolves the central bank from playing any more than an incidental role in soaring commodity prices that happened to begin in earnest when QE2 was announced last August – in light of the central bank's poor track record in understanding what drives markets and how prices are set.

About half of the speech was devoted to silencing critics who argue the Fed's easy money policies have driven the trade-weighted dollar lower and commodity prices higher, the excerpt below being a representative sample.

While supply and demand fundamentals surely account for most of the recent movements in commodity prices, some observers have attributed a significant portion of the run-up in prices to Federal Reserve policies, over and above the effects of those policies on U.S. economic growth. For example, some have argued that accommodative U.S. monetary policy has driven down the foreign exchange value of the dollar, thereby boosting the dollar price of commodities. Indeed, since February 2009, the trade-weighted dollar has fallen by about 15 percent. However, since February 2009, oil prices have risen 160 percent and nonfuel commodity prices are up by about 80 percent, implying that the dollar's decline can explain, at most, only a small part of the rise in oil and other commodity prices; indeed, commodity prices have risen dramatically when measured in terms of any of the world's major currencies, not just the dollar. But even this calculation overstates the role of monetary policy, as many factors other than monetary policy affect the value of the dollar.

Now, for someone who clearly didn't understand what was happening with cause/effect and supply/demand as it related to the housing bubble six or eight years ago, it's hard to take this sort of analysis seriously. Actually, it's laughable.

In short, Bernanke is saying, “Fed actions are only partly responsible for the dollar's decline and it only fell 15 percent while energy prices have risen five or ten times that amount. Therefore, monetary policy played an insignificant role in the recent surge in energy prices”.

While this may make sense in the mind of the world's most important economist (that's a scary thought in itself) who, clearly, has a big stake in the game, it demonstrates a naivete about what drives traders to buy and sell and how a world of freakishly low interest rates motivates investors to reach for yield.

Perhaps more importantly, it smacks of hubris – that the rest of the world just doesn't get it.